Q: I plan to retire in a couple of years and am strategizing my money options for maximum gain. Therefore I am allowing myself 12 years to roll over as much money as possible from 401k and 457 to Roth IRA. I am targeting to keep my income below the $250,000 threshold for married filing jt. I want to pay the taxes with my taxable account. I will have to sell LT appreciated stock. Does the sale of the appreciated stock count toward the $250,000 threshold? If so, then I suppose I will have to start selling off my stock now to bring up the cost basis in time for retirement when my income will ramp up due to the conversions.
A: Selling appreciated stock in an after-tax (non-IRA or 401(k) account) will increase your "modified Adjusted Gross Income" (MAGI) for both regular tax and the new 3.8% Medicare surtax on net investment income purposes. So if you want to avoid increasing your MAGI over the $250,000 threshold for the 3.8% Medicare surtax, you will have to watch how much gain the stock sales generate.
The new Medicare surtax applies to the lesser of your "net investment income" or the amount your MAGI exceeds the $250,000 threshold. So there are two ways to reduce or eliminate the tax: one is to keep your MAGI under the threshold; the second is to reduce your net investment income. There are two ways to do that: one is to reduce your gross investment income by changing your investment mix. The other way is to keep close track of your investment related expenses, including an allocable portion of your state income taxes, and deduct them against the gross investment income.
For example, if you have money in bank accounts that generate interest income, think about moving the funds to California municipal bond based investments. Municipal bond interest is not included in gross income for the purposes of the 3.8% Medicare surtax.
Another possible approach is to sell stocks that would create capital losses to offset the gains from the sale of stock that has increased in value. If you think that the stock that you sold at a loss will increase in value you can repurchase it more than 30 days after you sold it. If you repurchase it within 30 days, you will not be able to deduct the loss because of the "wash sales" rules.
One last consideration, when you convert part of your regular IRA to a Roth IRA, the amount converted will increase your MAGI, but not your gross investment income. So you will need to keep track of both the capital gains you generate from the sale of the appreciated stock and the amount of the IRA conversion in calculating your MAGI in relation to the $250,000 threshold.
As an aside, this will be my last entry in the Ask the Experts blog. It has been a privilege to address Sacramento Bee readers' tax questions. Thank you and best regards.