Another Roth Conversion Question

[Ian S]

Tried searching this topic but it maybe just applies to a narrow segment of retirees. Anyway, I'm giving consideration to a Roth conversion for 2022 (I know, I should have done it at the start of the year or maybe not since market is kind of down) but am wondering if there's much use in doing in a major way. I will be 72 next year so RMD's will start. DH is still working and I'm receiving Social Security. We are in the upper part of the 12% tax bracket. I could do a conversion to get into the 22% bracket but am thinking now that I shouldn't go too far into the 22% bracket. I see us possibly reaching the 24% bracket sometime well into the future (hopefully) after one of us dies. It would definitely take one of us dying to reach the 32% bracket. There is a 16 year difference in our ages so that significantly lowers RMD's next year and after. DH will retire early but delay his SS so our income will take a hit in a few years. Also, The bulk of our investments are in TIRAs (70%), Roth (20%) and taxable 10%. The taxable will soon take a jump (after DM's estate is settled.)

Anyway, I'll definitely convert to use up the rest of the 12% bracket but beyond that I'm not sure. Thoughts?

 

[qwerty3656]

Something to consider is Trumps tax cuts are set to expire in 2026 (so tax brackets will be going up)

 

[OldShooter]

Well, generally speaking it's tax rate arbitrage -- complicated by IRMAA, ACA, SS taxation, state taxes, etc. Not just the federal rate.

So if your total cost, all factors, will be lower now than you expect to it to be in the future, then conversion now is beneficial.

 

[Dash man]

You should calculate what your RMDs will be for the next 20 years and see where it puts you tax wise. The early to mid 80s starts to get pretty big. Use a reasonable growth rate for your tax deferred amount AFTER inflation if you want to use today’s dollars, since inflation is unpredictable right now. I use 4% growth.
In our case our ages are the same and we have a significant amount in our tIRAs, so we’ve been doing some heavy conversions. My biggest fear is the tax bracket she’ll be in after I pass, when she’ll pay at a single rate. Right now tax rates are low too, and in 2026 the revert back to previous the TCJA rates.
You need to figure what is best for your situation.

ETA: Remember you can always use QCDs if you’re charitably minded. They can reduce your RMDs up to $100,000.

 

[Ian S]

Something to consider is Trumps tax cuts are set to expire in 2026 (so tax brackets will be going up)

Definitely a consideration. Thanks for reminding me!

 

[Romer]

Just a comment on timing, doing it when the market is down is actually better in my view as you would pay less tax on the same amount of shares. I just went through my tax estimate and saw I could do another $40K. My intent is first week of January to try and do all of next years conversions while the market is down. There is a risk it will go down more of course.

The tax rate increase in 2026 is a major driver in my reasoning for loading up on conversions. I can pay 22% or 24% now instead of 25% or 28% starting in 2026. That is why I chose the top of the 24% bracket for this year and next year. In 2024, I won't exceed the 22% bracket as I will be 2 years from Medicare and 2024 income will set my cost. With that in mind, you may want to look at the 22% top end as your boundary for now through 2025. If nothing else, it will reduce later RMDs and all things being equal, result in 3% reduction in taxes on the same amount of $$.

It helps that I have after tax funds to pay the tax and doing it quarterly next year helps spread that out as well

Everyone has their own comfort zone and preferences and I know some are for heavy conversions and others don't see the sense in it

 

[Ian S]

My biggest fear is the tax bracket she’ll be in after I pass, when she’ll pay at a single rate. Right now tax rates are low too, and in 2026 the revert back to previous the TCJA rates.
You need to figure what is best for your situation.

This concerns me too especially since I'm 16 years older and DH is therefore likely to have a significant number of years at the single tax rate.

 

[Ian S]

The tax rate increase in 2026 is a major driver in my reasoning for loading up on conversions. I can pay 22% or 24% now instead of 25% or 28% starting in 2026. That is why I chose the top of the 24% bracket for this year and next year. In 2024, I won't exceed the 22% bracket as I will be 2 years from Medicare and 2024 income will set my cost. With that in mind, you may want to look at the 22% top end as your boundary for now through 2025. If nothing else, it will reduce later RMDs and all things being equal, result in 3% reduction in taxes on the same amount of $$.

Thanks for the insight! It looks like I should consider the 22% top end as my boundary. It really doesn't look like there's much downside in doing so and considerable upside. I still think that something will be done to alleviate the pain of the tax cut sunset since it would be too costly politically for whomever is in charge at that time. We shall see.

 

[Dash man]

Thanks for the insight! It looks like I should consider the 22% top end as my boundary. It really doesn't look like there's much downside in doing so and considerable upside. I still think that something will be done to alleviate the pain of the tax cut sunset since it would be too costly politically for whomever is in charge at that time. We shall see.

