Roth Conversions to Next Highest Bracket?

[pb4uski]

.... Ultimately, the convert decision boils down almost entirely to the tax rate differential at time of conversion vs RMD. As noted previously, there is a smaller secondary benefit associated with using taxable funds to pay the tax, which in effect "transfers" money tax-free from taxable into the Roth.

+1. It's ultimately all just a tax savings play.

 

[UpAnchor]

I've been stewing over this ever since the new brackets were settled on. Convert to top of the 12% or the 22%?(Just can't get my spreadsheets to tell me when DW or I may end up filing single as a surviving spouse.) So I compromised tonight and converted roughly halfway to the top of the higher bracket. Time will tell if I wish I'd gone with one or the other. In any event my resulting tax rates as a percentage of taxable and gross income are pleasingly much less than that which I'd originally deferred at.

 

[bingybear]

I've been stewing over this ever since the new brackets were settled on. Convert to top of the 12% or the 22%?(Just can't get my spreadsheets to tell me when DW or I may end up filing single as a surviving spouse.) So I compromised tonight and converted roughly halfway to the top of the higher bracket. Time will tell if I wish I'd gone with one or the other. In any event my resulting tax rates as a percentage of taxable and gross income are pleasingly much less than that which I'd originally deferred at.

Converting to on income up to the top of the 12% is generally a good idea for most people with a good sized retirement account. On exception would be if one needed to stay in a range for health insurance reasons. Now going half way through the 22% might not make a lot of sense if you will have that bracket half full with LTCG (not matched with losses) or qualified dividends then it will be an expensive conversion.

 

[RunningBum]

I've done conversions to the top of the 12% bracket already. Can you think of any reason to convert more into the 22% bracket?

Right now, we have 82% in Traditional IRAs and 18% in Roths. So, we're top heavy in deferred accounts.

At 70, we'll be solidly in the 22% bracket and 85% of SS will be taxed. I don't see that changing. Of course, a decent amount will be taxed at 10% and 12%, so I'm not sure it makes much sense to convert at 22% now and then have some of it taxed lower down the road.

We probably won't have much non retirement taxable savings - most of the withdrawals will be coming from SS and retirement accounts. So, according to my TurboTax calculations probably 50% of the lower bracket taxable amounts will be coming from retirement accounts and 50% from SS.

Any reason to consider doing additional conversions (above the 12% bracket)? Thanks.

I haven't read the thread closely to see if this has been brought up, but since you say "we", I assume you are married. When one of you dies, the other could be in a higher tax bracket since RMDs will remain the same (partially offset by just one SS benefit). That makes a case to convert at 22% if there is no other reason not to.

 

[PatrickA5]

I haven't read the thread closely to see if this has been brought up, but since you say "we", I assume you are married. When one of you dies, the other could be in a higher tax bracket since RMDs will remain the same (partially offset by just one SS benefit). That makes a case to convert at 22% if there is no other reason not to.

I'm still trying to decide what to do. Yes, I'm married. Using the "single" brackets, it's pretty much a no-brainer to convert more now.

Using the MFJ brackets, it's not as much a slam dunk. Assuming all we have is SS and RMD's our income will be in the marginal 22% bracket. Problem is, a decent % of the RMD might be taxed in the 12% bracket. The effective tax rate of the RMD might only be 18% or so.

It's possible that we end up with other income that would push all of the RMDs into the 22% bracket, but that's not a given.

 

[RunningBum]

I'm still trying to decide what to do. Yes, I'm married. Using the "single" brackets, it's pretty much a no-brainer to convert more now.

Using the MFJ brackets, it's not as much a slam dunk. Assuming all we have is SS and RMD's our income will be in the marginal 22% bracket. Problem is, a decent % of the RMD might be taxed in the 12% bracket. The effective tax rate of the RMD might only be 18% or so.

It's possible that we end up with other income that would push all of the RMDs into the 22% bracket, but that's not a given.

What I'm saying is you are MFJ now, but one of you will be in the single bracket later unless you go at the same time. For how long, is anyone's guess.

The point about some of the RMD in 12% is valid, so maybe your goal is not to get it all converted. OTOH, if you have room in 12% later, you'll have some room for Qdividends and LTCGs at 0%. You might also see if you can avoid the SS hump.

