Anyone else have a 'problem' with ORP's "moving money to a roth" before RMD......

[pb4uski]

Ejman, maybe a mitigating factor is your deductions? Is the Oregon tax applied to the income or the income minus deductions and exemptions (as in Federal)?

I took a quick look at the OR form and it looks like TI equals federal AGI - federal taxes - SS taxes paid - US interest - federal govt pension income - itemized deductions +/- a host of special items that probably don't have a big effect to most people.

so I understand the higher rate but I'm not sure the additional soutractions offset the sky-high rate.

 

[Gotadimple]

ORP tells me to convert up to the top of the 0% tax bracket, but then calculates that incorrectly. If I use TurboTax to see how much I can convert and pay zero in taxes, it is a much larger number. I don't see that as a fault of ORP because it doesn't know my exact tax situation such as all the tax credits I get.

So my take-home message from this is that you have to double-check what ORP tells you by running real tax software. However in our case it appears that ORP is on the right track of paying zero income taxes to convert 401(k) to Roth IRA. It certainly does not suggest that I pay even 15% in taxes to do the conversion.

If you have time, read some of the background material at the ORP site. In that material James Welch suggests that rather than using the specific numbers the calculator provides, you use the pattern of distribution/movement. That is exactly what you are doing!

If you really like the software, make a small donation on his web site. I think he does a terrific job with it -- it's a great tool, as is Firecalc.

-- Rita

 

[Animorph]

This is not correct. A Roth conversion requires payment of income taxes on the amount converted. It is not tax-free. It's true that if you convert $100 from a TIRA to a Roth Ira you can end up with $100 more in the Roth, but you would also have had to pay the fed and state income tax on the $100 from another pocket.

I'm talking about withdrawing from a TIRA when you still have money in a taxable account. Do a conversion instead of a straight TIRA withdrawal.

Start with $200 in TIRA, $200 in taxable account, $0 in Roth.

1) TIRA withdrawal of $100, pay taxes ($20 say) on $100, keep $200-$20 in taxable account. Income $100, Taxes $20, Balances: TIRA $100, taxable $180, Roth $0

2) Roth conversion $100, pay taxes ($20) on $100, Use $120 in taxable account for income and taxes. Income $100, Taxes $20, Balances: TIRA $100, taxable: $80, Roth $100

Same $100 income and $20 in taxes, but with (2) you have moved $100 from your taxable account to your Roth account and from then on won't pay taxes on it, nor have to track capital gains on it.

Seems like a lot of posters on this thread are just planning on taking withdrawals and not doing conversions. If you have a taxable account this seems like a big mistake. That's why ORP is recommending all those Roth conversions.

 

[ejman]

Ejman, maybe a mitigating factor is your deductions? Is the Oregon tax applied to the income or the income minus deductions and exemptions (as in Federal)?

In California the marginal rate is 2% on $15k taxable income.

In my particular case deductions are not a big factor as I have no mortgage and no dependents other than us two. The Oregon tax is generally AGI minus fed tax, SS, Fed interest and a whole bunch of adjustments that don't amount to a hill of beans for most people. Bottom line is that I generally end up paying just as much if not more Oregon than Fed tax. So I understand any Roth conversions would just simply go on top unless Animorph has a special magic wand that could be shared with us.

 

[ejman]

I took a quick look at the OR form and it looks like TI equals federal AGI - federal taxes - SS taxes paid - US interest - federal govt pension income - itemized deductions +/- a host of special items that probably don't have a big effect to most people.

so I understand the higher rate but I'm not sure the additional soutractions offset the sky-high rate.

Yes, this is correct and no, the additional subtractions do not offset the high rate (at least for most people)

 

[kaneohe]

if you withdraw from a pre-tax account over and above any RMD and have a taxable account, you have an opportunity to move an equal amount of that taxable account money into a Roth with no impact on taxes by doing a Roth conversion instead. Placing taxable money into a Roth is as close to a free lunch as you can get.

.

