Questions on doing the first Roth Conversion at age 68

[NXR7]

We're looking at buying a manufactured home in Florida after selling our motorhome. For now we will retain our home in Ohio.

It looks like a Roth conversion yet this year can help us because we want as little a mortgage as possible. But I've never done one so here comes the data and questions.

Thanks for any guidance you can lend.


- Married filing jointly. Both people in their 60's, one 68 on Medicare and one 63 not. Health, so far, is good for both.

- My Roth IRA at Fidelity has a few hundred dollars in it but has been open at Fidelity for well over five years.

- Due to taxable dividends I believe that our taxable Social Security will always be at 85%.

- No ACA subsidies but my wife is on ACA for another year and a half.

- I think IRMAA is the biggest concern but am not sure. I do not believe we have any income that would materially raise AGI to MAGI.

- Calculators show my annual RMDs likely will be in the $30,000 range when they start in 2028 (I'm 68).

- Our federal tax rate last year was 7.6% (Turbotax's "effective tax rate"). The AGI amount was $85,000

- Our state (Ohio) tax rate was 1.5%

- We have very little variability in our income. The only thing that is COLA'd is Social Security.


The pre-tax account I would need to convert is about $225,000 in an old 401(k). It, too, is held at Fidelity. As I understand it, I would need to rollover the 401(k) to a traditional IRA first since the 401(k) does not allow partial liquidations. The money would stay at Fidelity to steamline the processes.


- The 22% tax bracket ranges from $89,451 to $190,750 for Married Filing Jointly in tax year 2023. So we're right at the threshold of having a 22% tax rate on some income due to our $85,000 AGI (last year). A Roth conversion definitely would be taxed at 22% federally.

- The IRMAA limit for a married couple is $194,000 for tax year 2023.

- To stay comfortably below triggering IRMAA I'm thinking an $80,000 Roth conversion could work. 22% of $80,000 is $17,600 plus whatever Ohio would ding me for. I'd probably end up with $60,000 spendable.


Other than the "death of a spouse thing" it seems the only benefit a Roth conversion yet this year would do is reduce the amount of pre-tax money withdrawal next year to keep our or IRMAA Land.


QUESTION: Since the 22% tax bracket starts at just $3,000 above our current AGI, effectively all of the conversion will be at 22% federal plus Ohio's cut, right?

QUESTION: If the above statement about 22% is correct then I see no real tax savings with an IRA conversion now or never. Is this correct?

QUESTION: If so, the only real advantage to an Roth IRA conversion is the reduction in the tax rate when one of us dies. (Plus the ability to withdraw more pre-tax IRA money next year without triggering IRMAA). Is that correct?

Again, thanks for any guidance or thoughts you can lend.

 

[GrayHare]

Sounds like you have a pretty good handle on things. Yes, your tax rate when you make the withdrawals is the key factor in any decision about when to convert.

 

[pb4uski]

I think that you are confusing AGI with Taxable Income (TI). The difference is deductions, and in most cases standard deduction which is $29,200 for MFJ with one person 65 or older for 2023. If your 2022 AGI was $85,000 as stated in the OP then your 2022 taxable income would have been ~$57,700.

The $89,450 that you quote is the top of the 12% tax bracket for 2023 and is taxable income, not AGI. So because of the standard deduction your AGI can be as much as $118,650 and still be in the 12% tax bracket.

Since you have dividends, you may want to fine tune it and stay within the 0% capital gains tax bracket which is taxable income of $89,250 for 2023, so adding in the $29,200 standard deduction that would be $118,450 of AGI that you could have and stay in the 0% capital gains tax bracket.

So subtract your AGI before any Roth conversions from the $118,450 and you'll get the amount that you can Roth convert without going over and it would probably be all at 12%, not 22%.

https://www.irscalculators.com/tax-calculator

 

[NXR7]

I think that you are confusing AGI with Taxable Income (TI). The difference is deductions, and in most cases standard deduction which is $29,200 for MFJ with one person 65 or older for 2023. If your 2022 AGI was $85,000 as stated in the OP then your 2022 taxable income would have been ~$57,700.

The $89,450 that you quote is the top of the 12% tax bracket for 2023 and is taxable income, not AGI. So because of the standard deduction your AGI can be as much as $118,650 and still be in the 12% tax bracket.


