tIRA to Roth question

[trapperjohn]

Several times, on this forum, I've heard people say that they plan to convert their tIRA over to a Roth. I know that there have been recent threads about the wisdom of converting vs not converting. That's not my question.

Rather, my question is related to the amount to convert each year until the total tIRA is converted

Usually, when people post that they plan to convert, they say that they will convert only enough to get them to the top of their current tax bracket for the tax year.

Why do you limit it to your current tax bracket? Why not just convert as much as legally possible in one transaction, perhaps after reserving some amount to pay the required taxes?

Here is the reason behind my question: I've created a spreadsheet to show me my total tax cost if I convert each year only up to the 15%, 25%, and 28% tax brackets. It also shows my account balances at age 90. I will always pay the lowest total tax, and have the highest ending Roth balance, if I converted enough each year up to the top of the 28% bracket.

If I convert only up to the 15% bracket, I would never deplete my tIRA. If I convert an amount each year to get me to the top of the 25% bracket, I pay more total tax and have a lower Roth balance at age 90.

Is there a flaw in my thinking that I don't see?

 

[Sirka]

IRA to a Roth

Why do you limit it to your current tax bracket?

I convert only up to the 15% bracket, because I don't want to pay higher tax now or later when RMD kicks in and SS income pushes our tax rate up. It is a balancing act.
Also, by transferring stocks with a paper loss, IRS 'shares' the risk of collecting taxes on gains as income later (or not).

 

[RunningBum]

My goal is to pay level tax throughout my life as much as possible, with the caveat that I don't know what future tax rates will be. This should result in the lowest taxes. I don't see how paying up to 28% now and 0% in retirement results in lower taxes.

To illustrate, say I have $500K in my tIRA. If I have time and room to convert up to the top of the 15% bracket every year, let's say the effective tax rate is 12% (just a guess, due to some taxed at 10% and some not at all due to exemptions and deductions), I'm going to pay $60K in taxes.

Let's say I decide to go the to 28% bracket. I'll just throw out 20% as the effective tax rate since some of that will be taxed at 0, 10, 15 and 25%. I'm going to pay $100K in taxes.

This is very simplified because my tIRA account is going to grow as long as there's a balance, so I'm going to wind up paying more taxes on the higher conversion amount. But my taxable account that I'm paying the conversion taxes from is also growing as I only pay a small amount of taxes each year, so it may be close to a wash. I don't see how it will cover the $40K difference unless my tIRA grows extremely well.

There are other complications, such as SS reductions if I'm still taking withdrawals, Obamacare subsidies, and whether I can really stay in the 15% bracket with MRDs.

I have no idea how your spreadsheet is telling you that taking more now works in your favor to tell you what the flaw is, but I'm guessing your spreadsheet does have an error. I have a phobia about downloading spreadsheets from people I don't know so I probably won't take a look at yours, but it seems intuitive to me that it is wrong, unless you can explain why it isn't. Maybe you can output your numbers in some kind of table format to show the math.

 

[user5027]

More to consider;

- the tax rate on long term gains and dividends.

- if you file married and one spouse dies the survivor will eventually be filing single, unless they remarry. This changes the tax brackets.

It is a big puzzle I look forward to solving.

 

[Sirka]

To illustrate, say I have $50K in my tIRA. If I have time and room to convert up to the top of the 15% bracket every year, let's say the effective tax rate is 12% (just a guess, due to some taxed at 10% and some not at all due to exemptions and deductions), I'm going to pay $60K in taxes.

To pay $60K in taxes, I think you meant $500K in IRA & that would be higher tax bracket. So did you mean $6K in taxes?

 

[RunningBum]

To pay $60K in taxes, I think you meant $500K in IRA & that would be higher tax bracket. So did you mean $6K in taxes?

I meant $500K, with the 2 examples being 1) spread out to the top of the 15% bracket over many and 2) converted in bigger chunks over fewer years to the top of the 28% bracket. All at once would make you pay even more in taxes.

 

[pb4uski]

The flaw in your example is that if you converted $500k it would throw you into the highest tax bracket for that year. My ultimate tax rate (in my 80s) is 15% based on my projections so it doesn't make any sense for me to convert more than the top of the 15% tax bracket.

