Backdoor Roth All At Once - Single Tax Year Pain

[Route246]

Currently I have no Roth and will probably have in excess of 3M RMD from tIRA exposure when I turn 73 in 6 years.

All IRA and 401K are in SPY-like equities now. tIRA is about 2M, 401K is about 800K and 401K is not part of this discussion. tIRA and 401K is about 20% of investable assets (currently).

I am in a high W2 bracket now until Sept 30 2025.

If and only if I do a backdoor Roth conversion I prefer it be done all at once (from 2M tIRA). I'm not concerned about the taxes, I will eat that and have accepted it.

My plan is contingent on the timing of the next market correction (20% or more). I have no doubts that this is possible before RMD kicks in in 6 years. I'm just thinking in terms of contingencies now, as I want to be ready in the event of a market correction, whatever and whenever that may be.

Questions:

• Is it possible to backdoor convert the entire 2M (whatever it is worth after correction) tIRA at once?
• Marginal taxes will probably be 37Fed + 12.3Cal, almost 50 percent, ouch!
• Funds would immediately go back into SPY for the long term and are not needed for living expenses
• Can I move the entire principal into Roth and pay taxes from other funds (thus protecting the entire amount under Roth)?

My thinking is this. First, I want a contingency for the next market correction. Second, I want to maximize my Roth shelter leverage if this happens and am willing to pay a premium for that. Third, I am a firm believer that significant market corrections are buying opportunities assuming no wars, country remains a democracy, Fed intervention is palpable, etc. That said, I'm willing to write those big checks if necessary. I believe the S&P will return 10% give or take over long periods of time. Lastly, I want this pain to happen only once and during the most painful period possible (a market correction). We have much more than we could ever spend in a lifetime and I'm willing to take a big hit if the opportunity presents itself. I am a firm believer of buying low and selling high. If a market correction happens, what better way would I be reducing my tax exposure and reducing RMD all at once?

Any flaws in this thinking? I know it is not optimal but it is less than 15% of investable assets and I feel like I would be getting a discount on the taxes.

 

[cathy63]

This would not be a "backdoor" conversion. It's just a normal conversion. Yes, you can convert the entire amount all at once if you want to.

Yes, you can convert the entire principal from the tIRA to Roth IRA and pay the tax from other funds.

Will you actually owe tax on the entire amount that's in the IRA though? Does any of that money consist of non-deductible contributions, or is it entirely made up of rollovers of tax deferred income?

I think this conversion would push all of your taxable investment income into the NIIT range during that year, so if you have accounts throwing off interest or dividend income, don't forget to account for the extra 3.8% on that income.

 

[GrayHare]

If you want a contingency for the next market correction, this time to Roth convert en masse is after the correction, not before it, because the taxable amount will be lower after a correction. I did that during the 2009/10 downturn and haven't looked back, but my conversion amount was much less than 2M. Most people convert in many smaller annual increments so as to not gut bumped into very high tax brackets.

 

[Dtail]

If you want a contingency for the next market correction, this time to Roth convert en masse is after the correction, not before it, because the taxable amount will be lower after a correction. I did that during the 2009/10 downturn and haven't looked back, but my conversion amount was much less than 2M. Most people convert in many smaller annual increments so as to not gut bumped into very high tax brackets.

At 14m in investment assets, he is probably already in the top tax bracket.

 

[USGrant1962]

While your thought of converting in down markets makes sense, I'm having difficulty figuring out why you even want to convert?

Apparently your IRA is less than 10% of your portfolio, so RMDs from that are not going to be a big driver on your already-high tax liability. If I was in your situation I would put all my fixed income in that IRA for tax efficiency, use if for any charitable contributions, and not really worry about it. If your heirs are below the max tax brackets you and they win.

 

[MarieIG]

Yes, you can convert following a correction (hopefully near the bottom but it's hard to tell) and yes, you can pay your taxes out of a taxable account. (I try to up my conversions in kind during market downturns.)

 

[MrEd]

Charles Schwab

the decision to convert is not so easy. as with many decisions you only know after the fact whether or not it was a good thing to do or it was a good thing not to do. much like taking social security....do you take it at 62 or 70.5 years of age. are the tcja tax cuts going to expire or will they be extended? who will be in office next year? will you be in a lower or higher tax bracket when you retire? if you pay $$$ in taxes now you will have that much less when you retire.

