How much would you Roth convert?

[Rainbowdash]

Hi, this is a question to all of you experts in the forum. We are a family of 3, 46,45,13. We are retired for about 2 1/2 years already. MFJ taking standard deduction. Our dividends from taxable accounts in 2021 was about $160k, this comes from mostly low fee index funds and covers our yearly expenses without selling shares. However I have a $2.5 M 401k that is pretax. I would like to do some Roth conversion, but how much?

If I don’t do any conversion, I pay very little in taxes. First $115k of dividends is 0% (including HSA and carry over capital loss) next $45k is 15% or $6750 (effective tax rate of 4.2% from my total dividend income) The fact that dividends stack on top of roth conversions, it will make my conversion tax bracket look like this:
1. First $35k will be 15%
2. Next $20k will be 25%
3. Next $35k will be 27%
4. Next $25k will be 30.8% (NIIT added)
5. Next $45k will be 40.8%
6. Next $45k will be 25.8% (yes it goes down)
7. Next $45k will be 27.8%
8. Next $115k will be 24% (yes it goes down again)

Is my math right?

Confession, I always planned to convert to the top of 12% income bracket, little do I know, it starts at 15%. If I convert to the top of 12% income bracket ($115000), I will be paying an extra $27500, for an effective tax rate of 24%

Our goal is not to convert it all as we want to take advantage of QCD at 70 years old and donate the max amount every year to charity. Neither my wife or I have longevity in our family. Any comments are more than welcome

Thank you

 

[RunningBum]

At a glance, the math looks right, just as you say, the dividends stacked on top of regular income get pushed into being taxed so it's 15% + your regular income bracket. I didn't check the bracket limits but I understand the brackets + dividends being taxed for the most part. I guess at some point NIIT goes away to drop you down to 24% at #8?

When you start taking SS, let's say at age 70 to give you the most number of years of conversion, the SS income will be fully taxed because of all that dividend income, so you'll probably be near the top or through the 15%, and maybe well into the 25%. RMDs are going to be running through the 25, 27, 30 and 40% marginal tax rates. So ideally you would want most of your 401K converted (ignoring the QCDs for the moment).

You've got 24/25 years to convert before SS kicks in, and 2 years later, RMDs. And while you are converting that 401k, it is growing, but that's a nice problem to have, right?

I would model this out, forecasting a growth rate on your 401K with reduction of the 401K balance with various conversions. Really, I think there are only 2 or 3 to consider:
- 27% (before NIIT added)
- 30.8% (top of 12% + 15% divs + 3.8 NIIT)
- 24% (top of 24% bracket)

I have a feeling that only going all the way thru #8, top of 24%, is really going to put a dent in your 401K balance. I would do this for the next 4 years, in case rates revert to previous levels in 2026. Then you could reevaluate what to do. If continuing to do these aggressive conversions would leave you with nothing for QCDs, perhaps go to the top of 24% some years, and top of 12% other years. Once you bite off that $45K chunk at 40.8%, you might as well keep going and take another $205K at 25/27/24%, but maybe you don't have to go into 40.8% or even 30.8% every year.

I just reread the last paragraph and see that you want to donate the max to charity every year, which I think is $100K. And I think you can convert the full $100K even if your RMD would be less, correct? In that case, converting to the top of 12% or stopping when NIIT kicks in might work for you. Basically you convert enough to keep it from growing but more or less keep it around $2M to $2.5M for QCDs. But I still think I'd convert to the top of 24% the next 4 years while you know rates are relatively low.

So much can change in the next 20-40 years so you have to stay adaptable, but I think using current tax laws is the way to go, and just adjust as needed. Some here think that Roths might somehow be taxed later, but I doubt that and for my own situation I'm going to get most of my tIRA converted and not worry about that possibility. I like the idea of paying the tax rate at hand and not risking that taxes could be much higher later. The inaction of not doing Roth conversions seems riskier to me with your kind of numbers.

 

[SevenUp]

Not sure where the 40.8% comes from - can you elaborate?

The case study spreadsheet might be useful to you. It will generate a marginal rate chart with minimal input needed from you, if you can use Excel.

 

[Rainbowdash]

At a glance, the math looks right, just as you say, the dividends stacked on top of regular income get pushed into being taxed so it's 15% + your regular income bracket. I didn't check the bracket limits but I understand the brackets + dividends being taxed for the most part. I guess at some point NIIT goes away to drop you down to 24% at #8?

When you start taking SS, let's say at age 70 to give you the most number of years of conversion, the SS income will be fully taxed because of all that dividend income, so you'll probably be near the top or through the 15%, and maybe well into the 25%. RMDs are going to be running through the 25, 27, 30 and 40% marginal tax rates. So ideally you would want most of your 401K converted (ignoring the QCDs for the moment).