Since you have dividends, you may want to fine tune it and stay within the 0% capital gains tax bracket which is taxable income of $89,250 for 2023, so adding in the $29,200 standard deduction that would be $118,450 of AGI that you could have and stay in the 0% capital gains tax bracket.

So subtract your AGI before any Roth conversions from the $118,450 and you'll get the amount that you can Roth convert without going over and it would probably be all at 12%, not 22%.

Ahh, thanks! Does the pic clarify things as to our income and taxes for 2022? I rounded the previous numbers off a bit in my first post.

None of the dividends are qualified because they are all in a 401(k). Had I known better, I would have immediately sold that company stock upon retirement to get it out of the 401(k) and immediately repurchased the stock. But that ship has sailed.

 

[GrayHare]

If all your dividends are received in a 401k, their qualification is irrelevant. Dividends, interest, cap gains, etc. all get blended together in a retirement account, which means their origin has no significance tax wise.

 

[qwerty3656]

My knee jerk reaction not diving too far into the numbers is that it seems that converting at the 22% rate may not be worth it. $30k a year in RMDs is pretty manageable. I would be surprised if you really lowered your overall tax liabilty. You should definitely do some projections and really confirm that you are lowering your RMD tax rate below 22% by converting now at 22%.

 

[gauss]

I have used i-orp.com in the past to perform lifetime studies of when to do Roth Conversions. It has a bit of a learning curve but may be useful. It basically tries to maximize the spending that you have available over a lifetime via mathematical optimization techniques.

If you do choose to use i-orp.com , I recommend putting in very simple examples first so that you can understand and interpret the report results correctly. You can then slowly add information/complexity to see how the reports change.

-gauss

 

[Al18]

Using Pb4uski numbers and advice, you should be able to convert $34000 from your 401k to a Roth IRA for this year and stay in the 12% bracket. You could pay taxes at the same time by calling up your Fidelity contact and having them withhold 10% for Federal Tax and 2% for Ohio tax, with $29,920 going into your RothIRA.

You could run the online calculator Pb4uski linked above to check these numbers.

It may take a few days for Fidelity to convert your 401K to a Rollover IRA and then do the Roth IRA conversion, so you shouldn’t wait too long if you go this direction. All the conversions need to be complete by 12/31/23

 

[pb4uski]

Ahh, thanks! Does the pic clarify things as to our income and taxes for 2022? I rounded the previous numbers off a bit in my first post.

None of the dividends are qualified because they are all in a 401(k). Had I known better, I would have immediately sold that company stock upon retirement to get it out of the 401(k) and immediately repurchased the stock. But that ship has sailed.

Yes. Do you have any LTCG? Since you don't have dividends I'll assume not for now. So if for 2023 your income before any Roth conversions was $85,000 then yout TI would be $55,800... in the 12% tax bracket which spans from $22,000 and $89,450 and your tax would be $6,256.

If you want to convert to the top of the 12% bracket then you could convert $33,650. That would increase your taxable income to $89,450 and increase your taxes to $10,294.

The $4,038 increase in tax due to the $33,650 Roth conversion is an effective tax rate on the conversion of 12%.

If you convert an additional $100, your tax increases to $10,316, by $22 because you are then in the 22% bracket.

IRRMA will not be an issue for you.

 

[Al18]

I ran the online calculator linked above. I suggest a small change to my post above. If you convert $33000 you should probably withhold 10% Federal tax and 3% Ohio tax.

I reduced the conversion amount by $1000 to keep you in the 12% bracket.

My AGI is slightly higher than yours and I’ve been making RothIRA conversions for a few years. I’ve found withholding 10% Federal taxes has worked well and resulted in a small tax refund when filing taxes.

 

[N02L84ER]

So if for 2023 your income before any Roth conversions was $85,000 then your TI would be $55,800... in the 12% tax bracket which spans from $22,000 and $89,450 and your tax would be $6,256.

If you want to convert to the top of the 12% bracket then you could convert $33,650. That would increase your taxable income to $89,450 and increase your taxes to $10,294.

The $4,038 increase in tax due to the $33,650 Roth conversion is an effective tax rate on the conversion of 12%.

If you convert an additional $100, your tax increases to $10,316, by $22.

I agree with this. In your situation, I would convert $33,650.

 

[NXR7]

Thanks! I did take $13,200 from an inherited traditional IRA this year to pay for house painting and new gutters. That more than satisfies the RMD for that account.


