Roth Conversions Trial Balloon

[kgtest]

Exact no, but you can get pretty close by leaving some amount to convert on or just before 12/31? All my income, interest, dividends etc. fall 10 days or more before 12/31 every year so I know almost exactly how much “room” I have. And I have until mid Jan to do the last estimated taxes too.

This is what my dad does. he will contribute half of what he "guesses" will be his limit at the beginning of the year...then towards November he converts the rest after doing dry runs through TurboTax. He usually waits for a dip but that might not come this year.

 

[Perryinva]

I did say IF in that situation. In my case, conversions of about $105k/y for 7 years before I file for SS amounts to a clean $40k savings. Well worth it. I can’t convert until 2021 when I am 63. If I file a year earlier @69, savings drops to about $36,300, best estimate. Knowing I save that extra $3700 filling the 12% bracket by not filing “adds” to the net gain of the longevity annuity, which may be enough to convince me. Maybe not.

 

[Midpack]

This is what my dad does. he will contribute half of what he "guesses" will be his limit at the beginning of the year...then towards November he converts the rest after doing dry runs through TurboTax. He usually waits for a dip but that might not come this year.

I assume that's what most people do. And if you miss and go over the top of the bracket you're trying to fill, you pay the higher rate on the amount you go over (e.g. marginal tax rates) - it's not a big deal. If you can't stomach the idea of paying a penny toward the higher bracket, you'd be wise to leave a little room at the top of the bracket you're trying to fill. Easy peasy.

 

[audreyh1]

And the surviving spouse, heirs, charity impact is another good reason - though it sounds like audreyh1 knows ways around that with estate planning?

In our case we can avoid the double RMDs on surviving spouse by having non-spouse beneficiaries on the IRAs. This works for us because each IRA is small with respect to our taxable retirement account - < 10%.

Secondly, with stepped up basis in joint taxable accounts the surviving spouse has the opportunity to reorganize investments to be far more tax efficient with no capital gains tax consequences. This will reduce the future taxable income generated by investments for the surviving spouse.

So in our case I’m not concerned about the surviving spouse issue.

 

[walkinwood]

Please let me know there is something off in my thinking. Like others have mentioned, there are other considerations besides tax arbitration in the ROTH conversion thought process. And these depend - as always - on each situation.

• The ratio of our tax deferred to taxable is 40% to 60%.
• Our only current "income" is fund distributions.
• Our distributions usually total just above the ACA threshold for 2 people - after deducting HSA contributions
• We have a couple of active funds that have a lot of capital gains, but also distribute a lot of dividends/cap gains each year. We believe in using index funds so we want to divest. They perform about on par with index funds before taxes.
• Our non-qualified dividends + interest is very low - a negative number after the standard & HSA deductions
• Leaving a legacy is not a big priority.

So our thought process is as follows

• Do nothing that would make us voluntarily go over the threshold (we use HSA plans). In our mid-late 50s, the ACA premium is $10,000+ and we'll have 10+ years of investment returns on that amount.
• If ACA threshold has been breached, generate cap gains up to the 0% threshold. At 70, with SS + RMDs, we'll be above the 0% threshold & will pay 15% on cap gains, so this is a 15% savings in taxes. This also reduces the distribution in the following years since we are moving from active to index funds & increases the chances that we'll be below the ACA threshold.
• When the ACA threshold no longer applies (ie.65+) or we have sold all our active funds - then consider ROTH conversions & use a lot of the thought processes already listed in prior posts.

 

[Ed_The_Gypsy]

I dunno. I do it online the last few days of the year every year for the last 6 years and have never had a problem.

I had a problem. I am glad no one else did.

 

[Clone]

In our case we can avoid the double RMDs on surviving spouse by having non-spouse beneficiaries on the IRAs.

The only caveat to passing the IRA to a non-spouse is that the recipient will need to immediately begin RMDs. These RMDs will be taxed at whatever incremental tax bracket the recipient might be in. The tax man will get his due somewhere. Now, if the recipient is in a very low tax bracket, this might frustrate Uncle Sam...

