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2014 year end strategies -- help!
Old 11-23-2014, 09:07 PM   #1
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2014 year end strategies -- help!

Hi --

Sorry for these newbie questions -- I've tried searching but haven't been able to come up with the answers.

I ER'd (involuntarily and about three years earlier than planned) in late 2013. Financially, it's fine, but now I'd like to do some tIRA-to-Roth conversions and rebalance my portfolio, and I'm stuck. Yes, I should have done this earlier in 2014, but elder-care responsibilities got in the way....

Tax status: single. Age: 56. 2014 Deductions: standard.

About half my portfolio is in IRAs or Roth IRAs; the non-tax advantaged holdings are in Vanguard mutual funds, ETFs, and two stocks.

I have four IRAs at Vanguard (all were 401(k) roll-overs, from four different employers). They only contain pre-tax contributions.

My income in 2014 will be about $16K in dividends and interest. My health insurance plan in 2014 is HSA eligible, so I can open an HSA and, as I understand it, put in $4,300 ($3,300 + $1000). This will reduce my income to a bit less than $12K.

Is this correct?

Next, I want to do two things: rebalance and convert.

Rebalance: I need to clean up my portfolio, in particular isolating the income/dividend generating holdings into my IRAs/Roth IRA. To do this, I will need to sell non-retirement holdings. As I understand it, as long as my tax bracket is 15% or less, I will not be taxed on capital gains. So this is the time to do a significant tidying, right?

Convert: I also want to convert some tIRA funds to a new Roth IRA, maximizing my utilization of the 15% tax bracket (up to $37,450 in taxable income).

And this is where I'm stuck: suppose I generate $20K in capital gains in rebalancing. There's no tax on the capital gains, but does it count as income, thereby reducing the amount I can safely convert by $20K? Or in the 15% tax bracket, will rebalancing/capital gains have no impact on how much I can convert without jumping to the next tax bracket?

Again, apologies: I'm having a hard time figuring out how these two actions affect each other, and in what order I should undertake them.

Thank you.
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Old 11-23-2014, 09:16 PM   #2
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I am not an expert but I do not think you can do anything with the tIRA until you are 59 and 1/2.


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Old 11-23-2014, 10:46 PM   #3
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First, don't forget that deductions and exemptions will reduce your income.

Second, cap gains (and qualified dividends) are 0% only to the extent that all income (less deductions and exemptions) stay under the 15% cap. The best way to understand this is to use a tax program and plug in some sample numbers, and look at the effect on the Qualified Dividends and Capital Gains Worksheet.

Those cap gains won't throw you above the 15% bracket, but what you'll find is that for each dollar above 37450 in all income that you convert, that $1 gets taxed at 15% income, PLUS you push $1 of cap gains to be taxed at 15%. Effectively you start getting taxed at 30% until all cap gains are taxed.

Think of a bucket that you can fit $37450 in. Income (such as Roth conversions) fill up the bottom, while cap gains are at the top, and deductions/exemptions are taken out of the bucket. As long as the bucket isn't full, income is taxed at 15%, and cap gains at 0%. But if it overflows, it's the cap gains and divs that overflow, and what overflows is taxed at 15%.

The other thing you haven't mentioned but may want to watch for is the ACA subsidy. If you already have health insurance covered, it's not an issue, otherwise you might want to try to qualify for a subsidy, and for that all income including divs and CGs are counted.
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Old 11-23-2014, 11:34 PM   #4
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How about waiting until Jan 2015 to rebalance?
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Old 11-24-2014, 06:15 AM   #5
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Get a real 2014 tax program and fill out your situation. Change the numbers to try out different scenarios. Otherwise, I don't think there is any way that you will really know what happens with your taxes and how much to convert., how much capital gains you will have, etc.

So you will need to even know and put into your test tax returns the cost basis and the sale amounts of things you will sell to rebalance. You will then know what limits you will be hitting. For instance, if your income is too high, you will go past the 0% long-term capital gains tax limit.
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Old 11-24-2014, 07:40 AM   #6
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Get a real 2014 tax program and fill out your situation. Change the numbers to try out different scenarios. Otherwise, I don't think there is any way that you will really know what happens with your taxes and how much to convert., how much capital gains you will have, etc.
This is the only way to do year-end planning. The tax tables are not a reliable estimate of marginal tax rates and the interaction of the various forms can lead to wrong conclusions unless you use tax software.
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Old 11-24-2014, 08:39 AM   #7
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You'all are making this more difficult than it needs to be. I just did this very calculation last week to determine cap gains/Roth conversions for 2014.

