ROTH Conversion Question

[BGH1]

Hello everyone, I have been enjoying reading posts over the years and we are 5.3 years from retirement.

We have after tax accounts which have very little tax impact if utilized for living. We also have large IRA accounts from 401k rollovers.

Upon retirement we are looking to live off of the after tax accounts as we convert some IRA funds over to ROTH (over 5 years as we defer SS).

I believe this would be more advantageous than living off the IRAs to spend down prior to RMDs.

Let me know what you think.

 

[RunningBum]

I agree. Given a choice between having money in a Roth (doing a conversion) or in taxable (living off tIRA money while preserving money in taxable accounts), having it in a Roth is better since it grows untaxed. The only exception I can think of offhand is if you have to access the money before 59.5 and haven't had money in the Roth long enough to withdraw it without penalty or tax.

 

[pb4uski]

What tax bracket do you expect to be in when you retire? Why would your after-tax account withdrawals have little tax impact.... are they mostly interest bearing?

I am in a situation where my taxable account funds are mostly in equities so they have little tax impact because qualified dividends and LTCG are tax free if your income is less than ~$104k for a couple.

But the problem that I experienced was that if I used taxable accounts to live off of the capital gains from sales to generate living expense money significantly reduced the amount that I could do in Roth conversions. I decided that for us a better strategy was to forgo living off of taxable funds and live off of tax-deferred funds and do Roth conversions to reduce our tax-deferred accounts while we were in a low tax bracket.

The reality is that we'll still be in the 22% tax bracket once we start SS and when RMDs kick in... but the RMDs will be lower because we withdrew and paid 12% or less vs 22% later.

And the cherry on top is that if DW or I pass on then the survivor gets a stepped up basis for some of our taxable account funds that we left alone and let grow effectively making some of that appreciation totally tax free.

 

[BGH1]

I agree. Given a choice between having money in a Roth (doing a conversion) or in taxable (living off tIRA money while preserving money in taxable accounts), having it in a Roth is better since it grows untaxed. The only exception I can think of offhand is if you have to access the money before 59.5 and haven't had money in the Roth long enough to withdraw it without penalty or tax.

Thanks RunningBum, I plan to covert and have the ROTH money grow long term, although I know the minimum time to draw is at 5 years.

 

[BGH1]

What tax bracket do you expect to be in when you retire? Why would your after-tax account withdrawals have little tax impact.... are they mostly interest bearing?

I am in a situation where my taxable account funds are mostly in equities so they have little tax impact because qualified dividends and LTCG are tax free if your income is less than ~$104k for a couple.

But the problem that I experienced was that if I used taxable accounts to live off of the capital gains from sales to generate living expense money significantly reduced the amount that I could do in Roth conversions. I decided that for us a better strategy was to forgo living off of taxable funds and live off of tax-deferred funds and do Roth conversions to reduce our tax-deferred accounts while we were in a low tax bracket.

The reality is that we'll still be in the 22% tax bracket once we start SS and when RMDs kick in... but the RMDs will be lower because we withdrew and paid 12% or less vs 22% later.

And the cherry on top is that if DW or I pass on then the survivor gets a stepped up basis for some of our taxable account funds that we left alone and let grow effectively making some of that appreciation totally tax free.

My aftertax account is from stock options we cashed out on some time and paid a boatload of taxes in doing so. So as a result we have very little taxes which will keep us in a very low tax bracket compared to RMD time.

I plan on converting possibly to 15% bracket over the five years, that’s when after tax funds will be gone. Then I will still have a couple years to use IRA money before RMDs, followed by SS.

I’m pretty sure SS as well as IRA pulls at RMD time will kick us to 22% bracket. I think this is the best strategy for us and hope it pans out.

 

[pb4uski]

So it sounds like the income and/or capital gains on whatever the proceeds of the stock options are invested in currently are minimal and would not impact the headroom that you have to do Roth conversions.

What you plan to do is effectively converting taxable account money to Roth money (less the taxes paid) .... at the end of 5 years your taxable account money will be gone and that amount, less taxes, will be in the Roth.

 

[BGH1]

Yes pb4uski, this is exactly what the current plan is. Now I’m looking at whether to convert my IRA or wife’s. She is 4 years younger, so my thought is convert equal amounts between us, but not sure it really matters.

 

[sengsational]

Classic i-orp question.

Set aside a few hours to read the help screens and get the inputs right.

The tool allows equity percent to be different between tax categories, but I recommend making those the same so the optimization is all on taxes.

The tool is often criticized for aggressive Roth conversions, so take the result as a high side mark. You can also limit conversions to the top of various tax brackets and see how far away from optimal that takes you. If it's just a little bit, then the bird in the hand applies.



Of course tax law might change or SS might get cut, etc, so it's anybody's guess, but there are some knobs to twiddle for you to get a feel for sensitivity of your plan to these kinds of things. But it's going to take time to get comfortable with the inputs and outputs, so I wouldn't try to rush it.

 

[Sunset]

It does not really matter which IRA you convert, unless some unexpected event happens like divorce.

 

[BGH1]

Classic i-orp question.



Set aside a few hours to read the help screens and get the inputs right.

The tool allows equity percent to be different between tax categories, but I recommend making those the same so the optimization is all on taxes.


The tool is often criticized for aggressive Roth conversions, so take the result as a high side mark. You can also limit conversions to the top of various tax brackets and see how far away from optimal that takes you. If it's just a little bit, then the bird in the hand applies.



Of course tax law might change or SS might get cut, etc, so it's anybody's guess, but there are some knobs to twiddle for you to get a feel for sensitivity of your plan to these kinds of things. But it's going to take time to get comfortable with the inputs and outputs, so I wouldn't try to rush it.

Thanks sengsational, I will spend some time with this to check my plan. As you said we have no idea what’s ahead, I’m hoping the ROTH conversion is still there and I’m already planning with 70% SS as an input, who knows.

 

[BGH1]

It does not really matter which IRA you convert, unless some unexpected event happens like divorce.

Thanks Sunset, I thought that was the case, the total amount for RMDs would remain relatively the same if converting mine, wife’s or both of ours. However I suppose if I just converted mine, it would lower my RMDs and for the 4 years until wife’s RMDs hit we could pull from her account.

 

[pb4uski]

Yes pb4uski, this is exactly what the current plan is. Now I’m looking at whether to convert my IRA or wife’s. She is 4 years younger, so my thought is convert equal amounts between us, but not sure it really matters.

We ended up converting my wife's, only because she had a smaller tIRA balance so we could convert the whole thing and end up with less accounts....so rather than her having a tIRA account and a Roth account she only has a Roth account. Then once hers was done, we started converting mine. YMMV.

 

[BGH1]

We ended up converting my wife's, only because she had a smaller tIRA balance so we could convert the whole thing and end up with less accounts....so rather than her having a tIRA account and a Roth account she only has a Roth account. Then once hers was done, we started converting mine. YMMV.

We will convert as much as we can while we can. May take the same approach as you.