Are Roth conversions worth it for us?

[Scuba]

DH & I currently have no Roths. We ER'd at 56 & 57 in 2016, but deferred comp payouts in 2017 & 2018 plus interest income put us into the 22% bracket so we have not done any conversions yet. Even if we will be in the 24% bracket with eventual RMD's, it doesn't seem worth it to do Roth conversions for that small benefit.

Am I correct that in order to stay in the 12% bracket and have 0% tax on dividends and LTCG, our MFJ income can be up to $101,200 ($77.2K+$24K)? However this income limit INCLUDES dividends and capital gains, correct? So for example, if our dividend income is $80K, then we could only do a $21K Roth conversion to stay in the 12% bracket - is that right?

If that is correct, I'm really not sure it's worth it for us to do Roth conversions. Even after 10 years, the % converted would be really low. And we'd have a lot more complexity ... right now each of us only has one tIRA account.

Please let me know if my thinking is off on this.

 

[HillCountry]

I would think it is wise to convert to the top of 22%.

The current tax law will revert back in 2026, and you will be looking at 28% or even 33%.


I myself will start the conversion in 2023, and it will last till 2046.

 

[Animorph]

You have the tIRA's. Do you have money in a taxable account to pay taxes on the Roth conversion? Doing a Roth conversion is like giving the IRS their 12% of your tIRA that they own anyway and replacing it in a Roth account with your own currently taxable money. Given a constant tax rate for the tIRA, getting some of your taxable money into a tax-free account is a nice tax bonus. That's in addition to any tax increase problems with tIRA withdrawals in the future.

In the absence of a taxable account, I'd just try to fill out any lower tax brackets you find yourself in. If you can use the withdrawal money, great. If not, do it as a Roth conversion. Roths are pretty uncomplicated since there's not a lot of tax paperwork.

 

[Corporateburnout]

Run your scenarios with I-ORP (extended version) and see if your disposable income will increase with Roth conversions and by how much. Although I wouldn't accept the results blindly it may help in the decision making process.

 

[ERD50]

Can you reduce your dividend income to give you more room for ROTH conversions? I traded a chunk of my taxable portfolio to BRK, zero divs. Some small caps have pretty low divs - work it in to your total overall AA.

Total return is all that matters, except when it comes to taxes sometimes.

-ERD50

 

[pb4uski]

DH & I currently have no Roths. We ER'd at 56 & 57 in 2016, but deferred comp payouts in 2017 & 2018 plus interest income put us into the 22% bracket so we have not done any conversions yet. Even if we will be in the 24% bracket with eventual RMD's, it doesn't seem worth it to do Roth conversions for that small benefit.

Am I correct that in order to stay in the 12% bracket and have 0% tax on dividends and LTCG, our MFJ income can be up to $101,200 ($77.2K+$24K)? However this income limit INCLUDES dividends and capital gains, correct? So for example, if our dividend income is $80K, then we could only do a $21K Roth conversion to stay in the 12% bracket - is that right?

If that is correct, I'm really not sure it's worth it for us to do Roth conversions. Even after 10 years, the % converted would be really low. And we'd have a lot more complexity ... right now each of us only has one tIRA account.

Please let me know if my thinking is off on this.

Well, saving $2.1k in taxes a year [$21k *(22%-12%)] for 10 years (56 to 66) is $21k... not a lot but not chump change either.

The other second order benefit is that you no longer pay tax on the growth nor on the taxable account funds used to pay the tax, which is effectively invested in the Roth.

 

[capjak]

I think it increases flexibility for the future (which account to take distributions) while hedging against the potential for significantly increased tax rates in the future. Probably worthwhile to have some tax free $$$

 

[Scuba]

I can see that the benefit of not paying tax on the growth could be beneficial, although if we can only put in $21K/year, the savings won’t be that significant. Even if it averages 10%/year growth, the taxes we’d save would be relatively minor in the scheme of things. I’ll have to look at our AA and see if it makes sense to reduce dividend income. I’ll also see what i-orp recommends. Thanks for the responses.

