Calculating ROTH conversion before end of year

[Looking4Ward]

I'd like to do a tIRA to Roth conversion before the end of the year at the maximum amount that keeps my tax liability as low as possible.

But in order to calculate it properly I need to know what portion of this year's CG distributions are short/long term and what portion of this year's dividends are qualified/non-qualified.

If I remember correctly, that information isn't available from Vanguard until the tax forms are produced in early 2017. So I can't wait for those.

Is there any way to estimate those two variables before the end of the year? It would basically be just for three funds (Vanguard Healthcare Fund, Wellesley, and Wellington).

 

[NgineER]

You can always recharacterize the Roth Conversion next year to land exactly where you want, you have until April 15, or October if you file for an extension.

 

[LOL!]

Vanguard.com publishes good estimates beforehand and even tells you the exact dates of upcoming updates. Have you not seen these web pages at Vanguard.com already?

Here is the link: https://personal.vanguard.com/us/insights/article/year-end-distribution-schedule-102016
Note that updates will occur overnight on December 9th and December 19th.

Updated estimates of year-end capital gains for applicable Vanguard mutual funds and ETFs, broken down by short-term, long-term, and total gains, plus estimated income and qualified dividend income percentages,

For others: Healthcare, Wellington and Wellesley are notoriously tax inefficient and probably return less after-tax than tax-efficient index fund, so these 3 funds should be kept in tax-advantaged accounts and not taxable accounts. Folks with these funds in taxable accounts should not reinvest distributions nor buy more shares in taxable as that just digs a deeper hole.

 

[Looking4Ward]

Vanguard.com publishes good estimates beforehand and even tells you the exact dates of upcoming updates. Have you not seen these web pages at Vanguard.com already?

I did and had actually posted a link to that notice a few weeks ago.

Didn't realize at the time that it also stated the estimates would be "broken down by short-term, long-term, and total gains, plus estimated income and qualified dividend income percentages"

That should be sufficient for me to be able to guess a conversion amount close enough to keep the effective tax rate at about 5% and make any necessary adjustments via recharacterization early next year if the preliminary estimates are way off.

 

[braumeister]

You can always recharacterize the Roth Conversion next year to land exactly where you want, you have until April 15, or October if you file for an extension.

That's by far the simplest and most accurate way to handle it.

 

[Animorph]

You can get what you want to the penny if you convert a little more than you'll need and then recharacterize when you do your taxes. Probably easier than doing your taxes now.

 

[Looking4Ward]

Up to what effective tax rate should I consider a savings now?

Per Taxcaster I can convert:

$20K = $1298 tax (7%)
$25K = $2536 tax (10%)
$30K = $4036 tax (13.5%)
$40K = $7036 tax (17.6%)

I won't be touching my tIRA until I begin drawing SS in 14 years at age 70 so I don't want it to be so large that between dividends/CG distributions in my taxable accounts and required minimum distributions from my tIRA that I have to then also pay taxes on my SS benefits.

 

[Looking4Ward]

For others: Healthcare, Wellington and Wellesley are notoriously tax inefficient and probably return less after-tax than tax-efficient index fund, so these 3 funds should be kept in tax-advantaged accounts and not taxable accounts. Folks with these funds in taxable accounts should not reinvest distributions nor buy more shares in taxable as that just digs a deeper hole.

That's a very good point. The only reason I still have them in my taxable is because the distributions and dividends they throw off are sufficient to cover my living costs but still low enough that I don't have to pay any taxes and the number of shares is constant.

If I were still accumulating and reinvesting CGD/Dividends then I would not want those funds in my taxable.

 

[jebmke]

That's a very good point. The only reason I still have them in my taxable is because the distributions and dividends they throw off are sufficient to cover my living costs but still low enough that I don't have to pay any taxes and the number of shares is constant.

If I were still accumulating and reinvesting CGD/Dividends then I would not want those funds in my taxable.

But these distributions are eating up space to do low/zero tax cost ROTH conversion.

 

[LOL!]

But these distributions are eating up space to do low/zero tax cost ROTH conversion.

That's right. Not only is return-of-capital tax-free, it doesn't even appear anywhere on your tax return, so it cannot increase Adjusted Gross Income and the tax pleasures that come with that.

That's why tax-efficient index funds can be really helpful in a taxable account in ways that are not so obvious.

 

[respond2u]

...
But in order to calculate it properly I need to know what portion of this year's CG distributions are short/long term and what portion of this year's dividends are qualified/non-qualified.

...

