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Old 04-15-2016, 05:57 AM   #21
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Other subtleties to consider:

It's possible the thresholds for taxation of Social Security will never be adjusted for inflation (I don't think they ever have been up to this point). This works in favor of converting now.

Since I own a lot of foreign stock ETFs I must file form 1116. Due to low overall tax rate as an early retiree living on dividends, I normally can't use most of my foreign tax credit. But when I convert, I can use more of it, since my overall tax rate goes up. For this reason, my actual marginal conversion rates drop from about 10% to 8% and from 15% to 12%.

A hidden cost for an early retiree is that you are giving up some free capital gains you could otherwise take if not converting (up to the top of the 15% bracket).

Don't forget about State taxes if they apply to your situation.

Conversion income can affect your ObamaCare subsidy.
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Old 04-15-2016, 06:02 AM   #22
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Quote:
Originally Posted by kramer View Post
Can someone provide details on the recharacterization process? My T-IRA and Roth IRA are with Vanguard.

I thought I read somewhere that it requires a write up and you send something to the IRS outside of the e-file system, but I don't really know. Ideally, I could do it all with Turbo Tax since I live abroad.
There is a form on the Vanguard website that you fill out and mail it in and then they process it. There is a field on a form in TT to input the recharacterization amount which reduces your Roth conversion.

Keep in mind:
Quote:
You can recharacterize a contribution or conversion anytime until the federal
income tax-filing deadline (including extensions) for that particular tax year. If you’ve
already filed your tax return or filed for an extension in a timely manner—without
recharacterizing—the IRS will grant you an automatic six-month extension, from
the standard April 15 tax deadline to October 15. However, you may need to file an
amended tax return.
https://personal.vanguard.com/pdf/s220.pdf
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Old 04-15-2016, 06:39 AM   #23
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In my situation, I've had to balance the value of Roth IRA conversions against the value of an ACA subsidy. Right now I'm just doing enough Roth IRA conversion to get us to the optimal subsidy level.
Yes, we are also following this path. In our case, tIRA to Roth IRA are our only "reported income" and we convert only about 21-22k each year until 65.

The ACA subsidy PLUS cost sharing benefit (only available on Silver Plans) is substantial, in our case we pay only 30/mo with max OOP 900/year and have a better/more comprehensive plan than we had with decades of corporate health plan coverage (plus the payroll deductions were close to 400/month)

The actual "tax bite" from the 21-22k is minimal or close to zero as with a standard deduction for MFJ, no other income.

We do not plan on filing for SS until FRA.
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Old 04-15-2016, 06:56 AM   #24
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Old 04-15-2016, 10:18 AM   #25
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We convert to the top of the 15% bracket. However, the conversion amounts are fairly small and drive the full 15% incremental tax. This is because we have 2 pension annuities and rental income that consume much of the 15% bracket. Our tax-deferred balances are fairly large and, even with these conversions over the next 15 years, we can't avoid some portion of RMDs getting taxed at 25%, assuming fairly modest growth rates. The chances of getting taxed at 28% are very small however. So converting into the 25% bracket does not seem advisable. We just convert what we can at 15% in order to reduce the amount eventually taxed at 25%, and build up some withdrawal flexibility and tax diversity. When working, we deferred tax at 28% and higher, so it's all good.
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Old 04-15-2016, 03:39 PM   #26
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Originally Posted by pb4uski View Post
That's exactly what I have been doing... my tax rate will be low from now until I start my pension and SS so I have been doing conversion to the top of the 15% tax bracket and paying ~10% of the converted amount in federal income tax. It is less than 15% because before Roth conversions our income is principally qualified dividends and capital gains and those are less than our deductions and exemptions so a portion of the Roth conversion is taxed at 0%, a portion at 10%, and a portion at 15% and that averages out to ~10%.

You can get a good idea of the impact by modeling it out in Taxcaster or TurboTax.

Be aware though that if you do too much and exceed the top of the 15% tax bracket that the incremental tax is onerous... about 30%... but that can easily be overcome but recharacterizing any excess above the top of the 15% tax bracket. The past couple years I have done my tax return and then recharacterized an amount sufficient so my taxable income is exactly the top of the 15% tax bracket.

I-orp would have me convert much more but I don't see the wisdom in doing that... I'm just not a believer.
+1 to everything said, including the comment about I-orp. I'm using the same strategy but used tax software to model returns, including modeling conversions while delaying SS until 70 as well as start of RMD's, to end of PF life. Fortunately, I don't need the ACA so don't have to worry about that complication.
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Old 04-15-2016, 07:51 PM   #27
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Originally Posted by kramer View Post
Can someone provide details on the recharacterization process? My T-IRA and Roth IRA are with Vanguard.

I thought I read somewhere that it requires a write up and you send something to the IRS outside of the e-file system, but I don't really know. Ideally, I could do it all with Turbo Tax since I live abroad.
see p.3-4here https://www.irs.gov/pub/irs-pdf/i8606.pdf
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Old 04-16-2016, 04:38 AM   #28
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Originally Posted by xdafly View Post
Yes, we are also following this path. In our case, tIRA to Roth IRA are our only "reported income" and we convert only about 21-22k each year until 65.

The ACA subsidy PLUS cost sharing benefit (only available on Silver Plans) is substantial, in our case we pay only 30/mo with max OOP 900/year and have a better/more comprehensive plan than we had with decades of corporate health plan coverage (plus the payroll deductions were close to 400/month)

The actual "tax bite" from the 21-22k is minimal or close to zero as with a standard deduction for MFJ, no other income.

We do not plan on filing for SS until FRA.
Just curious and not looking for specifics,,,,but what do you use to pay your bills? Do you maintain a large cash bucket?

I only ask cuz I am in the situation where I am already retired and my wife retires later this year and we will be on an ACA plan. I crunched the numbers and could get a plan similar to yours, but would need to do away with my muni bond income and live primarily on cash until our pensions and SS kick in a few years from now.

My muni bond income (while reportable when figuring ACA subsidies) helps pay current bills and we would need to max out the deductible and OOp expenses every year on a silver plan to make it worthwhile to reduce AGI below $30,000/year. Just curious how you meet current expenses?
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Old 04-16-2016, 09:28 AM   #29
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Originally Posted by shortstop14 View Post
In my situation, I've had to balance the value of Roth IRA conversions against the value of an ACA subsidy. Right now I'm just doing enough Roth IRA conversion to get us to the optimal subsidy level. Other than some dividends and interest, it's our only income, so I can dial it in pretty accurately. When I convert to Medicare at 65 I'll ramp up the conversions to the top of the 15% bracket.
i-orp, mentioned earlier, will model the tax consequences of including ACA and conversions in the same plan.
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