Join Early Retirement Today
Reply
 
Thread Tools Search this Thread Display Modes
Roth Conversions - Conventional Wisdom
Old 07-16-2015, 01:58 PM   #1
Thinks s/he gets paid by the post
 
Join Date: Oct 2006
Posts: 3,811
Roth Conversions - Conventional Wisdom

When I retired, we had enough money in taxable investments to cover expenses for a few years. We spent that money first, and that put us in the 15% marginal tax bracket.

Since I figured we'd be in the 25% bracket eventually, I converted some traditional IRA to Roth IRA, roughly up to the top of the 15% bracket. (I wasn't worried about going a little over since I figured that 25% now was no worse than 25% later.)

I think that's the "conventional wisdom" on tIRA => Roth IRA conversions.

But, now I'm thinking I should have filled up the 25% bracket as well.

When RMDs hit, we'll be in the 25% bracket. So we'll spend the 25% on FIT, then put any money we don't spend into taxable accounts.
It seems like I should try to get it out of the tIRA sooner. Sure, we'll spend the 25% on FIT in order to roll to the Roth. But, once it's there, it will be in a tax free account.

Right now, this seems like "duh, why didn't I see that sooner". Have I been missing something that everyone else around here knows? Or, maybe I'm missing the downside of conversions?
__________________

__________________
Independent is offline   Reply With Quote
Join the #1 Early Retirement and Financial Independence Forum Today - It's Totally Free!

Are you planning to be financially independent as early as possible so you can live life on your own terms? Discuss successful investing strategies, asset allocation models, tax strategies and other related topics in our online forum community. Our members range from young folks just starting their journey to financial independence, military retirees and even multimillionaires. No matter where you fit in you'll find that Early-Retirement.org is a great community to join. Best of all it's totally FREE!

You are currently viewing our boards as a guest so you have limited access to our community. Please take the time to register and you will gain a lot of great new features including; the ability to participate in discussions, network with our members, see fewer ads, upload photographs, create a retirement blog, send private messages and so much, much more!

Old 07-16-2015, 02:47 PM   #2
Moderator
MBAustin's Avatar
 
Join Date: Jul 2010
Posts: 4,146
I am doing Roth conversions each year into the 25% bracket because like you, our RMDs will put us there anyway. I haven't maxed out the bracket yet, but I may get a little more aggressive as DH gets closer to 70. We still have a few years.
__________________

__________________
"One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute." William Feather
----------------------------------
ER'd Oct. 2010 at 53. Life is good.
MBAustin is offline   Reply With Quote
Old 07-16-2015, 03:11 PM   #3
Recycles dryer sheets
 
Join Date: Jul 2014
Location: Undisclosed
Posts: 91
The catch when you have regular taxable investments when doing Roth conversions in the 15% tax bracket is that the LT cap gains and qualified dividends on the regular taxable investments are 0% but if you go into the 25% tax bracket those gains and dividends are taxed at 15%. It sounds like you no longer have regular taxable investments, so filling up the 25% bracket makes more sense in your situation now than it did earlier.
__________________
N02L84ER is offline   Reply With Quote
Old 07-16-2015, 03:46 PM   #4
Thinks s/he gets paid by the post
 
Join Date: Jul 2005
Posts: 3,862
Roth conversions early on can be beneficial, even if the tax rate is the same now as it would be at age 70. You are taking out $100 from the tIRA, paying $25 in taxes, placing the remaining $75 into the Roth, and adding $25 from your taxable account to your Roth to fill out the $100 you are allowed. You have the same $75 after-tax value you used to have in the tIRA before the conversion, plus an extra $25 that used to be taxable and is now tax free. Every year you can keep that $25 growing in the Roth adds to the advantage you see from the conversion. So, the earlier the better.

Per my calculations, I'm converting as much as possible as long as the current marginal tax rate is less than or equal to my anticipated age 70 marginal tax rate. In a few years that will slow down and I'll be able to stay within the 15% tax bracket with Roth conversions and then with RMD's. That maximizes the time my money stays in the Roth accounts.
__________________
Animorph is offline   Reply With Quote
Old 07-16-2015, 04:54 PM   #5
Thinks s/he gets paid by the post
 
Join Date: Nov 2011
Posts: 2,356
Two downsides about converting are 1) it's a guess about future tax rates, and 2) you lose the opportunity to deduct against that income. For example, medical expenses are likely to rise as we age, but if we have little-to-no taxable income, their deductability may be wasted.
__________________
GrayHare is online now   Reply With Quote
Old 07-16-2015, 05:10 PM   #6
Moderator
MichaelB's Avatar
 
Join Date: Jan 2008
Location: Rocky Inlets
Posts: 24,408
Quote:
Originally Posted by Independent View Post
Right now, this seems like "duh, why didn't I see that sooner". Have I been missing something that everyone else around here knows? Or, maybe I'm missing the downside of conversions?
It's a lot easier to see the average tax rate when looking back at the past. I think we have an aversion to paying taxes and naturally try to minimize our current tax burden by deferring until we no longer can. The option to pay more tax earlier is one that is most evident when it is no longer available.
__________________
MichaelB is offline   Reply With Quote
Old 07-16-2015, 05:30 PM   #7
Full time employment: Posting here.
 