This was an interesting, but for me, a confusing way to state this.
The more conventional way to state it is that a Roth conversion is beneficial if the tax rate at which you convert is lower than or equal to the tax rate when you make withdrawals (from TIRA) if you pay the conversion taxes from outside (the TIRA) funds. However I do agree with your example.

Another more conventional way to state it is that it is better to live on taxable funds and do a Roth conversion than to live on TIRA withdrawals
(assuming you have adequate taxable funds).

 

[kaneohe]

I am not familiar with the retirement calculator you used, but when I use Esplanner to do my own projections, it's quite clear that Otar's strategy is the correct one. Among its outputs Esplanner shows the federal and state income taxes for each year of its projections. If I were not to do the Roth conversions between my retirement age of 62 and 70, the RMDs would result in a much larger lifetime tax bill, especially since the SS benefits would then be taxed at a higher rate as well. It's may be a little counter-intuitive, but if your calculator provides details for each year of its projections, then it is easy to see the benefit. If it doesn't, then you should use Esplanner.

If tax rates do change they are likely to go up, but by the time I have finished my Roth conversions my taxable income will be very low.





I am assuming that tax brackets and rates don't change in a way that would affect

Is this something you buy or can you use it free online? I went to the website but it wasn't obvious to me that you could do anything there.....unlike Taxcaster or Firecalc.........probably blind, I guess.

 

[omni550]

Is this something you buy or can you use it free online? I went to the website but it wasn't obvious to me that you could do anything there.....unlike Taxcaster or Firecalc.........probably blind, I guess.

It's available for purchase, according to their site Our Products | ESPlanner Inc., and there's also a very simplified free version accessible there also.

The free version is (just don't log in) http://basic.esplanner.com/

omni

 

[kaneohe]

It's available for purchase, according to their site Our Products | ESPlanner Inc., and there's also a very simplified free version accessible there also.

The free version is (just don't log in) Home | ESPlannerBasic

omni

omni.......thanks for the link.

 

[RetireBy90]

I'm talking about withdrawing from a TIRA when you still have money in a taxable account. Do a conversion instead of a straight TIRA withdrawal.

Start with $200 in TIRA, $200 in taxable account, $0 in Roth.

1) TIRA withdrawal of $100, pay taxes ($20 say) on $100, keep $200-$20 in taxable account. Income $100, Taxes $20, Balances: TIRA $100, taxable $180, Roth $0

2) Roth conversion $100, pay taxes ($20) on $100, Use $120 in taxable account for income and taxes. Income $100, Taxes $20, Balances: TIRA $100, taxable: $80, Roth $100

Same $100 income and $20 in taxes, but with (2) you have moved $100 from your taxable account to your Roth account and from then on won't pay taxes on it, nor have to track capital gains on it.

Seems like a lot of posters on this thread are just planning on taking withdrawals and not doing conversions. If you have a taxable account this seems like a big mistake. That's why ORP is recommending all those Roth conversions.

Anamorphic -thanks for the follow up. If I am going to take a draw of $100 from my TIRA and move it to my taxable account, paying taxes of say $25 and deposit $75 into my taxable acct, the I could wd $31, pay taxes giving $25 to pay taxes on a $100 transfer. It would cost more to pay taxes on amount to pay taxes, bit I would not pay taxes any more on converted $$.

I've thought and read and discussed TIRA to ROTH conversions, and the one big risk I can come up with is what if we start a vat or federal sales or consumption tax. If so, you take a hit today and pay your taxes then pay sales tax making it double taxed. Not enough risk of happening nor is the cost if it happens enough to keep me from converting when it would otherwise make sense but you gotta list the potential risks to make an informed decision

 

[Cut-Throat]

Back on my original topic. I am surprised that no one mentioned what was happening to the markets during the 10 years of moving regular IRAs to ROTH IRAs. Most everyione assumed that their tax rates would go up, so it would be cheaper to pay now than later.