I have also been exploring a conversion but there are no clear cut answers.

fwiw.

 

[Exchme]

Your thinking is a little muddy on a couple of points.

Once you stop working, you may have several somewhat lower tax years before any RMDs start. Unless you will always be in the top bracket after you stop working, it is better for you to spread out the conversions. Doing it all at once may end up triggering AMT, the 26% or 28% rate for LTCGs/Qualified Dividends, etc. You pay for plenty of government, why leave a tip?

Spotting a market bottom is hard, I can never tell if we are partway down, at the bottom, partway up but going to go back down or a hundred other possibilities. It was always easy for me to spot in the rearview, but never in the moment.

It is a bit of a fallacy to think it is better to do conversions in a market correction. The issue is the taxes. Taxes are due in the quarter you do the conversion so you can't really wait around and the question is where does the money come from to pay the taxes? If the tax money was invested, it went down along with the market. If the tax money was sitting in cash and you could correctly spot the market bottom, you could just invest the cash at the market bottom and do the conversions another time, paying taxes from assets that went up in value and come out the same.

At your asset level, you should probably hire a one-time-fee CFP to do some tax planning for you. It could cost a few thousand $, but might save you a hundred times more.

 

[Route246]

At 14m in investment assets, he is probably already in the top tax bracket.

This is true. Additionally, because of SS and low cash position I will probably be in a high tax bracket forever, albeit capital gains tax rates should apply.

Your thinking is a little muddy on a couple of points.

Once you stop working, you may have several somewhat lower tax years before any RMDs start. Unless you will always be in the top bracket after you stop working, it is better for you to spread out the conversions. Doing it all at once may end up triggering AMT, the 26% or 28% rate for LTCGs/Qualified Dividends, etc. You pay for plenty of government, why leave a tip?

Spotting a market bottom is hard, I can never tell if we are partway down, at the bottom, partway up but going to go back down or a hundred other possibilities. It was always easy for me to spot in the rearview, but never in the moment.

It is a bit of a fallacy to think it is better to do conversions in a market correction. The issue is the taxes. Taxes are due in the quarter you do the conversion so you can't really wait around and the question is where does the money come from to pay the taxes? If the tax money was invested, it went down along with the market. If the tax money was sitting in cash and you could correctly spot the market bottom, you could just invest the cash at the market bottom and do the conversions another time, paying taxes from assets that went up in value and come out the same.

At your asset level, you should probably hire a one-time-fee CFP to do some tax planning for you. It could cost a few thousand $, but might save you a hundred times more.

I am planning to be in a high bracket even when I'm retired due to capital gains selling assets for cash. This is not part of my thinking because it is inevitable. The other advantage about doing a big conversion is reducing RMD once I turn 72. My thinking may be flawed until I get all of this loaded into a spreadsheet.

Yes, you can convert following a correction (hopefully near the bottom but it's hard to tell) and yes, you can pay your taxes out of a taxable account. (I try to up my conversions in kind during market downturns.)

Not really interested in timing a bottom, just going to be triggered when the inevitable correction happens, If it doesn't happen then nothing is lost. If it does happen during this time frame I need to be in position to act quickly and decisively. I don't want to be thinking about this when S&P dives 19% and I'm trying to analyze the situation. This is just a plan that will be in place initiated and triggered by a contraction in the S&P. It needs to be objective and without emotion and executed without any doubt or unease.

 

[SecondCor521]

I would try to asses the weighted average marginal tax rate in which you expect your beneficiaries of your traditional IRA to be in the 10 years after you pass away. If it's lower than your current rate, then you may be burning wealth for them for the sake of your personal goal of simplicity.

It sounds like you're wealthy enough to where it won't matter for you. It may matter for them.

To the extent that you are doing charitable giving, I would suggest looking into leaving some of your IRA to charity, doing annual QCDs (for you and spouse as applicable), or both. Avoiding taxes entirely on traditional IRA assets in either of these two ways also helps with RMDs, income taxes, and probably estate taxes in your case as well (although you probably have that planned out already as well).

HTH.

