Tax in Retirement

[Bogie]

This is the first year of retirement without earned income so I'm starting to plan for Roth Conversions. I pulled up TurboTax and started doing what-ifs. I will have some qualified dividend and Long-Term Capital Gains. The goal is to stay in the 15% tax-rate after doing the Roth Conversions. The surprising thing was that once I exceed the 15% tax bracket the tax rate jumps to 30%. It looks like this is due to every dollar above the 15% bracket causes the LTCG and qualified dividends to be also taxed so in effect those dollars are taxed at 30%.

 

[pb4uski]

You are correct, that is what happens. I actually wnet over by a small amount this year, about $500 and am loathe to pay $150 on that minor estimating error, so I'll probably recharacterize the $500 to avoid that situation. Ok, call me cheap.

What I do is an estimated tax return in late December after capital gain distributions are paid and then determine my Roth conversions. I still have to analyze where I went wrong this year but I suspect it probably relates to the gross up of international dividends for foreign taxes paid or some other estimating errors.

 

[Bogie]

I didn't know the effective tax rate would jump like that and it pretty much stays at that rate as soon as you bust out of the 15% tax bracket. I have an HSA I can contribute to so I'll contribute to that to lower my income if I convert too much to the ROTH to stay in the 15% bracket. I think I can contribute to the HSA for the previous year up until I file. I still have the HDHP. That way I don't have to go through the recharacterization step.

 

[Loving Life]

I don't understand this rush to go to ROTH (and yes, I am a CPA) Lets see - pay current dollars for tax now and then pray the rules don't change. Its a fools game

 

[LOL!]

^Check out what happens when one starts RMDs. That may help with the idea to do Roth conversions while in the 15% tax bracket or lower.

 

[Alan]

I don't understand this rush to go to ROTH (and yes, I am a CPA) Lets see - pay current dollars for tax now and then pray the rules don't change. Its a fools game

By the time we are 70.5 (in 10 years time) we will have 4 more pension income streams plus 2 sets of RMD's from IRA's so will be in a much higher tax bracket. I'm prepared to gamble that the rules won't change dramatically.

 

[Mulligan]

By the time we are 70.5 (in 10 years time) we will have 4 more pension income streams plus 2 sets of RMD's from IRA's so will be in a much higher tax bracket. I'm prepared to gamble that the rules won't change dramatically.

I retired permanently into the 25% bracket thanks to my pension which was the same bracket I worked in. I spent many years working in the 15% bracket, and I should have funded my Roth more then when I had the chance. Now when I occasionally work I fully fund my Roth... A no brainer to get tax free money the rest of your life from the accumulations. Besides I am ineligible for a regular IRA anyways. So I also have good reasons to rush into a Roth.


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[grasshopper]

I don't understand this rush to go to ROTH (and yes, I am a CPA) Lets see - pay current dollars for tax now and then pray the rules don't change. Its a fools game

Let me see I am drawing SS at mid 60's (age) converted $15k of tIRA to Roths and paid $1400 in taxes. Converting to the top of 15% doesn't even come anywhere near to eroding the tIRA. For us it is like taking capital gains, take them now at 0% or at 70.5 take them if needed at 28%. We are doing both.

 

[kaneohe]

I didn't know the effective tax rate would jump like that and it pretty much stays at that rate as soon as you bust out of the 15% tax bracket. ..........

It stays there until you have pushed all the QDIV/LTCG into the 25% bracket so depending on much of those you have .....that will determine when the effect stops.

 

[Bogie]

What a great deal as long as you're able to stay in the 15% bracket. You get LTCG and QDIV tax-free. Plus, up to a point the Roth conversion is at 15% but beware of the 30% tax rate. It's so well "hidden" it would be easy to be paying 30% on part of the Roth conversion which is exactly what I'm trying to avoid.

 

[Animorph]

I Roth convert much more than I want to, one fund per new Roth account. At tax time I recharacterize what I don't want to keep. That gives me full control over my taxes and allows me to select the conversions with the funds that have the highest gains and discard any with losses.

 

[48Fire]

I jumped tax brackets when I took on some contracting work... ouch!!