If you wish to stay in the 15% marginal bracket, single, standard deduction, you don't want your taxable income to exceed $36,900 for 2014. Add back in your standard deduction of $6200 and your personal exemption of $3950 means you don't want your gross income to exceed $47050. If you are eligible for an HSA deduction of $4300, then your total income can not exceed $51,350.

Total income is the sum of wages, interest, dividends, cap gains, self-employment, taxable social security, taxable pensions, taxable IRA withdrawal or conversions. If your only other income is $20,000, then you have up to $31,350 of capital gains AND taxable IRA conversions to play with. The more you do of one, the less room you have for the other.
Note that I did not address what taxes you may have to pay. The more of the $31K that is used for IRA conversions, the more taxes you will pay as the tax rate is greater than for cap gains. Also, assumptions like your eligibility for an HSA adjustment to income and if you do or do not have a basis in your IRAs will complicate the calculation and would require tax software. If you want to know how much taxes you need to pay with various scenarios, then a tax software program would be very helpful. But it isn't necessary for your straight forward question.
My retirement job for the last 13 years has been working for a CPA firm preparing tax returns Jan-April.
And you can convert tIRAs to Roth at your age. You can't contribute new money to any kind of IRA unless you have earned income (wages & self-employment profit).

Hope this helps.
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Old 11-24-2014, 08:55 AM   #8
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Originally Posted by BarbWire View Post

And this is where I'm stuck: suppose I generate $20K in capital gains in rebalancing. There's no tax on the capital gains, but does it count as income, thereby reducing the amount I can safely convert by $20K? Or in the 15% tax bracket, will rebalancing/capital gains have no impact on how much I can convert without jumping to the next tax bracket?
Tax software is the way to go. For example, TaxAct is 12.99 to download. Why not try that?
All of the responses above provide good information. ANd you might benefit for the long run by choosing a tax software program now, and going forward with these calculations.
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Old 11-24-2014, 09:12 AM   #9
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Thanks, all, for the responses. I'm starting to see how the pieces of the puzzle fit together. Early this morning I also got my TurboTax 2013 "cooperating" to run some scenarios -- not for final 2014 numbers, of course, but to play and see how things work as I tweak amounts. It's an eye-opening exercise.

Regarding ACA and subsidy: that's a 2015 question for me (if I understand correctly). My 2014 non-compliant policy wasn't purchased on the exchange (and was wonderful and exactly what I wanted). I have to enter the exchange for 2015 -- and will likely end up with a non-HSA policy.

So in 2015 I need to generate enough "income" to be between 137% and 400% of the FPL, spinning the conversion knob to find a sweet spot for the subsidy and cost sharing. But my 2014 income will not have an effect on the 2015 subsidy, correct? So that's why I want to optimize rebalancing and conversions in 2014, since those actions will generate income.

Or have I misunderstood how the ACA subsidies work?

Again, thanks to everyone for taking time to explain this all to me. The fog is slowly lifting.

Cheers!
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Old 11-24-2014, 09:18 AM   #10
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I rebalance first and then compute my tIRA>Roth conversion as the difference between the top of the 15% tax bracket and the taxable income just prior to the conversion. Then when I do the Roth conversion it is just shifting equities (or fixed income) money from tax-deferred to tax-free so it doesn't affect my AA other than for the taxes on the conversion which is a second order effect that I don't bother with (but could if I wanted to be anal about my AA).

So in your case I would start out with $36,900 of taxable income and add in the $3,950 personal exemption and $6,200 standard deductions and $4,300 HSA contributions to get the maximum income you could have and stay in the 15% tax bracket of $51,350. Then reduce that by the $16k of dividends and interest and $20k of LTCG from rebalancing and you would get a Roth conversion amount of ~$15k. If you have less capital gains you have a bigger conversion amount. (Edit: Sorry, I didn't see RE2Boys similar post until just now).

I usually have a pro forma tax return for 2014 in Turbo Tax with my best estimates and then solve for the amount of the Roth conversion that gets me to the top of the 15% tax bracket. I usually start it in December and update it as new information comes in (especially final year end dividends and capital gain distributions). Then between Christmas and New Year's I rebalance, do my Roth conversions and make my estimated federal and state income tax payments.