 

[RunningBum]

The flaw in your example is that if you converted $500k it would throw you into the highest tax bracket for that year. My ultimate tax rate (in my 80s) is 15% based on my projections so it doesn't make any sense for me to convert more than the top of the 15% tax bracket.

My example? I never said in my first post that one scenario was to convert the whole $500K. I said up to the 28% bracket since that's what the OP claimed was better for him over the 15% bracket. I did point out in my 2nd post that converting all at once would be a higher bracket.

 

[tomz]

Another factor to consider is the ACA subsidy. TIRA to Roth conversions count as income that could decrease (or eliminate) the subsidy, which in my case, is around $12K a year.

 

[Animorph]

OP, no I think you're probably doing it right.

The key is your (marginal) tax rate at age 70 when you are taking RMD's and all SS benefits have started. If that rate is 28% or higher, then you can beneficially convert to the top of the 28% tax bracket. If you have enough taxable funds. If you have enough tIRA value that you can't deplete it over a longer time at a lower tax rate. If the tIRA account isn't depleted enough to fall below the 28% tax bracket when RMD's start. Don't forget AMT, the 3.x% supplemental medical tax, state taxes, and maybe others.

There is a small benefit to having more after-tax value in the Roth than in the tIRA, so even if the tax rate is 28% now and after RMD's that still favors doing the Roth conversion as early as possible. But only up to 28%, plus maybe a few percent if the money will stay in the Roth a long time.


The guiding principal is to get as much of the tIRA into the Roth at the lowest tax rate. If you have no other income, then each year you can take some out free (deductions give you $0 taxable income), some at 10%, some at 15%, some out at 25%, and some out at 28%

 

[GrayHare]

Here is the reason behind my question: I've created a spreadsheet to show me my total tax cost if I convert each year only up to the 15%, 25%, and 28% tax brackets. It also shows my account balances at age 90. I will always pay the lowest total tax, and have the highest ending Roth balance, if I converted enough each year up to the top of the 28% bracket.

If your expected tax rate during retirement is at least 28%, then converting pre-retirement can indeed leave you with more after-tax net worth. If your expected rate is lower during retirement, your calculations are likely incorrect.

 

[davismills]

What's to stop the government from changing the laws and taxing Roth withdrawals in the future? Social Security taxes started out a 1% and look at them now. My late father always said "The Mississippi river starts with one drop of water".

 

[pb4uski]

My example? I never said in my first post that one scenario was to convert the whole $500K. I said up to the 28% bracket since that's what the OP claimed was better for him over the 15% bracket. I did point out in my 2nd post that converting all at once would be a higher bracket.

Ok, I misread it.

 

[pb4uski]

What's to stop the government from changing the laws and taxing Roth withdrawals in the future? ....

Nothing other than the wrath of taxpayers.

 

[wsmurdoch]

I've created a spreadsheet to show me my total tax cost if I convert each year only up to the 15%, 25%, and 28% tax brackets. It also shows my account balances at age 90. I will always pay the lowest total tax, and have the highest ending Roth balance, if I converted enough each year up to the top of the 28% bracket.

If I convert only up to the 15% bracket, I would never deplete my tIRA. If I convert an amount each year to get me to the top of the 25% bracket, I pay more total tax and have a lower Roth balance at age 90.

Is there a flaw in my thinking that I don't see?

You might try this spreadsheet: Retirement Calculator - Parameter Form and see what it says.

 

[Which Roger]

There are many, many variables in deciding what to do re. Roth conversion. Everyone's situation is different. My goal is not to maximize my net worth, but rather to maximize my chances of not going broke before I die. If I find myself in a very high tax bracket after RMDs kick in, it will mean that my investments have performed well, and I have "won the game", so I'll be smiling when I write a big check to Uncle Sam. If on the other hand, I find myself in a very low tax bracket then, due to poor investment performance, I will be better off than if I had done the Roth conversions when I was in a higher tax bracket. Also, since I don't have any heirs, most of my estate will likely go to charity. If I find myself with more money than I know what to do with in my RMD years, I can donate to offset the RMD income and thereby avoid the taxes. And of course there is no guarantee that I'll still be around to take RMDs.

 

[Animorph]

What's to stop the government from changing the laws and taxing Roth withdrawals in the future? Social Security taxes started out a 1% and look at them now. My late father always said "The Mississippi river starts with one drop of water".

