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0% LTCG and ROTH conversions
Old 10-30-2018, 02:36 PM   #1
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0% LTCG and ROTH conversions

Here's my situation with taxes, LTCG and ROTH conversions - I'll try to keep this general enough so that it might help others, and also get feedback if my thinking is wrong.

I'm 64 this year, so 7 tax years before RMDs, and I plan to delay SS (and maybe pension) to age 70. Our income for the next 7 years will be low enough to leave some room in the now 12% income bracket, and 0% LTCG bracket. With RMDs and SS/pension @ 70 we will be solidly in the (current) 22% bracket.

I struggled with the idea of ROTH conversions versus LTCG harvesting. I had decided to prioritize LTCG 0% gains, as that will likely be a 15% delta, versus an ~ 10% delta on ROTH conversions. I think that was the right calculation.

Also, I will need to sell some of those equities in my taxable account for income to bridge between now and age 70. So that seemed to clinch it! Capture all that 0% LTCG! Ahhh, not so simple...

The next factor is that RMD/SS/pension at 70 is well beyond what we expect to spend. So we very likely will not need to sell from our taxable after age 70. That makes it likely that our taxable account will go to our heirs. So now that tells me, I should only sell enough equities to fund our expenses between now and 70, and prioritize the funds with the lowest unrealized LTCGs. That would provide the most free cash, and leave room for some ROTH conversions in later years. As an example, I have three taxable funds with unrealized gains of 58%, 28%, and 6%. I can fund about half our projected expenses to age 70 with selling the fund at 6% and about half the funds that are at 28%. I'll do that up to the 0% LTGC bracket first, then do ROTH conversions in following years.

Since there is no 'wash sale' on gains, I'll probably just re-invest all but a few years worth for cash flow, and sell as needed until age 70.

Plus, we have a significant amount in ROTHs now, so if we do have a large expense in some years, we can tap from those ROTHs rather than sell any taxable equities.

That will leave the remaining unrealized LTGC to be stepped up to our heirs, so I figure there is no reason to capture 0% LTGC beyond what we need to sell for cash flow.


Maybe a simple summary of that is: the priority if you expect to leave an inheritance is equities that will be stepped up are good for heirs, ROTH accounts are good for heirs, Trad IRA less good - heirs will need to pay taxes on inherited IRAs (likely at least as much as our 12% conversion cost), so try to minimize trad IRAs for heirs. Make sense? Am I overlooking something, or have something wrong?

TIA -ERD50
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Old 10-30-2018, 03:02 PM   #2
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I like you got it exactly right for that scenario. Your approach clearly states the random thoughts Ive had for the last few years. Thanks!
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Old 10-30-2018, 03:24 PM   #3
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ERD50-
I am a year behind you, but came to the same conclusion, for all the same reasons, earlier this year. Only, I don't plan to sell any equities in the after tax brokerage account. We have a few bond funds that currently are right around zero gain. Between those and int/div/cap gains in that account we can easily fund the next 4 years, and probably all the way to 70, if I decide to defer my SS that long. This leaves around $70k for Roth conversions each year.

FWIW, I am also using int/div/cap gains in the IRA to buy brokered CD's, so there is little impact to our AA by selling the bond funds.
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Old 10-30-2018, 03:27 PM   #4
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Actually, for similar reasons I have been considering converting to top of 22% tax bracket (or even more) to avoid RMDs and perhaps reduce taxes on SS.

I'm now thinking of leaving taxable to grow and ultimately get stepped up basis and avoid tax entirely, living on tax-deferred and still doing some Roth conversions.

I wish I had thought of that 3 years ago (I'm 63)... but 0% LTCG on sales to fund living expenses were hard to resist and may have colored my thinking.

Still need to noodle on it but it seems a possibility given we are overloaded with tax-deferred.
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Old 10-30-2018, 03:52 PM   #5
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Thanks for the replies so far. I keep noodling on this, and putting my thoughts down for an 'audience' really helps force me to try to get it so I understand it.

For a little additional background on my situation, to help you better understand how your numbers may fit, my accounts are broken down as follows:

55% < IRA, RMDs will be taxed
15% < ROTH, no tax on WD
30% < Stock Funds, ~ 25% in unrealized gains

-ERD50
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Old 10-30-2018, 03:52 PM   #6
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Quote:
Originally Posted by pb4uski View Post
Actually, for similar reasons I have been considering converting to top of 22% tax bracket (or even more) to avoid RMDs and perhaps reduce taxes on SS.
.....
Still need to noodle on it but it seems a possibility given we are overloaded with tax-deferred.
I have given this some thought, as well, but just can't bring myself to basically pre-pay our son's taxes on an inherited IRA. Though I am actually still doing that on the Roth conversions at 12%, as we likely will never use those funds ourselves.

