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Roth conversions
Old 05-14-2018, 08:04 PM   #1
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Roth conversions

I have been thinking more and more about the intricacies of Roth conversions.
I am really wondering if Roth conversions may end up being more trouble than they're worth.
First of all I am waiting for my wife to stop working so we can have the lowest income possible. Then I figure we try to convert to the top of whatever bracket we are in - so far so good. But this will generate extra taxes, presumably paid from non IRA money. That means taking more money from taxable which could increase income and lower the actual room for withdrawing from traditional IRa
But wait, it gets worse. My tIRA holdings are generally the ones without dividends or capital gains. (Bonds, etc) But Roth IRA holdings being never taxed again are best made up of dividend and capital gains producers, so to keep my asset allocation in balance I will have to move the pieces around leaving me creating MORE capital gains when I sell some of the taxable account holdings to balance out the new holdings in the Roth. And then I have to buy more of those income producing assets that used to be in my tIRA but will now be in taxable account.
I do have a substantial tIRA, 30% of my holdings, but it is not clear to me how much I will really save with Roth conversions, when it is all said and done.
Help me understand the calculus, please.
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Old 05-14-2018, 08:14 PM   #2
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A lot of times (like for me) it's not necessarily just a matter of maximizing tax savings. We have enough money that whatever we can convert (at 12 or 15% tax), while it will help us avoid higher taxes from the RMD, it's even more of a bonus to be able to pass on that money to DD and her kids tax free. It's a fun game to minimize the taxes paid, using legal methods.

For some, maybe most, it probably isn't worth it assuming you're planning to use the money yourself. It often ends up being a wash between converting or just paying the taxes on the RMD.
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Old 05-14-2018, 08:22 PM   #3
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The general opinion is to allocate more bonds to IRAs than to your regular accounts, which you are already doing. That opinion stays the same when you convert from tIRA to Roth. Since dividends and cap gains receive preferential tax treatment as compared to bonds, keep more of those outside your IRAs, as you are apparently already doing.
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Old 05-14-2018, 09:49 PM   #4
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For me it's more a matter of tax diversification. I have minimal taxable account balance so shifting a bit into Roth to top of 25% bracket gives me flexibility to absorb a major unexpected expense without regard to tax implications. I don't expect to be in a lower bracket at RMD time, but converting now to reduce RMDs feels like a good idea.
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Old 05-14-2018, 10:15 PM   #5
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The general opinion is to allocate more bonds to IRAs than to your regular accounts, which you are already doing. That opinion stays the same when you convert from tIRA to Roth. Since dividends and cap gains receive preferential tax treatment as compared to bonds, keep more of those outside your IRAs, as you are apparently already doing.
I don't follow that. I have used my Roth Conversions for tech stocks and emerging market ETFs for the last couple years.

OP, is it worth it? It really depends on your situation over the long haul. What's your projected taxable income? Any inheritance down the road? How will the conversions (or having $ in Roths) effect health insurance cost (ACA and medicare)?

If your income is really low enough you can likely can make conversions that will be tax cheap, but they may be small.

You need to sort thru your situation.
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Old 05-14-2018, 10:28 PM   #6
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Yes, you have to apply it to your specific situation and look at tax rates after RMDs and social security versus the period between when your wife stops working and RMDs/SS.

But I can feel you on the asset allocation part. Like you, my traditional IRA is less than 30% of my net worth and it is 100% bonds. This means that for every dollar that I convert from IRA to Roth, I need to convert stocks in my taxable account to bonds to maintain my overall asset allocation (since I want my Roth to be near 100% stocks). I am not worried about capital gains in my taxable account since I will need those eventually to spend the money and my current capital gains tax rate is usually 0%. BUT, for each conversion, my overall holdings become less tax efficient in the present with more bonds in taxable.
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Old 05-14-2018, 10:54 PM   #7
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You can change your over all AA if you want to keep the interest based assets in the TIRA.

I typically only have LTCG from a couple ETFs that distribute some each year. Mostly I have Qualified Dividends. I also have a decent amount in carryover losses. I don't reinvest dividends automatically. Instead I use them for spending or rebalancing.

I've kept my taxes low, converted up to the top of the 15% bracket and funded our HSA
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Old 05-14-2018, 11:18 PM   #8
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Then I figure we try to convert to the top of whatever bracket we are in...
...or even higher, depending on the rate you expect to pay once SS and/or pension and/or RMDs kick in.
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Old 05-15-2018, 05:38 AM   #9
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You didn't give any numbers, so we can't do the calculus for you.

Break it into pieces. If you can convert at a lower rate than you'll be in later when you are taking SS, pension, and RMDs, it's worth converting.

The taxes you pay out of pocket may be part of the picture of how much you convert each year. So may an ACA subsidy, if you're striving for that. It's not easy to figure out all of the moving pieces, but you don't have to convert up to the last dime you can. Leave yourself some buffer.