Join Date: Apr 2015
Posts: 903
Quote:
Originally Posted by GrayHare View Post
Two downsides about converting are 1) it's a guess about future tax rates, and 2) you lose the opportunity to deduct against that income. For example, medical expenses are likely to rise as we age, but if we have little-to-no taxable income, their deductability may be wasted.
Alas this. It's a bit of a balancing act. Still, I figure if my problem when I turn 70 1/2 is high RMDs, then I'm ahead of the game.
__________________
hnzw_rui is offline   Reply With Quote
Old 07-16-2015, 06:35 PM   #8
Recycles dryer sheets
Rothman's Avatar
 
Join Date: Apr 2013
Posts: 249
Independent, I think your realization is right on track. All the extra years of growth after conversion compound the benefit. ACA subsidies are the only thing that complicates the answer, as that may make lower conversions beneficial until you have Medicare, then go heavy to 70.


Sent from my iPad using Early Retirement Forum
__________________
Rothman is offline   Reply With Quote
Old 07-16-2015, 07:00 PM   #9
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
pb4uski's Avatar
 
Join Date: Nov 2010
Location: Vermont & Sarasota, FL
Posts: 16,399
Quote:
Originally Posted by Animorph View Post
Roth conversions early on can be beneficial, even if the tax rate is the same now as it would be at age 70. You are taking out $100 from the tIRA, paying $25 in taxes, placing the remaining $75 into the Roth, and adding $25 from your taxable account to your Roth to fill out the $100 you are allowed. You have the same $75 after-tax value you used to have in the tIRA before the conversion, plus an extra $25 that used to be taxable and is now tax free. Every year you can keep that $25 growing in the Roth adds to the advantage you see from the conversion. So, the earlier the better.

Per my calculations, I'm converting as much as possible as long as the current marginal tax rate is less than or equal to my anticipated age 70 marginal tax rate. In a few years that will slow down and I'll be able to stay within the 15% tax bracket with Roth conversions and then with RMD's. That maximizes the time my money stays in the Roth accounts.
I'm not sure if it makes much of a difference.

Let's say I have $25 in taxable and $100 in tax deferred and my current and later tax rates are 25%.

If decide not to convert at a 7% annual return, the $100 will grow to be $197 in 10 years and the $25 will grow to be $49 in 10 years. If I then withdraw that $197 and pay the 25% tax of $49, I have $197 left to spend.

Alternatively, if I convert the $100 and pay $25 in tax so the taxable account is gone and I have $100 in the tax-free Roth and the roth grows at 7% for 10 years I have $197 to spend.

Same thing.
__________________
If something cannot endure laughter.... it cannot endure.
Patience is the art of concealing your impatience.
Slow and steady wins the race.
pb4uski is online now   Reply With Quote
Old 07-16-2015, 07:19 PM   #10
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
pb4uski's Avatar
 
Join Date: Nov 2010
Location: Vermont & Sarasota, FL
Posts: 16,399
There are some downsides to the 25% bracket that cause it to be more than 25%, especially if you have tax preferenced income.

For example, tax a 60 yo married couple with standard deductions and $30k of qualified dividends and LTCG. Their tax is zero.

If they convert $65,500 then their TI is $74,900 (the top of the 15% tax bracket) and their tax is $5,816.

If they convert $141,800 then their TI is $151,200 (the top of the 25% tax bracket) and their tax is $26,388.

So the tax on the $76,300 extra conversion income from the top of the 15% tax bracket to the top of the 25% tax bracket is 27% ($26,388-$5,816)/($141,800-$65,500).

All per Taxcaster (2015).
__________________
If something cannot endure laughter.... it cannot endure.
Patience is the art of concealing your impatience.
Slow and steady wins the race.
pb4uski is online now   Reply With Quote
Old 07-16-2015, 08:23 PM   #11
Thinks s/he gets paid by the post
 
Join Date: Oct 2006
Posts: 3,811
Thanks for all the responses. So far, I have these cautions regarding going beyond the 15% bracket, or "filling up" the 25% bracket with conversions:

1) Getting into the 25% bracket increases taxes on qualified dividends and capital gains.

