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Retired this year and should we start Roth Conversion this year?
Old 11-14-2019, 01:40 PM   #1
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Retired this year and should we start Roth Conversion this year?

Hi All,

Happy to report that we retired earlier this year and have taken some very big international trips and so far we are enjoying our ER very much. Since we are coming to year end almost, have a question for the group related to Roth Conversion from Traditional IRA account.

Here are some details related to this question:
- We are currently 55/50 of age and expect a tax torpedo in about 10-20 years when we are eligible for social security (not sure exactly when we will take them) and RMD start
- Since we worked in the beginning of the year before pulling the ER trigger, this year we have about 40K earned income (W2) and we will not have any earned income next year.
- Our passive income from investment dividend and interest is around 125K this year but will probably increase by 10-15K next year as we deploy some cash into equity/bond.

The key questions are -
A. Should we start converting from the Traditional IRA to Roth this year, which will be add to the 2019 tax year or should we wait till next year when we do not have any earned income?
B. Is there anything that we need to be aware of or think through before we start the conversion? For example, I assume that we should start with hubby's IRA as he is 5 years older and maybe only start mine at later retirement years.

Thank you in advance! Please let me know if there are other details needed to answer this question.
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Old 11-14-2019, 03:09 PM   #2
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So you're in the 12% bracket this year with $40K earned income, plus interest and non-qualified dividends, less your deduction--perhaps the $24K standard deduction. Assuming most of those dividends are qualified, some of those are taxed at 15%, and some are not taxed. For every $1 you convert, it is taxed at 12% and you push another $1 of QDivs into being taxed at 15%, for an effective 27% rate. This continues until all of your QDivs are taxed, which happens when you hit the 22% bracket (actually $200 under, for some odd reason). So believe it or not, the more you convert, the lower the marginal tax rate is, to a point. You'll drop from 27% to 22% at the point mentioned above.

One thought I have is to convert every other year--to the top of the 24% bracket one year, and in other years just enough to cover the standard deduction. It really depends on how much you have to convert, and how aggressive you want to be. If you have a huge amount you might want to convert to the top of 22 or 24% every year.

A. So it seems counter-intuitive, but 2019 is probably a good year to convert because you are fairly close to being out of that 27% (12%+15%) rate already, so you might as well push through it and beyond. Does that make sense?

I could be wrong, but I would think that with such large passive income, the SS hump won't be a concern. I think you'll already have SS fully taxed (85%) so you won't have extra income being taxed and also pushing more SS into being taxed, which is what the SS hump is.

Someone correct me if any of this is wrong.

B. I'm not married so I haven't looked at it, but it seems like your thinking is right, to start with his since he faces RMDs earlier. Others may know more about this.
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Old 11-14-2019, 03:54 PM   #3
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Originally Posted by RunningBum View Post
.....(actually $200 under, for some odd reason). ....
The $200 is due to the difference between the top of the 0% preferenced income tax bracket of $78,750 and the top of the 12% ordinary income tax bracket of $78,950.

In 2020, the gap rises to $250... $80,250 vs $80,000.

Because our Congress are morons who can't keep things simple, when the 2017 Tax Act was passed they decided to introduce a small difference between the top of the 0% preferenced income tax braacket and the top of the second ordinary tax bracket where before they were aligned.
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Old 11-14-2019, 04:06 PM   #4
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Commonly, what people do is to convert to the top of the tax bracket that they expect to be in once any pensions and SS starts.

So in OP's case, take $125k of taxable interest and dividends and 85% of SS plus any pension less deductions and see what your ultimate tax bracket is... then convert to the top of that tax bracket. If their combined SS income is less than $79,764 then that would be the top of the 24% tax bracket of $168,400.

$125,000 + ($79,764 * 85%) - $24,400 = $168,399
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Old 11-14-2019, 05:29 PM   #5
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Originally Posted by pb4uski View Post
Commonly, what people do is to convert to the top of the tax bracket that they expect to be in once any pensions and SS starts.

So in OP's case, take $125k of taxable interest and dividends and 85% of SS plus any pension less deductions and see what your ultimate tax bracket is... then convert to the top of that tax bracket. If their combined SS income is less than $79,764 then that would be the top of the 24% tax bracket of $168,400.

$125,000 + ($79,764 * 85%) - $24,400 = $168,399
Sorry could you clarify where the $79,764 number comes from? I estimate that our combined SS income when the time comes will be less than $79,764.

