2021 Conversion Decision

[SALTedOut]

I think I made a final decision but wanted to get insight from the group to see if the concensus was the same as what I'm thinking. Below is a screenshot of a simplified spreadsheet section (missing other income columns) showing the 2021 tax calculations at three different levels of conversations ($50K, $100K and $150K).

The question becomes:
1. do a small conversation ($50K) to get a very low 2021 tax liability plus the $2,800 stimulus refund.
2. do a larger conversation ($100K or $150K) resulting in a higher 2021 tax liability, no stimulus refund, but lower future RMDs.

The last two columns show the estimated RMDs based on projected future balances of my IRA. These RMDs assume that after 2021 I aggressively convert up to the IRMMA limits until RMD age. If I don't do many conversations between now and age 72 my RMDs would be closer to $200K in Year 1 and $315K in Year 15.

I've got sufficient funds outside of the IRA to pay the taxes on the conversations.

 

[chassis]

My vote is do not do Roth conversions. They don't benefit most people. For the very few people benefited by Roth conversions, the benefits are small as a percentage of net worth, and the date at which the benefit is realized is very late in life (age 80+).

 

[SevenUp]

Instead of ETR (assuming that means Effective Tax Rate, and further assuming "effective" means (total tax)/(total taxable income)), use marginal tax rates - as in (change in tax)/(change in income) - for your evaluation.

Or maybe that's what you are already doing and it's just semantics around the word "effective"?

See Roth IRA conversion - Bogleheads for more.

 

[SevenUp]

...the date at which the benefit is realized is very late in life (age 80+).

The benefit can be realized as soon as the next tax year, if conversions for this tax year can be done at a marginal tax rate lower than in future years.

 

[RunningBum]

Instead of ETR (assuming that means Effective Tax Rate, and further assuming "effective" means (total tax)/(total taxable income)), use marginal tax rates - as in (change in tax)/(change in income) - for your evaluation.

Or maybe that's what you are already doing and it's just semantics around the word "effective"?

See Roth IRA conversion - Bogleheads for more.

I agree. Look at the delta. Treat the $2800 loss on the higher conversion as an additional tax. Compare the delta rate to the rate of the tax on the projected RMD reduction later. Unless the RMD will be your only income, you need to look at the total tax picture.

 

[pb4uski]

Since you expect that you will for sure be paying 22% later, I would increase conversions to the point that the total net tax increase is 22% of the total conversion amount... I'm thinking about $60-65k of Roth conversion but I'm not sure how the stimulus refund is impacted.

With the qualified income/LTCG you have after you exceed the LTCG 0% rate bracket you are in a marginal rate of 27% for quite a while.

 

[Exchme]

Roth optimizations are complex and depend on the whole life and even estate goals and heir's situation. We need more information to even speculate reasonably.
Ages?
Current tax deferred & taxable balances?
Other income?
Need for ACA?
Estate planning to optimize heir's inheritance vs give to charity vs let the government take it because you don't care after your dead?
Heir's expected tax brackets if you are trying to optimize for them?

From the scraps we do have of using the MFJ std deduction and the projection that RMDs at age 72 will be about $200K and knowing that RMDs at that age are about 4% of the account balance, we can deduce that the OP projects $5MM tax deferred at that time.

For such a large amount, I think OP is off track, a $2800 subsidy is nothing compared to the effect of tax leveling possible with well planned Roth conversions. Some considerations -
-Current tax brackets will go up in 2026.
-One of you may pass away early, leaving the other in a single tax bracket.
-The estate tax exemption will revert to $11.7M in 2026, so if OP has other assets and lives a long time, the estate tax may bite.

It would not surprise me if the optimum strategy (at least to protect the surviving spouse of one dies early) turned out to be conversion to the top of the 24% bracket for several years.

(Edit: forget to mention intended asset allocation on the list of data needed)

 

[googily]

As someone with no direct heirs and a pretty big nest egg, mostly in tax deferred, I have started to look at it a little differently. Right now between taxable and paycheck I have enough to cover my expenses, but I am doing Roth conversions to the top of 24% mainly because I want to pull money out of my spousal inherited IRA (which I can do before 59.5 without penalty) to have more cash on hand for big purchases that I may make spur of the moment--and given that I don't need it in the next few years most likely, I might as well just convert most of those dollars to Roth.

I just look at it like having a bigger paycheck each year where I can dump a big chunk of it into Roth, almost like an after tax 401k IRR conversion.

I'll never come close to converting all of my tax deferred, but I'd also hate to not be getting more out of there and into Roth now while taxes remain sort of low, especially as a single filer.