2) Conversions get into the MAGI that is used for ACA subsidies.

3) Congress could change the law and our future tax rates may be less than expected.

4) We could get big enough tax-deductible medical expenses after age 70 to push us down into the 15% bracket.

In our case, we didn't/don't have taxable dividends or cap gains to worry about.
We were born too early for ACA.
I'm going to give (3) a near-zero probability.

But (4) is interesting. Certainly, our "worst case" future involves large nursing home expenses. I figured a long term stay would eventually become tax deductible. I'll have to look at some numbers on that.

Animorph, I get the idea of using conversions to convert taxable assets into Roth assets. But, we were using the taxable assets for living expenses. If we had put them into the Roth, we would have increased our tIRA withdrawals.
__________________
Independent is offline   Reply With Quote
Old 07-16-2015, 10:14 PM   #12
Thinks s/he gets paid by the post
 
Join Date: Jul 2005
Posts: 3,862
Quote:
Originally Posted by pb4uski View Post
I'm not sure if it makes much of a difference.

Let's say I have $25 in taxable and $100 in tax deferred and my current and later tax rates are 25%.

If decide not to convert at a 7% annual return, the $100 will grow to be $197 in 10 years and the $25 will grow to be $49 in 10 years. If I then withdraw that $197 and pay the 25% tax of $49, I have $197 left to spend.

Alternatively, if I convert the $100 and pay $25 in tax so the taxable account is gone and I have $100 in the tax-free Roth and the roth grows at 7% for 10 years I have $197 to spend.

Same thing.
If you don't convert, and you are in the 15% CG tax range then your tax is $49 on the $197 tIRA withdrawal plus $3.60 in CG tax. Net is $193.40

If you do convert, you do have $197 tax free. That's an extra 1.86% to spend after just 10 years.

Not life changing, but not the same thing.
__________________
Animorph is offline   Reply With Quote
Old 07-17-2015, 05:05 AM   #13
Recycles dryer sheets
Rothman's Avatar
 
Join Date: Apr 2013
Posts: 249
Quote:
Originally Posted by pb4uski View Post
I'm not sure if it makes much of a difference.



Let's say I have $25 in taxable and $100 in tax deferred and my current and later tax rates are 25%.



If decide not to convert at a 7% annual return, the $100 will grow to be $197 in 10 years and the $25 will grow to be $49 in 10 years. If I then withdraw that $197 and pay the 25% tax of $49, I have $197 left to spend.



Alternatively, if I convert the $100 and pay $25 in tax so the taxable account is gone and I have $100 in the tax-free Roth and the roth grows at 7% for 10 years I have $197 to spend.



Same thing.

Your neutral view assumes the conversion is available at the later date, I understood the OP to say because he didn't convert earlier he is now taking more RMD than needed to live and it's going to taxable account. In that scenario he is paying taxes on its growth. Why not convert to the top of the bracket you will be in retirement, unless you have expectations taxes will be lower in the future at your bracket?


Sent from my iPad using Early Retirement Forum
__________________
Rothman is offline   Reply With Quote
Old 07-17-2015, 06:35 AM   #14
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
pb4uski's Avatar
 
Join Date: Nov 2010
Location: Vermont & Sarasota, FL
Posts: 16,399
Quote:
Originally Posted by Rothman View Post
Your neutral view assumes the conversion is available at the later date, I understood the OP to say because he didn't convert earlier he is now taking more RMD than needed to live and it's going to taxable account. In that scenario he is paying taxes on its growth. Why not convert to the top of the bracket you will be in retirement, unless you have expectations taxes will be lower in the future at your bracket?
I agree with the idea of converting to the top of the tax bracket that you expect to be in retirement, what I'm objecting to is the notion that Animorph suggested that Roth conversions can be beneficial even if your current rate is the same as your tax rate in retirement. If the rate is the same it is not beneficial.
__________________
If something cannot endure laughter.... it cannot endure.
Patience is the art of concealing your impatience.
Slow and steady wins the race.
pb4uski is online now   Reply With Quote
Old 07-17-2015, 06:40 AM   #15
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
pb4uski's Avatar
 
Join Date: Nov 2010
Location: Vermont & Sarasota, FL
Posts: 16,399
Quote:
Originally Posted by Animorph View Post
If you don't convert, and you are in the 15% CG tax range then your tax is $49 on the $197 tIRA withdrawal plus $3.60 in CG tax. Net is $193.40

If you do convert, you do have $197 tax free. That's an extra 1.86% to spend after just 10 years.