We’ve been filling the 24% bracket. We decided paying IRMAA for a few years and higher taxes will save us more later on, for more years. Of course, we have to live long enough to make it worth while. If I don’t, I won’t care. If I do, I’m brilliant!!

 

[TheWizard]

It's NOT just tax rate arbitrage that drives Roth conversions.
It's staying out of even higher IRMAA tiers after age 72.
And it's about having a slush fund for large purchases without adding to your taxable income for the year.

I'm single nowadays and in the upper part of the 24% bracket and doing fine.
So I don't view the surviving spouse in a higher bracket as a big issue; there are various ways to "solve" this "problem", including not leaving all of the deceased spouse's assets to the surviving spouse...

 

[OldShooter]

It's NOT just tax rate arbitrage that drives Roth conversions. It's staying out of even higher IRMAA tiers after age 72. ...

Sure it is. IRMAA is just another tax that must be considered.. As I said, the arbitrage play has to consider the total tax to be paid now versus the total tax expected to be paid if the tIRA distribution is taken at some future date. For some, total tax also includes the the conversion income's effect on an ACA tax subsidy. State income tax may be a factor too. It's a complicated calculation, further confused by the need to predict future events.

 

[TheWizard]

Sure it is. IRMAA is just another tax that must be considered.. As I said, the arbitrage play has to consider the total tax to be paid now versus the total tax expected to be paid if the tIRA distribution is taken at some future date. For some, total tax also includes the the conversion income's effect on an ACA tax subsidy. State income tax may be a factor too. It's a complicated calculation, further confused by the need to predict future events.

Ok, if we're talking about all possible future taxes, then I think we're roughly in agreement.
And I agree that predicting the future isn't so easy...

 

[OldShooter]

Ok, if we're talking about all possible future taxes, then I think we're roughly in agreement.
And I agree that predicting the future isn't so easy...

Well, yes. But there are a lot of current taxes that arise when making a conversion. I think people tend to forget about those. Reduced ACA subsidy, for example. Taxes paid on a current distribution are usually well beyond the federal income tax number, which is the one that usually gets thrown around.

 

[TheWizard]

Well, yes. But there are a lot of current taxes that arise when making a conversion. I think people tend to forget about those. Reduced ACA subsidy, for example. Taxes paid on a current distribution are usually well beyond the federal income tax number, which is the one that usually gets thrown around.

I was never an ACA person.
And now at age 72 and RMDs, I'm in a strange situation with inflation recently.
Tax brackets for 2022 were adjusted back in October, 2021.

But IRMAA tiers for 2024 won't be set until October (?) of 2023, though we have estimates now, per TFB.

Bottom line is that I can't realistically Roth convert up close to the next projected IRMAA threshold this year without going from the 24% marginal bracket to the 32% marginal bracket.
No way am I going to do that...

 

[Exchme]

Roth Conversions are too complex to optimize without a model that lets you study possible futures.

One key "resistance" point that you might not have thought about is the top of the 0% LTCG bracket (AGI of $109,250 for 2022). Once your AGI hits that, then you will pay 12% on the next Roth conversion $ as ordinary income, plus that $ will push a $ of capital gains/qualified dividends into the 15% bracket, giving you a 27% marginal bracket. That 27% bracket lasts until all of your capital gains are taxed, after which you are in the 22% bracket ordinary income bracket. Depending on the size of your LTCGs/qualified dividends, that can be a big hurdle to overcome.

You also have to look at taxability of your SS benefits. Until your income is high enough that 85% is counted as taxable income, the effective tax rate you are in is very high.

 

[sengsational]

My thinking has been that logically, one would target the top of the bracket, generally speaking. IOW, if the first third of the bracket is good, so is the last 2/3 of it.

Complicated, as discussed, by all of the other cr*p that happens in the tax and Medicare space. That's why I buy the tax software in November and "titrate" my conversion+tIRA withdrawal. The tax software keeps an eye on all the things that show up there, and I manually have an estimate for the IRMAA, to keep that in the mix. Then I do the transactions in December. I never understood why people do them in January, when the entire year of uncertainty is ahead of you. But I digress.

For long-term planning, i-orp is back in operation! That takes some time to get the inputs correct, but I think it's worth the trouble. It will likely offer an aggressive conversion solution if you let it go unrestricted. I like to turn off conversations and see what all the machinations really are supposed to be saving (in my case, not all that much as a percentage).

 

[TheWizard]

Roth Conversions are too complex to optimize without a model that lets you study possible futures.