 

[DrRoy]

I'm going to convert up to the top of the 12% bracket and stop there.

 

[flintnational]

Regarding the complexity issue, in Vanguard it is literally a few clicks to set up a ROTH (IIRC). And then annually a couple of clicks to move money into the ROTH.

 

[pb4uski]

I can see that the benefit of not paying tax on the growth could be beneficial, although if we can only put in $21K/year, the savings won’t be that significant. Even if it averages 10%/year growth, the taxes we’d save would be relatively minor in the scheme of things. I’ll have to look at our AA and see if it makes sense to reduce dividend income. I’ll also see what i-orp recommends. Thanks for the responses.

Unless you have a lot of unrealized gains of there would be a high tax cost to switching, one option for this period before SS might be to go into munis in your fixed income allocation in your taxable portfolio and put equities in tax-free and tax deferred. That would lower your income and allow you to do higher Roth conversions at a lower tax cost.

 

[gauss]

The numbers will likely change significantly if something happens to one of you and the survivor files single as opposed to a joint return.

I would strongly recommend that you study this scenario also before making a decision not to convert to Roths in your early years.

Also, you framed your question in terms of filling out your current tax bracket via Roth conversions or not. Have you computed how long it will take to convert your tax deferred account balances to Roth if you constrain yourself to remaining in your current tax bracket?

-gauss

 

[kgtest]

I would think it is wise to convert to the top of 22%.

The current tax law will revert back in 2026, and you will be looking at 28% or even 33%.


I myself will start the conversion in 2023, and it will last till 2046.

This is what I do and I'm still working. Although my family has a long life expectancy with majority of the last 100 years living into 80s and a lot into 90s.


But what I concern myself more with is legacy money that can be inherited via stretch-ira while avoiding RMD along the way.



I also anticipate inheriting IRAs which will definitely bump my future tax rate...coupled with the idea that taxes generally never go down... it seems like a risk worth taking.



I was lucky last year DW filed separate and was able to convert the last of her IRA money to Roth at a super low tax bracket since she gave birth and was out of work for a bit. The next time she might have the oppurtunity to convert could likely be 13-14 years away at year 1 of our ER when tax brackets should be low again (or if we MFS and have another kid).



I encourage anyone with a spouse giving birth that has access to Roth to look into conversions during the year's the baby is delivered since earned income is likely going to lower your tax bracket.



If I can have a 50/50 split of IRA / Roth IRA money when RMD comes I would be happy. All depends on how my conversion timing and market gains compare to each type of account over oooh the next 35 years.


There is a huge psychological aspect to paying up to 22% tax on the conversion today, I've seen it in guys eyes, but honestly, you need to really answer two questions...


1. Is the tax on this money you pay on the conversion later going to be more, and

2. Do I plan to leave an IRA inheritance?



If the answer to one or the other is yes, I would seriously consider the conversion immediately.

 

[oldphd]

DH & I currently have no Roths.

Two thoughts...

One is that if it's a close call, having diversity (some traditional and some Roth) yields flexibility.

Second, even i you decide not to do it now, you might consider doing a small conversion to start the 5 year clock ticking in case you change your mind at a later date. Could be due to a change in personal circumstances, tax laws, etc.

 

[Corporateburnout]

The numbers will likely change significantly if something happens to one of you and the survivor files single as opposed to a joint return.

I would strongly recommend that you study this scenario also before making a decision not to convert to Roths in your early years.

-gauss

+1.

When I run our numbers with only one of us it shows a dramatic decrease in disposable income not to mention the increase in Medicare premiums. Our plan is to Roth convert at least 50% of our TIRA.

