Dear Rick:
I got divorced in 2018. In the divorce settlement I received the house, our IRAs of about $75,000 and a monthly income for 10 years when I turn 65. Ever since I got divorced, I have not filed a tax return because I have no income. The money I receive from my ex-husband, I was told was a property settlement and thus, I did not have to pay taxes on the money. After reading your column about Roth IRA conversions, it seems to me that I should take advantage of it. My first question is am I eligible for a Roth IRA conversion even though I have no income? My second question is, if I do a Roth conversion, will I have to file a tax return? My last question is, how much do you think I should convert? You should know that I have no intention to go back to work. Eventually, I will be able to collect Social Security, and when I turn 65, I will get a pension. My pension and Social Security will more than cover my needs, and I figure my IRA would act as a supplement.

Thank you.

Amy

Dear Amy:
Yes, you are eligible to do a Roth conversion and it is definitely something that you should take advantage of. After all, at a very low cost, if any, you can convert taxable money into tax-free money. Therefore, you definitely should take advantage of a Roth conversion.

With regard to how much you should convert, my thought is that each year you should convert enough so you don’t pay any taxes. For this year, since you have no taxable income, you should be able to convert up to $ 12,200 and stay in a zero-tax bracket. My recommendation is that you do this every year so that hopefully, by the time you have to draw down on the money, it will all be within the Roth IRA, thus allowing you to withdraw the money without paying taxes. There probably will be some Michigan taxes you owe; however, that number should be nominal at best. The bottom line, by following this strategy, in a few years you will be able to convert your entire IRA virtually tax free.

Because you are converting existing IRA money into a Roth, you would have to file tax returns on a year-by-year basis. However, your tax return would be a relatively simple return to complete.

It is important to remember that for anyone who is thinking about doing a Roth conversion this year, the transaction must be completed before the end of the year. IRA custodians get busy near the end of the year and that is why I always remind people that you do not want to wait until the last minute to do a Roth conversion. In addition, keep in mind that the sooner you do a Roth conversion, the sooner your money will convert from growing tax deferred to tax free. Therefore, there is no reason to delay in doing the Roth conversion.

In the situation at hand, it is the perfect scenario where someone should take advantage of a Roth conversion. That being said, it still makes sense for people to convert even if they would have to pay taxes, as long as by converting it doesn’t throw them into a higher tax bracket. Therefore, everyone should be looking at their tax situation; and if you can take advantage of converting some of your existing IRAs into a Roth IRA, and it keeps you in the same tax bracket, why not.

One last note regarding the conversion, don’t forget that you don’t have to wait until the end of year to do your 2020 Roth conversion. You can do it right after the first of the year. The advantage of doing a conversion early is that it would give your money more time to grow on a tax-free basis.

Good luck!

Rick is a fee-only financial advisor. If you would like Rick to respond to your questions, please email him at Rick@bloomassetmanagement.com.
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