Is it a great (no brainer) idea to Roth convert?

[rai-zero]

hi, first post

A little background info. Both my wife and I are in the highest tax bracket so we want to shelter as much as possible from (IMO) unfair taxation.

We are 42 (me) and 40 (wife) and plan on retirement early (ie. age 50, 51, 52, 53 depending on the market and how our investments are doing).

When retired, we'll be living off both retirement and non-retirement (tax sheltered) investments, but our 'income' from retirement accounts will be taxed as income at the highest tax rate (still)

We have two sizable roll-over IRAs which I could convert to Roth in the few years. This is my question, but any other advice would be appreciated.

at retirement our nest egg would be something like
-1/3 non-retirement (ie. taxible) account.
-1/3 401K (ish) (ie. tax shelter money counted as income on withdrawl)
-1/3 from this current roll-over IRA which can either stay in a normal IRA (ie. subject to income tax or converted to a Roth).

The question is this: the money to convert is sizable and so would come off the non-tax shelter account so that would be less but the upside is that the Roth will be tax free on withdrawl.

Currently our income bars us from a Roth, but the new rule change takes effect here is what I would be talking about..

Roth IRA Provision Effectively Eliminates Income Limits on Roth IRAs Establishes Major New Tax Shelter For High-Income Households, Revised 5/15/06

The tax reconciliation bill conference agreement gives the appearance of retaining the current income limits on who can make contributions to Roth IRAs. In reality, however, the legislation changes the Roth IRA rules in a way that effectively eliminates the income limits on these contributions. As a result, all income limits on the use of Roth IRAs would in effect be dismantled by the legislation

The reconciliation bill conference agreement would eliminate the income limits on Roth IRA conversions starting in 2010, while leaving the income limits on Roth IRA contributions in law. But by lifting the income limits on conversions, the conference agreement provision effectively eliminates the income limits on contributions to Roth IRAs as well, by making possible a two-step process that circumvents those limits. High-income households first would be able to contribute several thousand dollars every year to a non-deductible traditional IRA, for which there is no income limit. Then, starting in 2010, they could convert their non-deductible IRAs to Roth IRAs

The Senate Finance Committee issued the following press release:
The conference agreement would allow all taxpayers, regardless of income, to convert their traditional IRAs to Roth IRAs. Under current law, only taxpayers with income below $100,000 per year may do so. The provision is effective for taxable years beginning after December 31, 2009. Taxpayers who convert their IRAs in 2010 would have two years to pay the resulting tax. Taxpayers who convert their IRAs in 2011 and beyond would have one year to pay the resulting tax. The provision does not sunset.

 

[rai-zero]

questions to consider..

-will the future tax rate (ie. when we retire in 2020) be lower or higher or the same for high income families?

-will the conversion (ie. up-front) tax money be more than adequatly made up for by future tax savings when we withdrawl in 15 years (over the rest of out lives so it could be 30+ years in retirement)?

-taking money out of non-retiremment account to put into ROth conversion (pay for tax of conversion) effectivly moves that money into the Roth (ie. tax shelter) it seems like too good to be true what are the pitfalls?

 

[RunningBum]

Hi and welcome.

http://www.early-retirement.org/for...ld-i-convert-my-ira-401-k-roth-not-30664.html is a good place to start to see what discussions have already taken place here. You probably want to read these rather than count on some of the knowledgeable people re-post on your thread.

Your first question in post 2 is the difficult one to answer, what will future taxes look like? Few are thinking they'll be lower but nobody knows.

Basically I think the summary is that if you think your tax rate now will be the same as when you retire, go ahead and convert if you can pay the taxes from outside funds. You'll come out ahead, only because you paid the taxes and converted the full amount.

If you're in a higher rate now, it's probably not a good idea.

If it's a large sum, and converting the whole thing would put you in a higher bracket, you might convert some each year, enough to push you to the top of your tax bracket but not over. You don't have to convert the whole thing at once.

 

[segfault]

Are you absolutely sure you will still be in the highest tax bracket after you retire? I'm not asking you to post numbers, but if you assume that someone has a $1M taxable portfolio, and its dividends and capital gain distributions are 5% per year, that equates to $50,000 in taxable income (and it'd be subject to the lower 15% capital gains rate).

If you follow the strategy of keeping most of your bonds and cash in tax-advantaged accounts (the 401k and IRA), you might end up in a lower tax bracket than you think.