I didn't know those mattered at all when transferring from a traditional IRA to a Roth IRA.

I thought it was simply the total amount being converted, and all that is taxed as passive income (no SS/Medicare).

What am I missing?

Thanks,
r2u

 

[pb4uski]

That's by far the simplest and most accurate way to handle it.

+1. I have done that for the last two years.

 

[Looking4Ward]

But these distributions are eating up space to do low/zero tax cost ROTH conversion.

That's right. Not only is return-of-capital tax-free, it doesn't even appear anywhere on your tax return, so it cannot increase Adjusted Gross Income and the tax pleasures that come with that.

That's why tax-efficient index funds can be really helpful in a taxable account in ways that are not so obvious.

Now I understand. Problem is I've got so much in capital gains between the three funds (I've held them for years now) that it would be difficult to convert them to index funds. Maybe that's what my focus should be over the next few years, converting those funds over time to minimize capital gains tax and then once they are converted be able to take full advantage of the empty "space" to do larger ROTH conversions.

 

[Sunset]

Up to what effective tax rate should I consider a savings now?

Per Taxcaster I can convert:

$20K = $1298 tax (7%)
$25K = $2536 tax (10%)
$30K = $4036 tax (13.5%)
$40K = $7036 tax (17.6%)

I won't be touching my tIRA until I begin drawing SS in 14 years at age 70 so I don't want it to be so large that between dividends/CG distributions in my taxable accounts and required minimum distributions from my tIRA that I have to then also pay taxes on my SS benefits.

Another way to look at it:
$20K = $1298 tax (7%)
$25K = $20K + $5K => $1298 tax (7%) + $1238 tax (25%)
$30K = $20K + $5K + $5K => $1298 tax (7%) + $1238 tax (25%) + $1500 tax (30%)
$40K = $20K + $5K + $5K + 10K => $1298 tax (7%) + $1238 tax (25%) + $1500 tax (30%) + $3000 tax (30%)

Looks like once you cross the 25K to 30K step you are paying 30% taxes on the last amounts.
The lowest tax rate is the $20K level, and if you test it out, the same low level might really extend to $21K or $22K in your situation.

 

[pb4uski]

That is exactly the way to look at it. I would stop at $20k or some point in between $20k and $25k that brings you tot he top of your current tax bracket. To me, paying 25-30% is too much.

Also, be sure to include any applicable state income taxes in your evaluation.

 

[mpeirce]

Another way to look at it:
$20K = $1298 tax (7%)
$25K = $20K + $5K => $1298 tax (7%) + $1238 tax (25%)
$30K = $20K + $5K + $5K => $1298 tax (7%) + $1238 tax (25%) + $1500 tax (30%)
$40K = $20K + $5K + $5K + 10K => $1298 tax (7%) + $1238 tax (25%) + $1500 tax (30%) + $3000 tax (30%)

Looks like once you cross the 25K to 30K step you are paying 30% taxes on the last amounts.
The lowest tax rate is the $20K level, and if you test it out, the same low level might really extend to $21K or $22K in your situation.

This is exactly the exercise I went through a couple of weeks ago. Looking at the incremental tax rate for various amounts is key for ROTH conversions IMHO.

 

[Looking4Ward]

EDIT: I'll start a new thread for a question that would have been off-topic.

 

[Trooper]

Great thread which answers many of my questions also. How do recharacterizations work? I understand that if I OVER-convert from tIRA to Roth in 2016, I can put monies back into the tIRA before filing federal taxes in 2017 (for 2016), once my taxable income is clearer.

Does it also work in reverse? In other words if I UNDER-convert in 2016 can I convert more in 2017 for 2016? If the answer to this is 'no', then I will err on the side of converting too much in 2016.

 

[NgineER]

No, you can only undo parts or all of what you did. It does not work in reverse.

 

[walkinwood]

+1 on a great thread
One recommendation - put those numbers into a tax program to see how they affect taxes. There are so many variables in our tax code that using a spreadsheet or calculator may miss some wrinkle.

 

[walkinwood]

Now I understand. Problem is I've got so much in capital gains between the three funds (I've held them for years now) that it would be difficult to convert them to index funds.

My situation exactly!

Maybe that's what my focus should be over the next few years, converting those funds over time to minimize capital gains tax and then once they are converted be able to take full advantage of the empty "space" to do larger ROTH conversions.

I've come to the conclusion, that in my situation, moving from active to index funds gradually - by using up the 0% Cap gains brackets - is better than doing IRA to ROTH conversions.