The fallacy that I see with the calculator, is that it assumes a constant even growth rate of your assets (You just plug in a number of what percentage they are growing). One of the uncontrollable factors of the withdrawal stage is the sequence of investment returns. In the first 10 years of retirement, a severe market downturn would greatly increase a portfolio's chance of failure. Paying more taxes by moving money from a Regular IRA to a ROTH IRA exacerbates this even further.

My take away from this; If you are in a stable or Up market environment, paying some more in taxes to reduce future tax liability may be good thing. Not so much in a severe market downturn.

 

[Lsbcal]

...(snip)...
My take away from this; If you are in a stable or Up market environment, paying some more in taxes to reduce future tax liability may be good thing. Not so much in a severe market downturn.

Not sure why you are focusing on this as we probably agree we have no crystal ball on future market movements. The current market appears to be about average valuations (based on trailing PE and forward PE estimates).

IMO the only obvious period of a bubble in the last decade was the 2000 growth bubble. Unfortunately, it got a lot more obvious in retrospect.

 

[Cut-Throat]

Not sure why you are focusing on this as we probably agree we have no crystal ball on future market movements. The current market appears to be about average valuations (based on trailing PE and forward PE estimates).

IMO the only obvious period of a bubble in the last decade was the 2000 growth bubble. Unfortunately, it got a lot more obvious in retrospect.

What I was focusing on does not require a crystal ball at all.....Example You are year 2 into retirement. Your portfolio plunged about 40% the previous year....The question is do you move assets from a regular IRA into a ROTH up to the 15% tax level. And then pay the taxes with your now diminished portfolio? .....I would not, I would minimize taxes at this point.

 

[Lsbcal]

What I was focusing on does not require a crystal ball at all.....Example You are year 2 into retirement. Your portfolio plunged about 40% the previous year....The question is do you move assets from a regular IRA into a ROTH up to the 15% tax level. And then pay the taxes with your now diminished portfolio? .....I would not, I would minimize taxes at this point.

In 2008 and 2009 I did the Roth conversions. Those conversions grew quite nicely inside the Roth's up to the present. So in that case the market turn was very welcomed. I'm not saying I knew what was coming and planned this. Just that I viewed the conversions (and still do) as a separate decision from market dynamics.

On the other hand, had it been 1999 I think that you have a point. The bubble atmosphere at the end of 1999 was a warning to curtail conversions. I was not doing any conversions in those years but just funding the IRA's.

On the other hand (assume I have 3 hands), if one knows enough to curtail conversions (because you want Uncle Sam to share in your equity losses if they occur) then why not just move the money out of equities? In that case you are then OK with conversions (non-equity to non-equity).

 

[Rustward]

The fallacy that I see with the calculator, is that it assumes a constant even growth rate of your assets (You just plug in a number of what percentage they are growing). One of the uncontrollable factors of the withdrawal stage is the sequence of investment returns. In the first 10 years of retirement, a severe market downturn would greatly increase a portfolio's chance of failure. Paying more taxes by moving money from a Regular IRA to a ROTH IRA exacerbates this even further.

ORP does have a Monte Carlo feature.

No tool of this nature is perfect. The ones that are available all seem to have their strengths and weaknesses. They all require the user to make some assumptions, such as length of plan, inflation rate, social security benefit (as there seems to be some uncertainty that we will receive what current SS estimates say we will), do you plan to work in retirement and how much will you make and for how long, etc. The deterministic ones require you to specify returns...

The future is uncertain. You just have to plan for yourself using the assumptions that you think are most likely to materialize, or if you prefer, use worst case assumptions. Either way, you are probably going to be off. If someone strongly believes the first n years of his retirement will see overwhelmingly negative returns, that person might be better off in CD's.

My take away from this; If you are in a stable or Up market environment, paying some more in taxes to reduce future tax liability may be good thing. Not so much in a severe market downturn.

Roger that.

I think you are trying to put too fine a point on this. Use these tools to establish a general direction, not a precise compass heading. If you don't like what one tool is telling you, then that probably is not the tool for you.