 

[SecondCor521]

-The estate tax exemption will revert to $11.7M in 2026, so if OP has other assets and lives a long time, the estate tax may bite.

$11.7M is the current (2021) exemption amount.

The estate tax exemption will revert to $5M plus inflation adjustments in 2026. We don't know what all the inflation adjustments are, but the 2026 amount will probably be around $6M.

(Unless changed earlier, of course.)

 

[Exchme]

$11.7M is the current (2021) exemption amount.

The estate tax exemption will revert to $5M plus inflation adjustments in 2026. We don't know what all the inflation adjustments are, but the 2026 amount will probably be around $6M.

(Unless changed earlier, of course.)

My language was imprecise. We agree the relevant estate exemption for 2026 and beyond is $5.85M (inflation adjusted to 2021).

OP used the standard deduction in his screenshot that is for married folks, so I inferred that he is married, therefore I multiplied that the estate exemption by 2 to get the relevant number for he and his wife combined. The idea was to allow easy comparison to my back calculation of $5MM tax deferred balance at age 72 and OP's statement that they can pay taxes out of taxable, so there must be some other money or other income too. The point of the comparison was that with long life and favorable markets, estate taxes could be in the picture.

Basically impossible to be much help to OP without information, it's all just guessing.

 

[SALTedOut]

Exchme, So far this is the most complete answer that does not make assumptions to base the response and I appreciate that.

Roth optimizations are complex and depend on the whole life and even estate goals and heir's situation. We need more information to even speculate reasonably.
Ages?
Current tax deferred & taxable balances?
Other income?
Need for ACA?
Estate planning to optimize heir's inheritance vs give to charity vs let the government take it because you don't care after your dead?
Heir's expected tax brackets if you are trying to optimize for them?

From the scraps we do have of using the MFJ std deduction and the projection that RMDs at age 72 will be about $200K and knowing that RMDs at that age are about 4% of the account balance, we can deduce that the OP projects $5MM tax deferred at that time.

For such a large amount, I think OP is off track, a $2800 subsidy is nothing compared to the effect of tax leveling possible with well planned Roth conversions. Some considerations -
-Current tax brackets will go up in 2026.
-One of you may pass away early, leaving the other in a single tax bracket.
-The estate tax exemption will revert to $11.7M in 2026, so if OP has other assets and lives a long time, the estate tax may bite.

It would not surprise me if the optimum strategy (at least to protect the surviving spouse of one dies early) turned out to be conversion to the top of the 24% bracket for several years.

Agree, as with 95+% of the questions posted here I did not provide enough information thinking I could keep this simple, but it never is. While I won't get into all the details we are both 54. I'll have a pension starting at 58 of $45K (non-COLA) and SS starting at 70 of approx. $55K which includes mine plus 1/2 for my spouse. There is no need for ACA because 1) I'd never qualify for any subsidy and 2) the coverage in TX sucks. My previous employer allows me to stay on a retired insurance policy and while the price is high, the coverage is very good. I'm also well aware of the surviving spouse tax penalty and the likely upcoming reduction in estate exemption. My heirs while young in their careers are both professionals who have solid salaries and great growth potential.

If I don't do any conversions between now and RMD age you are correct that my IRA balance will be approaching $5M assuming 5% growth. It's currently at 80/20 investment ratio.


When you said "For such a large amount, I think OP is off track" I'm assuming you think my conclusion is that I should do a smaller conversion in order to get the $2,800 stimulus money. That is actually not what I'm thinking. I purposefully did not say what my conclusion was because I did not want to lead anyone to where I wanted to go. I've concluded so far exactly as you did that the $2,800 "free" money is chump change in this equation. Between increasing tax rates, the surviving spouse tax penalty, etc. that aggressive conversions are the correct answer for me.

Thanks again for the thorough and well thought out response.

 

[SALTedOut]

My language was imprecise. We agree the relevant estate exemption for 2026 and beyond is $5.85M (inflation adjusted to 2021).

OP used the standard deduction in his screenshot that is for married folks, so I inferred that he is married, therefore I multiplied that the estate exemption by 2 to get the relevant number for he and his wife combined. The idea was to allow easy comparison to my back calculation of $5MM tax deferred balance at age 72 and OP's statement that they can pay taxes out of taxable, so there must be some other money or other income too. The point of the comparison was that with long life and favorable markets, estate taxes could be in the picture.

Basically impossible to be much help to OP without information, it's all just guessing.