 

[Scuba]

A bit more information about our situation:
- We recently took over management of our taxable portfolio from an FA and rolled it into Fidelity. We have now sold all but two individual bonds in this portfolio so the interest income generated by the taxable portfolio will be around $1,400 - i.e., minimal. However the equities (mostly in ETF's) will likely generate dividend income of ~$80K.
- We have a large unrealized capital gain in our taxable account that would be very costly to realize. It is our goal to ultimately get out of individual stocks and be 100% invested in ETF's in our equity portfolio; however it will probably take at least 5 years, maybe longer to do this depending on how valuations fluctuate going forward if we don't want to increase our tax bracket.
- We are also carrying 2-3 years of emergency funds/living expenses in our taxable portfolio, invested in SPAXX generating a few thousand of interest income.
- My tax deferred portfolio is 100% invested in real estate deeds of trust. This is our fixed income allocation. We've had this portfolio for 7-8 years and the average return is in the range of 8-9%. One complexity of converting some of this to a Roth is that the amount of money we need for one transaction far exceeds what we could convert to a Roth and stay in the 12% bracket. So, we'd have to invest it in a much lower paying fixed income investment while we waited until the Roth built up enough to do trust deeds within it.
- DH has a relatively small tIRA at Vanguard invested in a balanced fund. We could convert it to a Roth, over time, without changing asset allocation. Since we have the rest of our money in Fidelity, probably what we would do is first roll it over to Fidelity as a tIRA and then do small Roth conversions each year.
- We did a small amount of after-tax contributions to our 401K's/tIRA's. All 401K's were rolled over already into our tIRA's. I do think it would be a good move for us to get these out of our tIRA's into Roths. I never would have done it if I had realized the complexity it creates to co-mingle after tax and pre-tax contributions. Luckily we didn't do much, maybe $20-$25K total, and they are a small percentage of our tIRA's so the pain of having to do the allocations between pre-tax and after-tax dollars could be eliminated if we roll those out into Roths. At least, I think that's the case.
- We have no targeted legacy except to leave behind our cremation expenses and enough for any unpaid bills. We have an oceanfront condo that we hope to age in place in, and it's already worth far more than needed to end up with a nice net check for our beneficiaries. Therefore the advantages of Roths to heirs are not important to us.

Given the issue with the trust deeds in my tIRA, I'm less inclined to convert any of it unless there is a huge benefit financially to do so. I really like the diversification that the real estate trust deeds provide, not to mention the nice returns.

I've run several scenarios in i-Orp now, some allowing the model to plan Roth conversions, and other scenarios constraining it to no Roth conversions. The results are not that different, but are actually marginally better not doing the Roth conversions. I've submitted some questions to i-Orp to make sure I didn't do something wrong when populating the template as I was surprised that all of my results were so close.

Right now without additional information, I think we should either limit our Roth conversions to the after-tax tIRA contributions, or possibly convert DH's tIRA in full over a few years. But I'm open to more input ... your comments are very helpful and specific, and I really respect your opinions - thank you!

 

[Lisa99]

We chose to not do conversions due to the negative impact on our ACA premium costs. We’re keeping our premiums as low as possible during our early years of retirement.

 

[cathy63]

- We did a small amount of after-tax contributions to our 401K's/tIRA's. All 401K's were rolled over already into our tIRA's. I do think it would be a good move for us to get these out of our tIRA's into Roths. I never would have done it if I had realized the complexity it creates to co-mingle after tax and pre-tax contributions. Luckily we didn't do much, maybe $20-$25K total, and they are a small percentage of our tIRA's so the pain of having to do the allocations between pre-tax and after-tax dollars could be eliminated if we roll those out into Roths. At least, I think that's the case.

I assume you know this, but just in case it's not clear, you cannot roll just the after-tax contributions into the Roths. It will always have to go in the same proportion as it currently exists in the tIRA; so you don't actually get any relief from tracking the basis until the entire account has been converted. I have the same situation in my tIRA as there was no back-door Roth option when I first put after-tax money in there and then rolled a 401K in.

It is actually not that complex to handle it though. I let TurboTax keep track of it and all the numbers just carry over from year to year, and it calculates the taxable portion of each Roth conversion and adjusts the basis on form 8606.

 

[ocean view]

IIRC when you do a Roth conversion from an account with both pre and post tax contributions, you don’t get to choose which funds you are converting. The post tax basis is allocated pro rata based on the value of the tIRA. So if your post tax basis is x% of your total account value at 12/31, then x% of the converted funds will be allocated as the post tax conversion amount.

