Those Who don't/didn't do Roth Conversions

[Route246]

I may be totally wrong on this as I have not studied Roth the way others have but isn't the goal of paying tax now is to exempt gains moving forward from taxable liability upon withdrawal? If I were young and had access to high-risk, high-reward investments that could go into a Roth it would be perfect.

I think Peter Thiel is the posterboy for this. If I were to pay tax and deposit to a Roth at an advanced age the amount of asset growth is doing to be a small percentage of growth that I would have realized if I deposited to Roth at a much younger age.

In California where I live my marginal tax rate is about 33% (give or take) so on 100K I would deposit 67K and pay 33K in taxes. How long would it take to compensate and reconcile RMD to break-even given my marginal is going to be 33% when RMD kicks in. From my standpoint, if I prepay I prepay and have no choices left later. If I don't prepay I have the option to donate or use some other creative method to avoid taxes if I see fit. I don't know how much I'll have but if I have enough I would like to donate to my university as an option.

Anyway, I also view a Roth as prepaying something (tax) that may be avoided in the future (possibly) but it is my choice. It is really like a non-refundable prepayment arrangement that I would be making with the tax collector.

A Eurail pass is a good metaphor. You're prepaying rail fare with the hope you'll use more fare than you prepaid. The problem is, you're prepaying in the hope you don't get called home for an emergency (can happen with elderly parents, etc.), you don't have an accident (unlikely) or get sick (depends on your health, etc.). These all need to get factored in. If you break even then you wasted money in my opinion. If you leveraged for 125% of fare value then you may have a nice payback. I prefer 200% leverage for prepaying for anything.

Similar to Route246, but not quite at their admirable level of assets, I have grappled with this idea of being in a relatively high tax bracket in retirement. What I've determined after much analysis is that during a window between various taxable near-term liquidity events (ex. sale of r.e., RSU's, etc.) but before RMD's kick in I could have a handful of years in a reasonably low tax bracket as I would be living off of what you might think of as already taxed funds, or rather a taxable portfolio in which a large chunk of the investments would have little by way of gains (because I would have already been taken to the cleaners on taxes, at the highest rates imaginable, ugh). Anyhow, putting the tiny violins aside, I intend to utilize this window to do some amount of Roth conversions, not that I'm convinced I'll come out ahead in the end, but more as a down the middle approach in the face of many unknowns, including a bet that there is a reasonably high probability the future will involve higher overall tax rates.

 

[Gumby]

Does NIIT apply to tax-deferred withdrawals? I don't think so in which case it would not impact the example. And I think IRMAA would kick in both cases.

In any event, I think the bottom-line conclusion that there are no savings from continued deferral if the tax rates are the same.

NIIT doesn't apply directly to tIRA withdrawals (or 401k withdrawals), but if those things drive your AGI over $250,000 (MFJ), then NIIT will apply to those other things that it does apply to (i.e. - net investment income in taxable accounts). https://www.irs.gov/newsroom/questions-and-answers-on-the-net-investment-income-tax

 

[pb4uski]

I may be totally wrong on this as I have not studied Roth the way others have but isn't the goal of paying tax now is to exempt gains moving forward from taxable liability upon withdrawal? If I were young and had access to high-risk, high-reward investments that could go into a Roth it would be perfect.

I think Peter Thiel is the posterboy for this. If I were to pay tax and deposit to a Roth at an advanced age the amount of asset growth is doing to be a small percentage of growth that I would have realized if I deposited to Roth at a much younger age. ...

I think we would all agree that Roth is a great place to put high growth assets as you say in the second paragraph and we are well aware of Thiel (and Mitt Romney too).

On the first part you are right but the math works differently than you think. See example below from post #441.

... let's say you're in the 40% tax bracket and have $1m in tIRA and the investment will triple over 10 years.

Scenario A: Convert and pay $400k in tax, then the remaining $600k triples in value over 10 years to $1.8m tax-free.

