Roth Conversion

[I am He]

As if we don't have enough threads (however I don't want to hijack any, either).
Assumptions for my chart: 54 and 52 years old

-I've run taxes due for me, MFJ (+one dep.), and forfeiting 7 months of ACA subsidy for this, our first year of FIRE.

-After this one year of conversion, no future taxes will be due if the future annual conversions are low enough to keep us qualified for the ACA subsidy (ballpark $84k including current investment income). Approx. $20-25k/year.

-Plan to leave $100k in the traditional IRA (after years of conversions) so it will fund future QCDs = the RMD

-The IRA column subtracts that $100k from the remaining balance and divides the balance by the years of future conversions

-Avg. tax rate=only the taxes due on this year's conversions as the balance is targeted as zero as well as leaving money for the QCD

-Guessing both of us will be OK but a cancer diagnosis raises the possibility that only one will be here (as a HoH) which wasn't planned for initially. This is one reason I have shorter years listed due to a possible change from MFJ to HoH if needed.

My questions are: are you seeing any glaring problems AND knowing the average TR on the conversion changes by about 1% for every $20,000, how much would you convert this year knowing it will then be growing in the Roth bucket henceforth? Being conservative, this Roth will hold more bonds than anything else so not likely to grow a lot but will be the ballast of the portfolio.

 

[davebarnes]

My strategy is:
1. Stocks in the Roth. Tax-free growth.
2. Bonds/cash in the taxable account. Low income to pay taxes on.

 

[pb4uski]

Looks like you didn't account for growth in the IRA over time. At 5%, that $354k tIRA will grow by $17.7k, so after the $14k conversion the tIRA will be $357.7k, not $340k... so it is like a dog chasing its tail in terms of substantially reducing large tIRA balances.

 

[I am He]

It's interesting that I've shown that the tax rate on a half mil can be 4.5% (or as little as zero) if slowly converted after a one time conversion of $106k to a max of about 16% on $400k and almost no one offers their opinion of a sweet spot being to immediately take the tax hit on (say) $200k and be happy with "the bird in the hand" or only do $170 or go for $260?

 

[I am He]

Looks like you didn't account for growth in the IRA over time. At 5%, that $354k tIRA will grow by $17.7k, so after the $14k conversion the tIRA will be $357.7k, not $340k... so it is like a dog chasing its tail in terms of substantially reducing large tIRA balances.

I guess I have a couple of goals: 1 to fund a Roth for tax free opportunity whether for bonds/ballast or for income and 2 that the tIRA RMDs are for charity. Specifically since we give and I'm not sure that we will deduct the gifts other than via a QCD so why not just plan to use the tIRA as a DAF? Therefore if its balance grows, that means giving grows!

But my chart is looking at the balances solely as a one time amount that needs to be converted in 19 and will slowly convert more over the years at the zero tax rate.

 

[pb4uski]

It's interesting that I've shown that the tax rate on a half mil can be 4.5% (or as little as zero) if slowly converted after a one time conversion of $106k to a max of about 16% on $400k and almost no one offers their opinion of a sweet spot being to immediately take the tax hit on (say) $200k and be happy with "the bird in the hand" or only do $170 or go for $260?

How do you get 4.5%? or as little as zero? Looks like it is consistently 22%+ to me so I'm not particularly impressed.

I guess part of it is that your framing of the table isn't intuitive.

 

[I am He]

The amount on the conversion amount is approx 24% (far right column)

The balance after the xxxx dollar conversion in this one single year will be taxed at zero if I can keep the annual (future) conversions at the zero tax bracket. Hence the taxes paid in 2019 are then prorated to the total tIRA amount.

So if I pay $46,800 in tax on a $200k conversion, today, the other $360k is drawn out $17,333/year for 15 years with a zero rate (and leaving $100k for QCDs left in the tIRA).

$46,800/$560,000= 8.36% Avg tax rate, overall.

This is why I'm trying to figure out what amount to do this year when I only need to repay 7 months of ACA coverage as in the future it will be 12 months if our income goes up too much. We probably have up to $25-30k of annual room to convert in 2020 and beyond.

Sorry if didn't delineate terribly well. This is a complex issue that I'm blessed to have. TY!

 

[I am He]

I suppose one future thing is also needing to take inherited RMDs from parents in the next xxx years as they're in their 80s. This income would leave less room to do conversions at our current opportune level.

 

[pb4uski]

.... So if I pay $46,800 in tax on a $200k conversion, today, the other $360k is drawn out $17,333/year for 15 years with a zero rate (and leaving $100k for QCDs left in the tIRA). ...

How do you get the last part?... $17.3k a year can be withdrawn at a zero rate?

That $17.3k a year would be income and would be subject to ordinary tax rates. The only way it would be zero rate is if the $17.3k plus your other ordinary income is less than the standard deduction ($24.4k in 2019 for MFJ), so that only leaves room of $7.1k of other ordinary income (interest, non-qualified dividends, short-term capital gains, pensions, taxable SS, etc.)

