Roth Conversion help

[boilerman]

Hi Everyone
I am considering starting a series of Roth conversion and would like for others to sanity check my situation and assumptions. Thanks in advance, I owe so much to the wisdom on this board!

My reasons for converting are to avoid higher taxes at 70 when I take Social Security, avoid what I believe will be higher tax brackets in the future, and to reduce the tax impact when one of us passes away and is left filing single.

I retired about 2.5 years ago from Megacorp with the following income:
- $67K per year pension
- DW collects taxable Social Security of $21K per year and is on Medicare.
- tIRA withdrawal of $48K per year
- 2020 taxable income after MFJ standard deduction is
$67 + $21 + 48 – 24.5 = $111K

I have about 12 years before I have RMDs to worry about and would like to convert my ~ $1.3M tIRA to Roth. Converting to the top of the 24% bracket ($326,600) would allow about $215K of conversion this year and would require an additional $50.5K federal taxes to be paid. My desire is to do similar sized Roth conversions for 5 or 6 years to move all tIRA money to Roth.

I live in a state with no income tax. I expect to pay the additional taxes from after-tax accounts.

I have unrealized long term capital gains in after-tax accounts that I would expect to take in the coming years, particularly as I need to raise money to pay the additional taxes.

I expect to have an IRMAA surcharge for DW’s 2022 Medicare premium of $231 per month (based on this year’s surcharges. I’d expect that would go up some by 2022.)

I also expect to be above the $150K threshold for limitations on deducting Schedule E Rental property losses from income. Those losses would carry over to future tax years.

When I start Medicare in 2025, if I am still doing Roth conversion, are we both subject to the IRMAA surcharge? I know that my 2025 Medicare premium will be based on 2023 tax returns. Is there any chance we could get relief from the IRMAA surcharge with IRS form SSA-44?

Will I get hit with this NIIT 3.8% surcharge? I don’t understand how this is figured.

Is there anything else I am missing or not considering? This is a large dollar amount transaction for me and I don’t want to have any surprises.
Thanks!

 

[pb4uski]

I think you have a good handle on the issues. I think you would be best to take a spreadsheet and prepare a plan for what converting to the top of the 24% tax bracket over the next 10-12 years will do for you and the same for just converting to the top of the 22% tax bracket.

If you do nothing, what tax bracket would you expect to be in at age 70? If you do conversions to the top of the 22% or 24% tax bracket, what tax bracket would you expect to be in at age 70?

 

[kaneohe]

..................................................
I have unrealized long term capital gains in after-tax accounts that I would expect to take in the coming years, particularly as I need to raise money to pay the additional taxes.

.............................................................

When I start Medicare in 2025, if I am still doing Roth conversion, are we both subject to the IRMAA surcharge? ........................................Is there any chance we could get relief from the IRMAA surcharge with IRS form SSA-44?

Will I get hit with this NIIT 3.8% surcharge? I don’t understand how this is figured.

.........................................................

sounds like you are considering this carefully..................Yes you are both subject to the IRMAA surcharge. Doubtful if you would get relief.........take a look at that form.........my understanding is that relief is only granted for the specific reasons on the form.

NIIT charges 3.8% on your net investment income or the amount of it above 250K AGI which ever is less. You don't mention interest, dividends..........just the CGs so you could figure it out.

 

[SecondCor521]

You and your spouse will both be subject to IRMAA surcharges when you're both on Medicare. Note that there are IRMAA surcharges for both Part B and Part D.

I doubt you would qualify for IRMAA relief unless you meet one of the listed reasons, although it'd probably be worth it to try anyway.

You can google "NIIT site:irs.gov" and read up on that. I think you're right to be considering it in your calculations.

My immediate suggestion would be to consider doing your Roth conversions over the next 12 years instead of the next 5-6 years. This would probably allow you to avoid NIIT. It would also help with IRMAA for your spouse and possibly for you as well.

Yes, the rates may go back up in 2025/2026, but between NIIT (3.8%) and IRMAA (varies, but can be 0-30%), you may be paying more in taxes by trying to get things done sooner than you would by taking the slower route. I just looked and the old rate that might come back is only 28%, so by being in a hurry you're saving at most 4 percentage points.

I'd suggest trying to model a ~$130K or so conversion annually for the next decade or so and see how that pencils out compared to your current plan.

ETA: Note that it might even be reasonable to consider spreading the conversions out even further (to age 72). That would give you an additional 7 years to play with and may keep you in even lower brackets (either federal or state or both).

