Roth Conversions

[jkern]

Just curious, do most people that do Roth conversions fill up the 15% bracket, or they stop at 10%?

 

[mpeirce]

We fill up the 15% federal bracket.

Assuming current tax law in the future (not true, but what are you going to do...), we'll be up in the 25% or more when RMDs kick in in 15 years so convert as much as we can.

 

[Whisper66]

I plan to do what seems to be optimal based on the I-orp tool. For my situation that will mean filling up the 25% bucket. (Large amount in tax deferred accounts).


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[Animorph]

I fill up the 25% bracket, and for a few years a little beyond that.

 

[NW-Bound]

I played a bit with I-ORP optimizer. Its recommendation for Roth conversion depends on what I enter as the projection for stock gain. At the default of 6% nominal gain over 2.5% inflation, it tells me to go max out to fill up the 25% bracket. When I cut the gain down to about 4%, it cuts back to the 15% bracket. Of course, if my 401k+IRA were larger, than there would be more chance of its RMD hitting the 25% bracket even if future market return is lousy.

I think filling up 15% bracket is safest for most people, because their distribution from their tax-deferred stash tends to be within this bracket in future years. You may not have it reach 25% bracket if the market is lousy, but if it is highly unlikely that you will be down in the 10% bracket, then you might as well pay 15% now.

Of course if you want to make use of ACA subsidy, then it gets more complicated.

PS. It also depends on how much I want to leave behind for my kids. Now, how does it decide between leaving money behind in IRA or in Roth or after-tax? Interesting problem.

 

[NW-Bound]

OK, here's something interesting I just observed with I-ORP. This is a very interesting program that one can play with for hours.

The program has a toggle switch that you can use to tell it to do Roth conversion or not. In one situation, when I enable Roth conversion, it tells me to go max out up to the top of 25% bracket until the year when SS starts. See my earlier post. When the Roth conversion is turned off, the result was that I would pay about $26K more in taxes over the retirement period of 30 years.

That's $26K nominal spread out over the 30 years, so is much less than $26K now or a few $100s/yr due to inflation. That's a lot less than what I would have expected for a pretty heavy Roth conversion!

Hmmm... Perhaps the IRS or Congress is not as dumb as we think. They let us have what we think is a loophole, but it is only for appeasement. In the end, we still pay roughly the same. They throw us a little bone.

 

[Alan]

I've been converting to the top of the 25% bracket because RMDs + SS will move me into the 40% bracket as we will be living in the UK then. (Roth distributions are tax free in the UK as well as the US)

 

[RE2Boys]

Top of 15% bracket. Also trying to reduce my basis in T-IRAs for spousal simplification if I leave this world. Got all of DW T-IRAs converted, working on mine. got the basis down to about a third of original number, but it has taken many years.

 

[NW-Bound]

Out of curiosity, I just check out UK tax law.

Tax of 40% starts at £31,786, after personal exemption of £10,600. For a couple, that's £52,986, which is US$79,000.

Yikes! In the US, a couple still pays 15% up till $95,500. And then, they do not pay any tax on qualified dividends or cap gains.

I love Uncle Sam!

 

[Alan]

Out of curiosity, I just check out UK tax law.

Tax of 40% starts at £31,786, after personal exemption of £10,600. For a couple, that's £52,986, which is US$79,000.

Yikes! In the US, a couple still pays 15% up till $95,500. And then, they do not pay any tax on qualified dividends or cap gains.

I love Uncle Sam!

You have that wrong.

Each person is taxed individually so each person has the £10,600 tax free allowance and each person then has £31,786 taxed at 20% for regular income. Qualified dividends have the first £5,000 tax free and then are taxed at 5% if you are in the 20% or below. Capital gains have a tax free examption £11,100, then are taxed at 18%.

All our taxable investments are in my wife's name so we expect to pay 0% UK tax on our dividends and cap gains. I will be paying taxes only on my pension income plus SS when I start receiving it.


I have already done a test run of what we will pay in UK taxes and it is about $3k more than in the US. But the UK has health services free at point of service plus various other allowances for Seniors including free bus passes, free prescriptions, free eye tests etc.


ETA
Dividend income is actually completely free of tax at present. The new tax rates I mentioned above come into force next year.

 

[GrayHare]

That's $26K nominal spread out over the 30 years, so is much less than $26K now or a few $100s/yr due to inflation. That's a lot less than what I would have expected for a pretty heavy Roth conversion!

