Rethinking my yearly Roth conversions

[FREE866]

Here's my situation:


I'm 57 years old, retired and my plan (for now) is to take SS at 67.
I've been doing partial Roth conversions for the last four years to the top of the 12% bracket. I pay the taxes on the conversions out of my regular personal taxable brokerage account.



When I run my numbers I realize that RMDs won't be required until 75 and that and SS will have me still in the same tax bracket I am now. I liked the idea of having a large Roth in the future, but now I'm thinking why use my taxable brokerage account money to pay taxes when I can keep it invested by not doing Roth conversions?
I initially thought that years out my tax bracket would definitely be higher than it is now, but that might very well not be the case.


Thoughts or any insight would be welcome.


Thank you.

 

[Wile E. Coyote]

Diversification with Taxable versus Non-Taxable seems worthwhile.

You can take a break on conversions and you still have time to decide to do some more or not.

 

[RetiredHappy]

We have never done ROTH conversions and we have been retired for 8 years. We are in the 24% tax bracket already (different problem) but I do view it that when I hand over my taxable account money to pay taxes for ROTH conversions, I am not only paying those taxes ahead of when RMD is triggered, but the loss in the capital gains of those money as well.

 

[Dtail]

If you remain in the same bracket at RMD time, it might not make sense to convert more.
We gave up larger conversions due to large ACA tax subsidies as a substitute.
Next year on Medicare, so still reviewing next steps before RMD's at 75.

 

[FREE866]

If you remain in the same bracket at RMD time, it might not make sense to convert more.

That is the big unknown.


If over the next 18 years the Traditional IRA soars in value ( which is entirely possible given it's all stock) the RMD could be 6 figures, thus propelling me into a higher bracket. The other possibility is that RMDs , by then, go away. Not probable , but I think a greater possibility than it used to be.


I've always though liked the idea of having a nice fat Roth 10-20 years down the road.



Appreciate all the comments.

 

[SevenUp]

I've been doing partial Roth conversions for the last four years to the top of the 12% bracket. I pay the taxes on the conversions out of my regular personal taxable brokerage account.

When I run my numbers I realize that RMDs won't be required until 75 and that and SS will have me still in the same tax bracket I am now.

1) Paying the tax from your taxable account means "tie (in marginal rates between now and later) goes to the Roth." See "Traditional plus taxable" vs. Roth.

2) Your marginal tax rate - either now or in the future - may not be the same as your bracket rate, due to how qualified dividends (see example in the wiki linked earlier in this sentence) and/or how Taxation of Social Security benefits works.

Have you looked at your current and expected marginal tax rates?

 

[FREE866]

1) Paying the tax from your taxable account means "tie (in marginal rates between now and later) goes to the Roth." See "Traditional plus taxable" vs. Roth.

2) Your marginal tax rate - either now or in the future - may not be the same as your bracket rate, due to how qualified dividends (see example in the wiki linked earlier in this sentence) and/or how Taxation of Social Security benefits works.

Have you looked at your current and expected marginal tax rates?

My current effective fed rate is 4% and state/city is 8.8%


no idea what future will be

 

[pb4uski]

Here's my situation:


I'm 57 years old, retired and my plan (for now) is to take SS at 67.
I've been doing partial Roth conversions for the last four years to the top of the 12% bracket. I pay the taxes on the conversions out of my regular personal taxable brokerage account.



When I run my numbers I realize that RMDs won't be required until 75 and that and SS will have me still in the same tax bracket I am now. I liked the idea of having a large Roth in the future, but now I'm thinking why use my taxable brokerage account money to pay taxes when I can keep it invested by not doing Roth conversions?
I initially thought that years out my tax bracket would definitely be higher than it is now, but that might very well not be the case.


Thoughts or any insight would be welcome.


Thank you.

If you're darn, tooting sure that you will be in the 12% tax bracket once SS and RMDs start then there is no real benefit to doing 12% Roth conversions... IOW, paying 12% now or 12% later doesn't matter.

One way to quickly test the hypothesis is to assume that you started SS today and had RMDs starting today and what tax bracket would you be in when SS and RMDs are added to whatever other income that you might have. Many people would end up in a higher tax bracket, but it is situational.