 

[PatrickA5]

What I'm saying is you are MFJ now, but one of you will be in the single bracket later unless you go at the same time. For how long, is anyone's guess.

The point about some of the RMD in 12% is valid, so maybe your goal is not to get it all converted. OTOH, if you have room in 12% later, you'll have some room for Qdividends and LTCGs at 0%. You might also see if you can avoid the SS hump.

I understood what you were saying. It's a given I should do more conversions if I assume one of us dies early and the other pays single rates for a long period of time.

With 10 years until RMD's, it's a tough call. Once DW quits work, we will be drawing down the Trad IRA. It's possible that with those drawdowns, we end up completely in the 12% bracket once RMDs start. It's also possible we end up with all of the RMDs in the 22% bracket. Or, more likely a mix.

Right now, we don't have any QDiv or LTCGs to muddy up the calculations, but that could change too.

I DO like the idea of having a large amount of Tax Free (Roth) income available. It makes a lot of different tax play scenarios possible. I might do a couple of years of larger conversions just to top off the Roths - even if the ending tax results aren't quite optimal. It gives more options.

Thanks for all of the thoughtful replies.

 

[RunningBum]

Sure. Everyone's situation is different. Like you, I like having all of the options to consider.

 

[PatrickA5]

I've decided to bite the bullet and do conversions this year up to $160K, which is the point that I can still get the full American Opportunity Credit for DS's college. I'll let you know in 10 years if I made the right decision.

 

[oldphd]

Like other posters, I find myself in the no brainer to do 12% bracket, and probably desirable to do 22%. But a couple of unknowns are out there, like what does the market do, how long are we each around, what if there are some high medical cost years, etc. Won't know the right answer until many years from now.

One thing I am contemplating is how to do the conversion, whatever the amount is. I'm thinking of doing them spread out over the year, say once a month or so, for DCA. Much like you put money into your 401k or wherever as you get regular paychecks. Not looking to guess that going in on 1/1 gives most time in the market, or wait for a drop, but pick a day, the 15th of the month, and stick in equal dollar amounts. Depending on the how precise you can (or want) to be, you settle things up at the end of the year after knowing any other income.

Once I get to the point where taxable accounts are used up, I'm also thinking of using the Roth as the primary source of money to spend. It is said to take money from your tax deferred IRA and let the Roth grow, but why not just do the conversions to the level you want, and have some interest bearing account in the Roth and take what you need. Indirectly it's the same idea but you're getting income tax free as the money idles waiting to be used.

 

[Smitty700]

I made a decision for my Roth conversions to push me up into higher brackets in 2018 as I'm moving to ACA health plans for the first time in 2019. Taking the tax hit in 2018 will enable me to use that Roth money to stay under the income limits for subsidies, thus well worth the high brackets.

 

[Jim in PA]

I’m not planning to spend most of my IRA funds. With that, it will end up passing to my two kids. If it’s in a ROTH they can use the stretch IRA provisions with tax free RMDs. (Yes, they can do that with traditional IRAs, but the RMDs are taxable.) Since they are young, the RMDs won’t be that much. I have discussed with them using the funds as a retirement account or fund. Maybe early retirement, huh?

 

[eroscott]

I've done conversions to the top of the 12% bracket already. Can you think of any reason to convert more into the 22% bracket?

Because personal taxes are expected to expire in years ahead and will be at higher rates. Convert now while taxes are lower is the very common consensus.

 

[Doc0]