Not life changing, but not the same thing.
Good point, but that $3.60 tax is easily avoided if the growth is the result of qualified dividends or if you do gains trading of the taxable account while in the 15% tax bracket so the actual 15% CG tax would probably be more like 35 cents. Hardly beneficial.
__________________
If something cannot endure laughter.... it cannot endure.
Patience is the art of concealing your impatience.
Slow and steady wins the race.
pb4uski is online now   Reply With Quote
Old 07-17-2015, 04:47 PM   #16
Thinks s/he gets paid by the post
 
Join Date: Jul 2005
Posts: 3,862
Quote:
Originally Posted by pb4uski View Post
Good point, but that $3.60 tax is easily avoided if the growth is the result of qualified dividends or if you do gains trading of the taxable account while in the 15% tax bracket so the actual 15% CG tax would probably be more like 35 cents. Hardly beneficial.
Depends on your specific taxes. If you can hold the $100 in a taxable account and never pay taxes on dividends or capital gains then a tIRA or a Roth does nothing for you.
__________________
Animorph is offline   Reply With Quote
Old 07-17-2015, 05:03 PM   #17
Full time employment: Posting here.
Dog's Avatar
 
Join Date: Apr 2006
Posts: 781
Is there a limit to how much you can add to a Roth once you are retired? Are there any special rules or gotchas other than staying within 15% or 25% tax rate? I seem to recall someone telling me I could not use my 72t distributions from a tIRA to fund a Roth.
I apologize if this has been answered before and would appreciate the link to prior discussion. Thank you!
__________________
"Tell me, what is it you plan to do with your one wild and precious life?" - Mary Oliver
Dog is offline   Reply With Quote
Old 07-17-2015, 07:34 PM   #18
Thinks s/he gets paid by the post
 
Join Date: Oct 2006
Posts: 3,811
Quote:
Originally Posted by Rothman View Post
Your neutral view assumes the conversion is available at the later date, I understood the OP to say because he didn't convert earlier he is now taking more RMD than needed to live and it's going to taxable account. In that scenario he is paying taxes on its growth. Why not convert to the top of the bracket you will be in retirement, unless you have expectations taxes will be lower in the future at your bracket?
Actually, I still have a couple years before RMDs. But I do wish I had asked this question sooner.
__________________
Independent is offline   Reply With Quote
Old 07-17-2015, 09:15 PM   #19
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
pb4uski's Avatar
 
Join Date: Nov 2010
Location: Vermont & Sarasota, FL
Posts: 16,399
Quote:
Originally Posted by Animorph View Post
Depends on your specific taxes. If you can hold the $100 in a taxable account and never pay taxes on dividends or capital gains then a tIRA or a Roth does nothing for you.
True, but the Roth allows you to invest in corporate bonds and have the interest income be tax-free and you can't do that in a taxable account unless you invest in munis.
__________________
If something cannot endure laughter.... it cannot endure.
Patience is the art of concealing your impatience.
Slow and steady wins the race.
pb4uski is online now   Reply With Quote
Old 07-17-2015, 10:30 PM   #20
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jun 2005
Posts: 8,615
Quote:
Originally Posted by N02L84ER View Post
The catch when you have regular taxable investments when doing Roth conversions in the 15% tax bracket is that the LT cap gains and qualified dividends on the regular taxable investments are 0% but if you go into the 25% tax bracket those gains and dividends are taxed at 15%. It sounds like you no longer have regular taxable investments, so filling up the 25% bracket makes more sense in your situation now than it did earlier.
Yep and 15% + 15% is 30%. I noticed this by using TurboTax. I will be in the 15% tax bracket this year if I work play my cards right. However, if i go over, all that extra income will be taxed at 30% because of the above.

I need to have less dividend income so that I can convert more. Since I have lots of carryover losses to offset capital gains, I am going to think about selling just before dividends are paid and buy back the next day in order to avoid getting the dividends. I bet dividend investors will think I am crazy.
__________________

__________________
LOL! is offline   Reply With Quote
Reply


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
 
Thread Tools Search this Thread
Search this Thread:

Advanced Search
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are Off
Pingbacks are Off
Refbacks are Off


Similar Threads
Thread Thread Starter Forum Replies Last Post
What the Conventional Wisdom Didn't Teach About Avoiding Heartburn ItDontMeanAThing Health and Early Retirement 21 03-15-2012 01:25 AM
VA versus Conventional Mortgage jimbohoward69 FIRE and Money 2 09-13-2010 01:42 PM
The WSJ and the conventional wisdom Martha FIRE and Money 15 05-13-2007 04:41 PM
Non-conventional treatment for hypertension, Dante Other topics 21 04-23-2006 09:08 PM
ER Roth conversions unclemick FIRE and Money 8 03-05-2004 11:25 PM

 

 
All times are GMT -6. The time now is 11:17 AM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2017, vBulletin Solutions, Inc.