Or higher taxes on tIRA's, taxable accounts, or on tIRA balances, or a national VAT or sales tax? I don't think the Roth is anything special. I think a VAT or sales tax would be the most likely way to tax Roth accounts, but that would hit tIRA's and taxable accounts as well.

 

[Options]

My plan is to delay SS until 70 and Roth convert up to the 15% bracket for some years before then. This will help minimize effects of the RMD tax torpedo. As 2 of every 3 of my PF dollars is in after tax, this should work out better than not converting.

 

[MBAustin]

Due to large capital gains the past two years, we've been in the 28% bracket, but I've continued to do some modest Roth conversions because when my pension kicks in next year, that will probably keep us at least in the 28% bracket and potentially higher with capital gains. Plus I have to start taking RMDs next year from the IRA I inherited from my mother. I don't see the tax brackets being adjusted down in the future, so converting some to a Roth gives us some additional options in the future and also some advantages to the kiddos if (as I hope) they inherit it.

So we're just doing our part to help reduce the federal deficit for a few years.

 

[mpeirce]

Out of curiosity, has anyone run a model showing what amount in an IRA when one is 70 and having to take RMDs would put you into the 28% bracket? (for simplicity, assuming no other income and no change in tax laws)

 

[fh2000]

Out of curiosity, has anyone run a model showing what amount in an IRA when one is 70 and having to take RMDs would put you into the 28% bracket? (for simplicity, assuming no other income and no change in tax laws)

There are a lot of factors going into the calculation. Every couple is different due to the age/work history/SS amount/401K amount.

In my case, DW is 5 1/2 years younger than I. Though we worked exactly the same number of years in US, her 401k total is 30% higher than mine.

I have an elaborate spreadsheet with all different possible cases: when to begin our SS; how much to convert to Roth, how much is used as ACA MAGI etc.

For now it appears to me that the best case is that we start our SS at 70, and start Roth conversion right after we RE and turn 59 1/2, we can maintain 15% tax bracket into RMD years using today's dollar.

By the time I am 70 1/2, my 401K will have $40,000 remaining, and my DW will have $320K remaining. This is because I have more years to convert, and DW will have fewer years plus she will be the only member purchasing ACA at later years, so we plan to convert hers less in order to receive subsidy if it is still available.

There is just too many variables involved. We will be doing this calculation each year even after we RE next year.

 

[ImThinkin2019]

The math problem discussed here is the one I was trying to solve, which ultimately led me to purchase ESPlanner. What I was trying to do is find the optimum (and variable) Roth conversion amount each year given my particular SS, pension, deferred salary, and assets situation.

I hope to be leaving money to heirs so the end goals I was shooting for were to getr a reasonable living standard and a maximized after-tax estate, with the estate mostly in Roths.

ESPlanner made the calculations easier and more accurate than any other method I tried. I'm like most of us here, so before shelling out the money to buy it I made my own spreadsheet, tried other spreadsheets, Fidelity, ********, firecalc, i-orp, Vanguard, Financial Engines, etc etc etc.

One of the interesting findings that ESPlanner showed us was that in our particular situation we are better off taking SS at 62. That was not obvious and is counter to conventional wisdom. We keep revising our model and retesting and still get the same result.

The positive of ESPLanner is that it calculates the taxes for you, every year. The negative is that the Roth conversion process in the current version of ESPlanner is a three step process. Hopefully in the future someone will come up with a new software tool which has an "optimization function" built in.

 

[pb4uski]

Out of curiosity, has anyone run a model showing what amount in an IRA when one is 70 and having to take RMDs would put you into the 28% bracket? (for simplicity, assuming no other income and no change in tax laws)

I did the 25% since there is such a significant difference between 15% and 25% and less difference between 25% and 28%. I did it for a single, but for a couple it would be double assuming they were of the same age.

However, the assumption that there is no other income is dubious. What you could do is subtract other income from the 47,050 before multiplying by the RMD factor if there is other income, but if the income is only SS it gets trickier as some SS would likely be exempt from tax.

Top of 15% tax bracket $36,900

Personal exemption 3,950

Standard deduction 6.200

Subtotal 47,050

Age 70 RMD 27.4

Result 1,289,170