One key "resistance" point that you might not have thought about is the top of the 0% LTCG bracket (AGI of $109,250 for 2022). Once your AGI hits that, then you will pay 12% on the next Roth conversion $ as ordinary income, plus that $ will push a $ of capital gains/qualified dividends into the 15% bracket, giving you a 27% marginal bracket. That 27% bracket lasts until all of your capital gains are taxed, after which you are in the 22% bracket ordinary income bracket. Depending on the size of your LTCGs/qualified dividends, that can be a big hurdle to overcome.

You also have to look at taxability of your SS benefits. Until your income is high enough that 85% is counted as taxable income, the effective tax rate you are in is very high.

For single people, the 15% LTCG tax starts with taxable income over $41,675 for 2022.
85% of SS gets taxed somewhere in that ballpark as well.

Once you get over those hurdles, you're good with Roth conversions until you get up toward the Medicare IRMAA tiers...

 

[SoReady]

I've been using this to estimate the IRMAA thresholds for 1 and 2 years out.

FinanceBuff

 

[braumeister]

I've been using this to estimate the IRMAA thresholds for 1 and 2 years out.

FinanceBuff

+1
I don't believe there is any better source of estimates.

 

[OldShooter]

Just to make the stew thicker and @Exchme's model more complicated, consider estate planning:

In our case virtually all of our portfolio is in a mixture of Roths and tIRAs.

After our deaths, a good chunk will go to charity. This will be tIRA funds, on which the charity will pay zero tax. Giving Roth conversions would be to flush money down the toilet.

Our son and two grands will also get tIRA funds on the expectation that their net tax rates will be lower than ours currently. Note they are young enough that there is no IRMAA, SS taxation, or other ancillary issues.

One grand will be the beneficiary of a special needs trust that must last much longer than ten years. He will get Roth funds because liquidation of a tIRA within the ten year limit would result in a lot of undistributed money getting taxed at the high (35% IIRC) trust income tax rate.

Are we having fun yet?

 

[TheWizard]

...After our deaths, a good chunk will go to charity. This will be tIRA funds, on which the charity will pay zero tax. Giving Roth conversions would be to flush money down the toilet.

Our son and two grands will also get tIRA funds on the expectation that their net tax rates will be lower than ours currently. Note they are young enough that there is no IRMAA, SS taxation, or other ancillary issues...

Depending on your overall financial situation, when the first of you passes, consider bequeathing a PORTION of your tIRA funds to your descendants rather than 100% to surviving spouse.

This starts a ten year clock going for the inheritors sooner than otherwise and reduces excess income and taxes to the surviving spouse...

 

[OldShooter]

You're saying this because of reducing RMDs? Not sure I understand. Actually it would be pretty friction-free to give more to charity via QCDs. We'll think about it and look at some numbers.

 

[TheWizard]

You're saying this because of reducing RMDs? Not sure I understand. Actually it would be pretty friction-free to give more to charity via QCDs. We'll think about it and look at some numbers.

It depends entirely on the particulars of each couple's financial situation.
But it's fairly common to read of couples in the 12% bracket now, MFJ, with eventual surviving spouse projected to be in 22% bracket. This can happen if selecting 100% pension/annuity to survivor option along with hefty tax-deferred accounts.

QCDs are good for charities but not for individual inheritors, who now have ten years to deplete an inherited IRA.
But two separate bequests from the two parents gives them up to twenty total years to pay taxes on the inheritance on top of employment income...

 

[Exchme]

Just to make the stew thicker and @Exchme's model more complicated, consider estate planning:

In our case virtually all of our portfolio is in a mixture of Roths and tIRAs.

After our deaths, a good chunk will go to charity. This will be tIRA funds, on which the charity will pay zero tax. Giving Roth conversions would be to flush money down the toilet.

Our son and two grands will also get tIRA funds on the expectation that their net tax rates will be lower than ours currently. Note they are young enough that there is no IRMAA, SS taxation, or other ancillary issues.

One grand will be the beneficiary of a special needs trust that must last much longer than ten years. He will get Roth funds because liquidation of a tIRA within the ten year limit would result in a lot of undistributed money getting taxed at the high (35% IIRC) trust income tax rate.

Are we having fun yet?

In my own modeling, I actually put in wild guesses of the kid's future finances (they are in steady income type jobs where that's not quite as stupid as it sounds) and run models for them too to get a feel for their tax brackets after they inherit from us.

I have yet to be able to tune the models to see the future, darn it.

No matter how much or how little analysis folks do, they will need to update it occasionally as markets, health, life and financial needs change.

 

[pjigar]

Like many said, Roth IRA conversion has so many moving parts. There is no rule of thumb. I took a stab at creating a "calculator" which allows you to combine some of the variables. I did not find any objective way to include AFA subsidies. Here is the calculator that you can customize.