However, the whole notion of keeping brokerage account money invested by not doing Roth conversions is a red herring... it doesn't work.

Let's take a small example that you have $10,000 in a tIRA and $1,200 in a taxable account and are in the 12% tax bracket now and later. To keep it simple let's say that invetments double in 10 years.

Option 1 would be to convert. You end up with $10,000 in a Roth and nothing left in taxabe since the $1,200 is used to pay the taxes on the conversion. The $10,000 Roth doubles over 10 years and is worth $20,000 in 10 years.

Option 2 would be to wait and withdraw at end of 10 years. The tIRA doubles to $20,000 and the taxable account doubles to $2,400. When the $20,000 is withdrawn and 12% taxes of $2,400 paid from the taxable account, you still ony have $20,000 left to spend.

So if there is no tax rate arbitrage then there is no economic benefit.

* actually there might be a small economic benefit to the Roth because if the annual growth on the $1,200 in taxable account money is taxed every year then it wouldn't really double to $2,400, but would be $2,214 (1200*(1+7.18%*(1-12%))^10) so the Roth actually has a slight advantage.

 

[SevenUp]

1) Paying the tax from your taxable account means "tie (in marginal rates between now and later) goes to the Roth." See "Traditional plus taxable" vs. Roth.

2) Your marginal tax rate - either now or in the future - may not be the same as your bracket rate, due to how qualified dividends (see example in the wiki linked earlier in this sentence) and/or how Taxation of Social Security benefits works.

Have you looked at your current and expected marginal tax rates?

My current effective fed rate is 4% and state/city is 8.8%

The effective rate doesn't matter. See Marginal Vs Effective Tax Rates And When To Use Each.

Have you looked at your marginal rates? The case study spreadsheet (looks like that was used to generate the charts in the linked wiki articles) can be helpful to look at your situation.

 

[FREE866]

The effective rate doesn't matter. See Marginal Vs Effective Tax Rates And When To Use Each.

Have you looked at your marginal rates? The case study spreadsheet (looks like that was used to generate the charts in the linked wiki articles) can be helpful to look at your situation.

Marginal fed rate is 12%


State marginal rate is 8.8%


My previous comment on state was confusing...sorry

 

[FREE866]

If you're darn, tooting sure that you will be in the 12% tax bracket once SS and RMDs start then there is no real benefit to doing 12% Roth conversions... IOW, paying 12% now or 12% later doesn't matter.

One way to quickly test the hypothesis is to assume that you started SS today and had RMDs starting today and what tax bracket would you be in when SS and RMDs are added to whatever other income that you might have. Many people would end up in a higher tax bracket, but it is situational.

However, the whole notion of keeping brokerage account money invested by not doing Roth conversions is a red herring... it doesn't work.

Let's take a small example that you have $10,000 in a tIRA and $1,200 in a taxable account and are in the 12% tax bracket now and later. To keep it simple let's say that invetments double in 10 years.

Option 1 would be to convert. You end up with $10,000 in a Roth and nothing left in taxabe since the $1,200 is used to pay the taxes on the conversion. The $10,000 Roth doubles over 10 years and is worth $20,000 in 10 years.

Option 2 would be to wait and withdraw at end of 10 years. The tIRA doubles to $20,000 and the taxable account doubles to $2,400. When the $20,000 is withdrawn and 12% taxes of $2,400 paid from the taxable account, you still ony have $20,000 left to spend.

So if there is no tax rate arbitrage then there is no economic benefit.

* actually there might be a small economic benefit to the Roth because if the annual growth on the $1,200 in taxable account money is taxed every year then it wouldn't really double to $2,400, but would be $2,214 (1200*(1+7.18%*(1-12%))^10) so the Roth actually has a slight advantage.

Thx for all that




the "hypothetical test" is really not a fair test because in 17 years my RMD will be so much greater than it would be if I started it today using the current balance.


but assuming even just a 7% growth in the next 18 years on the TIRA , yes the RMD will be huge and would send me into the 24% bracket from todays 12%

 

[SecondCor521]

I think Roth conversions work well when one knows that there will be a measurably higher total marginal rate (fed + state + IRMAA + ACA + whatever else) later that can be avoided by converting now.