Scenario B: Don't convert and the $1m triples to $3m in 10 years. Then you take it out, pay 40% ($1.2m) in taxes and have $1.8m to spend.

Same thing... deferral of taxes does nothing for you if the tax rate is the same!

 

[Dtail]

I think many of us deferred income while we were working under that premise that our tax rate in retirement would be lower than our tax rate while working and for most people that is true.

I know in my case it is. As much as I bellyache about taxes on tax-deferred withdrawals, Roth conversions and RMDs, at the end of the day the tax that I am paying on those are still less than the tax I avoided when I deferred that income. Not only that, when I deferred the income the income would have been subject to state income tax and now I reside in a no income tax state so there are additional savings.

For those whose tax rate in retirement is more than it was when you deferred that income... CONGRATULATIONS! You have obviously been much more financially successful than you were when you decided to defer that income so it is somewhat of a success tax.

Many folks miss this point and just use think about the current tax rates vs. projected future tax rates.
The original deferment is typically a winner for the majority.

 

[pb4uski]

Many folks miss this point and just use think about the current tax rates vs. projected future tax rates.
The original deferment is typically a winner for the majority.

Agreed. For me, the current decision is whether to pay about 10.6% now (a blend of 10% and 12% vs no Roth conversions) or ~18% later (a blend of 12% and 22% or perhaps 15% and 25% depending on what Congress does).

However, no matter what I chose it will be less than the 28% federal and 5% state taxes that I avoided when I deferred that income!

 

[CardsFan]

Many folks miss this point and just use think about the current tax rates vs. projected future tax rates.
The original deferment is typically a winner for the majority.

Yup. Deferred most at 28%. Converting about 5% of the tIRA every year now at about 20% fed rate (including increased tax on SS due to higher income). This is where I will be in 5 years when RMD's kick in. Might as well get it into the Roth now, lower RMD's, and maybe push IRMAA off for a few years.

 

[RunningBum]

Looking at your past tax rate when you originally deferred the income is just a "feel good" measurement that has nothing to do with whether to convert now vs. withdraw later.

 

[CardsFan]

Looking at your past tax rate when you originally deferred the income is just a "feel good" measurement that has nothing to do with whether to convert now vs. withdraw later.

You have a point. MAYBE there is a more OPTIMUM plan. And if I knew when we would hit the dirt, and what the market would do til then, I could pick that plan.

NO plan is optimum unless in the rear view mirror. You pick the one that makes sense at the time.

You say it is a "feel good" to withdraw at a lower rate than deferred. No it is financially better. Optimum? Who knows?

 

[LateToFIRE]

Looking at your past tax rate when you originally deferred the income is just a "feel good" measurement that has nothing to do with whether to convert now vs. withdraw later.

LOL, stated harshly, but I think quite true. But, forgive us for wanting to assure ourselves that we made a good decision albeit in the distant past.

For me, most my income the last 20 years has been in the top or next to top federal income tax bracket. And on top of that, I've been paying NY state and NYC taxes, one of the highest tax regimes in the country. So, there's no question my tax rate in retirement is substantially lower than all that, one because I'll largely be drawing on taxable account funds that have already been slaughtered by taxes once already, and two, I'll be living in a different local tax regime.

But, all that bragging aside, you're still correct. Got nothing to do with the RothC or no RothC question.

 

[Dtail]

Looking at your past tax rate when you originally deferred the income is just a "feel good" measurement that has nothing to do with whether to convert now vs. withdraw later.

This is true in a sense.
However, we effectively expanded the thread to include the original deferred decision as part of an overall financial savvy decision making process.

