Can you do a Roth conversion with stocks?

Full Transcript

In this video, we're going to talk about a Roth conversion with stocks. Now, I'm going to go over four tips to make this a little bit easier so you know how to make the conversion, pay the least amount in taxes, and just you don't make any mistakes.

So this is going to be in response to a question that I got now. I'm only going to be focusing on moving the stocks or ETFs or mutual funds, bonds, actual property from your traditional IRA over to the Roth side. But this question is in response to a little bit more complicated scenario, but that is what I'm going to answer.

So the question comes from V Patel. And he's asking, "I had no gains but instead losses. I contributed $1,500 to the Roth IRA. And after the recharacterization, again, we're talking about the fix here of $1,438. This money was invested in mutual funds the S&P 500 my guess is an index in my Roth IRA and after recharacterization, it's got sent to the traditional IRA with the same mutual fund. So pretty much right now I have a traditional IRA with the S&P 500 worth $1,438. Do we need to convert this to cash before converting to a Roth IRA or using Vanguard and there is a button that says convert to the Roth IRA."

Now, this is kind of an interesting question because it's not just the rules and regulations it is also the broker-dealer. In this case, it's going to be Vanguard, where you're holding the actual positions inside of the traditional or the Roth IRA. So it actually depends on where you're holding it, whether or not they will technically do it.

Now, they can do it by the law. You can move property from the traditional IRA over to the Roth IRA. It doesn't have to be cash. You don't have to sell out of the positions. Now, the real benefit in doing that is you just don't have to go through another transaction. And you could take the position, keep the position.

You don't have to sell the position. However, there are no additional taxes. You're not going to have long-term or short-term capital gains, which is something that we talk a lot about with investments, whether or not you should sell your position at this point for taxes. But there are no taxes when you're selling a position inside of the traditional or the Roth IRA, it's only in the actual conversion.

So this actually brings me to point number one. And that's the conversion in the taxes of it. Now, in this scenario, we went from a Roth and over to the traditional back to the Roth. So it's technically a nondeductible contribution that we're dealing with. So if it's nondeductible, we do the conversion, there are no taxes. But think about this for a second.

If you're making the nondeductible contribution, let's say you're doing it for 2021 but you're in 2022, you're going to realize that tax benefit last year for 2021 because conversions happen in the year that you make them. So if it's a nondeductible contribution, you made a nondeductible contribution. The conversion is not taxable because it's nondeductible unless the pro-rata rule.

But we're also going to talk about that conversion because it's not taxable dollars, they've already been taxed. So you're not going to get taxed twice. So by making the nondeductible really affects last year's taxes if you're electing to make it for the previous year. Of course, we're in 2022 right before filing our taxes. If you're already past that deadline, the April filing deadline, then making that non-deductible contribution is going to happen in that year and that'd be for 2022.

So that is something to pay attention to. You actually have some control here. You can take it for 2021 or you can make a deductible contribution in the traditional IRA if you're if you meet the income limit and the qualifications and then the conversion conversions are taxable in the year that you make them so you can move the stocks from the traditional to the Roth side.

So tip number two, you probably already figured out you can move the stocks, bonds, ETFs, mutual funds whatever positions you have, it just matters on the broker-dealer. Now tip number three is actually pretty important, so pay attention to this one that when you're doing the conversion, if it is taxable if you're getting hit with the pro-rata rule or you're doing a pretax into the traditional and then converting, then it's taxable pay with outside dollars, don't withhold from the actual transaction because you want as much money in the Roth IRA because remember, it's tax-deferred tax-free in retirement.

You want to maximize the amount of money that's in the Roth IRA. So pay those tax that tax bill with outside dollars. Now, obviously, if you don't have them, you know that choice but if you can pay them with outside dollars.

And point number four is don't forget to pro-rata rule if you're doing a nondeductible contribution and then doing the conversion, even though you're doing it with stocks, you still might get hit with the pro-rata rule.

So you need to pay attention to that. The pro-rata rule, super important. Now, if it's a free tax, then just a regular conversion, no pro-rata rule. But if that is the case, it aggregates all IRAs. So if you have a set of simple traditional IRAs, they all get aggregated. It's not just that one account, it's all of them.

So the pro-rata rule is very important. You don't want to get hit with a surprise tax bill. So that is how you can do a conversion with stocks. It is possible. Depends on your broker-dealer. There are just a couple of things that you need to pay attention to in order to do it successfully. So you don't have any surprises down the road.

And let me know if you have any questions or comments down below. If you enjoyed this video, be sure to subscribe. And of course, like always leave your comments down at the bottom and we'll see you on the next one.