Personally, I use Fidelity RIP, ORP, FireCalc, and Quicken Retirement Planner AKA Lifetime Planner. I generally use 90% of assets, 3% inflation, and 2.5% real return, and do runs with 100% of SS benefits and 75% SS benefits. FireCalc gets four runs, two in deterministic mode, and two in its native mode. My approach is probably opposite from what most people do. I have the tool solve for the amount I can safely spend per year, then decide if my budget can live with that amount. FireCalc and ORP do this effortlessly. With RIP and Quicken I do this by varying the annual expenses until the plan breaks, then back off the expense number a little. Sounds difficult but it takes just a few runs if you use a binary search to home in on the expense number. Summarize this into a little 5x2 spreadsheet and analyze by closing one eye, and squinting with the other eye until the numbers are fuzzy but readable, and usually conclude everything will be OK.

You might consider sending an email to James S Welch Jr. orplanner@gmail.com <orplanner@gmail.com

 

[Rustward]

What I was focusing on does not require a crystal ball at all.....Example You are year 2 into retirement. Your portfolio plunged about 40% the previous year....The question is do you move assets from a regular IRA into a ROTH up to the 15% tax level. And then pay the taxes with your now diminished portfolio? .....I would not, I would minimize taxes at this point.

I know it is poor form to quote oneself, but I am going to do it anyway.

You should plan to reevaluate periodically and be prepared to adjust to current conditions over time.

Edit to add: Lsbcal did make a good point: You get more bang for your buck if you convert at the bottom of a down market. However that makes you a market timer, and how do you know where the bottom is?

 

[GrayHare]

Converting while a tIRA is at a depressed value minimizes taxes. I converted most tIRA to Roth in 2010 while stocks were still recovering and the tIRA income could be spread across 2011 and 2012. Haven't yet had to pay all the tax due, and meanwhile the Roth's value has increased more than the total tax bill, with that gain being all tax free.

 

[Lsbcal]

....
Edit to add: Lsbcal did make a good point: You get more bang for your buck if you convert at the bottom of a down market. However that makes you a market timer, and how do you know where the bottom is?

You don't know where the bottom is, you do know you are closer a low then you were before. So that is good "market timing" . There are many examples of poor market timing.

 

[Cut-Throat]

Edit to add: Lsbcal did make a good point: You get more bang for your buck if you convert at the bottom of a down market. However that makes you a market timer, and how do you know where the bottom is?

Really? Where did the extra money come from to pay the taxes at the 15% Level?......Withdrawing more money from stocks whether for Taxes or Expenses immediately after a down market year affects the portfolio in a very negative manner. And if you are not drawing from Stocks, you are changing your asset allocation to a more risky allocation.

Don't confuse this with buying equities during a down market year. You are keeping the same asset allocation. Just moving from Regular IRA to ROTH IRA.

 

[RunningBum]

What I was focusing on does not require a crystal ball at all.....Example You are year 2 into retirement. Your portfolio plunged about 40% the previous year....The question is do you move assets from a regular IRA into a ROTH up to the 15% tax level. And then pay the taxes with your now diminished portfolio? .....I would not, I would minimize taxes at this point.

Oh, absolutely I would convert! This is an ideal situation, to get a dip, pay taxes at a low point, and then let it recover in a forever tax free Roth account. Of course there's no guarantee the market will recover, but chances seem better on it going up from a 40% drop than after a big run-up.

If you hit an immediate dip, you can always recharacterize the conversion.

A long extended downturn is a problem in any case, but it is worse to have Roth assets depreciate because you can't take a tax write-off on them. But you can't predict that, and if you could, you wouldn't be in the market.

Your point about a tax overhaul to a VAT is valid, but I suspect such a tax would be an add-on. They would keep income tax rates the same, but add a smaller VAT. Strictly a guess on my part but I don't think the growing base of retirees would stand for a major shift to a spending tax.

 

[MichaelB]

Doing a ROTH conversion after a major market decline is dangerous. The potential benefit is the future difference between the two tax rates - capital gains vs ordinary income - vs the immediate tax expense. The only way I see that as feasible is if the portfolio, after conversion and tax, is still big enough to maintain spending. It the market decline plus conversion plus tax drops the portfolio survival rate too far it's too risky IMHO.