I'm converting based on proposed need for the money. I'm converting about 1M over 4 years. Some of my TIRA money was post tax so I can convert at a discount which saves a little. Also stocks are down so I can convert more shares for the same tax hit. I'm living off cash while converting so all of my income and therefore tax bite is from conversion. The upshot is I can convert 1M for about 12 cents on the buck given my situation. The Roth is for self insurance and extraordinary expense not ordinary income. Everybody is going to die from something and it goes Heart, Cancer, Diabetes, Neurodegenerative and those long term can be expensive. Take cancer 1/3 gets some kind of cancer over a life time and if you're the 1, 1/5 dies. That means 4/5 survive and cancer treatment can be expensive. 2018 study shows 92K/yr average cost. Of those survivors 42% went 100% broke in 4 years treating their disease. If there are 2 of you the odds double. At 65 an Alzheimer diagnosis is 1/10 at 85 1/3. If you get it the natural history is 12 years of likely care. If you're a woman age 65 the chance of living to 90 is 30% and 1.5% living to 100 so if you pull the Alzheimer ring at 85 there is a good chance of needing 7-10 years of care. If you put 1M in a Roth at 60 there is a good chance you will have 3-4M at 85 to cover your extraordinary cost and for me at 12 cents on the dollar it's a bargain from a risk management perspective. The government is getting those taxes one way or another whether it's by your plan or by RMD. I have other money for my daily hamburgers, so the Roth covers the extraordinary risk. By making your TIRA smaller you will RMD at a lower rate and can use the cap gain tax advantage to sell appreciated stock or if you die your spouse will pay less tax over the course. If you have a big honkin TIRA once you RMD it's coming out at ordinary progressive rates. Lets say you're living at the top of the 12% bracket and you need an extra $92K to pay off your cancer over 4 years? That's an extra $112K/yr you'll need to withdraw from the TIRA to pay off the cancer AND the extra taxes, and still keep your household together. If you have excess money, to me Roth conversion is a no brainer. Pay me now pay me later the progressive nature of the tax code will clean your clock. Better to pay me now when your better able to control your bracket according to an optimized plan instead of dire straits.

 

[pb4uski]

.... Once I get to the point where taxable accounts are used up, I'm also thinking of using the Roth as the primary source of money to spend. It is said to take money from your tax deferred IRA and let the Roth grow, but why not just do the conversions to the level you want, and have some interest bearing account in the Roth and take what you need. Indirectly it's the same idea but you're getting income tax free as the money idles waiting to be used.

I actually changed strategy in 2018 since I have a substantial tax torpedo in the horizon in 7-8 years. I'm leaving taxable accounts to grow and get stepped-up basis once one of us passes or a stepped up basis for or heirs. We'll live off of tax-deferred account withdrawals and Roth conversions.

LTCG on taxable account sales (~50% of sales proceeds) was reducing our headroom to take money out of tax-deferred. OTOH, if our taxable had been in cash then we would have just focused on Roth conversions.

 

[Chuckanut]

If the Bear market comes on strong in 2019 I may convert a greater percentage of the shares in my reg IRA account to my Roth account.

 

[Ronstar]

I converted up to 12% in 2018. My plan is to convert about $300k over 5-6 years. I'm going to use the $ as working capital toward purchasing a downsized house. This will provide some flexibility in timing our current house and condo sales, without needing a mortgage. Some years we may be at 12%, others 22%. But we'll have to pay a greater % when the RMD's kick in in 6 and 7 years.

 

[CRLLS]

I did the Roth conversion in December to the top of the 12% tax bracket and maybe a couple hundred over that. If I pay 22% on that last hundred, no big deal. I am watching today and the next couple of days to see how the market is doing. Then I'll decide if I do another conversions right away for 2019 or DCA.\ thru the year.

 

[oldphd]

I actually changed strategy in 2018 since I have a substantial tax torpedo in the horizon in 7-8 years. I'm leaving taxable accounts to grow and get stepped-up basis once one of us passes or a stepped up basis for or heirs. We'll live off of tax-deferred account withdrawals and Roth conversions.

LTCG on taxable account sales (~50% of sales proceeds) was reducing our headroom to take money out of tax-deferred. OTOH, if our taxable had been in cash then we would have just focused on Roth conversions.

I've followed your posts on this subject, since I've pondered the same question. And my LTCG gains were of the same order as yours. I think it comes down to a combination of the relative size of the different accounts and personal preference. No right or wrong answer, but do what feels best for your individual situation. Bottom line: Good problem to have!

 

[pb4uski]

Amen!

 

[DAYDREAMER]

Because personal taxes are expected to expire in years ahead and will be at higher rates. Convert now while taxes are lower is the very common consensus.

