Cap gains vs Roth conversion

[bloom2708]

I didn't work for part of 2022.

I want to manufacture some income for 2022.

For income tax purposes, is $50k realized capital gains (100% long term gains, taxable account) treated the same as $50k Roth conversion (from Trad rollover IRA)?

I should know this, but I know this fine group knows.

 

[Gumby]

If I understand correctly, you will either 1) sell stock and take capital gains in your taxable account or 2) pull money from your traditional IRA (whether you put it in your Roth or not is irrelevant).

Scenario 1 - if your capital gains are long term (i.e. - from assets held for more than one year), you will pay capital gains tax at either 0% or 15%, depending on your AGI (for MFJ - $83,350 is the cutoff point for 0%). If the gains are from assets held less than a year, they are taxed as ordinary income at whatever your marginal tax rate is.

Scenario 2 - if you take money from a tIRA, it is all taxed as ordinary income at your marginal tax rate. And that is true whether you roll it to a Roth IRA or just take it out and put it in your regular taxable account.

In most cases, I think Scenario 1 would result in lower taxes.

 

[bloom2708]

Thanks Gumby. All "Long term" gains. I will add that to my original post.

I know $50k of Roth Conversions would result in the future gains being not taxed.

Whereas if I harvest the gains in taxable and re-invest in stock index funds, those future gains would be taxable.

Does the gain itself get added to AGI?

 

[Gumby]

Thanks Gumby. All "Long term" gains. I will add that to my original post.

I know $50k of Roth Conversions would result in the future gains being not taxed.

Whereas if I harvest the gains in taxable and re-invest in stock index funds, those future gains would be taxable.

Does the gain itself get added to AGI?

I guess I was assuming you needed the money to spend this year, but you are quite correct. If you Roth convert, future gains will be untaxed.

AGI will include the amount of any capital gains if you sell taxable assets. So, for instance, if you are married filing jointly, had Zero other income, sold assets sufficient to generate $125,900 in long term capital gains*, and took the standard deduction of $25,900 -- you would have an AGI of $125,900, you would have taxable income of $100,000, which would be all long term capital gains. You would pay 0% tax on the first $83,350, You would pay 15% tax on $16,650 for a tax bill of $2498.

If you Roth convert $125,900 out of your tIRA and had Zero other income, you will also have an AGI of $125,900 and taxable income of $100,000. But it will be all ordinary income, so you'll pay 10% of the amount up to $20,550; 12% of the amount from $20,551 to $83,550, and 22% of the amount from $83,551 to $100,000. For a total tax bill of $13,234.




* so, for example, you bought 10,000 shares of XYZ at $1.00 per share and sold it at $13.59 per share. You actually get $135,900 in proceeds from the sale, but $10,000 was your basis, so the capital gain is only $125,900

Note that once your taxable income reaches $459,750, the capital gains tax goes to 20%.
Note also that I assume you have no after tax contributions in your tIRA.

And, most importantly, note that it is AGI that drives taxation of social security, ACA subsidies and IRMAA premiums.

 

[bloom2708]

Perfect. That is the information I needed.

I will have about $40k in income with partial year job. Less 25,900 married standard deduction.

I have $50k in long cap gains in my taxable account.

Was thinking of selling the VTSAX in taxable and buying the same amount of VTSAX [-]after 31 days[/-] in Trad IRA to keep my stock/bond mix.

 

[Gumby]

I don't think you need to wait 31 days. The wash sale rule does not apply to sales for a capital gain, only sales that result in a capital loss.

 

[SevenUp]

If 2022 will be an unusually low income year, doing the Roth conversion usually leads to a better long term result. For some estimates, see the '0% LTCG or t->R' tab in the case study spreadsheet if you can use Excel.

If you just want to estimate tax for this year, Tax estimation tools - Bogleheads may be useful.

 

[bloom2708]

I don't think you need to wait 31 days. The wash sale rule does not apply to sales for a capital gain, only sales that result in a capital loss.

Yes, good point. Usually thinking loss harvesting. Thanks.

 

[Montecfo]

If 2022 will be an unusually low income year, doing the Roth conversion usually leads to a better long term result. For some estimates, see the '0% LTCG or t->R' tab in the case study spreadsheet if you can use Excel.

To be true, it seems like that would require the case for an individual's Roth conversions to be a very strong one, particularly if the alternative is 0% as appears to be the case here.

Or am I missing something?

 

[Gumby]

I agree. Based on his numbers of $40k ordinary income, $50k LTCG and the standard MFJ deduction, he would pay 0% tax on the LTCGs, versus paying about $6000 (12%) on the equivalent Roth conversion.