That's likely because your tax rate now is close to that expected in the future. If one's tax rate during conversion to Roth is the same as the rate during later tIRA withdrawals, conversion to Roth adds nothing to one's after-tax net worth. This assumes the tIRA contains all pre-tax dollars.

 

[sengsational]

That's likely because your tax rate now is close to that expected in the future. If one's tax rate during conversion to Roth is the same as the rate during later tIRA withdrawals, conversion to Roth adds nothing to one's after-tax net worth. This assumes the tIRA contains all pre-tax dollars.

I agree. Roth conversions are hyped pretty large here, but the author of i-orp says "the IRA to Roth IRA conversion decision should probably be made based on considerations other than increasing disposable income" in this http://www.i-orp.com/ModelDescription/Conversions.pdf

The i-orp tool now has the capability to run an optimization with PPACA "on" (taking advantage of the premium tax credit and limiting income) as well as with or without Roth conversions. Everyone's situation is different; some people get very little benefit from conversions and/or PPACA, others more. I'm a bird in the hand kind of guy, and PPACA currently comes out on top and I see the benefit each year, which is why I'm going with the PPACA over larger Roth conversions.

 

[NW-Bound]

I did not realize the reason is as simple as explained above, until I looked closely at the tax brackets and saw that the range of the 25% marginal tax rate is large enough that it is easy to fall entirely in it, with little wiggle room to get out.

For 2015, the range for 25% tax rate is $99.5K to $175.8K for a married couple when standard deduction and exemptions are included. So, unless the market return is either terrible or exceptional, it is not likely for me to drop under or go beyond this range. It is only with good expected market returns that I have a chance to go to the 28% range, and that is when I-ORP recommendation is to do Roth conversion to the top of 25% bracket.

There's still a bit of room for "tweaking". That is SS is taxed only at 85%, so there's still a bitty bit of tax difference between pre-SS and post-SS IRA withdrawal.

 

[harley]

Hmmm... Perhaps the IRS or Congress is not as dumb as we think. They let us have what we think is a loophole, but it is only for appeasement. In the end, we still pay roughly the same. They throw us a little bone.

Actually, the loophole (IMO) is the non-taxed inheritance of the IRA. I always assumed the personal situation would be pretty much a wash, and since I'd be paying taxes on the later withdrawals with inflation depreciated dollars it might even work out better to not convert. But being able to leave a healthy inheritance to DD and her spawn that would never be taxed was a brilliant advantage, again IMO.

Of course, they're talking about shutting that down, and probably will before I shuffle off the coil.

 

[Cobra9777]

I'm planning to convert to the top of the 15% bracket starting next year. First 2 years of ER, our tax bracket has been very high due to exercising my remaining employee stock options. We also have pensions and rentals that fill up much of the 15% bracket. So even with 15 years to go, we can't convert enough to prevent RMDs being partially taxed at 25%.

There are some higher return scenarios which would cause RMDs to push us into the 28% and even 33% brackets. But I'm very hesitant to convert into the 25% bracket based on that. If it happens, then I suppose that'll be a "good" problem to have. There are equally plausible downside scenarios where nothing gets taxed at 25%. So who knows. I'm stopping at 15%.

I don't share the enthusiasm for Roth conversions expressed by many on this forum. Only reason I'm converting at all, is to create some incremental withdrawal flexibility. In all likelihood, I'm just pre-paying taxes for the kids. Hard to get enthusiastic about that, particularly given the recurring budget proposals to weaken the Roth's legacy-friendly attributes.

 

[ERD50]

I ... There are equally plausible downside scenarios where nothing gets taxed at 25%. So who knows. I'm stopping at 15%.

I don't share the enthusiasm for Roth conversions expressed by many on this forum. Only reason I'm converting at all, is to create some incremental withdrawal flexibility. ....

Pretty much agree. The actual tax savings may or may not be that great. But it will provide flexibility if I need to pull a bunch one year for some big one-time expense, esp if I've already spent down my non-deferred money ( which would probably have a fairly high cost basis, so low tax hit). Pulling from a ROTH might keep me in a lower bracket. Might.

-ERD50

 

[youbet]

Just curious, do most people that do Roth conversions fill up the 15% bracket, or they stop at 10%?

I filled up the 25% bracket the past few years. Our upcoming RMD's will come out above that.

 

[SecondCor521]

Everyone's situation is different; some people get very little benefit from conversions and/or PPACA, others more. I'm a bird in the hand kind of guy, and PPACA currently comes out on top and I see the benefit each year, which is why I'm going with the PPACA over larger Roth conversions.