Again, all correct. Current ratio of IRA/ROTH/taxable is 2/1/6 so there is plenty outside of IRAs to pay the tax on the conversions. Also, estate taxes and tax efficiency for heirs, depending on markets and future law changes, could definitely come into play.

 

[SecondCor521]

My language was imprecise. We agree the relevant estate exemption for 2026 and beyond is $5.85M (inflation adjusted to 2021).

OP used the standard deduction in his screenshot that is for married folks, so I inferred that he is married, therefore I multiplied that the estate exemption by 2 to get the relevant number for he and his wife combined. The idea was to allow easy comparison to my back calculation of $5MM tax deferred balance at age 72 and OP's statement that they can pay taxes out of taxable, so there must be some other money or other income too. The point of the comparison was that with long life and favorable markets, estate taxes could be in the picture.

Basically impossible to be much help to OP without information, it's all just guessing.

Ah, gotcha. Agreed on all of it. I should have accounted for the fact that OP was MFJ - that ambiguity occurred to me fleetingly but I ignored it. Mea culpa.

 

[SecondCor521]

When you said "For such a large amount, I think OP is off track" I'm assuming you think my conclusion is that I should do a smaller conversion in order to get the $2,800 stimulus money.

I think if you reread Exchme's post, you'll find your assumption in error, and that he agrees that larger conversions are more likely to be the right choice in your case.

 

[SALTedOut]

I think if you reread Exchme's post, you'll find your assumption in error, and that he agrees that larger conversions are more likely to be the right choice in your case.

I think that is what I said.

 

[Exchme]

Exchme, So far this is the most complete answer that does not make assumptions to base the response and I appreciate that.



Agree, as with 95+% of the questions posted here I did not provide enough information thinking I could keep this simple, but it never is. While I won't get into all the details we are both 54. I'll have a pension starting at 58 of $45K (non-COLA) and SS starting at 70 of approx. $55K which includes mine plus 1/2 for my spouse. There is no need for ACA because 1) I'd never qualify for any subsidy and 2) the coverage in TX sucks. My previous employer allows me to stay on a retired insurance policy and while the price is high, the coverage is very good. I'm also well aware of the surviving spouse tax penalty and the likely upcoming reduction in estate exemption. My heirs while young in their careers are both professionals who have solid salaries and great growth potential.

If I don't do any conversions between now and RMD age you are correct that my IRA balance will be approaching $5M assuming 5% growth. It's currently at 80/20 investment ratio.


When you said "For such a large amount, I think OP is off track" I'm assuming you think my conclusion is that I should do a smaller conversion in order to get the $2,800 stimulus money. That is actually not what I'm thinking. I purposefully did not say what my conclusion was because I did not want to lead anyone to where I wanted to go. I've concluded so far exactly as you did that the $2,800 "free" money is chump change in this equation. Between increasing tax rates, the surviving spouse tax penalty, etc. that aggressive conversions are the correct answer for me.

Thanks again for the thorough and well thought out response.

Yes, I mean that the $2800 is probably trivial in your case, Roth conversions are likely the much bigger fish. Another point to consider, to the extent you can, you should stash your bonds in your tax deferred to slow its growth and keep your stocks in Roth to speed its growth. For me, I'm about 50/50 taxable vs tax deferred and the value of that simple step of tax efficient asset placement was about 1/3 of the value of all the Roth conversions combined.

(For the purists out there, that is after correcting for the subtle but real asset allocation shift that happens when you do that).

I also live in TX and have to agree that the ACA choices here are not good. For the two of us, our cost will be $1500-2400/month for "insurance" with super high deductibles and most plans have very restrictive provider lists. You are very fortunate to have the opportunity to avoid that.

 

[chassis]

The benefit can be realized as soon as the next tax year, if conversions for this tax year can be done at a marginal tax rate lower than in future years.

@SevenUp can you please detail this out? What are the mechanics of this?

 

[SevenUp]

My vote is do not do Roth conversions. They don't benefit most people. For the very few people benefited by Roth conversions, the benefits are small as a percentage of net worth, and the date at which the benefit is realized is very late in life (age 80+).

The benefit can be realized as soon as the next tax year, if conversions for this tax year can be done at a marginal tax rate lower than in future years.

@SevenUp can you please detail this out? What are the mechanics of this?

1) Convert in year 1 at a tax cost of 12%.
2) Realize in year 2 (due to starting SS, or starting a deferred pension, or whatever) that any withdrawals (or conversions) from traditional accounts will now come with a tax cost of 22% (or more).

Thus the conversion in year 1 saved 10% of the conversion amount, compared with withdrawing/converting in later years.

Does that make sense?