I see your point, and yes, it is likely worth the paperwork. But it still leaves the TIRA with RMDs that will force a 35% tax rate, especially if I delay SS until 70.
For the moment, I have not decided for this year and I'm in the same situation at Al, which is I can control my income to near zero and do a maximum Roth conversion in the 15% bracket. But I'm vacillating on whether I want to establish yet another account for each of us.
Looking back, I wonder if it would have been better had I simply put the "matched" amount into my 401k.
The difference between 35% and 15% on $40K is $8K. Maybe I'm missing something, but it sounds to me like you're viewing this as "all or nothing". Doing a partial conversion is far away from all, but it's sure better than doing nothing.I see your point, and yes, it is likely worth the paperwork. But it still leaves the TIRA with RMDs that will force a 35% tax rate, especially if I delay SS until 70.
You sir are a man of action. I have been looking at the same think and need to pull the trigger.
I want to be sure that I am understanding this issue correctly before 2010 expires.After doing some calcs, it seems to me that you need to keep EVERYTHING under the 15% bracket. Otherwise, not only are you being taxed 15% on the conversion income (assuming that's the bracket your income less divs and LTCG lands), but also 15% for every dollar your divs and LTCGs push you over the 15% bracket, so effectively each dollar over the bracket costs you 30%. Is that right?
Yes, you stack blocks. As long as your stacks together don't go over the 15% mark ($34K for singles), the LTCG and dividends are not taxed. Ideally you push exactly to that limit. Such that your last dollar converted is taxed at 15%, and your LTCG and divs remain untaxed.I want to be sure that I am understanding this issue correctly before 2010 expires.
RB, I cannot understand your meaning in the post quoted above. Under current law, in no case will you ever pay 30% on ltcg(s). You will either pay 0%, or 15%, depending on whether all taxable income including capital gains falls within the 15% bracket. If all taxable income is at or under the 15% bracket, your capital gains will be taxed at 0%, and your ordinary income will be taxed according to where it falls in the 10% or 15% brackets.
In no case will capital gains push your ordinary income into higher brackets. You stack blocks. Ordinary income blocks go on the bottom, and LTCG (&qual divs) get stacked above the ordinary income. As long as your ordinary income blocks do not themselves reach beyond the 15% bracket, your capital gains will not affect the tax you pay on this ordinary income. However, the amount of ordinary income can affect the rate you pay on the ltcg(s), as it can cause them to fall above the 15% bracket, below which they are taxed at 0%, into higher brackets where they are taxed at 15%.
The LTCG direct tax rate will not go above 15%- however if you have very large capital gains it can push your AGI and total taxable income to points where certain deductions, credits, etc. get scaled back or eliminated, so it can effectively raise your total taxes.
The above applies to garden variety low term capital gains, and currently also to qualified dividends. There are special categories of capital gain that do not qualfy for 0% or 15% capital gains tax.
As getting this right is important, I would welcome any comments, criticisms, or additions.
Ha
Yes, you stack blocks. As long as your stacks together don't go over the 15% mark ($34K for singles), the LTCG and dividends are not taxed. Ideally you push exactly to that limit. Such that your last dollar converted is taxed at 15%, and your LTCG and divs remain untaxed.
If you add to the lower bock of ordinary income by converting more of your Roth IRA, part of the upper block now pokes over that 15% line. That amount that is over the line is taxed at 15%. So if you converted $100 too much, that $100 of ordinary income is taxed at 15%, PLUS $100 of your LTCG is now taxed at 15%. That's a $30 tax on that $100 you added. That's the effective 30% rate I mentioned. If you don't have any LTCG or dividends, this doesn't apply.
I put a long post on it here: http://www.early-retirement.org/forums/f28/roth-conversion-question-53607.html#post1010935
Run it through a tax program yourself or let's see if others agree. Sue J had one addendum, that I didn't mention the personal exemption that you deduct from your income.
At the risk (again) of sounding like the one-note song, I have to wonder if the 35% rate will stay at 35% or will it go even higher. (I just assume that lowering the 35% rate will not happen in my life time.) So, if you can convert at 15%, 25%, 28% it would seem like a comparative "bargain". I console myself with the thought that this is a "good" problem to have (though my problem isn't as big as having $2,000,000 ) It just seems that anything you can convert at less than 35% (even if it barely reduces the TIRA nest egg) is a good thing to do. As always, YMMV.