 

[RunningBum]

Not sure where cap gains comes into this since we are talking about Roth conversion vs. IRA distributions later, which is ordinary income now vs ordinary income later. I suppose there may be some cap gains from selling from your taxable account to pay the conversion taxes, but after a 40% drop you probably don't have many gains!

As far as the portfolio being in danger, it's the 40% drop put it in danger. Yeah, you may not want to spent your last $ in your taxable account to pay conversion taxes, but I'm assuming we're talking about partial conversions, and the Roth has been open long enough that you'll be able to pull from it soon. (Can you do a partial conversion to a Roth and pull from a Roth in the same year?) Assuming we are talking about the same tax rates now and in the future (say, 15%), I don't see how having the money in a TIRA and 15% more in taxable is any safer than having the money in a Roth and having paid the taxes. It may feel safer, but having taxes looming on the TIRA money is an expense that will eventually hit.

Maybe I'm missing something and can learn. Can you give me an example of how it is more dangerous, or is it just the short term cash flow issue of putting it in a new Roth that you couldn't touch for 5 years if you are under 59 1/2?

The potential benefit isn't the tax rates, it's the amount being taxed. If I have $100 in a TIRA and it drops to $60 and I convert at a 15% OI rate, I pay $9 in taxes. If I wait to convert and it recovers to $100 and I then convert, I pay $15 in taxes. As I said before, there's no guarantee of recovery, but it does seem likely. And even if it doesn't recover and the TIRA is still $60 when I want to convert it or need it as a distribution, I still pay the $9 in taxes.

 

[Lsbcal]

As in so many cases, all this can depend on the individual's particular situation. In my case, when I converted in 2008 the taxes were paid from the taxable money account. I was going to have to pay those taxes eventually anyway. So I saw this as a chance to move part of a 60/40 portfolio to a tax free on withdrawal Roth at a time of lowish valuations. It was a scary and unpleasant time and this was one tactic that I felt was a positive one given our resources. Now if we were on the edge of portfolio survival that might be a different story.

Now suppose the market just kept going down as in the 1930's. Then it would be a lot tougher on me. Maybe I just got lucky! Here is a chart comparing the 1929, 1987, and 2008 declines. The red arrow shows where I made the Roth conversion. I think Cut Throat was right in 1929. I just got it right in 2008 -- luck or skill? That is life I'm afraid, scary.

 

[RunningBum]

Yeah, but we weren't talking about converting just before a 40% crash, cut-throat said after the crash. 1929 still wouldn't have done well, but eventually did recover.

Besides, no retiree should be 100% in the market, I feel like I'm fairly aggressive at 115-age, so a 40% portfolio plunge (which was what was stated) would be more than a 60% stock market crash.

 

[kaneohe]

Perhaps some numbers might give this some perspective. Assume MFJ and converting up to top of 15% bracket. Assume no taxable income except for the Roth conversion. In rounded numbers you can have a maximum taxable income of 70K or an AGI (assuming std deduction) of 90K on which you would pay taxes of 10K for the Roth conversion. In reality you woud probably have a somewhat smaller conversion due to other income, and a somewhat smaller tax due to LTCG/QDIV.

If that 10K/yr tax for 2-3 yrs would spell disaster, then you probably shouldn't do the conversion but it seems like this wouldn't have been a good situation to begin with even w/o the bear market. After 3 yrs of conversion you would have 270K in the Roth. Assuming you were over 59.5 y.o. and and had a Roth for 5yrs, the Roth funds would be available for use.

Seems like the basic rule of Roth conversion still holds tho........if you can convert at a tax rate now <= the tax rate you would have paid on the TIRA later, then it makes sense to do the conversion. If the portfolio was in jeopardy, you would probably reduce spending and be in a lower tax bracket than if you had converted the full 90K so conversion (at least full conversion) would not make sense in this case.