Maybe, when we are taking RMD's and are solidly in the 22% bracket anyway, We'll start some more conversions. Depends on the market and the tax laws. OTOH, If the market drops 50%, and I have the nerve, all equities in the IRA should be converted to Roth right away. The question is: will I have the nerve to do that and pay the tax bill?
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Old 10-30-2018, 05:01 PM   #7
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Other uses for appreciated stock are donations to charities, and gifts. You get the full value deduction and the charity gets the stepped up basis. Gifts work if they are going to someone in the 0% LTCG range.
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Old 10-30-2018, 05:27 PM   #8
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Can you live off (withdraw) current Roth contributions (>5 years old) and then use the whole tax bracket for Roth conversions? That way youd maximize the amount you could convert.
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Old 10-30-2018, 05:48 PM   #9
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^^^^ I don't see where that accomplishes much.

Let's say I need $75k to live. If I live off $75k from my Roth and then do a $75k Roth conversion then my Roth is unchanged.... no different from just taking $75k from my tIRA for living.
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Old 10-30-2018, 06:01 PM   #10
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Quote:
Originally Posted by ERD50 View Post
Thanks for the replies so far. I keep noodling on this, and putting my thoughts down for an 'audience' really helps force me to try to get it so I understand it.

For a little additional background on my situation, to help you better understand how your numbers may fit, my accounts are broken down as follows:

55% < IRA, RMDs will be taxed
15% < ROTH, no tax on WD
30% < Stock Funds, ~ 25% in unrealized gains

-ERD50
Similar story here:

56% < IRA, RMDs will be taxed.... was 53%
23% < ROTH, no tax on WD.... was 3%
21% < Taxable, ~ 34% in unrealized gains... was 43%

The was numbers were when I retired 7 years ago. Despite doing a lot of Roth conversions tax-deferred is relatively unchanged.
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Old 10-30-2018, 07:13 PM   #11
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My preliminary modeling suggest that I am much better off to start living off of tax-deferred rather than taxable and also do Roth conversions to the top of the 22% tax bracket. That is based on the age 80 sum of taxable accounts (inherited with stepped up basis so no adjustment for taxes), 88% of tax-deferred (assumes 22% tax by my kids... will likely be more) and tax-free balances. Spending is the same for all scenarios.

Ending value of the above is 146% of default strategy of living off taxable until SS starts with Roth conversions to the top of the 12% tax bracket and then just taking RMDs. I need to scrub the numbers but the benefits seem compelling.
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Old 10-30-2018, 07:17 PM   #12
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Quote:
Originally Posted by pb4uski View Post
Similar story here:

56% < IRA, RMDs will be taxed.... was 53%
23% < ROTH, no tax on WD.... was 3%
21% < Taxable, ~ 34% in unrealized gains... was 43%

The was numbers were when I retired 7 years ago. Despite doing a lot of Roth conversions tax-deferred is relatively unchanged.
And that is still a good thing.
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Old 10-30-2018, 07:23 PM   #13
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Yes, hard to complain about the returns for the last 7 years.
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Old 11-01-2018, 12:04 PM   #14
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I had an interesting conversation with a guy that I know who does tax planning for high net worth individuals on this topic.

He was talking about putting part of the tIRA in an oil & gas venture that was drilling wells on proven reserves. In the first year, the wells would be drilled but would not be operating yet... allegedly the value of the investment would be low because the cash was spent drilling the wells but since they are idle there is not yet any cash flow coming in... for example 15c on the dollar. At that point when the value is low you do the Roth conversion so you only pay tax on 15c rather than on $1.

After the investment is in the Roth, production commences and the cash flow starts and the investment increases in value.

The thing that didn't make sense to me is why the valuation even when the wells were idle would not be based on expected cash flows once the wells were active.

Probably not anything I'm interested in other than the idea to convert more when values are low... which may come in handy if we have a recession and the market becomes bearish.

At this point, I'm leaning towards leaving taxable alone rather than continuing to tap it and changing to live on tax-deferred withdrawals to reduce tax deferred while I'm still in a low tax bracket.... plus small Roth conversions to the top of the 12% bracket until we are 65 and go on Medicare... then move to a no tax state and be aggressive on Roth conversions (to top of 22% tax bracket or even 24% tax bracket) until we start SS.... but still more noodling to do.
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Old 11-01-2018, 12:33 PM   #15
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.... The thing that didn't make sense to me is why the valuation even when the wells were idle would not be based on expected cash flows once the wells were active. .... .
Yes, it does not make sense. Or, it isn't as sure a thing as he suggests. Maybe it worked a few times for him, but there can't be anything close to a guarantee on that.

If it is a near sure thing, the current price would reflect the future anticipated price, minus the return of a risk-free investment over that time, minus whatever % uncertainty.

I saw this happen when a stock I followed was going to be bought out by another company, effective in 90 days. At the next open, the stock traded basically at the announced price, minus the return of three month treasuries. In this case, it was a near certainty that the buy out would be approved, the firm had the money, no monopoly issues, etc.

But the concept is a good one, it can't really hurt to time a conversion with a dip in the market. If you make a sideways move, you aren't really market timing. Of course it could drop further, that only means you could have done better, but you don't lose.

-ERD50
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