 

[audreyh1]

The only caveat to passing the IRA to a non-spouse is that the recipient will need to immediately begin RMDs. These RMDs will be taxed at whatever incremental tax bracket the recipient might be in. The tax man will get his due somewhere. Now, if the recipient is in a very low tax bracket, this might frustrate Uncle Sam...

Since this would be split among multiple siblings, getting older too and with limited retirement resources and in lower tax brackets, this should be an OK trade off.

 

[pb4uski]

.... Although you are avoiding a big chunk of taxes, you are also foregoing the returns on all the money you put into taxes before 70 that could have compounded another 20-30 years (less annual taxes).

And those prepaid taxes will reduce your portfolio, and you won't breakeven until well into your 80's in my case for example. That was true if I converted to 22% or 24%. ....

No, I don't think so.... the return on the money used to pay taxes is at best a secondary issue... it is principally about tax rate arbitrage.

Example: One has $10k in tIRA, $2k in taxable, 20% tax rate and 7% rate of return for 10 years.

Alternative 1: Convert $10k to Roth, use $2k taxable to pay tax... in 10 years Roth has grown to $19,672 (=10000*(1+7%)^10) that can be spent.

Alternative 2: Keep money in tIRA... $10k tIRA grows to $19,672. $2k taxable grows to $3,449 (=2000*(1+(7%*(1-20%)))^10) After paying $3,934 in tax on tIRA withdrawal you have $19,186 to spend.

The difference is the $486 in taxes paid on the growth of the taxable account over the 10 years.

 

[SevenUp]

No, I don't think so.... the return on the money used to pay taxes is at best a secondary issue... it is principally about tax rate arbitrage.

Example: One has $10k in tIRA, $2k in taxable, 20% tax rate and 7% rate of return for 10 years.

Alternative 1: Convert $10k to Roth, use $2k taxable to pay tax... in 10 years Roth has grown to $19,672 (=10000*(1+7%)^10) that can be spent.

Alternative 2: Keep money in tIRA... $10k tIRA grows to $19,672. $2k taxable grows to $3,449 (=2000*(1+(7%*(1-20%)))^10) After paying $3,934 in tax on tIRA withdrawal you have $19,186 to spend.

The difference is the $486 in taxes paid on the growth of the taxable account over the 10 years.

Yes. Even if the withdrawal tax rate had dropped to 18%, converting at 20% ten years earlier and paying the tax from taxable would have been favorable.

 

[Chuckanut]

And anyone can lay out scenarios where Roth conversions would have been a mistake, but you can't know that in advance. No different than basic investing where an unexpected sequence of returns can foil the best plans. If you let sequence of returns scare you, you won't invest in anything much less do Roth conversions.

+1

I have done another small Roth Conversion this year - just enough to keep me in the same tax bracket (I hope. )

I figure that in a few years between between turning on SS at 70 and the required RMD from my tIRA, I will probably be in a higher bracket from those alone. Toss in the extremely profligate spending of our elected Federal representatives, and higher tax rates seem probable. And I am not naive enough to think it will just hit the Billionaires and multi-multi millionaires who are asked to pay their 'fair' share.

It's my best calculated guess of a decision. I could be wrong.

 

[LOL!]

Figuring out how much to convert can be tricky for some folks who get tax credits that go away with rather low income. We jump from the 12% tax bracket to the 37% tax bracket because of loss of tax credits and skip the in-between tax brackets. Only by using tax prep software did we discover this because loss of tax credits was not on our radar.

Around here I think most folks know about the ACA cliff, but there are other cliffs that folks can fall over, too.

 

[RunningBum]

Figuring out how much to convert can be tricky for some folks who get tax credits that go away with rather low income. We jump from the 12% tax bracket to the 37% tax bracket because of loss of tax credits and skip the in-between tax brackets. Only by using tax prep software did we discover this because loss of tax credits was not on our radar.

Around here I think most folks know about the ACA cliff, but there are other cliffs that folks can fall over, too.

I know of a couple of smaller cliffs, but nothing that should cause that much of a jump. Help us out and tell us what they are.

 

[LOL!]

Education tax credits: American Opportunity Tax Credit phase-out. Lifetime Learning Credit phase-out.

