Alternatives to Roth Conversions, and Spend Down Strategy?

[RetiredAt55.5]

Hello. I retired about a year ago, and have been struggling with 2 these issues - (1) Do I want to do partial Roth conversions, and (2) should I follow the conventional strategy of spending first my taxable assets, then my tax deferred assets, and lastly our Roth assets.

I understand that at 70 we will be subject to RMD's on our 401K's and IRA's, and we will have a decent tax hit at that point.

I had a one time financial plan done up by Vanguard last year and they recommended (1) and (2) above.

However, I like my taxable investments and they generate about 26K of capital gains and qualified distributions annually which I can use to partially fund our retirement expenses. Plus, these are taxed at a low rate as long as we keep our other income low enough.

So my alternate strategy is to spend down our 401K first, since that will lessen the RMD tax hit later.

In terms of the Roth assets, my spouse and I have side jobs that pay enough that we can each add $6,500 to them each year. I just can't "warm up" to doing Roth conversions and paying taxes now. I realize that we will likely end up paying more in taxes later by not doing conversions now. I can't help thinking though, that if we have extra money (whether it's taxable or tax-exempt money) to pay the taxes on the conversions, gosh, that money could instead stay invested in the market for another 10 to 15 years.

Also spinning in my head is healthcare and income limits for getting subsidies (impacted again by doing Roth conversions), but for now I'm ignoring that since I'm waiting for the politicians to finish arm wrestling.

Any feedback is most welcome!

[evilanne]

You will still have 5 years to do conversions between Medicare & RMDs when you don't need to worry about income impacts. I don't worry about subsidy since I have reasonable HI from work. Either choice will work...Good Luck in whatever you decide.

[jebmke]

capital gain distributions are bad news

[capjak]

Have you run iorp?

https://www.i-orp.com/ORPparms.html

[kaneohe]

Quote:

Originally Posted by RetiredAt55.5 ............................ I just can't "warm up" to doing Roth conversions and paying taxes now. I realize that we will likely end up paying more in taxes later by not doing conversions now. I can't help thinking though, that if we have extra money (whether it's taxable or tax-exempt money) to pay the taxes on the conversions, gosh, that money could instead stay invested in the market for another 10 to 15 years. .................................................!

Assume you are now in 25% marginal tax bracket and will be in 25% later.
You have 100K in TIRA.

1)You withdraw 100K, pay 25K in taxes and convert 75K to Roth. Some yrs later, the Roth has doubled to 150K......so you have 150K after tax.
2)You leave the 100K in TIRA. All of it including the 25K you would have spent for the taxes on the Roth conversion stays invested working for you. In some yrs later, the 100K has doubled to 200K and you pat yourself on the back for not converting. You then withdraw the funds and pay the 25% tax of 50K leaving you after tax 150K, exactly the same as the Roth even tho you had those extra funds working for you.

In the end, this is a quantitative math problem , not a qualitative one thinking about stuff. Even though you had extra funds working for "you", you also paid
more taxes w/ TIRA. The key variable (sometimes not known for sure) is your future marginal rate. If higher then current rate, Roth wins; if lower ,TIRA win; if the same , not much of a difference although if you pay conversion tax w/ outside funds, Roth is marginally better.

[euro]

Quote:

Originally Posted by jebmke capital gain distributions are bad news

Can you elaborate on that?

[walkinwood]

I think the best strategy here is different for each of us.

First - cap gains distributions are bad because they force you to pay cap gains taxes. However, if your AGI is below the 15% bracket you pay no taxes. If you need that money to fund your expenses even better. So it is very dependent on individual situations.

In my case, I am choosing to realize cap gains each year while keeping below the threshold where I'll have to pay fed taxes. (I still have to pay CO taxes). In my case, I have some active funds that I have owned for decades and I want to simplify my portfolio to a few index funds. This will take me a few years to do.

If you're below 400% of poverty for your family and are in the individual health insurance market, subsidies will provide a return today v/s possible future savings with ROTH conversions.

You could also just do ROTH conversions till the 10% bracket or if you have a lot of deductions, till you have to start paying fed taxes.

Lots of options. Enter your data into the 2016 turbo tax or similar program and play around with the different options and see what your taxes end up being.

Personally, I think that planning based on future tax policy is the most risky option. Who would have guessed that congress would propose an age based healthcare subsidy irrespective of income? Who knows what's going to happen in the future?

Good luck.