What PPACA limit do you target (if any)?

I'm trying to figure out my own plan for next year, and I'm thinking 249% of FPL to get both subsidies and cost-sharing.

2016 will be the first year where I get to choose my AGI and it's freaking me out a little.

 

[MasterBlaster]

OK, here's something interesting I just observed with I-ORP. This is a very interesting program that one can play with for hours.

The program has a toggle switch that you can use to tell it to do Roth conversion or not. In one situation, when I enable Roth conversion, it tells me to go max out up to the top of 25% bracket until the year when SS starts. See my earlier post. When the Roth conversion is turned off, the result was that I would pay about $26K more in taxes over the retirement period of 30 years.

That's $26K nominal spread out over the 30 years, so is much less than $26K now or a few $100s/yr due to inflation. That's a lot less than what I would have expected for a pretty heavy Roth conversion!

Besides a limited (apparent) Roth benefit, Do you trust that tax laws will remain as they are ? Or will they find a way to tax (again) "excess" Roth withdrawals.


Do you trust them enough to pay up-front ? Do you trust them enough to do a large conversion ?

 

[NW-Bound]

No, I do not trust anybody to do anything. There is really no way to run, hide, or crawl away from the long reach of the taxman's arm.

Why don't we just draw the whole thing at once, eat the 39.6% top tax bracket? It hurts but once, and what is left is now really ours, so we can convert to krugerrands and hide it under the mattress, or bury it in the backyard. See if they can find it now!

Then now being a "poor" man of no means, you get full SS benefits!

 

[Ed_The_Gypsy]

I've been converting to the top of the 25% bracket because RMDs + SS will move me into the 40% bracket as we will be living in the UK then. (Roth distributions are tax free in the UK as well as the US)

Same here. I should have started converting earlier if I wanted to stay in the 15% bracket.

If things go as planned, with basically only a tiny pension, SS and Roths, after 70, we will never pay taxes (or even need to FILE) ever again.

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[NW-Bound]

... For 2015, the range for 25% tax rate is $99.5K to $175.8K for a married couple when standard deduction and exemptions are included...

Correction: The above income range should have been $95.5K to $171.8K.

 

[Animorph]

Besides a limited (apparent) Roth benefit, Do you trust that tax laws will remain as they are ? Or will they find a way to tax (again) "excess" Roth withdrawals.


Do you trust them enough to pay up-front ? Do you trust them enough to do a large conversion ?

But do you trust them enough not to raise the rates you'll pay on tIRA withdrawals in the future?

I'm don't have enough certainty in either direction to avoid or encourage Roth conversions beyond what current tax rates support.

 

[NW-Bound]

Pretty much agree. The actual tax savings may or may not be that great. But it will provide flexibility if I need to pull a bunch one year for some big one-time expense, esp if I've already spent down my non-deferred money ( which would probably have a fairly high cost basis, so low tax hit). Pulling from a ROTH might keep me in a lower bracket. Might.

-ERD50

I agree. Roth conversions are hyped pretty large here, but the author of i-orp says "the IRA to Roth IRA conversion decision should probably be made based on considerations other than increasing disposable income" in this http://www.i-orp.com/ModelDescription/Conversions.pdf

Yes, I need to remind myself of this point as I write the check to the IRS.

My after-tax accounts have been shrinking at an alarming rate ever since I stopped my part-time work. The fact that the IRA/401k accounts grew to more than make up for it did not seem to help my unease. The reason is that the retirement accounts still have to be taxed, and worse, I had to be 59-1/2 to draw it without penalty or a 72(t) plan. When you have to ask for permission to draw, it feels more like the gummint's money than my own.

So, I need to even out the drawing of the retirement accounts for tax purposes as well as to keep a reserve fund for unusual expenses. And instead of drawing it to an after-tax account, a Roth account will be a better holding place.

 

[MasterBlaster]

But do you trust them enough not to raise the rates you'll pay on tIRA withdrawals in the future?

I'm don't have enough certainty in either direction to avoid or encourage Roth conversions beyond what current tax rates support.

Well it goes without saying that tIRA withdrawals in retirement will be taxed at some TBD average rate. Roth conversions however are taxed at your (perhaps higher) current marginal tax rate.

Even with future tax rate increases, the future average rate just may be less than your current marginal rate.

- Your mileage may vary though