 

[Route246]

I would try to asses the weighted average marginal tax rate in which you expect your beneficiaries of your traditional IRA to be in the 10 years after you pass away. If it's lower than your current rate, then you may be burning wealth for them for the sake of your personal goal of simplicity.

It sounds like you're wealthy enough to where it won't matter for you. It may matter for them.

To the extent that you are doing charitable giving, I would suggest looking into leaving some of your IRA to charity, doing annual QCDs (for you and spouse as applicable), or both. Avoiding taxes entirely on traditional IRA assets in either of these two ways also helps with RMDs, income taxes, and probably estate taxes in your case as well (although you probably have that planned out already as well).

HTH.

Thank you for the sage advice. It is less than 20% of my assets and I'll have a 401K rollover next year so there will still be 1M in tIRA after the rollover. I'm just looking at converting 2/3 of my IRA/401K assets.

Additionally, this will happen if and only if a 20% market correct happens. Otherwise I'll reach age 73 with 3M RMD-vulnerable assets instead of 1M RMD-vulnerable assets.

 

[teej1985]

I would try to asses the weighted average marginal tax rate in which you expect your beneficiaries of your traditional IRA to be in the 10 years after you pass away. If it's lower than your current rate, then you may be burning wealth for them for the sake of your personal goal of simplicity.

It sounds like you're wealthy enough to where it won't matter for you. It may matter for them.

To the extent that you are doing charitable giving, I would suggest looking into leaving some of your IRA to charity, doing annual QCDs (for you and spouse as applicable), or both. Avoiding taxes entirely on traditional IRA assets in either of these two ways also helps with RMDs, income taxes, and probably estate taxes in your case as well (although you probably have that planned out already as well).

HTH.

Have you mathed out how much to keep in traditional IRA for QCD purposes?

 

[Route246]

Have you mathed out how much to keep in traditional IRA for QCD purposes?

That is the one thing we have not done yet but in a few years we will probably start giving significant amounts away to my university (private, medium size, highly rated) as I view my school as giving me the head start in my career climb. I'm not interested in getting my name on a building or hall but I would like to pay back something in appreciation for a long career made slightly better and easier based on my 7 years spent there in graduate and undergraduate school. Other small charities like the local humane society will probably get their share, too.

 

[SecondCor521]

Have you mathed out how much to keep in traditional IRA for QCD purposes?

Not sure if you were asking me, but I do have a spreadsheet for long range planning, and it does have a QCD function built into it. It's rough but does the job as well as I need it to.

My general plan is that I don't want to go above X% in federal marginal tax rate. If I see that I'm exposed to that (and I should be able to see it coming), then I can do QCDs to steer away. I've got charities that I would be happy to help in that way.

Because one can do QCDs on top of one's RMD, and one can do $105K of QCDs per year, it's a pretty powerful tool to steer away from those higher tax rates.

 

[athena53]

I watched a webinar by a guy named Craig Wear who advocates the "bite the bullet and do it all at once" tactic. I decided not to- once the taxes are paid on the massive withdrawal, that money is gone. They also offered to help me develop an optimal strategy for "only" $9,000. I still get e-mails from them and may unsubscribe.

Most likely case is that I won't touch the IRAs except for RMDs and QCDs and DS and DDIL will be left with a (low) 7-ifgure inherited IRA they'll have to withdraw over 10 years. There are worse problems to have.

 

[Dash man]

We’ve been doing Roth conversions for a number of years and will stop when the tIRA is at or below $1M. That will be used for QCDs over the rest of our lives. We will have charities of our choice set up in case we check out early.
We’ve managed to put a significant amount in our Roth accounts that are currently three times the remaining tIRAs. We’ve paid a lot in taxes and IRMAA out of our taxable accounts, but feel it has been worth it. Our daily spending is out of our taxable accounts. We anticipate once DW begins social security in two years, that our cash flow will be about $320,000/year with about $90k tax free dividends and interest from our Roth accounts. Everything will be state tax free except interest and dividends from our taxable accounts. IRMAA should drop significantly. Charitable deductions should keep overall taxes much lower than we’ve been paying. QCDs will prevent us from paying RMDs.
I’m a believer in Roth conversions.

 

[Montecfo]

Not sure why concern about RMDs would motivate you to want to instead pay the highest tax possible.

