Olivier Truong

IRAs

IRAs are a legal container around investments that have favorable tax implications. Said another way, there’s two types of investments: regular and IRA. Anyone can make a regular investment. You invest your after-tax money and you pay taxes on the capital gains. An IRA is the same thing except that it can, under the right circumstances, allow you to invest pre-tax money and remove taxes you’ll have to pay on capital gains.

Two types of IRAs exist: traditional and Roth.

  • Traditional IRAs let you put in pre-tax money (achieved via using after-tax money and claiming a tax deduction when you file your taxes). When retirement comes, you’ll have to pay regular income tax (based on whatever income bracket you end up in) on all withdrawals. Basically, traditional IRAs just let you put off paying taxes so you can maybe pay less when you are in a lower income bracket.
  • Roth IRAs let you put in after-tax money (regular money that sits in your bank account that ends up being taxed when you file taxes). When retirement comes, you pay no taxes on withdrawals. No taxes on capital gains, nada.

Why would you use a Roth IRA if you expect your income bracket to be lower during retirement?

  • You make too much now to deduct taxes from traditional IRA contributions. Basically you get little to no benefits from making non-deductible contributions to a traditional IRA.

My own IRA history

  • 2/25/2015 5500 - deducted in 2014 tax return (filed in 4/2015)
  • 6/05/2015 5500 - deducted in 2015 tax return (filed on 4/2016)
  • 06/03/2016 5500 - nondeductible in 2016 tax return (filed in 2017)
  • 1/03/2017 5500 - nondeductible in 2017 tax return (filed in 2018)
  • 1/03/2018 5500 - nondeductible in 2018

So with that history, how do I convert this traditional IRA to Roth IRA?

  • Just convert it all on Vanguard. You’ll pay taxes on the pre-tax money from 2014 and 2015 (total $11000). You won’t have to pay taxes again on the nondeductible contributions (well duh, why would you) from 2016, 2017, and 2018. You’ll pay regular income tax on any capital gains that have accrued to date (as opposed to those capital gains being tax-free or under some other tax rules). In the end, you’ll end up with all that money into a Roth IRA.

How to convert a traditional IRA to Roth IRA on Vanguard?

  1. Open a new Roth IRA account (see https://investor.vanguard.com/ira/how-to-convert-traditional-ira-to-roth-ira)
  2. After it’s created you’ll be able to exchange funds from your traditional IRA to your new Roth IRA