My post tax contribution is .1% of my tIRA, last year I converted $58k and something like $38 was treated a post tax. An administrative PITA.

If someone else knows of an election you can make to convert the post tax basis all at once, I’d be thrilled.

 

[Scuba]

Bummer! I did not know you couldn’t just convert the post-tax piece. Thanks for that info.

ACA is not an issue for us. We have a pre-ACA plan.

 

[pb4uski]

To be clear though, if you have a 401k with pre and post tax contributions and roll it over, the pre tax will go into a tIRA and the post tax will go into a Roth.... but you can't do one and not the other.

Can I roll over just the after-tax amounts in my retirement plan to a Roth IRA and leave the remainder in the plan?

No, you can’t take a distribution of only the after-tax amounts and leave the rest in the plan. Any partial distribution from the plan must include some of the pretax amounts. Notice 2014-54 doesn’t change the requirement that each plan distribution must include a proportional share of the pretax and after-tax amounts in the account. To roll over all of your after-tax contributions to a Roth IRA, you could take a full distribution (all pretax and after-tax amounts), and directly roll over:

• pretax amounts to a traditional IRA or another eligible retirement plan, and
• after-tax amounts to a Roth IRA.

OTOH, if you have a tIRA with pre and post tax contributions then it is essentially blended and any Roth conversions are blended a well but the after-tax contributions factor into the taxable amount of the distribution.

 

[pjigar]

I can see that the benefit of not paying tax on the growth could be beneficial, although if we can only put in $21K/year, the savings won’t be that significant. Even if it averages 10%/year growth, the taxes we’d save would be relatively minor in the scheme of things.

Do you think so? Now assume that the conversion money is held for 20-30 years or even passed to heirs. Someone is going to benefit from compounding. Sooner you start, the better.

 

[Scuba]

Do you think so? Now assume that the conversion money is held for 20-30 years or even passed to heirs. Someone is going to benefit from compounding. Sooner you start, the better.

We aren’t willing to pay up front $$ for the benefit of heirs. We don’t have any children. We’d only do this if the numbers show it will benefit us.

So if we contribute $21K and pay 12% federal plus several % state, we’ll have an immediate cost to convert of say $3-$4K. Then if it grows 10% the first year in the Roth, we don’t have to pay tax on $2.1K, a savings of $300-$400. How many years would it take for this to create a significant financial advantage? Seems like it would take 10+ years to break even, considering the time value of money.

 

[Gotadimple]

We aren’t willing to pay up front $$ for the benefit of heirs. We don’t have any children. We’d only do this if the numbers show it will benefit us.

So if we contribute $21K and pay 12% federal plus several % state, we’ll have an immediate cost to convert of say $3-$4K. Then if it grows 10% the first year in the Roth, we don’t have to pay tax on $2.1K, a savings of $300-$400. How many years would it take for this to create a significant financial advantage? Seems like it would take 10+ years to break even, considering the time value of money.

That may be true if you never claim Social Security. Once you do claim it, it is taxable, and your RMDs from your Traditional iRA will make more of your SS taxable. Additionally, the combination of Social Security, RMDs, and interest could impact your Medicare Part B premium.

Best to consider the impact of all income sources once you hit 70. Having some finds in a tax-free account can help you manage the tax burden later on. (I hope)



- Rita

 

[gauss]

That may be true if you never claim Social Security. Once you do claim it, it is taxable, and your RMDs from your Traditional iRA will make more of your SS taxable. Additionally, the combination of Social Security, RMDs, and interest could impact your Medicare Part B premium.

Best to consider the impact of all income sources once you hit 70. Having some finds in a tax-free account can help you manage the tax burden later on. (I hope)

+1 That was the type of issue that I was trying to get at a few posts ago. I was inquiring if OP would be done converting by the time he reached RMD/SS age if he limited himself to conversions in his current tax bracket.

I know this is not the case for myself -- that is to say that I would need to fill the entire next tax bracket to get the funds converted pre RMD age (at least under 2017 tax law).

-gauss