Taxes don't have to be paid out of pocket, but it is better if you do.

Your AA certainly doesn't have to change with the conversion. If it's too much tax impact in getting the "perfect" mix in each account type, don't do it, or do it over time. There's still value in converting even if you leave less than optimal investments in the Roth. Perhaps as you spend down from taxable you'll have room for equities in the Roth. Or you can harvest any part of your taxable that shows a loss or minimal gain. Don't reinvest dividends and CGs in taxable accounts if you are doing that.
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Old 05-15-2018, 06:54 AM   #10
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Quite complex to say the least,with SS decision all wrapped up in this.
Currently most of our portfolio is in TIRA's. All taxables is in CD's/Cash. Small portion in Roth is in SP500. Thus conversions are easy from a rebalancing concept and Taxable accounts involved to pay taxes come from cash.
DGF and I have separate returns, so can play between the two, but I need to control ACA income, so conversions not really good for me right now, but have started converting small portions for DGF.
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Old 05-15-2018, 07:19 AM   #11
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The tax you pay on conversions is just part of the expenses you need to plan for in your withdrawal from the taxable account. No real calculus required. In our case, we keep 3% of the AA in cash. With other cash inflow (dividends and 2 small pensions), that's enough for 2.5-3 years of "gap closure." So Roth tax just comes from the same stash and then we replenish/rebalance as necessary.

As for AA, we've got a LONG way to go before our tax-deferred is all bonds. In your case, I might be tempted to just let the AA drift toward higher equity for now rather than sell highly-appreciated equities to buy bonds. Another option would be to move shares of your bond funds in-kind from tIRA to Roth. But then you've got bonds in Roth, which is not optimal.

Anyway, seems to me those are surmountable problems. Whether or not conversions are worth it, depends almost entirely on tax rate differentials (and ACA if applicable). Many early retirees live on the taxable account with very low taxes. So if there's a large tax torpedo coming with SS and RMDs, it's almost a no-brainer to convert to the top of the 12% bracket. Beyond that is less of a no-brainer IMO. Of course it all depends on your specific situation. But I wouldn't automatically reject it based on the two issues you mentioned.
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Old 05-15-2018, 07:29 AM   #12
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...or even higher, depending on the rate you expect to pay once SS and/or pension and/or RMDs kick in.
... and jumping into a higher bracket due to getting taxed as Single - as opposed to MFJ today.
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Old 05-15-2018, 08:03 AM   #13
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... and jumping into a higher bracket due to getting taxed as Single - as opposed to MFJ today.

...Or already being in a higher bracket due to being taxed as a single.


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Old 05-15-2018, 12:02 PM   #14
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I just signed up DW for Medicare, and found depending on your income you may pay twice as much. This was a fluke for us, in that we had high income in 2016 and they use 2016 taxes to base the cost you pay. Hopefully next year when they get 2017 taxes we will revert back to a lower cost. There are a lot of things to think about when doing conversions and for me, there are also the benefit of knowing how much tax I'll pay when doing a draw from the Roth vs traditional. Also having the tax paid is comforting to me. I am still working and will retire in Aug or Sep. I'm making more and paying more taxes than ever in my working years, but still 100% of my 401K goes to Roth for the same reasons.


When I turn 70 I'll start SS and plan we are working from doesn't call for any need to take IRA distributions. This will allow us to only take minimum from the IRAs and leave the Roth alone till we need or want it.


Another reason I like Roth conversions is that if I decide to do something that takes a big chunk of $$ I won't need to figure the tax rates. If we get enough moved to the Roth in next 8 years, I can just buy that new $325K Rolls Royce SUV. Course, then I wouldn't have anything left and couldn't pay the insurance
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Old 05-15-2018, 12:39 PM   #15
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Originally Posted by urn2bfree View Post
I have been thinking more and more about the intricacies of Roth conversions.
I am really wondering if Roth conversions may end up being more trouble than they're worth.
First of all I am waiting for my wife to stop working so we can have the lowest income possible. Then I figure we try to convert to the top of whatever bracket we are in - so far so good. But this will generate extra taxes, presumably paid from non IRA money. That means taking more money from taxable which could increase income and lower the actual room for withdrawing from traditional IRa
But wait, it gets worse. My tIRA holdings are generally the ones without dividends or capital gains. (Bonds, etc) But Roth IRA holdings being never taxed again are best made up of dividend and capital gains producers, so to keep my asset allocation in balance I will have to move the pieces around leaving me creating MORE capital gains when I sell some of the taxable account holdings to balance out the new holdings in the Roth. And then I have to buy more of those income producing assets that used to be in my tIRA but will now be in taxable account.
I do have a substantial tIRA, 30% of my holdings, but it is not clear to me how much I will really save with Roth conversions, when it is all said and done.
Help me understand the calculus, please.
As someone who has been doing this for 5 years, you're definitely overthinking it compared to my experience. We are both retired and absent Roth conversions would pay no taxes as my pension and taxable interest is less than the standard deduction and the rest of our income is 0% qualified dividends and LTCG.

