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Old 08-26-2012, 04:37 PM   #41
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What I was focusing on does not require a crystal ball at all.....Example You are year 2 into retirement. Your portfolio plunged about 40% the previous year....The question is do you move assets from a regular IRA into a ROTH up to the 15% tax level. And then pay the taxes with your now diminished portfolio? .....I would not, I would minimize taxes at this point.
I know it is poor form to quote oneself, but I am going to do it anyway.

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You should plan to reevaluate periodically and be prepared to adjust to current conditions over time.
Edit to add: Lsbcal did make a good point: You get more bang for your buck if you convert at the bottom of a down market. However that makes you a market timer, and how do you know where the bottom is?
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Old 08-26-2012, 04:42 PM   #42
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Converting while a tIRA is at a depressed value minimizes taxes. I converted most tIRA to Roth in 2010 while stocks were still recovering and the tIRA income could be spread across 2011 and 2012. Haven't yet had to pay all the tax due, and meanwhile the Roth's value has increased more than the total tax bill, with that gain being all tax free.
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Old 08-26-2012, 05:24 PM   #43
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Originally Posted by Rustward View Post
....
Edit to add: Lsbcal did make a good point: You get more bang for your buck if you convert at the bottom of a down market. However that makes you a market timer, and how do you know where the bottom is?
You don't know where the bottom is, you do know you are closer a low then you were before. So that is good "market timing" . There are many examples of poor market timing.
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Old 08-26-2012, 05:57 PM   #44
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Edit to add: Lsbcal did make a good point: You get more bang for your buck if you convert at the bottom of a down market. However that makes you a market timer, and how do you know where the bottom is?
Really? Where did the extra money come from to pay the taxes at the 15% Level?......Withdrawing more money from stocks whether for Taxes or Expenses immediately after a down market year affects the portfolio in a very negative manner. And if you are not drawing from Stocks, you are changing your asset allocation to a more risky allocation.

Don't confuse this with buying equities during a down market year. You are keeping the same asset allocation. Just moving from Regular IRA to ROTH IRA.
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Old 08-26-2012, 06:11 PM   #45
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Originally Posted by Cut-Throat View Post
What I was focusing on does not require a crystal ball at all.....Example You are year 2 into retirement. Your portfolio plunged about 40% the previous year....The question is do you move assets from a regular IRA into a ROTH up to the 15% tax level. And then pay the taxes with your now diminished portfolio? .....I would not, I would minimize taxes at this point.
Oh, absolutely I would convert! This is an ideal situation, to get a dip, pay taxes at a low point, and then let it recover in a forever tax free Roth account. Of course there's no guarantee the market will recover, but chances seem better on it going up from a 40% drop than after a big run-up.

If you hit an immediate dip, you can always recharacterize the conversion.

A long extended downturn is a problem in any case, but it is worse to have Roth assets depreciate because you can't take a tax write-off on them. But you can't predict that, and if you could, you wouldn't be in the market.

Your point about a tax overhaul to a VAT is valid, but I suspect such a tax would be an add-on. They would keep income tax rates the same, but add a smaller VAT. Strictly a guess on my part but I don't think the growing base of retirees would stand for a major shift to a spending tax.
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Old 08-26-2012, 06:14 PM   #46
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Doing a ROTH conversion after a major market decline is dangerous. The potential benefit is the future difference between the two tax rates - capital gains vs ordinary income - vs the immediate tax expense. The only way I see that as feasible is if the portfolio, after conversion and tax, is still big enough to maintain spending. It the market decline plus conversion plus tax drops the portfolio survival rate too far it's too risky IMHO.
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Old 08-26-2012, 06:43 PM   #47
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Not sure where cap gains comes into this since we are talking about Roth conversion vs. IRA distributions later, which is ordinary income now vs ordinary income later. I suppose there may be some cap gains from selling from your taxable account to pay the conversion taxes, but after a 40% drop you probably don't have many gains!

As far as the portfolio being in danger, it's the 40% drop put it in danger. Yeah, you may not want to spent your last $ in your taxable account to pay conversion taxes, but I'm assuming we're talking about partial conversions, and the Roth has been open long enough that you'll be able to pull from it soon. (Can you do a partial conversion to a Roth and pull from a Roth in the same year?) Assuming we are talking about the same tax rates now and in the future (say, 15%), I don't see how having the money in a TIRA and 15% more in taxable is any safer than having the money in a Roth and having paid the taxes. It may feel safer, but having taxes looming on the TIRA money is an expense that will eventually hit.

Maybe I'm missing something and can learn. Can you give me an example of how it is more dangerous, or is it just the short term cash flow issue of putting it in a new Roth that you couldn't touch for 5 years if you are under 59 1/2?

