Anyone else have a 'problem' with ORP's "moving money to a roth" before RMD......

[teejayevans]

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.
TJ

 

[RunningBum]

Perhaps some numbers might give this some perspective. Assume MFJ and converting up to top of 15% bracket.

MFJ stands for ??

 

[kaneohe]

sorry...Married Filing Jointly

 

[pb4uski]

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.

 

[pb4uski]

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?

 

[kaneohe]

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.

 

[pb4uski]

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

 

[RunningBum]

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.

 

[Free To Canoe]

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

 

[Lsbcal]

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.

 

[heyyou]

Roth conversions are the tax-sheltered version of tax loss harvesting in taxable accounts. I convert from whichever traditional IRA mutual fund is down the most.

For a specific taxpayer, if it is clear that you will owe later taxes in a higher tax bracket, then convert during those years prior to SS or other delayed income sources. If the situation doesn't fit or doesn't appeal to you, don't bother. I like converting in the 15% bracket, knowing that at the top of that bracket my average tax for MFJ is 10.8%.

Adjusted Gross Income is important for figuring muni bond income with your marginal tax rate, but your average tax rate matters for Roth conversions. Those average tax rates are low enough for me to take the risk of early tax payments. This is just another form of delayed personal consumption that has worked well in the past for me, with no guarantee that it will work every time in the future. YMMV

As mentioned earlier, for a married couple, they can have $90.2K of 2012 income before bumping out of the 15% bracket. That is the Married Filing Jointly deduction with two exemptions added to the top of the 15% bracket.

For MFJ, $36.9K is the top of the 10% bracket and you two are paying 4.7% tax on that amount of income.

 

[bobbee25]

The Roth has a major advantage over the std IRA for your beneficiaries, ie. son, daughter etc.

Also, the std IRA RMDs for a surviving spouse can be pretty high.