So you are saying that I could convert up to $3,399 based on the following right?
$168,399
- 40,000 (earned income)
- 125,000 (interest and dividend passive income)
----------------
$3,399 (amount to be converted)
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Old 11-14-2019, 05:38 PM   #6
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Originally Posted by RunningBum View Post
So you're in the 12% bracket this year with $40K earned income, plus interest and non-qualified dividends, less your deduction--perhaps the $24K standard deduction. Assuming most of those dividends are qualified, some of those are taxed at 15%, and some are not taxed. For every $1 you convert, it is taxed at 12% and you push another $1 of QDivs into being taxed at 15%, for an effective 27% rate. This continues until all of your QDivs are taxed, which happens when you hit the 22% bracket (actually $200 under, for some odd reason). So believe it or not, the more you convert, the lower the marginal tax rate is, to a point. You'll drop from 27% to 22% at the point mentioned above.

One thought I have is to convert every other year--to the top of the 24% bracket one year, and in other years just enough to cover the standard deduction. It really depends on how much you have to convert, and how aggressive you want to be. If you have a huge amount you might want to convert to the top of 22 or 24% every year.

A. So it seems counter-intuitive, but 2019 is probably a good year to convert because you are fairly close to being out of that 27% (12%+15%) rate already, so you might as well push through it and beyond. Does that make sense?

I could be wrong, but I would think that with such large passive income, the SS hump won't be a concern. I think you'll already have SS fully taxed (85%) so you won't have extra income being taxed and also pushing more SS into being taxed, which is what the SS hump is.

Someone correct me if any of this is wrong.

B. I'm not married so I haven't looked at it, but it seems like your thinking is right, to start with his since he faces RMDs earlier. Others may know more about this.
Sorry - I don't quite get where you got the 27% ... I did not think the way to calculate the effective rate is adding the tax rate for the ordinary (e.g. earned) income with the 15% rate for dividend.

Could you care to expand a bit? I think maybe I am just new to this topic.

I was originally thinking that between the 40K earned income and the 125K passive income, we would be at the 24% tax rate for the married file jointing, i.e. $168,4000.

So we would be convert up to $34,400 based on the following at the 24% tax rate:
$168,400
- 40,000 (our earned income for 2019)
-125,000 (our passive income for 2019)
+ 24,000 (standard deduction)
+ 7,000 (HSA contribution deduction)
--------------
34,400

pb4uski suggested something else based on social security amount in the future, which I am also trying to clarify. Thank you!
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Old 11-14-2019, 05:47 PM   #7
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Originally Posted by Prague View Post
Sorry could you clarify where the $79,764 number comes from? I estimate that our combined SS income when the time comes will be less than $79,764.

So you are saying that I could convert up to $3,399 based on the following right?
$168,399
- 40,000 (earned income)
- 125,000 (interest and dividend passive income)
----------------
$3,399 (amount to be converted)
I believe pb4 is saying if you have $79,764 or more in SS benefits, you will be in the 24% tax bracket even without RMDs.

I don't think this is right though. Some of those dividends are qualified, are they not? It would be helpful to get a breakdown of how much of that $125K in interest and dividends are qualified.
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Old 11-14-2019, 06:02 PM   #8
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Originally Posted by RunningBum View Post
I believe pb4 is saying if you have $79,764 or more in SS benefits, you will be in the 24% tax bracket even without RMDs.

I don't think this is right though. Some of those dividends are qualified, are they not? It would be helpful to get a breakdown of how much of that $125K in interest and dividends are qualified.
Not sure the exact amount of qualified dividend this year but I estimate it to be about 90K out of the 125K.
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Old 11-14-2019, 06:10 PM   #9
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Sorry - I don't quite get where you got the 27% ... I did not think the way to calculate the effective rate is adding the tax rate for the ordinary (e.g. earned) income with the 15% rate for dividend.

Could you care to expand a bit? I think maybe I am just new to this topic.
Sure, I'll try. It really helps to look at and understand the "Qualified Dividends and Capital Gains Worksheet" worksheet on your tax form that is used to calculate your actual income tax amount for most people who have dividends and cap gains.

If you have low income, your Long term capital gains (LTCGs) and qualified dividends (QDivs) aren't taxed. However, it's not unlimited. Once your total taxable income, including earnings, Roth conversions, interest, all dividends and cap gains, etc, less deductions, exceeds $78,750, LTCGs and QDivs start being taxed at 15%. But only the part that overflows the $78,750 mark.

So let's say of that $125K you have of interest and dividends, $75K of that is QDivs, and $50K is not. After $24K of deductions, you have $26K of regular taxable income. That means the first $52,750 of QDivs is tax free, but the rest is taxed at 15%.

If you add $1000 income for Roth conversions, that $1000 is taxed at 12%, because that's the bracket you're in for regular income. But now you've left only $51,750 of QDivs to be tax free; you just pushed an extra $1000 to be taxed at 15%. That adds up to 27%. The impact of that $1000 conversion is $270 in extra taxes.

It's much like the SS tax hump, if you understand that, where additional income is not only taxed, but it causes more of your SS to be taxed.