If I were in the OP's situation where it's likely the same bracket now or later, I'd probably hold off and do watchful waiting, maybe converting some later as the situation becomes clearer.

I understand the "tie goes to the Roth" idea, but I think a more important consideration is the "risk asymmetry" argument, which is that needlessly excessive conversions are more damaging than unnecessarily conservative non-conversions. In the former case, you may have paid too much in taxes and you discover that when you are running out of money. In the latter, your money is compounding out of control and you could have converted some earlier but paying 28% when you've got "too much" money is more of a theoretical problem than an actual one.

 

[pb4uski]

Thx for all that




the "hypothetical test" is really not a fair test because in 17 years my RMD will be so much greater than it would be if I started it today using the current balance.


but assuming even just a 7% growth in the next 18 years on the TIRA , yes the RMD will be huge and would send me into the 24% bracket from todays 12%

So from what you wrote here it sounds like you are better off paying 12% now than more than 12% later.

 

[FREE866]

So from what you wrote here it sounds like you are better off paying 12% now than more than 12% later.

Right. 18 years is a long time so based on FIRECALC etc if I do no conversions I'm looking at tripling my TIRA balance which would result in hefty RMDS. Maybe I'll do Roth conversions for the next 10 years until I hit 67 and start taking SS. I know a lot can change with planning so we'll see.

 

[RunningBum]

Also keep in mind that the 12% bracket is scheduled to turn into 15% unless action is taken. Doing another year at 12% doesn't compel you to keep doing them every year.

 

[SecondCor521]

Right. 18 years is a long time so based on FIRECALC etc if I do no conversions I'm looking at tripling my TIRA balance which would result in hefty RMDS. Maybe I'll do Roth conversions for the next 10 years until I hit 67 and start taking SS. I know a lot can change with planning so we'll see.

I do an iterative approach. I have my own prediction for what my tax bracket will be later, and convert this year based on that. Then next year, I update the IRA balances, tax brackets, etc. and repeat the conversion decision process.

This way I hope to do at least a reasonable job of converting the "right" amount over time. I doubt I'll get it exactly right in retrospect but at least it should hopefully be close.

(Roughly speaking I think I'll pay 25%-30% later, so I tend to be willing to pay somewhere between 20%-25% now. With a 30 year planning horizon I don't think my estimates can be much more precise than that.)

 

[Exchme]

...

but assuming even just a 7% growth in the next 18 years on the TIRA , yes the RMD will be huge and would send me into the 24% bracket from todays 12%

Given that you will be in the 24% bracket in the future, Roth Conversions through the 22% bracket now are probably favorable (you didn't mention ACA so I assume you don't need to limit income for that). In addition to the obvious point that 22%<24%, current tax rates are scheduled to go up in 2026, so 24% will become 28%, and you are not currently subject to IRMAA, IRMAA will add about another 5% to your marginal tax cost once RMDs start. Once IRMAA enters your life, my guess is converting to the top of the base IRMAA tier is still likely to be profitable.

 

[Al18]

I’m also Roth converting up to the 12% bracket, but paying the taxes out of the IRA.

You can move assets in kind, from IRA to Roth. Ideally, you want your quickest appreciating assets in the Roth, while the slower appreciating assets (balanced funds and fixed) in your regular IRA.

8.8% marginal rate to state/city is really high - are you in NYC? You may want to consider moving about 80 miles south to the middle of NJ. Considerably lower state taxes, and an extra tax break once you are 62 where much of your retirement withdrawals are not taxed.

 

[DrRoy]

If you pay now, you are presumably doing it on a smaller amount. All the growth in the Roth account will be untaxed.

 

[FREE866]

I’m also Roth converting up to the 12% bracket, but paying the taxes out of the IRA.

You can move assets in kind, from IRA to Roth. Ideally, you want your quickest appreciating assets in the Roth, while the slower appreciating assets (balanced funds and fixed) in your regular IRA.