 

[TheWizard]

We have not done any Roth conversions for the same reasons people have listed here. It never made sense as we live below our means and RMD, SS, etc. (We are 66/65) will always keep us in a high bracket and I am still working at maximum earning power at age 66. Our IRA/401 assets are around 3M, investable around 11M, not including real estate. CPA told us we will always be in a high bracket and will always be paying high tax as we do plan to sell equity positions at some point and pay capital gains. Why should we contribute taxes in the highest bracket now on money that is not needed and probably will never be needed? Additionally, we pay a huge penalty in losing the compounding that the government now subsidizes through tax deferment. It never made sense as our savings always far exceeded our retirement needs (assuming I did not die early). We have so much deferred capital gains in our brokerage account side that just the rebalancing is going to handcuff us to being in a high bracket for the rest of our lives. Roth really does nothing for us in that mode of operation except severely reduces compounding our our taxable equity base. I was always suspicious and felt it was a scam by the feds to get some tax relief now. Maybe I'm wrong but it doesn't mean I made a mistake.

Still working at age 66?
Wowza...

 

[pb4uski]

Looking at your past tax rate when you originally deferred the income is just a "feel good" measurement that has nothing to do with whether to convert now vs. withdraw later.

I agree. But what's your problem with feeling good?

But the original rate was relevant to the post where it was first mentioned.

 

[RunningBum]

You have a point. MAYBE there is a more OPTIMUM plan. And if I knew when we would hit the dirt, and what the market would do til then, I could pick that plan.

NO plan is optimum unless in the rear view mirror. You pick the one that makes sense at the time.

You say it is a "feel good" to withdraw at a lower rate than deferred. No it is financially better. Optimum? Who knows?

It is financially better but you no longer have any control over what rate you originally deferred the income at. You could have made a serious blunder in deferring income at a 0% tax rate, or a great decision to defer at 39.6%. But that is in the past.

The conversion decision is mostly about the current and future tax rate*. If you are currently in the 12% bracket and expect to later be at 22%, it probably makes sense to convert to the top of 12%. There may be other factors at play, but the original tax rate long ago at time of deferral is not a factor today. You can feel good if you deferred at 39.6% and can convert at a lower 12%, or feel bad because you deferred at 0% and convert at a higher 12%, but neither is a factor in your decision to convert or not.

For those still working and deferring income, or course it is a factor in that decision. But this thread is about conversion, not income deferral.

* Other factors might be expected tax rate of your heirs, impact on ACA subsidy or IRMAA, and other things that I don't want to mention every time. My point is that the original tax rate when income was deferred is not a factor.

 

[RunningBum]

The reason I bring this up is that I have seen people say that they deferred income at xx% rate, should they defer now if they can do so at a lower rate? That's not the right question anymore, it's whether they can do it at a lower rate now than converting or withdrawing later.

 

[TheWizard]

The reason I bring this up is that I have seen people say that they deferred income at xx% rate, should they defer now if they can do so at a lower rate? That's not the right question anymore, it's whether they can do it at a lower rate now than converting or withdrawing later.

Sort of.
Converting a bit to avoid higher IRMAA later is another good reason...

 

[CardsFan]

The reason I bring this up is that I have seen people say that they deferred income at xx% rate, should they defer now if they can do so at a lower rate? That's not the right question anymore, it's whether they can do it at a lower rate now than converting or withdrawing later.

The greatest enemy of a good plan, is the dream of a perfect plan" - Carl Von Clausewitz, 1780-1831 Prussian general and military theorist.

 

[oscar1]

Sort of.
Converting a bit to avoid higher IRMAA later is another good reason...

Help me understand this “avoid higher IRMAA” comment. Yes your Medicare premiums go up as your income goes up due to things like IRA conversions, but it’s peanuts, right. Base Individual Part B monthly is $174.70 for 2024 ($2,096/yr). Part D = $31.50/month. That is for individuals making up to $129k/married $258k (like 98% of us). Even if your income jumps to $500k/$750k, your IRMAA premiums go to $419 (part b, $5k annual) and $76 (part D). My point: who cares what happens to IRMAA premiums? It’s a nothing compared to other tax issues. I always hear people complaining that their IRMAA premiums go up. What am I missing?!