Let's assume that he takes the $50k and invests in the same stock in Roth on the one hand and in taxable on the other. If his investment rises at 7% per year, every year. In ten years he would sell and have a LTCG of $48,357 if the investment were held in a taxable account. If his situation does not meaningfully change with respect to other income (and the tax law doesn't change), he will probably still pay 0% tax on that gain. So, unless he's facing marginal tax rates up at 24% or so when RMD's hit, he is never likely to break even on the taxes incurred by Roth converting now instead of harvesting untaxed LTCGs in taxable.

 

[Huston55]

OP-

Here's an old thread discussing this for a "prototypical" RE couple. Your situation will almost certainly vary a bit but, there's some good discussion here.

https://www.early-retirement.org/fo...-instead-of-doing-roth-conversions-90648.html

 

[Gumby]

OP-

Here's an old thread discussing this for a "prototypical" RE couple. Your situation will almost certainly vary a bit but, there's some good discussion here.

https://www.early-retirement.org/fo...-instead-of-doing-roth-conversions-90648.html

Thanks for linking that discussion. It's a good one.

 

[SevenUp]

If 2022 will be an unusually low income year, doing the Roth conversion usually leads to a better long term result. For some estimates, see the '0% LTCG or t->R' tab in the case study spreadsheet if you can use Excel.

If you just want to estimate tax for this year, Tax estimation tools - Bogleheads may be useful.

To be true, it seems like that would require the case for an individual's Roth conversions to be a very strong one, particularly if the alternative is 0% as appears to be the case here.

Or am I missing something?

One can try different cases in that '0% LTCG or t->R' tool. It claims

This addresses the situation of being in a low bracket (12% or less) this year and having two possibilities: 1) Tax Gain Harvest: incur Long Term Capital gains but pay $0 federal tax 2) Convert traditional to Roth at 12% federal, with the expectation of being in a higher tax bracket after retirement

 

[Gumby]

I agree. Based on his numbers of $40k ordinary income, $50k LTCG and the standard MFJ deduction, he would pay 0% tax on the LTCGs, versus paying about $6000 (12%) on the equivalent Roth conversion.

Let's assume that he takes the $50k and invests in the same stock in Roth on the one hand and in taxable on the other. If his investment rises at 7% per year, every year. In ten years he would sell and have a LTCG of $48,357 if the investment were held in a taxable account. If his situation does not meaningfully change with respect to other income (and the tax law doesn't change), he will probably still pay 0% tax on that gain. So, unless he's facing marginal tax rates up at 24% or so when RMD's hit, he is never likely to break even on the taxes incurred by Roth converting now instead of harvesting untaxed LTCGs in taxable.

One other thing I forgot to mention is that, unless you pay the tax due on the tIRA withdrawal from other sources, you will only be able put the amount net of taxes into the Roth (in this case, only about $44k), which means it would take even longer to break even versus just harvesting capital gains at 0%

 

[pb4uski]

Perfect. That is the information I needed.

I will have about $40k in income with partial year job. Less 25,900 married standard deduction.

I have $50k in long cap gains in my taxable account.

Was thinking of selling the VTSAX in taxable and buying the same amount of VTSAX [-]after 31 days[/-] in Trad IRA to keep my stock/bond mix.

Yes, as others have confirmed, you could realize $50k of LTCG and pay no tax on those LTCG.

Also, you could do ~$21,850 of Roth conversions and your tax on those Roth conversions would be about $2,441... about 11.2%... probably much lower than you will pay on tax-deferred withdrawals or RMDs once any pensions and SS are going for you.

 

[ERD50]

In case it got missed in the earlier posts, since you had earned income ("I will have about $40k in income with partial year job.") , you can make a direct contribution to your Roth, up to the annual limit for your age. That would have no effect on your taxes (well, a secondary effect if you had to sell some taxable to make up for the money you put into the Roth to support your living expenses - then that would be taxed).

-ERD50

 

[pb4uski]

In case it got missed in the earlier posts, since you had earned income ("I will have about $40k in income with partial year job.") , you can make a direct contribution to your Roth, up to the annual limit for your age. That would have no effect on your taxes (well, a secondary effect if you had to sell some taxable to make up for the money you put into the Roth to support your living expenses - then that would be taxed).

-ERD50

Plus if you are married your spouse can contribute even if s/he didn't have earned income, as long as your income exceeds the contribution limit, which it would at $40k of earned income.