[2017ish]

Quote:

Originally Posted by kaneohe ... In the end, this is a quantitative math problem, not a qualitative one thinking about stuff. Even though you had extra funds working for "you", you also paid more taxes w/ TIRA. The key variable (sometimes not known for sure) is your future marginal rate. If higher then current rate, Roth wins; if lower ,TIRA win; if the same , not much of a difference although if you pay conversion tax w/ outside funds, Roth is marginally better.

I agree with Kaneohe. But, due to the always evolving nature of our tax laws, I doubt that we'll convert more than 1/2 of our (large) deferred stash. As it is, we'll assume constant brackets and do the best we can in getting a big chunk converted. (And if we get the sads for paying taxes on those moves, we'll just have to remember that just about no matter what, we are converting/withdrawing at lower rates than those we avoided via deferral.)

[sengsational]

Quote:

Originally Posted by capjak Have you run iorp? https://www.i-orp.com/ORPparms.html

+1
It takes some time to get all of the inputs perfected, but then you can run with and without Roth conversions and it will give you an idea of how much difference you're talking about.

Depending on the situation, Roth conversions can be of very little value, some value, or a lot of value. The problem with the latter situation is that it means doing big conversions now and having very little pain at RMD time. Lot's of folks have a problem with this because even though optimizing might net you an extra 1 or 2 percent increased spending, that presumes everything goes as planned (i.e. you live long enough to enjoy many years of low RMD taxes, tax rates and rules stay the same vs change to your benefit, etc).

But I think running with Roth conversions "on" and "off", and also running with a long horizon (99% chance you won't make it to that age), vs expected horizon (50% chance you won't make it to that age), can be instructional. You'll feel better about the decision you make about Roth conversions.

[pb4uski]

I retired at 56. The first year, it was uncertain whether LTCG would continue to be taxed at 0% for those in the 15% tax bracket or lower so I gains traded (realized a boatload of gains, paid not tax and reinvested in the same securities but increased by basis). They later made the 0% permanent.

Since then, we have lived off our taxable portfolio and done Roth conversions to the top of the 15% tax bracket (by recharacterizing any excess). Over the last 4 years, we have recharacterized $229k and paid $17k in tax (7.3%)... given that I saved 28% or more when the income was deferred and expect to pay 25% or more once we start SS I think having to pay only 7.3% is a screaming deal... I have saved over $40k in just 4 years.

These Roth conversions reduce future RMDs the same way withdrawals do. Our tax deferred accounts have still grown slightly, but the real shift in our case is from taxable funds (44% at retirement to 25% now) to tax-free (3% at retirement to 18% now).

I think it is the right strategy for us. We have a fairly unique access to very affordable ACA HDHI plan and subsidies are not very rewarding in our case, so the value of the tax savings exceeds the value of the ACA subsidies.

Another benefit is that the income and growth of the Roth accounts is tax free, so even if our tax rate were the same now and later we come out ahead by having more money in the Roth. To the extent that the tax-deferred accounts exceed our bond allocation, those tax-deferred investments in equities effectively convert tax-free income (in our case) to income subject to ordinary tax rates... so I want to get the tax deferred funds down to less than our bond allocation as soon as I can... and being able to do it at ~7% is icing on the cake.

[Koolau]

Always a cheerleader for Roth conversions, I acknowledge that you really have to be aware of the potential consequences - especially taxes. Right now, even at 70 I am trying to work through whether to lower my tax deferred account (401(k)) by further conversion EVEN as I'm being forced to take RMDs. I see a number of "gotchas" on the horizon if I don't do something now.

OP has an opportunity to do conversions now without triggering "gotchas" like taxable SS and increased Medicare premiums. All else being equal (I'm 25% taxable for the duration!) I like the idea of having as much in Roths and as little in tax deferred as possible. Naturally, your situation and your mileage may vary.

[RetiredAt55.5]

Thanks for all the replies, much appreciated! I can see I have "homework" to spend some quality time using the iorp website and TurboTax.

[Ed_The_Gypsy]

H&R Block has a free on-line estimator that I use for that I use for that purpose together with a spreadsheet to use as a ledger sheet.

[Ed_The_Gypsy]

It is also very simple.

[pb4uski]

Quote:

Originally Posted by RetiredAt55.5 Thanks for all the replies, much appreciated! I can see I have "homework" to spend some quality time using the iorp website and TurboTax.

My experience with i-orp is that it suggests converting a lot more than I was comfortable with.... given that future growth is tax free and we expect to be in the 25% tax bracket for at least a while later on... if we live long enough i-orp may be right but I just have trouble paying so much in tax now... but I am keen to convert as much as possible at low marginal tax rates.