Thank you for posting that spread sheet. You show an effective tax rate for converting up to the 22% tax bracket to be 17%. When factoring in the $24000 tax deduction for a married couple, the effective tax level drops to 15%. 15% tax is what I estimated would be the hit on my 401k when doing a withdrawal or conversion, but never really thought about was that a tax bracket or effective tax rate. Since withdrawing/converting to the top of the 22% bracket is really only 15% effective tax (and no capital gains,ACA to worry about), I need to rethink to how much to convert over the next 17 years before age 70 RMD'S. We have $1.1 million in 401k's to convert. We will be recieving pensions ($56k/yr total at 55) that add to the conversion equation.

 

[deserat]

I'm single and converted some of my IRA to Roth up to the 22% bracket. As I look forward, I just see my tax bracket staying at 22% or beyond (and any changes), so converting now makes sense. It is hard to figure out how to nail it if you have many different streams of income from different sources (some pension, some income, some investments, etc). My issue is my consulting income being not easily predictable. To whit, I had an outstanding invoice and asked the payor if they would pay in Dec or Jan. They ended up paying in December, which meant less conversion opportunity.

However, as one poster said, good problem to have.

Other side is my father, who has not taken RMDs at all as he is still working at 78...I had the talk with him about how to manage the RMDs when he does retire (if he does). He is not....uhhh....savvy in these areas and takes offense easily. It took a few discussions and a link to the IRS RMD calculation site for him to realize the possible tax bomb he has on his hands....although, interestingly, at his age, it says he has 24 years of life left (?!?) for conversions....his wife also nudged him to look at this and I hope they talk to their CPA about this issue. For such a smart guy (engineering, math, pilot, computers) he's very un-smart in this realm we talk about here...he just keeps earning lots. He's a professor and loves his job, so I am concerned if/when he does retire, what he will do....

 

[FinancialDave]

I've done conversions to the top of the 12% bracket already. Can you think of any reason to convert more into the 22% bracket?

Right now, we have 82% in Traditional IRAs and 18% in Roths. So, we're top heavy in deferred accounts.

At 70, we'll be solidly in the 22% bracket and 85% of SS will be taxed. I don't see that changing. Of course, a decent amount will be taxed at 10% and 12%, so I'm not sure it makes much sense to convert at 22% now and then have some of it taxed lower down the road.

We probably won't have much non retirement taxable savings - most of the withdrawals will be coming from SS and retirement accounts. So, according to my TurboTax calculations probably 50% of the lower bracket taxable amounts will be coming from retirement accounts and 50% from SS.

Any reason to consider doing additional conversions (above the 12% bracket)? Thanks.

This is as you alude to a complex question involving crossing a number of tax brackets in retirement. I did just such an article recently showing that for the average size of $1 million in tax advantaged accounts it is mostly going to be Traditional withdrawals in the 12% and lower brackets and 22% from the Roth. To that end as you are aluding to it is not wise to do a lot of conversions in a higher tax bracket than you are in now:

https://seekingalpha.com/article/4182914-risk-roth-ira-revolution-part-ii

Dave

 

[FinancialDave]

Because personal taxes are expected to expire in years ahead and will be at higher rates. Convert now while taxes are lower is the very common consensus.

I don't know the reason for showing effective tax rates on this table as conversions are ONLY measured on a MARGINAL basis. The marginal tax rate can cover more than one tax bracket if you are doing a large conversion.

When you compare the front end taxes (contributions or conversions) to the back end taxes during retirement they are always done on a marginal basis.

Dave

 

[newellcr]

eroscot, Nice post. OP, we have been doing large Roth conversions for several years, once going to 28%. We will be in a $150 to $180k bracket for the long term. Our concern is the NIIT with conversions at $250k AGI. 22%, 24% is of less concern than the 3.8%NIIT. Worse yet loosing the child care credits at $400k is unacceptable, but maybe not for some. Watched my dad have to file as single after mom passed and 'struggled' with the RMD shock and the realization that they didn't get the most out of the 15% bracket. Taxable income, age, amount to convert, other tax law changes, children aging out of deduction status, current and anticipated rates, access to 401k funds to convert, among other factors make the 'calculation' an educated guess for some. Cheers,