Pushing qualified dividend income from 0% tax rate to 15% tax rate and really 27% tax rate because the Roth conversion gets taxed at 12%, so 12% + 15% = 27%.

Probably some others as well.

 

[pb4uski]

I must be missing something, income and dividend/LTCG rates aren’t additive. And going from 12% to 37% would mean an income of $78,950 to $612,351 for MFJ? I’m not familiar with tax credits in that neighborhood.

What LOL! is referring to is if your income is a combination of ordinary income and preferenced income, once you breach the 12% bracket (actually the $200 lower 0% preferenced income bracket) with additional ordinary income your marginal tax rate is 27% for a while.... 12% on the additional ordinary income plus 15% on preferenced income that the incremental ordinary income pushes from the 0% preferenced income bracket to the 15% preferenced income bracket... then once all preferenced income has been pushed into 15% then only the marginal ordinary tax bracket applies.

So let's say that you have $10k of qualified dividends and that, plus your ordinary income are right at the top of the 0% preferenced income bracket. If you add $5k of Roth conversions (ordinary income) the $5k gets taxed at 12% ($600) and $5k of qualified income gets pushed from the 0% bracket into the 15% bracket ($750)... so your tax increases by $1,350... or 27% of the $5,000 increase in income and you'll be at that marginal rate until the entire $10k is pushed into the 15% bracket, then you'll have $200 at 12% and then any additional ordinary income would be 22%.

Stupid system.

 

[RetireBy90]

Figuring out how much to convert can be tricky for some folks who get tax credits that go away with rather low income. We jump from the 12% tax bracket to the 37% tax bracket because of loss of tax credits and skip the in-between tax brackets. Only by using tax prep software did we discover this because loss of tax credits was not on our radar.

Around here I think most folks know about the ACA cliff, but there are other cliffs that folks can fall over, too.

Another cliff applies if you have rental property. With my wages and 2 small military pension we have not been able to take depreciation the past few years.

 

[audreyh1]

What LOL! is referring to is if your income is a combination of ordinary income and preferenced income, once you breach the 12% bracket (actually the $200 lower 0% preferenced income bracket) with additional ordinary income your marginal tax rate is 27% for a while.... 12% on the additional ordinary income plus 15% on preferenced income that the incremental ordinary income pushes from the 0% preferenced income bracket to the 15% preferenced income bracket... then once all preferenced income has been pushed into 15% then only the marginal ordinary tax bracket applies.

So let's say that you have $10k of qualified dividends and that, plus your ordinary income are right at the top of the 0% preferenced income bracket. If you add $5k of Roth conversions (ordinary income) the $5k gets taxed at 12% ($600) and $5k of qualified income gets pushed from the 0% bracket into the 15% bracket ($750)... so your tax increases by $1,350... or 27% of the $5,000 increase in income and you'll be at that marginal rate until the entire $10k is pushed into the 15% bracket, then you'll have $200 at 12% and then any additional ordinary income would be 22%.

Stupid system.

Yes, this is how it pretty much hits us. Any additional ordinary income pushes long-term cap gains income and qualified dividend income from 0% to 15% tax (or even 18.8% if crossing the NIIT threshold).

Once we start drawing SS it won’t matter as the 12% bracket will be filled, but right now it initially hits as a 27% or even 30.8% marginal tax.

 

[Perryinva]

Tax Torpedo PLUS the possible loss of ACA credit, IRRMA increase, etc, can make the marginal net cost significant, if you are anywhere near those areas or use those services. I’ve never been fortunate (?, smart enough?) to have set myself up for low taxed/preferred income, and so even though my income has been in about the same ballpark, I have always paid taxes well past those cliffs, so I don’t miss them. Knowing my overall taxes will be about half what they were when working, never needing ACA and not having to pay myself first for savings, seems plenty grand to me, because of the larger net to me increase. Like always having a mortgage, even in retirement, it seems normal, and has always been profitable, so why change.

 

[pb4uski]

I completed my month subscription with Income Strategy. It was an interesting tool, albeit a bit clunky and complex. Income Strategy results seems to suggest that at the end of the day my withdrawal/conversions strategy didn't change the end results much, suggesting that anything would be fine so I didn't find it very valuable.