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[pb4uski]

I don't understand this rush to go to ROTH (and yes, I am a CPA) Lets see - pay current dollars for tax now and then pray the rules don't change. Its a fools game

Well FWIW, here is a CPA who totally disagrees with you. I paid 7% or 10% tax on my 2014 Roth conversion as I recall. It is very unlikely to get any lower and if rates change they are most likely to go up and be higher when I had to RMD from my IRA especially considering that SS and pension income will be received at that point in time which pushes me into a higher tax bracket. It was a for sure that I would pay taxes on that tax-deferred income so the issue was just what the rate was going to be.

Even if the tax-free benefits of a Roth get changed in the future, I'm still WAY ahead.

 

[harley]

I don't understand this rush to go to ROTH (and yes, I am a CPA) Lets see - pay current dollars for tax now and then pray the rules don't change. Its a fools game

Or even better, wait for taxes to go up (because they probably aren't going down anytime soon), then be forced to pay significantly more due to RMDs. As opposed to paying significantly less now in retirement to convert the money than we saved by putting it away while working.

Maybe you can explain what is going to happen in the future that makes this such a bad decision. Go ahead, I think we can follow the math.

 

[Bogie]

I don't understand this rush to go to ROTH (and yes, I am a CPA) Lets see - pay current dollars for tax now and then pray the rules don't change. Its a fools game

I looked a one of your previous posts and it looks like you agree with taking money out of IRA's up to the 15% tax bracket to reduce RMD's that start at 70 1/2. The part you apparently disagree with is whether the distribution goes to a taxable account or a Roth. The earnings in the Roth are tax-free and if that ever looks like it is about to change you can just withdraw all of the ROTH tax-free. How is that not better than paying tax on the earnings in a taxable account?

 

[flyingaway]

This is the first year of retirement without earned income so I'm starting to plan for Roth Conversions. I pulled up TurboTax and started doing what-ifs. I will have some qualified dividend and Long-Term Capital Gains. The goal is to stay in the 15% tax-rate after doing the Roth Conversions. The surprising thing was that once I exceed the 15% tax bracket the tax rate jumps to 30%. It looks like this is due to every dollar above the 15% bracket causes the LTCG and qualified dividends to be also taxed so in effect those dollars are taxed at 30%.

Can anyone explain to me why LTCG is taxed at 30% when the total income is above the 15% bracket? I thought LTCG is taxed at 15% when the total income is within the 25% bracket.

 

[Bogie]

Can anyone explain to me why LTCG is taxed at 30% when the total income is above the 15% bracket? I thought LTCG is taxed at 15% when the total income is within the 25% bracket.

I'll explain it through an illustration. LTCG and QDIV are taxed at 0% if your total income after deductions is less than $73,800 in 2015. If your income is at the top of the 15% tax bracket of $73,800 and you add $1000 to your income you will pay 15% tax on the $1000 which is $150. That $1000 also causes $1000 worth of your LTCG or QDIV to be taxable at 15% which is an additional $150. The additional $1000 results in $300 of additional tax which is a 30% incremental tax. True, the LTCG and QDIV are taxed at 15% but the $1000 of income is also taxed at 15%.

 

[bmcgonig]

I Roth convert much more than I want to, one fund per new Roth account. At tax time I recharacterize what I don't want to keep. That gives me full control over my taxes and allows me to select the conversions with the funds that have the highest gains and discard any with losses.

Could you elaborate on that? Also, what do you mean "one fund per new account" ?


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[Telly]

You are correct, that is what happens. I actually wnet over by a small amount this year, about $500 and am loathe to pay $150 on that minor estimating error, so I'll probably recharacterize the $500 to avoid that situation. Ok, call me cheap.

What I do is an estimated tax return in late December after capital gain distributions are paid and then determine my Roth conversions. I still have to analyze where I went wrong this year but I suspect it probably relates to the gross up of international dividends for foreign taxes paid or some other estimating errors.

In early December I started collecting data on Divs and CGs, to come up with a target convert amount. As more announcements occur, I keep tuning it. Unfortunately, some of mine don't actually post till Dec. 28, and I don't want to wait that late, as I need to fill out convert form online, print, and mail in, then watch account to see that conv. is done properly. I don't want to wait too close to end of year, in case something goes wrong, want time to fix it.