I agree with you that, given a do-over, I would not have put more into the 401(k) than it took to get the match. It was nice at the time, but, come age 70, it's going to feel like major surgery without anesthetic.
Here is my un-anesthetized tax surgery!
An example for a single (keeps things simpler)
Current IRA value = $1,500,000
Age to start Roth Conversion: 59.5
Age to start RMD amounts: 70
So 10 opportunities to do the Roth Conversion (RC).
For 2010, this is the headroom I have available for stacking up my blocks.
15% Bracket $34,000
Exemption $3,650
Deduction $5,700
CarryOver $3,000
Total Headroom = $46,350
These are the 2010 blocks I have to stack.
Dividends = $4,500
STCap Gain = $3,000
Roth Convert = $38.850
Total Stack Value = $46,350
Now if I take my current IRA value and assume that it will earn 5% for the next 10 years. And during that 10 years, I take out $35,000 each year as a Roth Conversion. Using Excel, here is my IRA’s performance until age 70.
2010$1,500,0002011$1,534,2082012$1,610,9182013$1,691,4642014$1,776,0372015$1,864,8392016$1,958,0812017$2,055,9852018$2,158,7842019$2,266,7232020$2,380,059
Therefore, in 2020, I will be required to take an RMD of (1/24.7)= 4% of $2,380,059 = approx $100,000.
I will also have $35,000 of Social Security coming in at age 70. Gains from my taxable portfolio might also need to be taken, and so I fear a 33% tax bracket at age 70.
So what happened to the concept that putting away in a 401k would lead to paying less taxes?
The myth unraveled?
If only I had been similarly duped! Oh, the pain of it!Interesting that I feel duped by "conventional wisdow".
Yes, as long as you don't hit the estate tax. Then you are better off paying the income tax on the conversion if it will bring you down under that cap.An important consideration is if you have heirs, if they are in the %15 tax bracket, and you won't be spending down your IRA, it would be just as well for them to inherit an IRA and pay 15% as oppose to you paying 25% to do the conversions.
TJ
Zero, do you really have $1.5M or thereabouts in your 401K/IRA? Wow, what a great problem to have! Congrats!
Three observations:
1) If you convert $35K each year for 10 years, that's $350K converted at an 18% lower tax bracket, or $63K saved on taxes. It's actually a bit better since some of that conversion is taxed in the 10% bracket, and the part that offsets your deductions+exemption is free.
2) How about converting up to the top of the 28% bracket each year? Converting ~$170K each year for 10 years will bring your IRA down quite a bit. Maybe to the top of 25% is enough. Run your numbers and see how it looks. That amount over the first $350K won't be nearly as good as the 18% gain as the first part, but even if you get a 3% gain on the next million that's another $30K. I'm not sure how your numbers will actually work out but it's worth a look.
I know I talked about that hidden "30%" rate, but you're only looking at $7500 taxed at that rate before you fall back to a real 25% rate since there will be no more of the divs + ltcg block getting pushed above the $34K line.
3) Which tax bracket where you in when you contributed most of the 401K money? Remember that this was taken off the top so that's money that would've been taxed at the highest rate you were at. Now when you convert and withdraw, you are filling in the lower brackets first and finally may peak at 28% or 33%. I don't think you were duped as badly as you think you were.
However, that does make a point that if you are going to have a successful career and have a good income in retirement, it may not make that much sense to slam all you can in a 401K in your early 20s when you are in a lower tax bracket. Just getting the company match may be all you want to do. But how does one know?
zero,
i took a look at your ira example with the same thought that runningbum stated i.e. that you should do some conversion at higher tax brackets. when i did this i found some things.
1) if you fill up the 25% tax bracket for those years then at in 2020 it looks like you will have less in your ira than you have now and the RMD wont push you out of the 25% tax bracket.
2) if you fill up the 28% tax bracket with conversions over that decade your ira will be almost entirely converted by 2020
3) the numbers you posted as ira balances after 2011 dont show that you are doing the converting you said you did. eg. the 2012 balance is 5% higher than the 2011 balance so no conversion was made.
and my analysis didnt increase the tax brackets for inflation which means that you would be able to convert even more than my analysis did and therefore your ira balance will be even smaller making the RMD smaller also