 

[SecondCor521]

Help me understand this “avoid higher IRMAA” comment. Yes your Medicare premiums go up as your income goes up due to things like IRA conversions, but it’s peanuts, right. Base Individual Part B monthly is $174.70 for 2024 ($2,096/yr). Part D = $31.50/month. That is for individuals making up to $129k/married $258k (like 98% of us). Even if your income jumps to $500k/$750k, your IRMAA premiums go to $419 (part b, $5k annual) and $76 (part D). My point: who cares what happens to IRMAA premiums? It’s a nothing compared to other tax issues. I always hear people complaining that their IRMAA premiums go up. What am I missing?!

I'll try. For context, I'll be 55 this summer, am single, and am FIREd.

The IRMAA surcharges are increased annually based on the costs of the Medicare program. In my spreadsheet, I just used the latest rate increase I could find, which was 7.7%. That might be too high, or it might be about right.

Compounded at 7.7% for 33 years, the second IRMAA tier ($161K single now) premium would be $28,864 additionally over the base Medicare rates for Part B and Part D per year.

If someone aims for the top of the second IRMAA tier in 33 years, that would be an AGI of $427,026.

That works out to an incremental IRMAA marginal rate of 6.76%. Not bad, but worth attempting to manage to avoid (which I do).

Someone not paying attention and not Roth converting, could easily have an IRA compound to a large amount, with correspondingly large RMDs. Those plus SS might force them into such IRMAA tiers, at which point they're kind of hard to avoid.

The other thing that people dislike is that IRMAA is a series of mini-tax cliffs (or steps) - going over an IRMAA breakpoint by $1 of AGI results in the entire additional IRMAA surcharge for the entire year. It's a painful error to make. They work differently than ordinary tax brackets, where only the portion into the higher bracket is taxed at that higher amount and only to the extent that the bracket breakpoint is exceeded.

 

[RobLJ]

We are withdrawing to the top of the 12% bracket but don't spend it all, which goes into a brokerage. I will need to shift the brokerage next year to index and municipals, which is do-able.
I thought sending to a Roth was more work than it was worth, although I think some correctly pointed out I was being lazy. But was it worth it for 100k over 5 years? Maybe.
As others have pointed out, we are paying less than in our working years, actually about 5% less and we benefited from the 401b and 403b deferments when we needed them when the sons were in college, etc.

I know most of you have spreadsheets which you update to figure out the Roth benefit, and probably we would benefit, but if/when I croak or DW croaks, the problem will be how to spend the 12% taxable, unless I/her are getting chemo or something. It frankly doesn't seem to be worth my time. And power to all of you who have figured it out, although I think it is a wash in terms of total tax.


We're not all that frugal, but with the house paid off and the Bolt and RAV and solar, we don't spend that much, other than European hiking. I need to hang out on the Blow the Dough thread more. The 4 and 6 year old grandsons really enjoyed their ski lessons Monday (they live in Merced), so that's one way of blowing the dough, along with their college accounts. And there is the 1 year old granddaughter. And charities.

 

[Winemaker]

DW and I are both presently paying $257+ each for Medicare and IRMAA penalties. we are just trying to optimize now while we can for future years. Not rocket scientist math at this point.

 

[Slim11]

I may be totally wrong on this as I have not studied Roth the way others have but isn't the goal of paying tax now is to exempt gains moving forward from taxable liability upon withdrawal? If I were young and had access to high-risk, high-reward investments that could go into a Roth it would be perfect.

I think Peter Thiel is the posterboy for this. If I were to pay tax and deposit to a Roth at an advanced age the amount of asset growth is doing to be a small percentage of growth that I would have realized if I deposited to Roth at a much younger age.