You've got 24/25 years to convert before SS kicks in, and 2 years later, RMDs. And while you are converting that 401k, it is growing, but that's a nice problem to have, right?

I would model this out, forecasting a growth rate on your 401K with reduction of the 401K balance with various conversions. Really, I think there are only 2 or 3 to consider:
- 27% (before NIIT added)
- 30.8% (top of 12% + 15% divs + 3.8 NIIT)
- 24% (top of 24% bracket)

I have a feeling that only going all the way thru #8, top of 24%, is really going to put a dent in your 401K balance. I would do this for the next 4 years, in case rates revert to previous levels in 2026. Then you could reevaluate what to do. If continuing to do these aggressive conversions would leave you with nothing for QCDs, perhaps go to the top of 24% some years, and top of 12% other years. Once you bite off that $45K chunk at 40.8%, you might as well keep going and take another $205K at 25/27/24%, but maybe you don't have to go into 40.8% or even 30.8% every year.

I just reread the last paragraph and see that you want to donate the max to charity every year, which I think is $100K. And I think you can convert the full $100K even if your RMD would be less, correct? In that case, converting to the top of 12% or stopping when NIIT kicks in might work for you. Basically you convert enough to keep it from growing but more or less keep it around $2M to $2.5M for QCDs. But I still think I'd convert to the top of 24% the next 4 years while you know rates are relatively low.

So much can change in the next 20-40 years so you have to stay adaptable, but I think using current tax laws is the way to go, and just adjust as needed. Some here think that Roths might somehow be taxed later, but I doubt that and for my own situation I'm going to get most of my tIRA converted and not worry about that possibility. I like the idea of paying the tax rate at hand and not risking that taxes could be much higher later. The inaction of not doing Roth conversions seems riskier to me with your kind of numbers.

Excellent comment RunningBum, very useful. thank you.

Yes #8 tax drop is due to NIIT going away

Your suggestion of converting different amounts every year is well taken. The problem on paying higher taxes is that I’ll have to sell some after tax funds to pay for it and hence incurring in more taxes. So in reality my conversion tax rates are probably even higher than the one I calculated.

The reason I mention about our family longevity is that we both expect to live only till our 70s. So, if I don’t convert anything and RMD starts at 72, it may not be that many years that we will be “killled” by taxes. Our daughter won’t be inheriting this pretax 401k as it will be all donated to charity.

Can you explain how my dividends may be taxed at 25% once I start taking SS?

I believe I can donate $100k per year for QCD even if my RMD is less than that

 

[Rainbowdash]

Not sure where the 40.8% comes from - can you elaborate?

The case study spreadsheet might be useful to you. It will generate a marginal rate chart with minimal input needed from you, if you can use Excel.

Yes 40.8% comes from 22% marginal tax rate plus 15% of my dividends that is “pushed out” of 0% bracket and 3.8% NIIT.

 

[CardsFan]

Our daughter won’t be inheriting this pretax 401k as it will be all donated to charity.

In this case, why are you worried about Roth Conversions?

EDIT: [-]Let the money grow, or start donating now.[/-]

I forgot about the 10% penalty at your age. I would let it grow and start donating when you get to 59.5.

 

[target2019]

You could download Flexible Retirement Planner and try different inputs, etc. to see the scale of what you might accomplish with the conversion. See below for something I spent 5 minutes on to model your question, with 25K conversion each year. I have it going out to 95, and made other guesses, so better inputs will change this.

And of course it's just a picture based on your model inputs and Monte Carlo.

 

[OverThinkMuch]

MFJ has 10% & 12% income tax brackets reaching up to $81k, plus $26k standard deduction. I think you can convert $106,700 of Roth and pay $9328 income tax on just that part.

MFJ for dividends is 15% from $80k to $250k, and then NIIT kicks in until $500k, costing 18.8%. So you pay 15% of $160k, and then NIIT 3.8% on the last $17k. I add that up and get $646 NIIT and $24k from the 15% bracket.

My rough calculations show $34k in taxes for both a $106,700 Roth Conversion and paying tax on $160,000 of dividends. That's how I would take advantage of the 10-12% tax brackets, and pay only a little bit in NIIT.

https://www.nerdwallet.com/article/taxes/federal-income-tax-brackets
https://www.nerdwallet.com/article/taxes/capital-gains-tax-rates

 

[RunningBum]

Can you explain how my dividends may be taxed at 25% once I start taking SS?

85% of your SS will be taxed at regular income rates. If your SS benefit is $40K, for example, that's $34K of taxable income and that will impact your taxes just like $34K of conversions would without SS. So SS uses $34K of your $35K space at 15% (0% regular income and 15% for dividends pushed into being taxed). You get $1K more of conversion/RMD income at that rate, then you start into the 25% space.