Since I expect to be in the 22% tax bracket once SS starts, I convert to the top of the 12% tax bracket.

Over the last 5 years, we have converted ~ $1/4 million and paid about 7.4% in federal tax. Taxes come out of taxable account cash which is ~5% of our total nut. So I figure that I have saved about $36,500 over the 5 years ($1/4 million *(22% avoided -7.4% paid)... plus, the converted amounts are tax free forever. I don't mind paying the taxes with taxable funds as it is the equivalent of being able to make Roth contributions (compared to having taxes withheld from the converted amount).

When I do the conversion I redeem domestic equities in my tIRA and buy the same domestic equities in my Roth so the conversion has NO impact on my AA. Even if it did, I rebalance in my tax-deferred account, so there are no tax consequences of rebalancing.
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Old 05-15-2018, 12:59 PM   #16
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When I do the conversion I redeem domestic equities in my tIRA and buy the same domestic equities in my Roth so the conversion has NO impact on my AA. Even if it did, I rebalance in my tax-deferred account, so there are no tax consequences of rebalancing.
I did some where I just transferred in kind from TIRA to Roth. There really is little need to sell and buy again. The down side of moving in kind is you may need to pick whole share, but I'm not sure of that requirement.

When you sell and buy again, you could get wash sales if you also sell in taxable accounts.
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Old 05-15-2018, 01:25 PM   #17
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As someone who has been doing this for 5 years, you're definitely overthinking it compared to my experience. We are both retired and absent Roth conversions would pay no taxes as my pension and taxable interest is less than the standard deduction and the rest of our income is 0% qualified dividends and LTCG.

Since I expect to be in the 22% tax bracket once SS starts, I convert to the top of the 12% tax bracket.

Over the last 5 years, we have converted ~ $1/4 million and paid about 7.4% in federal tax. Taxes come out of taxable account cash which is ~5% of our total nut. So I figure that I have saved about $36,500 over the 5 years ($1/4 million *(22% avoided -7.4% paid)... plus, the converted amounts are tax free forever. I don't mind paying the taxes with taxable funds as it is the equivalent of being able to make Roth contributions (compared to having taxes withheld from the converted amount).

When I do the conversion I redeem domestic equities in my tIRA and buy the same domestic equities in my Roth so the conversion has NO impact on my AA. Even if it did, I rebalance in my tax-deferred account, so there are no tax consequences of rebalancing.

You nailed it right here...

saved about $36,500 over the 5 years ($1/4 million *(22% avoided -7.4% paid)... plus, the converted amounts are tax free forever.

FORMULA
taxSaved(X) = ($rothConverted *(futureTaxRt% - currentTaxRt%))

Just need to remember to do the math and capture the currentTaxRt% for the duration of the conversions to solve for X
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Old 05-15-2018, 01:36 PM   #18
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I did some where I just transferred in kind from TIRA to Roth. There really is little need to sell and buy again. The down side of moving in kind is you may need to pick whole share, but I'm not sure of that requirement.

When you sell and buy again, you could get wash sales if you also sell in taxable accounts.
Other brokerages might be different... but at Fidelity, mutual funds can be transferred in-kind in full and fractional shares. So you just pick the dollar amount of your conversion. No reason to sell and then buy. ETFs and individual securities must be transferred in full shares. We only own ETFs, so my Roth conversion is always an in-kind transfer of full shares. Result is that I might undershoot the top of the 15% (now 12%) bracket by $50 or so. No biggie.
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Old 05-15-2018, 04:39 PM   #19
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FORMULA
taxSaved(X) = ($rothConverted *(futureTaxRt% - currentTaxRt%))

Just need to remember to do the math and capture the currentTaxRt% for the duration of the conversions to solve for X
Not quite.

Future withdrawals from tIRA do not have to equate current amounts of annual conversions. They are whatever is needed at the time, or - as a minimum - the RMDs.
Besides, future tax amounts mean little unless you have reasons to assume zero future inflation. What matters is their present value.

The formula could look like:
taxSaved(X) = [present value of ($RMD * futureTaxRt%)] - ($rothConverted * currentTaxRt%)
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Old 05-15-2018, 05:28 PM   #20
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The formula could look like:
taxSaved(X) = [present value of ($RMD * futureTaxRt%)] - ($rothConverted * currentTaxRt%)
What about the length of time that your IRA could be growing tax-free? If you hold it for 10 years, instead of paying taxes today, you could be compounding earnings on the entire amount, rather than a reduced amount. I think it's a bit more complicated than the formula above.
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