In California where I live my marginal tax rate is about 33% (give or take) so on 100K I would deposit 67K and pay 33K in taxes. How long would it take to compensate and reconcile RMD to break-even given my marginal is going to be 33% when RMD kicks in. From my standpoint, if I prepay I prepay and have no choices left later. If I don't prepay I have the option to donate or use some other creative method to avoid taxes if I see fit. I don't know how much I'll have but if I have enough I would like to donate to my university as an option.

Anyway, I also view a Roth as prepaying something (tax) that may be avoided in the future (possibly) but it is my choice. It is really like a non-refundable prepayment arrangement that I would be making with the tax collector.

A Eurail pass is a good metaphor. You're prepaying rail fare with the hope you'll use more fare than you prepaid. The problem is, you're prepaying in the hope you don't get called home for an emergency (can happen with elderly parents, etc.), you don't have an accident (unlikely) or get sick (depends on your health, etc.). These all need to get factored in. If you break even then you wasted money in my opinion. If you leveraged for 125% of fare value then you may have a nice payback. I prefer 200% leverage for prepaying for anything.

There is a lot more to the equations. You may make to much and NOT ABLE to contribute tona roth while working. Likewise the tax exemption may help you stay under a certain tax bracket while working. So the 401 k at that point makes sense, then you retire early, so you can do a conversion and pay less taxes. If you let it grow in the IRA when you take contrabutions the amount of money saved may bump you up to the next tax level. I was not able to contibute to a roth, but I could sock away the max in the tax defered plan helping with taxes. This worked for me. Not I have the options of rolling some over, to maybe defer future taxes from the minimum distrabutions later. Not everone can buy a europass.

 

[Gumby]

We were partially eligible for a Roth IRA for only two years while we were working, and we contributed then. We contributed as much as we could to tIRA, 401k etc. because our federal marginal tax rate was as high as 39.6% at some points and never less than 24%. Since we retired, we have been modestly Roth converting to build a stash of money we can draw on if necessary for large unexpected expenses without any tax consequences. Any tax arbitrage between what we pay on the conversions now (22%) and what we might save on RMDs later is negligible.

 

[Slim11]

We were partially eligible for a Roth IRA for only two years while we were working, and we contributed then. We contributed as much as we could to tIRA, 401k etc. because our federal marginal tax rate was as high as 39.6% at some points and never less than 24%. Since we retired, we have been modestly Roth converting to build a stash of money we can draw on if necessary for large unexpected expenses without any tax consequences. Any tax arbitrage between what we pay on the conversions now (22%) and what we might save on RMDs later is negligible.

This is kinda the conclusion I came to. If I live longer its an asset, die younger , dosent help much, but I can leave it for the kido. But I think they changed those rules a bit also. So for me its just hedging my bets, and covering the bases. I may live longer, and if I do it will help considerably. But I am also converting from a 457 at 50, so its all accessible for me now. That why I am only moving half out to a IRA, then moving it to a roth over the next 15 years. Not everyone is in the same boat, but we have the same rules.

 

[rayvt]

Help me understand this “avoid higher IRMAA” comment. ... It’s a nothing compared to other tax issues. I always hear people complaining that their IRMAA premiums go up. What am I missing?!

You aren't missing anything. People are focusing on a trivial issue and just bitching.

Even at the highest IRMMA rate the Medicare premium is less than half what we were paying for our post-retirement employer group policy. That was $1000/mo each.


And at the income levels where IRMAA kicks in, the additional premium is just a drop in the bucket.

 

[RetireBy90]

Looking at your past tax rate when you originally deferred the income is just a "feel good" measurement that has nothing to do with whether to convert now vs. withdraw later.

Well I’m still behind you 100%. It might even be fun to look back like that if you made good choices, and it is informative for those not yet RE. HOWEVER, what you did or didn’t do shouldn’t be considered part of conversion or draw strategy. For me it is hard enough to factor in lots of side issues like rates when single file, IRMAA, and performance of different asset classes.
You can only go forward from here. IMHO