I don't know how else to explain it other than to run a simple tax return with those type of numbers, and watch the impact on the worksheet I mentioned. I'll warn you that H&R Block's tax program doesn't show this worksheet, but rather puts this calculation where it's harder to find. Turbo Tax does show the form.

Somewhere I have a diagram that shows this, but I can't find it now.
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Old 11-14-2019, 06:30 PM   #10
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I think I can describe that picture.

You've got a bucket, that holds $78,750.

You add regular income to it (less deductions). That's heavy, and sinks to the bottom. This income is taxed at the rate for whatever bracket you are in.

Then you add QDivs and LTCGs. This is lighter and sits on top. Anything you can fit into that bucket is tax free. Anything that over flows the bucket is taxed at 15% (or higher for high income investors).

So once that bucket is full, anything more you add to it causes more of that QDiv money to overflow the bucket and become taxed.

Roth conversions is regular income, so if you add it to the bucket, it is taxed, and it also causes the same amount of QDivs to overflow out of the bucket and be taxed at 15%.

If you've filled the bucket with the heavier regular income dollars, all of you QDivs have now overflowed the bucket and are taxed. This means if you add even more regular income (Roth conversions), they will be taxed at their rate, but you haven't overflowed any more QDivs (since they are all out of the bucket), so you don't have the additional 15% tax.

Does that make sense? I know how to explain things as I see them, but I'm not sure it always makes sense to others.
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Old 11-15-2019, 01:11 AM   #11
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Somewhere I have a diagram that shows this, but I can't find it now.
An example of that situation is charted in Marginal tax rate - Bogleheads, with reference to a spreadsheet that one can use to develop similar charts for other situations.
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Old 11-15-2019, 05:28 AM   #12
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My plan is to convert up to the top of the 12% bracket.
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Old 11-15-2019, 07:28 AM   #13
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Running Bum's picture above is a nice creative (and original) method of thinking about it. The more conventional way is a stacked bar chart with the
QDIV/LTCG bar sitting on top of the bar of ordinary income. Deductions come from the bottom of the stack so reduce ordinary income first. A picture illustrating this is here https://www.bogleheads.org/forum/viewtopic.php?t=86849 in the 12/11/11 post by tfb. Note that this is before the tax change from last yr so the numbers are slightly different but the idea is the same. The 15% bracket was changed to 12% .
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Old 11-15-2019, 08:10 AM   #14
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.... So we would be convert up to $34,400 based on the following at the 24% tax rate:
$168,400
- 40,000 (our earned income for 2019)
-125,000 (our passive income for 2019)
+ 24,000 (standard deduction)
+ 7,000 (HSA contribution deduction)
--------------
34,400

pb4uski suggested something else based on social security amount in the future, which I am also trying to clarify. Thank you!
You got it except the standard deduction for 2019 is $24,400 so the conversion amount would be $34,800 (I left the HSA deduction alone... and the $168,400 is the top of the 22% tax bracket, not the 24% tax bracket).

If you did no conversions at all, you would have $43,600 of ordinary income ($19,400 at 10% the rest at 12%... $4,844 in tax), $35,150 of qualified dividends at 0% and $54,850 of qualified dividends at 15% ($8,228 in tax)... for a total of $13,072 in tax.

If you converted $34,800 you would have $78,400 of ordinary income ($19,400 at 10% the rest at 12%... $9,020 in tax), $350 of qualified dividends at 0% and $89,650 of qualified dividends at 15% ($13,448 in tax).... for a total of $22,468 in tax... and the tax cost of the $34,800 in Roth conversion is $9,396... 27% because the $34,800 of Roth conversions is taxed at 12% and pushes $34,800 of qualified dividends from the 0% tax bracket into the 15% tax bracket.

OTOH, if you converted $124,800, you would have $168,400 of ordinary income (at 10%, 12% and 22%... $28,765 in tax) and $90k of qualified dividends at 15% ($13,500 in tax) for a total tax of $42,265... so that next $90k of conversions increases the total tax by $19,797... a less than 22% because the first $550 of the additional Roth conversion is taxed at 12%, the remaining $89,450 at 22% and it pushes $350 of qualified dividends from the 0% tax bracket into the 15% tax bracket.

But in total, the tax on your $124,800 of Roth conversions is $29,193 or 23.4%... essentially a blend of 27% and 22% and some noise.

And finally, if 24% doesn't bother you.... you could convert an additional $153,050 (so $277,850 in total) at 24% since the top of the 24% tax bracket is $321,450... for a total tax of $78,997 and a tax on the $277,850 in conversions of $65,925 or 23.7%. While this seems a bit outrageous, it might be something to consider because if one of you passes with high tax-deferred balances and you end up filing as a single then you'll be in a much higher tax bracket than 24%.
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Old 11-15-2019, 09:31 AM   #15
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You got it except the standard deduction for 2019 is $24,400 so the conversion amount would be $34,800 (I left the HSA deduction alone... and the $168,400 is the top of the 22% tax bracket, not the 24% tax bracket).