I would also consolidate the four tIRAs into one to simplify things.
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Old 11-24-2014, 09:20 AM   #11
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RE2Boys gave an outstanding answer, since he presented a clearly explained analysis of the calculations that will be performed by tax software, should you choose to use it. I would only add that it probably would be to your advantage to go ahead and run the numbers through a tax software package, both to confirm the calculations and to get a more accurate estimate of what your actual tax liability will be, using various combinations of capital gains and Roth conversions. You can't really ignore your tax liability, since you may very well find that you haven't withheld enough taxes and end up paying a penalty for underwithholding. Once you know your tax liability for 2014, you will be able to file an estimated tax payment for the fourth quarter, if needed, and eliminate the underwithholding.
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Old 11-24-2014, 10:12 AM   #12
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FreeTaxUSA® FREE Tax Filing, Online Return Preparation, E-file Income Taxes is a tax prep site that already has it's 2014 forms ready. Our situation is fairly simple but I've used them for filing for years.

I've already done a first draft guesttimate for 2014 on the site.
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Old 11-24-2014, 10:23 AM   #13
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Yes, the replies from RE2Boys and pb4uski are very clear indeed -- and as I play this morning with scenarios in my 2013 Turbo Tax, I now see how the bits fit together. (I've used Turbo Tax for, perhaps, 20 years now. I don't see how people do their taxes without tax software and stay sane.)

pb4uski: I have four tIRAs (all with similar holdings) at Vanguard because, long ago, I was advised to keep 401(k) money earned in different states clearly separated, as states could -- and in the case of California aggressively did -- demand state income tax on 401(k) monies earned in their states. This was advice from a retiree who had earned income in several states including California, and was battling with the California tax authorities who wanted to tax all of his retirement income unless he could demonstrate what fraction was not earned in California. This might be unnecessary cautious, but it doesn't add much complexity.

karluk: I've been paying quarterly taxes this year to cover 100% of my 2013 tax liability, so I should be OK on the under-withholding penalty, even if I owe more than I've pre-paid. I'll adjust the Jan 15 payment to cover the additional taxes for Roth conversion (paid of course from current cash reserves, not from IRA funds!)

thanks!
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Old 11-24-2014, 10:31 AM   #14
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If your income is 16K have you considered applying for Medicaid?
In my state we have Managed Care companies like UnitedHealthcare run plans for Medicaid. All my doctors are in the "Community Plan" aka the Medicaid plan. It is like a super Platinum plan for almost nothing.
After factoring in the loss of health benefits, Roth conversions do not make a lot of sense, at least in my case.
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Old 11-24-2014, 10:44 AM   #15
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jim584672: it sounds like you live in an enlightened and progressive state.

Unfortunately, I live in Texas -- which is neither enlightened nor progressive -- where Medicaid is a nightmare.

That said, in 2015 I will endeavor to manage my income level to achieve a good subsidy for a silver PPO plan. Significant Roth conversions in 2015 will probably not make sense, given the loss in premium subsidy and cost sharing.
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Old 11-24-2014, 10:53 AM   #16
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Texas didn't expand Medicaid so you don't have the option, too bad.
Best bet for you would be don't go over 200% FPL and go with a Silver cost-sharing plan.
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Old 11-24-2014, 12:27 PM   #17
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....pb4uski: I have four tIRAs (all with similar holdings) at Vanguard because, long ago, I was advised to keep 401(k) money earned in different states clearly separated, as states could -- and in the case of California aggressively did -- demand state income tax on 401(k) monies earned in their states. This was advice from a retiree who had earned income in several states including California, and was battling with the California tax authorities who wanted to tax all of his retirement income unless he could demonstrate what fraction was not earned in California. This might be unnecessary cautious, but it doesn't add much complexity. ...
You may want to check with Vanguard. I recall this being a risk in my state many years ago but then there was a court case that effectively said that the state could not impose state income taxes on pension benefits or IRA withdrawals that were based on pensions earned/income deferred when one was a state resident. What I don't know is if that case was specific to my state or whether it applies more broadly, but Vanguard would know.
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Old 11-24-2014, 01:58 PM   #18
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Texas didn't expand Medicaid so you don't have the option, too bad.
Best bet for you would be don't go over 200% FPL and go with a Silver cost-sharing plan.

200% or 250%? I can check that but yes, that will be my strategy for 2015: generate, if necessary, enough income to be above 137% but under 2xx%.

Thanks!
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