 

[I am He]

I've never done this , so I don't know if I'm checking off all the right boxes on my software for a conversion but let's try this:

$82,800 in taxable income ($10k interest, $44,800 dividends (42 qualified) $28k of conversion)
-$24,400 deduction (MFJ)
=$58,400 in Taxable income (line 11b)

Tax=$1,663 less child credit of $1,663= $0 tax

 

[pb4uski]

Your $58,400 is $16,400 of ordinary income and $42,000 of qualified income. The qualified income is 0% and the $16,400 of ordinary income should be at 10%, so your tax whould be $1,640... the $1,663 is probably because it is using the tax tables... so that looks right.

Let's put aside the child care credit because you won't have that the entire 20 years.

Without the conversion, your tax would be $0. So the $28,000 conversion is taxed as follows: the first $11,600 is not taxed because it is "covered" by the excess of the $24,400 standard deduction over the $12,800 of interest and non-qualified dividends, and the remaining $16,400 is taxed at 10%.... so the total tax on the conversion is $1,640 (but is offset by child care credit).

Another thing to factor in in your projections is that in future years you will have SS income and presumably it will be taxable and that taxable SS income and interest and non-qualified dividends might well exceed the standrd deduction.... in which case all of your Roth conversion would be subject to tax of 10% or more.... which is why I questioned the zero tax in your previous post.

You may also want to consider doing more conversions in 2019... additional conversions to the top of the 0% preferenced tax bracket of $78,750 would only be taxed at 12%.... so you could add as much as $20,350 and only pay 12%. Some of that additional tax might be covered by a higher child care credit unless the $1,663 is at the max.

 

[I am He]

I'm debating converting up to $300k as a bird in the hand. The cancer scare isn't 100% resolved and as I understand it, it may be within the next 2-3 years which could swing us from MFJ to HoH.

54 and 52 years old so we have a possible 17-20 year horizon for doing conversions. We have about another 12 years with a dependent.

This year is a bit out of the ordinary as there's still about 11k in earnings which won't be there in the future and $3850 in ACA to pay back vs $7k/year in the future if we over convert by going over the ACA cliff. And then there's that possibility that our income will go up if we inherit a few RMD's from the folks which would likely be $5-10k/year should that ever happen.

Just debating what might be a rational way to balance the unknowns with the knowns? A definite number of moving parts. Converting a lot now frees up some of those but it's tough to want to pay taxes even if it's an overall modest tax rate.

 

[I am He]

PS...I read your other post. My first car was a Ghia Fiesta and partied hard in that car! I wish I could pee before I ski but after 14 screws and two plates after an icy hill, I'm left with stand up jet-skiing to carve my turns.

 

[MileKing]

Appears you have 13 years on the ACA before youngest is eligible for Medicare. Not clear what your annual spend is, but wondering if you have sufficient assets in taxable accounts (including earnings on same) to cover your spend for 13 years.

 

[pb4uski]

ACA subsidies complicate it a lot because of the cliff.... so you can ignore the possibility of additional Roth conversions in 2019 since at MAGI of $82,800 you are already close to the cliff of $83,120.

 

[I am He]

I'd like to say yes, however this cancer scare has upped the amount of our out of pocket expenses more than calculated. Easily by $8k/year and if both of us "spent," double that.

Overall, I'd say it shouldn't be a problem assuming a 2-3% WR and a non imploded economy (bear, probably fine; crash, maybe fine).

College in 8+ years is the only major expense. And ideally, I'd like him to have to fund most of it himself (with some loans so he has true skin in the game) and we pay it off afterward (which means we pay it off about 12 years).

ACA is pretty important so drawing down most of the IRA now may be better than later should we have a need to liquidate a large amount (kicking us out of the ACA and be at a point where the premiums are much, much higher as we'll be in our 60s).

 

[I am He]

ACA subsidies complicate it a lot because of the cliff.... so you can ignore the possibility of additional Roth conversions in 2019 since at MAGI of $82,800 you are already close to the cliff of $83,120.

Yeah...all my spreadsheet had amounts voiding this year's subsidy and I'm OK with that. I'd like to take that pill and only swallow it once which is why I'm not only going to go over the cliff but over the hills and far a way from it, one time.

Assuming all future conversions are under my taxable floor (net $0 taxes) it isn't inconceivable to pay on a $280,000 conversion with the tax averaging @12.04% on $560,000 in the tIRA although perhaps I should shoot for only 10% at $235k or 9% at $210k or $180k at 7.41%.

 

[SevenUp]

It's interesting that I've shown that the tax rate on a half mil can be 4.5% (or as little as zero) if slowly converted after a one time conversion of $106k to a max of about 16% on $400k and almost no one offers their opinion of a sweet spot being to immediately take the tax hit on (say) $200k and be happy with "the bird in the hand" or only do $170 or go for $260?

Perhaps because it isn't clear what your chart shows. Some of us can't follow a simple “Behold!” and need a little more explanation.

The marginal rates, not your average rate, will determine the after-tax amounts for different conversion strategies.