If you did no conversions at all, you would have $43,600 of ordinary income ($19,400 at 10% the rest at 12%... $4,844 in tax), $35,150 of qualified dividends at 0% and $54,850 of qualified dividends at 15% ($8,228 in tax)... for a total of $13,072 in tax.

If you converted $34,800 you would have $78,400 of ordinary income ($19,400 at 10% the rest at 12%... $9,020 in tax), $350 of qualified dividends at 0% and $89,650 of qualified dividends at 15% ($13,448 in tax).... for a total of $22,468 in tax... and the tax cost of the $34,800 in Roth conversion is $9,396... 27% because the $34,800 of Roth conversions is taxed at 12% and pushes $34,800 of qualified dividends from the 0% tax bracket into the 15% tax bracket.

OTOH, if you converted $124,800, you would have $168,400 of ordinary income (at 10%, 12% and 22%... $28,765 in tax) and $90k of qualified dividends at 15% ($13,500 in tax) for a total tax of $42,265... so that next $90k of conversions increases the total tax by $19,797... a less than 22% because the first $550 of the additional Roth conversion is taxed at 12%, the remaining $89,450 at 22% and it pushes $350 of qualified dividends from the 0% tax bracket into the 15% tax bracket.

But in total, the tax on your $124,800 of Roth conversions is $29,193 or 23.4%... essentially a blend of 27% and 22% and some noise.

And finally, if 24% doesn't bother you.... you could convert an additional $153,050 (so $277,850 in total) at 24% since the top of the 24% tax bracket is $321,450... for a total tax of $78,997 and a tax on the $277,850 in conversions of $65,925 or 23.7%. While this seems a bit outrageous, it might be something to consider because if one of you passes with high tax-deferred balances and you end up filing as a single then you'll be in a much higher tax bracket than 24%.
Thanks for the detailed response! Yes, you are right about the $168,400 being the top of the 22% bracket and the extra $400 in the 2019 standard deduction.

Right now thinking of just doing the $34,800 conversion for 2019 and maybe doing more next year when we have $0 earned income in 2020 (first year of full retirement). The extra $19,797 tax bill is a bit hard to swallow at the moment.

However, regardless whether to convert $34,800 or $124,800, would that cause an issue for estimated tax? We have sent in 3 quarters of estimated tax without taking into consideration of the extra taxes for Roth Conversion. While we can certainly increase it in the Q4 estimated tax that we will send in December, I think that maybe an issue as they generally expect a more consistent estimated tax. Has anyone run into such issue before or most folks know the amount of Roth conversion at the beginning of the year thus not having to deal with this issue?

@pb4uski - Thank you again for your time!
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Old 11-15-2019, 09:36 AM   #16
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.... However, regardless whether to convert $34,800 or $124,800, would that cause an issue for estimated tax? We have sent in 3 quarters of estimated tax without taking into consideration of the extra taxes for Roth Conversion. While we can certainly increase it in the Q4 estimated tax that we will send in December, I think that maybe an issue as they generally expect a more consistent estimated tax. Has anyone run into such issue before or most folks know the amount of Roth conversion at the beginning of the year thus not having to deal with this issue?

@pb4uski - Thank you again for your time!
It would cause an additional complication but not a problem.

When you file your taxes you will need to file a Form 2210 and fill out section AI to use the annualized income method... essentially, it recasts your income elements and resulting tax by quarter and as long as your year-to-date estimated payments equal or exceed your year-to-date estimated tax then you're all set. FYI the quarters in the section AI are not calendar quarters but are odd... to 3/31, 5/31, 8/31 and 12/31 rather than 3/31, 6/30, 9/30 and 12/31.
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Old 11-15-2019, 10:10 AM   #17
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Yes, I've used Form 2210 to show that I had a large income spike at the end of the year with a conversion, so my large 4Q estimated tax payment was sufficient. It was more work when itemizing deductions because you had to assign all income and deductions per quarter, but now that I'm taking the standard deduction it'd just be showing all the income by quarter.
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Old 11-15-2019, 03:37 PM   #18
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This has been an incredibly helpful discussion as I try to determine what is going on with my taxes. I was hitting 27-28% marginal tax rates on potential conversions, and couldn't figure out why. The explanation of moving qualified dividends from 0% to 15% is what is driving it, combined with part of the conversion driving me into the NIIT range.

Thanks for the multiple clear explanations, as well as the links to the graphs at Bogleheads, which I remembered but could not find.
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