 

[Rainbowdash]

In this case, why are you worried about Roth Conversions?

Great question, my understanding is that I can deduct charity contributions from 20% up to 60% of my AGI depending on the charity. I expect my pretax 401k will at least double in value in 13 years when I turn 59 1/2 if I don’t do any conversion and quadruple when RMD starts.

 

[Rainbowdash]

MFJ for dividends is 15% from $80k to $250k, and then NIIT kicks in until $500k, costing 18.8%. So you pay 15% of $160k, and then NIIT 3.8% on the last $17k. I add that up and get $646 NIIT and $24k from the 15% bracket.

My rough calculations show $34k in taxes for both a $106,700 Roth Conversion and paying tax on $160,000 of dividends. That's how I would take advantage of the 10-12% tax brackets, and pay only a little bit in NIIT.

Your calculations are correct, I think there’s a typo and you meant “NIIT kicks in until $250k” for MFJ.

The reason my calculations are different is because I added the 15% of dividend tax as it is being “pushed out” of the 0% bracket

 

[Rainbowdash]

You could download Flexible Retirement Planner and try different inputs, etc. to see the scale of what you might accomplish with the conversion. See below for something I spent 5 minutes on to model your question, with 25K conversion each year. I have it going out to 95, and made other guesses, so better inputs will change this.



And of course it's just a picture based on your model inputs and Monte Carlo.

Thank you will download it and give it a try.

 

[RunningBum]

If you want to do more charitable giving now, I suggest setting up a DAF and funding it with your most appreciated stock/funds from taxable that you'd want to part with. Then you make charitable donations from the DAF on whatever timeline you want.

The advantages are that you get full write-off on the value of the donation and don't have to pay the capital gains on it. You can also clump your donation to the DAF in one or a few years (and itemize deductions those years) and distribute to the charities whenever. The years you donate to the DAF you can make larger Roth conversions since you'll have a larger write-off, and as you note there are limits on how what % of income you can donate in a year so the conversion allows for a larger donation.

It's easy to set up and fund a DAF at Vanguard or Fidelity if you hold an account at either, or transfer to either if you set up the DAF elsewhere. I opened mine at VG where most of my holdings are but moved it to Fido because Fido allows for smaller charity grants. That may not concern you. I was in a time crunch at the end of a year, otherwise I'd have just opened it at Fido and transfer the donated funds in from my VG brokerage account.

I think a DAF is probably more tax advantageous than QCDs because you can donate appreciated funds, and you can do it before age 70 1/2. The advantage of QCDs is that you get the taxable income reduction without itemizing which may be better for some.

 

[RetireBy90]

If you want to do more charitable giving now, I suggest setting up a DAF and funding it with your most appreciated stock/funds from taxable that you'd want to part with. Then you make charitable donations from the DAF on whatever timeline you want.

The advantages are that you get full write-off on the value of the donation and don't have to pay the capital gains on it. You can also clump your donation to the DAF in one or a few years (and itemize deductions those years) and distribute to the charities whenever. The years you donate to the DAF you can make larger Roth conversions since you'll have a larger write-off, and as you note there are limits on how what % of income you can donate in a year so the conversion allows for a larger donation.

It's easy to set up and fund a DAF at Vanguard or Fidelity if you hold an account at either, or transfer to either if you set up the DAF elsewhere. I opened mine at VG where most of my holdings are but moved it to Fido because Fido allows for smaller charity grants. That may not concern you. I was in a time crunch at the end of a year, otherwise I'd have just opened it at Fido and transfer the donated funds in from my VG brokerage account.

I think a DAF is probably more tax advantageous than QCDs because you can donate appreciated funds, and you can do it before age 70 1/2. The advantage of QCDs is that you get the taxable income reduction without itemizing which may be better for some.

+1 but DAF and QCD are from different pots, taxable and Tax Deferred. We use DAF today and will use QCD later when RMDs kick in with remainder of Non-Roth left to charities.

 

[Dash man]

You may want to get a tax planner that understands Roth conversions. There are also a lot of good videos on YouTube than can give you a sense of what you may want to do.
My take at this is you’ll be in a very high tax bracket when you reach RMD age. Minimizing taxes now may not save you the most in the long run. You should include Medicare’s IRMAA impact in your long term planning, along with a one spouse scenario.
You are young and this is the perfect time to do your long term financial planning, including tax and estate planning.
DW and I have about $2.6M left in tax deferred accounts. We are both 65 and doing large Roth conversions up to the top of the 24% bracket minimum. We are biting the tax bullet now to hopefully pay minimal taxes beginning in 2026 when the tax rates revert to pre TCJA. We are in the 4th IRMAA bracket until then and paying NIIT on another capital gains on dividends. But in 2026 and forward, we hope to reap the benefits of our current tax pain.
I also worry about my DW having to pay at single rates, or our son’s inheritance coming during their prime earning years from a tax deferred account.