So if I play it safe and decide to rollover $33,000 minus $13,200 I could rollover $20,000 to my Roth from other pre-tax accounts and probably stay in the 12% bracket, right?


I do take 10% for federal and 3% for state taxes out of all pre-tax withdrawals. That would net me $17,400 in the Roth.


Did I figure that correctly?

 

[GrayHare]

You will lose much of the advantage of converting to Roth if you withhold for taxes, i.e. if you pay taxes from the tIRA money itself. Instead, roll the full amount to Roth and pay the taxes with non-tIRA dollars.

 

[Out-to-Lunch]

You will lose much of the advantage of converting to Roth if you withhold for taxes, i.e. if you pay taxes from the tIRA money itself. Instead, roll the full amount to Roth and pay the taxes with non-tIRA dollars.

You are right, of course, that it's better to pay for taxes from non-IRA funds if those are available.

However, I think the OP is mostly looking to spread the tax bite for a large, lumpy withdrawal over two or more tax years. Tax-free grow of some funds that are currently in taxable accounts is not the main concern here. So I don't think, in this case, he loses "much of the advantage of converting to Roth."

 

[sengsational]

Your questions really are about getting the best deal from now until "plan sunset", which makes the i-orp results, as gauss suggests, a good thing to understand.

It can be interesting to flip Roth conversions on and off, and see what it does to the level, every year spend that is the model output.

My broken record comment with i-orp is not to have a different equity/bond split in the different buckets (tIRA, Roth, after tax). So use the average split in all buckets. Otherwise it will skew on expected rate of return, rather taxes.

Two typical observations include "wow, mega conversations" and after switching off conversions "wow, doesn't make too much difference". And the two together often results in deciding on smaller conversions. One last thing ...I'm new to IRMAA, and so I don't know how or if i-orp considers that.

 

[GrayHare]

OP is more likely to have medical deductions in the future that will reduce the effective tax rate on RMDs. That savings is lost by converting now while there are not such expenses to deduct.

 

[SnowballCamper]

OP is squarely in the 12% bracket and over 59.5. Did I miss something that puts the OP in a different tax bracket in the future... over ~30k more taxable income? What's the long term plan for the dollars being rolled into a Roth that makes it advantageous to convert?

QUESTION: If the above statement about 22% is correct then I see no real tax savings with an IRA conversion now or never. Is this correct?

I think this is correct.

 

[sengsational]

OP is more likely to have medical deductions in the future that will reduce the effective tax rate on RMDs. That savings is lost by converting now while there are not such expenses to deduct.

This year MFJ standard deduction is $27,700. And you need to spend 7.5% AGI for the medical spending to start to count. I might not have this right, but it seems to me that if you have health insurance and a paid-off house, you'll be taking the standard deduction. Doesn't that mean there's no tax advantage to be gained from possible increased medical spending? I figure if I spend more than my max out of pocket (say $8,000) in a year, I did something wrong. And that should be much less when on traditional Medicare with medigap. Usually I have to model stuff like this in a spreadsheet to be sure, but this one I haven't modeled, but only because the medical deduction seemed like a non-starter.

 

[pb4uski]

...Did I miss something that puts the OP in a different tax bracket in the future... over ~30k more taxable income? What's the long term plan for the dollars being rolled into a Roth that makes it advantageous to convert?...

The OP hasn't mentioned SS so I presume that he isn't collecting SS yet and adding 85% of SS will get him much deeper into the 12% bracket. If that is the case then RMDs would be a combination of 12% and 22% based on current rates... so 12% now is preferable to 12% and 22% later. Besides, it soulds like he has plans for the funds.

 

[NXR7]

Do you have any LTCG? Since you don't have dividends I'll assume not for now.

Not really. The stock I hold is all in a 401(k) and provides about $29,000 in pre-tax dividend income. That essentially "eats up" all of the Married Filing Jointly standard deduction.

Yes, that's considered high risk, I know. But I used to work for that company and they are as solid a company financially and culture-wise as there is. I'm comfortable with that risk.

If I continue to collect the same dividend for another six years I will have received as much in dividends as the stock was worth when I retired, and I'll still have the stock. One of the company's stated goals is to continue the dividend. I don't really care how much the stock price fluctuates because neither does the company management. The shareholders are along for the ride, so to speak. Selling that 401(k) stock probably will be the last retirement savings I'd sell.