 

[rai-zero]

Are you absolutely sure you will still be in the highest tax bracket after you retire?

If you follow the strategy of keeping most of your bonds and cash in tax-advantaged accounts (the 401k and IRA), you might end up in a lower tax bracket than you think.

You are correct (just looked), the highest tax bracket (35% is over $336K which I qualify for) but anything over over $188K is 33%.

I was wrong to think the highest tax bracket was $188K+ but IMO 33% or 35% (2% is just the same so I use the term 'highest tax bracket' to mean 33% and up)

401K and IRA money is put in pre-tax so it counts as income when withdrawn and I will be taking out about $188K (current dollars) per year. $188K current dollars when I'm 42 will be like $900K inflated dollars when I'm 82 years old.

Unless they revise the tax code or don't index for inflation, meaning if they keep it $188K+ in todays dollars than surely in 20+ year I will be taking out more than that per year.

If you count $336K as the highest tax bracket I will certainly be taking out that much in 2020 (and beyond) since after inflation to keep up to 60% to 70% of pre-retirement income.

Still lets say an example of $300K current IRA. Convert to Roth at 35% would cost $105K in tax (today).

if that $300K grows for 15 years to $1M then withdrawl over 30 years would still be growing over that time so probably $3M withdrawl over 30 years tax on $3M even at 25% is $750K

question is 07 tax bracket is $188K (joint) is 33% if that's the tax rate in 2028 when $188K (todays dollars) will be $400K future inflated dollars. Then to get a today's dollar income of $188K I'd need to withdrawl $400K when I'm 60 years old and $900K when I'm 80 years old (inflation adjusted).

You would have to assume $900K (even in future dollars) is going to be the top bracket and if it stays similar to todays tax bracket everything over $336K (if that is not moved up with inflation) then A LOT of my withdrawl will be in the top bracket.

I know $900K per year seems like a lot but I am talking 40 years from now 4% inflation. So if talking about today's dollars that would still be $188K which after taxes would get me (?) $120K per year.

Note I always assume the worst so I don't undershoot. Maybe I don't need $120K post tax but just to be safe that's what I am thinking.

 

[bongo2]

Those are brackets from 2006 tax year. 2007 was about 4% higher, and 2008 will be higher again. If you took $188k (maybe $210k or more with deductions and exemptions) out of your IRA in 2006 (with no other income) then none of your income would have been in the 33% bracket. On the other hand, things like the AMT and phase-outs may cause you to have a 30%-40% rate anyway. You say you have a fair amount of non-sheltered investments, so if you want to spend $120k you might not need to take even $120k out of your IRA.

There are a lot of complicating factors (AMT, state taxes, future rates, etc), but from a cursory review it looks like converting would not be a good idea. You would be locking in the highest bracket today with the possibility of withdrawing much of your savings in a lower bracket in the future.

 

[rai-zero]

There are a lot of complicating factors (AMT, state taxes, future rates, etc), but from a cursory review it looks like converting would not be a good idea. You would be locking in the highest bracket today with the possibility of withdrawing much of your savings in a lower bracket in the future.

thanks hard to figure the future but we know the tax bill for a conversion is steep (max tax rate plus AMT plus state tax).

IDK what the tax brackets will be in 20+ years, but hopefully they keep up with inflation.

 

[rai-zero]

good point to think about. I have to look at asset location and how I use my various accounts.

At first I thought it would be better to use my non-retirement accounts first and let my tax shelter accounts grow.

This say I retire at 53 years old, live off the non-retirement account for 10 years and use that all up.

Now I see it would be better to take from both tax shelter (income) and from non-tax shelter (non-income) with the aim to keep as much of my income in the lower tax bracket and anything over would come from the already taxed accounts.

 

[bongo2]

Now I see it would be better to take from both tax shelter (income) and from non-tax shelter (non-income) with the aim to keep as much of my income in the lower tax bracket and anything over would come from the already taxed accounts.

You got it. There is a calculator out there that claims to give you the optimal withdrawal mix. Retirement Calculator

 

[jIMOh]

If you are making 188k+ now, and plan to have around 4.7 M in assets when you start to retire, I think some tax planning is in order. Tax planning now in particular where you can do anything to lower yourself into the 28% bracket, for example. Or at least stay out of 35% bracket.

Reference Room
$200,300 is low point of 33% tax bracket
$131,500-$200,300 is range of 28% tax bracket.

assuming married filing jointly.