A growth fund posted a small Div in June, and they estimated a pretty good CG for end of Dec., but no Div info, so I estimated June's Div again for Dec. Oh boy, way off! They posted a BIG Div for year-end. That put us over $1500 over the top of 15%.

While looking at all this last year, DW said we can just add to our HSA early in the 2015 year to drop 2014 income down below the top, so that is what we are doing to back up.

Knowing that we had the contribute-to-HSA backup, I really ran the est. convert amount right to the limit.

I think of the HSA contribution idea as sort of a "financial reverse-titration"

 

[catotx]

Could you elaborate on that? Also, what do you mean "one fund per new account" ?

Here's a illustration from Fidelity

https://www.fidelity.com/viewpoints/retirement/how-to-reverse-a-roth-conversion

 

[jebmke]

I don't understand this rush to go to ROTH (and yes, I am a CPA) Lets see - pay current dollars for tax now and then pray the rules don't change. Its a fools game

Seems like a long shot that the top tax rate will fall below 30%. If you know your RMD is going to red-line the brackets, some conversion should be low risk.

 

[bmcgonig]

Here's a illustration from Fidelity



https://www.fidelity.com/viewpoints/retirement/how-to-reverse-a-roth-conversion

Thank you.

One thing I noticed in that fidelity doc is the following:

Potential benefits
Consider the following simple hypothetical example of an investor who recharacterized because his Roth IRA balance declined after he converted. Richard, looking to take advantage of the potential benefits of a Roth IRA in retirement, converted $50,000 from his traditional IRA to a Roth IRA on March 1. He paid the $12,500 tax on the conversion when he filed his taxes on April 15.


Seems like they're saying that Richard converted in March and then paid the taxes in April. However the conversion just be done before Dec 31 of the previous year, correct?


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[Animorph]

Could you elaborate on that? Also, what do you mean "one fund per new account" ?


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I Roth convert by transferring some shares from my tIRA, all from the same fund. As a slice and dicer I have plenty to chose from. At the beginning of the year I Roth convert into maybe 6 new Roth accounts, each holding just the shares of one fund, but all different funds. If any fund loses more than 10% I Roth convert another chunk of those fund shares into a new account, if available. At the end of the year I might convert a little more if the funds have any losses, including a Roth with cash.

At tax time I determine how much I want to Roth convert. I then recharacterize the Roth accounts with the lowest gains until I reach my target. This is possible because you are holding the shares of each fund in a separate Roth account. You can recharacterize a whole account, but you can't recharacterize only specific shares from a combined account. I'll do a partial recharacterization of one account to fine tune the conversion amount to the dollar.

One of the neat instances when you can retroactively decide what you want to do, based on past performance. Kind of a bummer if you Roth convert and the shares are down 10% at the end of the year. This way there are no regrets.

 

[Animorph]

Thank you.

One thing I noticed in that fidelity doc is the following:

Potential benefits
Consider the following simple hypothetical example of an investor who recharacterized because his Roth IRA balance declined after he converted. Richard, looking to take advantage of the potential benefits of a Roth IRA in retirement, converted $50,000 from his traditional IRA to a Roth IRA on March 1. He paid the $12,500 tax on the conversion when he filed his taxes on April 15.


Seems like they're saying that Richard converted in March and then paid the taxes in April. However the conversion just be done before Dec 31 of the previous year, correct?


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I haven't read the Fidelity article, but you are right. Maybe he just paid estimated taxes for it?

 

[kaneohe]

Thank you.

One thing I noticed in that fidelity doc is the following:

Potential benefits
Consider the following simple hypothetical example of an investor who recharacterized because his Roth IRA balance declined after he converted. Richard, looking to take advantage of the potential benefits of a Roth IRA in retirement, converted $50,000 from his traditional IRA to a Roth IRA on March 1. He paid the $12,500 tax on the conversion when he filed his taxes on April 15.


Seems like they're saying that Richard converted in March and then paid the taxes in April. However the conversion just be done before Dec 31 of the previous year, correct?


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Perhaps just clever/loose writing......note that no year is stated either there or in the accompanying chart for paying the taxes.