The potential benefit isn't the tax rates, it's the amount being taxed. If I have $100 in a TIRA and it drops to $60 and I convert at a 15% OI rate, I pay $9 in taxes. If I wait to convert and it recovers to $100 and I then convert, I pay $15 in taxes. As I said before, there's no guarantee of recovery, but it does seem likely. And even if it doesn't recover and the TIRA is still $60 when I want to convert it or need it as a distribution, I still pay the $9 in taxes.
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Old 08-26-2012, 06:50 PM   #48
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As in so many cases, all this can depend on the individual's particular situation. In my case, when I converted in 2008 the taxes were paid from the taxable money account. I was going to have to pay those taxes eventually anyway. So I saw this as a chance to move part of a 60/40 portfolio to a tax free on withdrawal Roth at a time of lowish valuations. It was a scary and unpleasant time and this was one tactic that I felt was a positive one given our resources. Now if we were on the edge of portfolio survival that might be a different story.

Now suppose the market just kept going down as in the 1930's. Then it would be a lot tougher on me. Maybe I just got lucky! Here is a chart comparing the 1929, 1987, and 2008 declines. The red arrow shows where I made the Roth conversion. I think Cut Throat was right in 1929. I just got it right in 2008 -- luck or skill? That is life I'm afraid, scary.


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Old 08-26-2012, 07:50 PM   #49
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Yeah, but we weren't talking about converting just before a 40% crash, cut-throat said after the crash. 1929 still wouldn't have done well, but eventually did recover.

Besides, no retiree should be 100% in the market, I feel like I'm fairly aggressive at 115-age, so a 40% portfolio plunge (which was what was stated) would be more than a 60% stock market crash.
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Old 08-26-2012, 08:17 PM   #50
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Perhaps some numbers might give this some perspective. Assume MFJ and converting up to top of 15% bracket. Assume no taxable income except for the Roth conversion. In rounded numbers you can have a maximum taxable income of 70K or an AGI (assuming std deduction) of 90K on which you would pay taxes of 10K for the Roth conversion. In reality you woud probably have a somewhat smaller conversion due to other income, and a somewhat smaller tax due to LTCG/QDIV.

If that 10K/yr tax for 2-3 yrs would spell disaster, then you probably shouldn't do the conversion but it seems like this wouldn't have been a good situation to begin with even w/o the bear market. After 3 yrs of conversion you would have 270K in the Roth. Assuming you were over 59.5 y.o. and and had a Roth for 5yrs, the Roth funds would be available for use.

Seems like the basic rule of Roth conversion still holds tho........if you can convert at a tax rate now <= the tax rate you would have paid on the TIRA later, then it makes sense to do the conversion. If the portfolio was in jeopardy, you would probably reduce spending and be in a lower tax bracket than if you had converted the full 90K so conversion (at least full conversion) would not make sense in this case.
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Old 08-26-2012, 08:18 PM   #51
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The reason to convert to roth is to prevent being bump up to higher brackets later when you are taking RMDs and SS. I wouldn't do it otherwise, like counting on higher tax brackets, up markets, etc. Ideally, I would like my money split 3 ways, taxable, roth, and pre-tax, this would give me the most flexibility.
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Old 08-26-2012, 08:24 PM   #52
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Perhaps some numbers might give this some perspective. Assume MFJ and converting up to top of 15% bracket.
MFJ stands for ??
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Old 08-26-2012, 08:55 PM   #53
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sorry...Married Filing Jointly
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Old 08-27-2012, 10:26 AM   #54
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Perhaps some numbers might give this some perspective. Assume MFJ and converting up to top of 15% bracket. Assume no taxable income except for the Roth conversion. In rounded numbers you can have a maximum taxable income of 70K or an AGI (assuming std deduction) of 90K on which you would pay taxes of 10K for the Roth conversion. In reality you woud probably have a somewhat smaller conversion due to other income, and a somewhat smaller tax due to LTCG/QDIV.

If that 10K/yr tax for 2-3 yrs would spell disaster, then you probably shouldn't do the conversion but it seems like this wouldn't have been a good situation to begin with even w/o the bear market. After 3 yrs of conversion you would have 270K in the Roth. Assuming you were over 59.5 y.o. and and had a Roth for 5yrs, the Roth funds would be available for use.

Seems like the basic rule of Roth conversion still holds tho........if you can convert at a tax rate now <= the tax rate you would have paid on the TIRA later, then it makes sense to do the conversion. If the portfolio was in jeopardy, you would probably reduce spending and be in a lower tax bracket than if you had converted the full 90K so conversion (at least full conversion) would not make sense in this case.
I agree with all of what you said but I think there are a couple other important things to consider.