You will lose much of the advantage of converting to Roth if you withhold for taxes, i.e. if you pay taxes from the tIRA money itself. Instead, roll the full amount to Roth and pay the taxes with non-tIRA dollars.

I've never really understood this although I've read it a lot. Right now our monthly expenses are paid for by a combination of SS, a meager pension, and the above-noted dividends. There isn't really anything left over to pay thousands more in taxes from after-tax existing funds so it's kind of a moot point.

OP is squarely in the 12% bracket and over 59.5. Did I miss something that puts the OP in a different tax bracket in the future... over ~30k more taxable income?

What's the long term plan for the dollars being rolled into a Roth that makes it advantageous to convert?

Great question. We currently "snowbird" from the north to Florida in a 5 year-old gas motorhome. We want to sell the motorhome and use its proceeds to partially fund a manufactured home purchase in the Naples, Florida area. I need to fund the other part somehow.

The motorhome should net us between $90,000 and $100,000 if I sell it myself, less if we consignment sell it. How long it will take is anyone's guess. A recent manufactured home on leased land will be in the neighborhood of $230,000 to $290,000.

We will retain our home up north for now. We have an ELOC on it already that paid for some improvements so I do not want to tap the remaining equity in the ELOC unless I had to.

The operational and maintenance expenses of the motorhome (gas/reservations for places to stay, etc.) can cost upwards of $10,000 a year which would be put towards expenses of a manufactured home.

Essentially the current motorhome and related expenses are a wash with what we know other people are paying for lot rent/insurance/utilities/etc on manufactured homes in the community we're looking at.

As an aside, $2,000 a month or more is the norm to rent a small piece of dirt to park an RV on in southern Florida during January, February, and March.

Obviously paying 12% tax versus 22% tax on a rollover is a good plan. I also cannot rollover so much money that I trigger IRMAA.

The more I could rollover to a Roth lessens the chances of triggering IRMAA in the future while also lessening how much money we would need to borrow to complete a purchase.

The OP hasn't mentioned SS so I presume that he isn't collecting SS yet and adding 85% of SS will get him much deeper into the 12% bracket.

We both are collecting SS. We are paying 85% on SS now (1040 line 6a) so that cannot go up unless the law changes.

Thanks for all of your thoughts and questions.

 

[GrayHare]

For a given tax rate, converting to Roth offers no benefit unless the tax is paid from funds coming from outside the IRA. That's the commutative property of mathematics in action. It tells us that "pay tax now then compound later" results in the same ending total as "compound now then pay tax later."

 

[SevenUp]

- I think IRMAA is the biggest concern but am not sure. I do not believe we have any income that would materially raise AGI to MAGI.

In that case, Roth Conversion with Social Security and Medicare IRMAA could alleviate (or cause) concerns.

- No ACA subsidies but my wife is on ACA for another year and a half.

If that were an issue, the similar Roth Conversion and Capital Gains On ACA Health Insurance article would be useful.

 

[SnowballCamper]

OP it seems to me you're wanting to spend some money on a Florida home, and I would certainly consider it ok to draw down retirement funds before RMDs in order to make such a purchase. Since you're over 59.5 you can do this any way you want... and avoiding the next tax bracket is certainly prudent, because it likely reduces higher taxes later.

I'm not sure how doing a Roth Conversion facilitates the new home purchase...

FWIW I elected to start drawing down my TSP (similar to 401k) decades before RMDs, in order to flatten the taxes paid over the future years.

Good luck!

 

[pb4uski]

...I'm not sure how doing a Roth Conversion facilitates the new home purchase...

In their case they have yet to find the house but are preparing... the money can sit in the Roth and growth will be tax free until they need the money at which time they can withdraw it from the Roth.

 

[SnowballCamper]

But you have to pay the tax now, and don't get any growth on that, which makes it a wash...

Convert 10,000 and pay tax with other funds:
At 12% marginal rate this costs $1,200 and you have future growth of some %, say 8%, so after conversion and withdraw from the Roth you have spent $1,200 in tax, withdrawn $10,000, and end up with $10,800 after growth.

Don't convert $10,000, and assume the same growth on the funds used to pay the tax in a future year:
The 10,000 grows at the same 8% to $10,800 and is then taxed at 12% upon withdrawal, $1,296. Also the $1,200 that you didn't use to pay tax has grown 8% as well, to $1,296. You end up with $10,800 in this scenario as well. And the cost in initial year dollars is the same...