Tax tips-

Capital gains rates for you are 15% and dividends are also taxed at 15%. Right now anyways. Planning 101 suggests this is 50%+ lower than taxes you will pay on ordinary income. I would stop putting significant monies into 401ks and start creating taxable accounts to sustain an income of $188k from taxable accounts during ER.

While drawing down the taxable accounts, I would suggest converting 401k and traditional IRA assets to a Roth IRA by capping out 15% or 25% tax bracket.

If you cap out 15% bracket (using SEPP rules) while drawing down taxable accounts, you will be doing 2 things:

1) converting tax defferred investments to Roth assets, paying only 15% federal taxes on a max of $65100 each year.
2) keeping ordinary income low enough to reduce capital gains rates to 5% during this stage of ER.

If you choose to cap out 25% bracket with SEPP which becomes a roth conversion, you will see the following:
1) you can convert $131450 from 401k/traditional IRA to Roth each year (2X as before)
2) you will pay 15% rate on capital gains and dividends

Once the money is in Roth, you have escaped the tax man on most of your savings (as the money was taxed at really low rates for someone of your income level).

I would draw up a plan, assuming you have 3-4 mil in assets.

Plan A- have enough in taxable accounts to get 401k/ trad IRA money converted before age 70.5. This is a 20 year stash of money needed in taxable accounts (assuming you retire at age 50).

Plan B-verify that the money in the Roths can generate enough income from age 70-death to live on at whatever lifestyle you want.

Plan C- verify the additional taxable investments do not put you into 35% bracket while working (unless the future tax savings is clearly worth it).

I would also verify you can convert traditional IRAs to Roth accounts using rule 72(t) or similar while spending money in taxable accounts.

 

[rai-zero]

thanks all for you well considered replies.

I have a few questions..

First, I don't know how much future estimates of social security can be counted on. But both myself and wife would be at the max rate (ie. reach the cap cut-off)

I go to the SS website estimator and it says if we start collecting how much. Depending on the age I elect to get my SS payments can be substantial. If my wife and myself could be earning from $80K to $100K+ per year as social security income.

Two questions, I assume this is counted as "income" so it's going towards making any other withdrawl income closer to the top tax bracket. In other words if the future 28%+ tax bracket starts at $200K I'd be half-way there with just my SS benifits.

Other question tax implications is it better to start the earliest (but smallest) SS payments or better to wait get more bang but means eating the retirement accounts sooner?

If I wait that would be several ER years where no SS benifit so I would be drawing down the retirement accounts.

 

[rai-zero]

Plan C- verify the additional taxable investments do not put you into 35% bracket while working (unless the future tax savings is clearly worth it).

I do not understand what this means, we ARE in the 35% bracket (as is) even after sizable tax-shelter plans for both my wife and I.

I guess you are saying DO NOT convert my current roll-over IRA to a ROTH since I'm at 40% tax rate (or whatever 35% plus state tax plus medicare tax).

If we don't put into 401K(s)/profit sharing plan all that money would also be in the top tax bracket as well as AMT etc.

I don't see how I could not deffer some current tax shelter in favor of non-tax shelter accounts.

I do see what you mean about converting IRA/401K to ROth after I retire, but it does seem like this plan requires more in non-tax shelter before I retire.

As I said I was planning on something like 1/3 (non-tax shelter) and 2/3 in tax shelter.

Thanks, Its hard for me to understand the idea of what you are saying, from now til I retire I am in the higest tax bracket so as much as I can is going into tax shelter and the rest is going into non-retirement account. But currently my tax shelter is 8x as much so even if I am able to be 50:50 shelter : non-shelter from here on the tax shelter will always be ahead of the non-shelter not to mention the non-tax shelter is going to be throwing off dividends every year.

 

[rai-zero]

jIMOh, I dig what you are saying and it's starting to come together somewhat. Just in case it makes any difference I'm 42 and plan on ER at (?) 53-55 range.

I want to have more than enough but not necessarly to leave an estate just with ER it's hard to know how many years it needs to last so I like to leave a margin for error. But it's hard to figure future tax rates is one thing we don't know and let me say today taxes are my biggest expense and look to be in the future but sounds like far less than current since my income will be less than 50% current (in todays dollars that is).

 

[bongo2]

rai-zero,

I think you're not getting a lot of replies becuase you're bouncing around on too many topics (taxes, roths, SS early v late, etc.). This stuff has been discussed a lot around here. Do a couple searches, look at the FAQs and see what you find.