8.8% marginal rate to state/city is really high - are you in NYC? You may want to consider moving about 80 miles south to the middle of NJ. Considerably lower state taxes, and an extra tax break once you are 62 where much of your retirement withdrawals are not taxed.

That's what I do--I move ETFs in kind from IRA to Roth.



Yes, I'm in NYC. The extra tax savings I get from a move to NJ would be very small in the big picture. I have an excellent housing situation in NYC.

 

[CincyDave]

If you pay now, you are presumably doing it on a smaller amount. All the growth in the Roth account will be untaxed.

This ^^^ Plus having more available in ROTH makes it easier to control income for things like IRMAA.

 

[thefist]

I’m one year older than you. Here’s a few more things to consider.

I didn’t see your asset allocation, but you said your IRA is all stock. Well, get your bonds or any alternatives in there. This will slow down the appreciation of the IRA and defer taxes on any interest until you decide to withdraw the funds.

You’re 59.5 soon. Begin small withdrawals that year instead of conversions. The conventional wisdom of spending order, taxable/deferred/roth, is not tax efficient. You’ve already seen you have potentially high RMDs later. At earliest opportunity, begin withdrawals from the IRA to at least fill the standard deduction, 10%, and possibly 12% bracket. Take the rest from taxable. This method will reduce the IRA balance and thus RMDs.

One can drive themselves bonkers about OPTIMIZATION. We don’t know future market returns, interest rates, tax rates, inflation, our health and date of death. Seek obvious IMPROVEMENT instead.

A Roth can be very valuable for large sum withdrawal. Say you were able to contribute or convert $7000 for 5 years. Later it has grown to $50k. Withdraw that in one lump sum to buy a car or another large expense, tax free. In small $7000 increments from the IRA it might not raise your marginal rate, but $50k lump withdrawal is likely to. Advantage Roth there.

 

[old medic]

, paying 12% now or 12% later doesn't matter

Well depending on investment growth, You could be paying that 12% on a lot more money... And then what if tax rates get raised in the future.
We started our Roths a couple years back, not started conversions yet. But our goal in the end is a nest egg to fall back on for BTD stuff, and what's left is for the grandkids... don't want to leave them a tax burden. .

 

[Jerry1]

I’m a simple guy. If I could get more money into my Roth at 12%, I’d do it - period. Why not max out the 12% bracket? It just seems like a no brainer to fill up the lowest bracket while you can. Odds seem to favor that taxes are more likely to go up than down, so what harm could there be in filling up the current lowest bracket? Even if you don’t put it in a Roth, I’d get it out of my IRA at the 12%.

Also, I’m guessing you were paying more in taxes when you put it into your IRA so from that point of view, it’s a win to get it out at a lower rate.

 

[pb4uski]

Right. 18 years is a long time so based on FIRECALC etc if I do no conversions I'm looking at tripling my TIRA balance which would result in hefty RMDS. Maybe I'll do Roth conversions for the next 10 years until I hit 67 and start taking SS. I know a lot can change with planning so we'll see.

That sounds about right. You can actually use FIRECalc to model that out. Use your current tIRA balance as your portfolio value and set spending equal to your current Roth conversion headroom and run for 18 years. The Roth conversions will increase for inflation but that's ok because tax brackets and standard deductions increase for inflation. The tIRA growth will be commensurate with the setting on the your Portfolio tab.

Below is the result for $100 Roth 100% in stocks with $6 annual Roth conversions after 18 years as an example:

... FIRECalc looked at the 136 possible 18 year periods in the available data, starting with a portfolio of $100 and spending your specified amounts each year thereafter.

Here is how your portfolio would have fared in each of the 136 cycles. The lowest and highest portfolio balance at the end of your retirement was $-62 to $580, with an average at the end of $113. (Note: this is looking at all the possible periods; values are in terms of the dollars as of the beginning of the retirement period for each cycle.) ...

My experience is that despite fairly aggressive Roth conversions, my tIRA balance isn't declining, but is just treading water... but still a lot better than letting it grow so I have huge RMDs later.

Even once you hit your FRA you might consider deferring SS until 70 to have more headroom for low-tax cost Roth conversions for a few more years.