The first is that in 2012 with the 0% tax rate on dividends and LTCG you want to make sure you are in the 15% bracket because if you creep over even slightly then the incremental cost of those last few dollars of Roth conversion are very expensive. Using Taxcaster I put in a MFJ with $5k of qualified dividend income and $83k of Roth conversion, which results in $69k of TI (the top of the 2011 15% bracket) and a tax of $8,754. If I increase the Roth conversion by $1k and TI becomes $70k, the resulting tax is $9,054; $300 more tax for that additional $1k of Roth conversion or a 30% effective tax rate.

The second is that if Obamacare stays in place and if you are eligible for a health insurance subsidy and if the cliff relating to such subsidies stays in place and if income for 2014 subsidies is based on 2012 tax return income then the more important constraint will be to keep your total income below 400% FPL (federal poverty level). The calculators that I have seen if you exceed 400% FPL (about $60k for a household of two) then you would lose about $9k in health insurance subsidies compared to designing your Roth conversion to be at 399% FPL. So if the 2014 health insurance subsidy is important to your finances then I think 399% FPL will be more of a constraint than the top of the 15% tax bracket.
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Old 08-27-2012, 11:41 AM   #55
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As a followup, I was actually curious about the interaction mentioned above so I considered two scenarios; both MFJ and Roth conversion income only.

Scenario 1 took a 2012 Roth conversion to top of 15% bracket ($88k in using the 2011 Taxcaster) and paid $9,506 in tax (10.8% effective rate) and was ineligible for any Obamacare health insurance subsidy in 2014 because the $88k of income significantly exceeds 400% FPL.

Scenario 2 limited the Roth conversion to 400% FPL (~$60k in 2012 for household of 2) which resulted in $5,304 in taxes and a ~$8,900 health insurance subsidy in 2014, so a net benefit of $3,596 (ignoring the time value of money).

So the incremental $28k of Roth conversion in 2012 results in an additional $4,202 in taxes paid in 2012 and the loss of ~$8,900 health insurance subsidy in 2014 for a total economic cost of $13,102 and an incremental cost of 46.8%.

Can this possibly be right?
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Old 08-27-2012, 12:34 PM   #56
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don't know if I using the calculator correctly but I got subsidy of $5800 for single and a much bigger number for family of 4. Those were the only family choices I saw on the calculator. How did you get family of 2?
In any case, it looks to be significant so good thing you brought up this subject.
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Old 08-27-2012, 12:55 PM   #57
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For a family of two I estimated by doubling the single person amount.

I input 400% FPL (rather than a dollar amount) for a 56 year old single adult with no employer coverage and a medium regional cost factor to get a $4.449 subsidy that I doubled (for two people rather than one) and rounded to get the ~$8,900. The same subsidy for 401% FPL is $0.

Health Reform Subsidy Calculator - Kaiser Health Reform

I see now that the subsidy is quite sensitive to age as well in that if I decrease the age from 56 to 51 and leave all else equal the subsidy declines from $4,449 to $2,867 and if I increase the age from 56 to 61, the subsidy increases from $4,449 to $5,800.

In any event, I think the conclusions is that if one is retired and paying for their own insurance that this is a significant item to be considered in deciding Roth conversion cost. YMMV
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Old 08-27-2012, 01:31 PM   #58
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In any event, I think the conclusions is that if one is retired and paying for their own insurance that this is a significant item to be considered in deciding Roth conversion cost. YMMV
I agree and have it in my notes on how much (if any) to convert, but I keep forgetting about it otherwise. Thanks for bringing it up again.
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Old 08-27-2012, 05:10 PM   #59
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As in so many cases, all this can depend on the individual's particular situation. In my case, when I converted in 2008 the taxes were paid from the taxable money account. I was going to have to pay those taxes eventually anyway. So I saw this as a chance to move part of a 60/40 portfolio to a tax free on withdrawal Roth at a time of lowish valuations. It was a scary and unpleasant time and this was one tactic that I felt was a positive one given our resources. Now if we were on the edge of portfolio survival that might be a different story.

Now suppose the market just kept going down as in the 1930's. Then it would be a lot tougher on me. Maybe I just got lucky! Here is a chart comparing the 1929, 1987, and 2008 declines. The red arrow shows where I made the Roth conversion. I think Cut Throat was right in 1929. I just got it right in 2008 -- luck or skill? That is life I'm afraid, scary.


Boy that is a handy graph to have around. Think I will borrow it.
Thanks
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Old 08-27-2012, 05:42 PM   #60
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Boy that is a handy graph to have around. Think I will borrow it.
Thanks
You are welcome.

One of the things I like about this chart is that just looking at equity prices, in the early months there was no way to separate out the different outcomes. Even looking out about 1.5 years from the peaks, the 2008 decline was much like the 1929 one. So simple minded technical analysis would not work.

Also shows how deep the 1929 decline was relative to other declines. And stocks back then were paying nice dividends. Companies have a nasty habit of stopping dividend payments when they are stressed.
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