Also it seems paying all at once now to achieve future "tax free growth" is kind of a contradiction. Unless you seek a psychic benefit (feel better having paid taxes).

It seems the good old multi-year approach probably makes the most sense. It is "tax cost averaging", a bit like dollar cost averaging investments.

 

[Sunset]

There is no advantage to converting a large IRA to Roth all at one, except to pay extra tax by going into higher tax brackets or by paying with today's dollars that are worth more than dollars in the future.

It's always possible we could in a few years fall into a recession and then like Japan did , stay in a very low return market for decades.

Far better for OP is to simply ignore the IRA or do conversions up to current tax bracket max each year, and then take RMD's in the future and sell less capital gain stock (which will pass tax free to heirs).

 

[pb4uski]

+1 I would not normally see much merit in converting a large chunk and paying the maximum in taxes on that large conversion.

Having money in a Roth gives you no benefit if we have a market correction other than perhaps less of a loss because you have 50% less since you have paid 50% to do the conversion. I don't see any wisdom in that.

The is a possible play since your tax rate is so high at 50% and you have significant taxable account assets. Here is an unrealistic example to illustrate the power of the principle.

Say you convert $2m and pay $1m in taxes so you have $2m in a Roth and it grows at 7% annually... in 10 years you have $3.934m [$2m*(1+7%)^10]

Alternatively you don't convert. The $2m in the tIRA grows to be $3.934m in 10 years (same calculation). But the $1m in taxable only grows to $1.411m [$1m*(1+7%*(1-50%))^10]. So if after the 10 years you cash out the tIRA then you only have $3.378m ($3.934M - $1.967m in taxes at 50% + $1.411m in taxable account).

$3.924m is better than $3.378m. Now realistically you can't hold for 10 years because of RMDs but it shows the power of shifting the taxable money to tax free.

You're rich and can afford professional help. Find a well regarded CPA with a PFS (Personal Financial Specialist) to help you.

 

[Route246]

+1 I would not normally see much merit in converting a large chunk and paying the maximum in taxes on that large conversion.

Having money in a Roth gives you no benefit if we have a market correction other than perhaps less of a loss because you have 50% less since you have paid 50% to do the conversion. I don't see any wisdom in that.

The is a possible play since your tax rate is so high at 50% and you have significant taxable account assets. Here is an unrealistic example to illustrate the power of the principle.

Say you convert $2m and pay $1m in taxes so you have $2m in a Roth and it grows at 7% annually... in 10 years you have $3.934m [$2m*(1+7%)^10]

Alternatively you don't convert. The $2m in the tIRA grows to be $3.934m in 10 years (same calculation). But the $1m in taxable only grows to $1.411m [$1m*(1+7%*(1-50%))^10]. So if after the 10 years you cash out the tIRA then you only have $3.378m ($3.934M - $1.967m in taxes at 50% + $1.411m in taxable account).

$3.924m is better than $3.378m. Now realistically you can't hold for 10 years because of RMDs but it shows the power of shifting the taxable money to tax free.

You're rich and can afford professional help. Find a well regarded CPA with a PFS (Personal Financial Specialist) to help you.

The $1M taxable in SPY, expected gain ~10% minus ~1.3%/2 dividends over that 10 years is more reasonable IMO. Is something wrong with this characterization? (All of my retirement accounts are in 100% SPY or VG500 or something similar now)

I am a firm believer that a market correction with requisite tests of the low are buying opportunities (re: Bob Brinker). The advantage I see for myself is increasing the odds of buying into a buying opportunity rather than buying at a random point in time. The gain or loss in the IRA has nothing to do with the trigger (correction, in this case). The motivating factor for me (as I believe) is to buy into the buying opportunity where the likelihood is to catch better SPY gains post-correction.

Not being naive here. Past performance is no indicator of future performance, etc, etc... I'm just trying to come up with a plan ahead of time and when and if it happens I don't want to be second guessing myself. I just want to have a plan in place and execute on it without thinking about it when it is happening. I'm significantly in equities now so I don't consider myself risk averse. Laying out $1M or whatever in taxes is not something I take lightly, either. It is a lot of money.

 

[pb4uski]

It was a hypothetical example. Substitute whatever rate you want.