 

[SevenUp]

Not sure where the 40.8% comes from - can you elaborate?

The case study spreadsheet might be useful to you. It will generate a marginal rate chart with minimal input needed from you, if you can use Excel.

Yes 40.8% comes from 22% marginal tax rate plus 15% of my dividends that is “pushed out” of 0% bracket and 3.8% NIIT.

By the time your ordinary income is taxed at 22%, all your dividends will have been taxed so there will be none left to "push out" from 0% to 15%.

Have you given that spreadsheet a try? It contains the Qualified Dividends and Capital Gain Tax Worksheet where those are split from ordinary income and taxed accordingly so you can see how that works.

Although, it (and probably every tax software) doesn't have the 2022 tax code implemented. For that matter, the major commercial software tools that allow e-filing don't have 2021 fully implemented.

 

[Rainbowdash]

By the time your ordinary income is taxed at 22%, all your dividends will have been taxed so there will be none left to "push out" from 0% to 15%.

Have you given that spreadsheet a try? It contains the Qualified Dividends and Capital Gain Tax Worksheet where those are split from ordinary income and taxed accordingly so you can see how that works.

Although, it (and probably every tax software) doesn't have the 2022 tax code implemented. For that matter, the major commercial software tools that allow e-filing don't have 2021 fully implemented.

Thanks for the correction, you are absolutely right.

I will use the spreadsheet to give it a try, I wish taxes are not as hard as it is…

 

[Rainbowdash]

If you want to do more charitable giving now, I suggest setting up a DAF and funding it with your most appreciated stock/funds from taxable that you'd want to part with. Then you make charitable donations from the DAF on whatever timeline you want.

The advantages are that you get full write-off on the value of the donation and don't have to pay the capital gains on it. You can also clump your donation to the DAF in one or a few years (and itemize deductions those years) and distribute to the charities whenever. The years you donate to the DAF you can make larger Roth conversions since you'll have a larger write-off, and as you note there are limits on how what % of income you can donate in a year so the conversion allows for a larger donation.

It's easy to set up and fund a DAF at Vanguard or Fidelity if you hold an account at either, or transfer to either if you set up the DAF elsewhere. I opened mine at VG where most of my holdings are but moved it to Fido because Fido allows for smaller charity grants. That may not concern you. I was in a time crunch at the end of a year, otherwise I'd have just opened it at Fido and transfer the donated funds in from my VG brokerage account.

I think a DAF is probably more tax advantageous than QCDs because you can donate appreciated funds, and you can do it before age 70 1/2. The advantage of QCDs is that you get the taxable income reduction without itemizing which may be better for some.

That’s a great idea, I forgot to mention on my post I’m intending to leave my after tax amount as inheritance and spending until we die. Anything above federal estate tax limit will be donated to charity. I will consider DAF once I see my after tax account go above estate tax limits.

 

[Rainbowdash]

You may want to get a tax planner that understands Roth conversions. There are also a lot of good videos on YouTube than can give you a sense of what you may want to do.
My take at this is you’ll be in a very high tax bracket when you reach RMD age. Minimizing taxes now may not save you the most in the long run. You should include Medicare’s IRMAA impact in your long term planning, along with a one spouse scenario.
You are young and this is the perfect time to do your long term financial planning, including tax and estate planning.
DW and I have about $2.6M left in tax deferred accounts. We are both 65 and doing large Roth conversions up to the top of the 24% bracket minimum. We are biting the tax bullet now to hopefully pay minimal taxes beginning in 2026 when the tax rates revert to pre TCJA. We are in the 4th IRMAA bracket until then and paying NIIT on another capital gains on dividends. But in 2026 and forward, we hope to reap the benefits of our current tax pain.
I also worry about my DW having to pay at single rates, or our son’s inheritance coming during their prime earning years from a tax deferred account.

Good point on IRMAA impact, I’m definitely going to consider a professional tax planner to help me navigate through this.

I want to mitigate the one spouse scenario by creating a trust when the first one dies. I would put in whatever the max is of that particular year before hitting estate tax limit to benefit our daughter.

 

[Dash man]

Good point on IRMAA impact, I’m definitely going to consider a professional tax planner to help me navigate through this.

I want to mitigate the one spouse scenario by creating a trust when the first one dies. I would put in whatever the max is of that particular year before hitting estate tax limit to benefit our daughter.

My mention of the one spouse scenario was regarding paying taxes on RMDs when filing individual income tax returns. Filing income taxes as an individual when RMDs come due can be brutal.