Top strategies (% are Total Value divided by highest Total Value):

• 100.00%....Starting in year 2019, withdraw using the conventional wisdom sequence (Taxable, IRA, Roth)
• 99.95%......Starting in year 2019, withdraw using the opposite conventional wisdom sequence (Roth, IRA, Taxable)
• 99.90%..... Starting in year 2019, withdraw using the conventional wisdom sequence (Taxable, IRA, Roth). Additionally use Roth conversions to target your modified adjusted gross income up to $169,999.00.

YMMV.

 

[MileKing]

Income Strategy results seems to suggest that at the end of the day my withdrawal/conversions strategy didn't change the end results much, suggesting that anything would be fine so I didn't find it very valuable.

Top strategies (% are Total Value divided by highest Total Value):

• 100.00%....Starting in year 2019, withdraw using the conventional wisdom sequence (Taxable, IRA, Roth)
• 99.95%......Starting in year 2019, withdraw using the opposite conventional wisdom sequence (Roth, IRA, Taxable)
• 99.90%..... Starting in year 2019, withdraw using the conventional wisdom sequence (Taxable, IRA, Roth). Additionally use Roth conversions to target your modified adjusted gross income up to $169,999.00.

YMMV.

Curious as to whether you ran your situation through either RPM or I-ORP and how the results are similar/different.

 

[pb4uski]

No, I haven't.

 

[Midpack]

Curious as to whether you ran your situation through either RPM or I-ORP and how the results are similar/different.

You can’t easily run a comparable I-ORP result. You’d have to match your spending to what I-ORP spits out, a completely different scenario than I wanted. And forcing a residual to reduce i-ORP spending isn’t the same.

 

[Midpack]

I completed my month subscription with Income Strategy. It was an interesting tool, albeit a bit clunky and complex. Income Strategy results seems to suggest that at the end of the day my withdrawal/conversions strategy didn't change the end results much, suggesting that anything would be fine so I didn't find it very valuable.

Top strategies (% are Total Value divided by highest Total Value):

• 100.00%....Starting in year 2019, withdraw using the conventional wisdom sequence (Taxable, IRA, Roth)
• 99.95%......Starting in year 2019, withdraw using the opposite conventional wisdom sequence (Roth, IRA, Taxable)
• 99.90%..... Starting in year 2019, withdraw using the conventional wisdom sequence (Taxable, IRA, Roth). Additionally use Roth conversions to target your modified adjusted gross income up to $169,999.00.

YMMV.

All consistent with my findings. To my surprise, reducing taxes didn’t translate to a much higher or lower ending portfolio.

And though I agree IS is somewhat “clunky and complex” - I needed to see the detailed results to be convinced and found no other way to do so. I-ORP is truly great for free, it’s not as flexible or detailed as Income Strategy.

However, remember this assumes future tax rates will continue with TCJA or the prior rate schedule - I don’t believe that for a minute. Unless someone found a way to predict and vary future tax rates.

There are also other significant reasons to consider Roth conversions, previously elaborated in several recent threads.

 

[PatrickA5]

I completed my month subscription with Income Strategy. It was an interesting tool, albeit a bit clunky and complex. Income Strategy results seems to suggest that at the end of the day my withdrawal/conversions strategy didn't change the end results much, suggesting that anything would be fine so I didn't find it very valuable.

Top strategies (% are Total Value divided by highest Total Value):

• 100.00%....Starting in year 2019, withdraw using the conventional wisdom sequence (Taxable, IRA, Roth)
• 99.95%......Starting in year 2019, withdraw using the opposite conventional wisdom sequence (Roth, IRA, Taxable)
• 99.90%..... Starting in year 2019, withdraw using the conventional wisdom sequence (Taxable, IRA, Roth). Additionally use Roth conversions to target your modified adjusted gross income up to $169,999.00.

YMMV.

What about the strategy of picking and choosing the best withdrawal rate from EACH of the three categories depending on the current years numbers?

I'm trying to even out the Taxable/Deferred/Tax Free monies a little bit to give me the opportunity to take what I need from each category to minimize taxes on an annual basis. At this point, I have no idea if it will make any real difference.

We only have savings and SS, so we aren't burdened by those horrible large pensions that other have