 

[RetireBy90]

One thing you could consider is drawing some of the $48K you show from TIRA from after tax funds if you have enough after paying taxes on conversions. If your after tax funds are sufficient that would allow for more of the conversion to be taxed at 22%.

 

[RetireBy90]

One other thing I am considering is doing a 2nd helping of conversions this year with markets down. My plan calls for doing conversions of about $120K each year. I’ve done my conversion for 2020, but thinking of doing another helping while markets are troubled. If I do, I’ll try to do 4 conversions of equal amount so I don’t try (and for sure) fail to pick the bottom. ;-)

 

[boilerman]

I think you have a good handle on the issues. I think you would be best to take a spreadsheet and prepare a plan for what converting to the top of the 24% tax bracket over the next 10-12 years will do for you and the same for just converting to the top of the 22% tax bracket.

If you do nothing, what tax bracket would you expect to be in at age 70? If you do conversions to the top of the 22% or 24% tax bracket, what tax bracket would you expect to be in at age 70?

Thanks - I have the spreadsheet for doing nothing and converting to the top of the 24% bracket but not the slower path converting to the top of the 22% bracket.

My do nothing scenario puts our income at my age 70 (when my SS starts) into the 24% tax bracket (MFJ) and the 32% bracket (single.) My DW is in poor health so filing single is possible. If the market does well in the next 12 years, my RMDs might push it higher.

I'm working on the spreadsheet for slower conversions right now...

 

[boilerman]

sounds like you are considering this carefully..................Yes you are both subject to the IRMAA surcharge. Doubtful if you would get relief.........take a look at that form.........my understanding is that relief is only granted for the specific reasons on the form.

NIIT charges 3.8% on your net investment income or the amount of it above 250K AGI which ever is less. You don't mention interest, dividends..........just the CGs so you could figure it out.

OK so we'd be stuck with IRMAA surcharges X 2.
Interest and dividends are small, but the capital gains would not be. So if the Roth conversions push AGI about $250K, then any capital gains have an extra 3.8% tax?

 

[kaneohe]

OK so we'd be stuck with IRMAA surcharges X 2.
Interest and dividends are small, but the capital gains would not be. So if the Roth conversions push AGI about $250K, then any capital gains have an extra 3.8% tax?

"NIIT charges 3.8% on your net investment income or the amount of it above 250K AGI which ever is less. You don't mention interest, dividends..........just the CGs so you could figure it out."

probably best to just do some simple examples: note CG stacked on top of ordinary income.
1)CG: 100K, AGI:250K.3.8% on CG=3.8K; 3.8% on CG above 250K=0; min=0
NIIT=0

2)CG=100K,AGI:251K; 3.8% on CG=3.8K; 3.8% on CG above 250K=3.8% of 1K=38; min=38; NIIT=38

3)CG=100K; AGI 400K; 3.8% on CG= 3.8K; 3.8% on CG above 250K=3.8% of
100K = 3.8K; min =3.8K, NIIT= 3.8K

at first NIIT will be limited by amount of CG> 250K; later it will be limited by
amount of CG as ordinary income increases. Also not taken account in 3), as
amount subject to NIIT increases, you may get a deduction for state taxes attributable to the CG ...........only, however, if you itemize those state taxes.

https://www.irs.gov/newsroom/questions-and-answers-on-the-net-investment-income-tax

 

[boilerman]

My immediate suggestion would be to consider doing your Roth conversions over the next 12 years instead of the next 5-6 years. This would probably allow you to avoid NIIT. It would also help with IRMAA for your spouse and possibly for you as well.

Yes, the rates may go back up in 2025/2026, but between NIIT (3.8%) and IRMAA (varies, but can be 0-30%), you may be paying more in taxes by trying to get things done sooner than you would by taking the slower route. I just looked and the old rate that might come back is only 28%, so by being in a hurry you're saving at most 4 percentage points.

My concerns with tax rates are that we will see increased tax rates due to a change in the political environment, concerns with the deficit, etc. and it's anyone's guess what that looks like but I'm willing to bet taxes aren't headed down.

And as I said above, my DW is in poor health...but even if she wasn't, unless both people in a marriage pass in the same year, filing single is a big hit. My spreadsheet shows a $16K per year increase in taxes at (my) age 70, if filing single.

But your suggestion is a good one to look at a slower conversion. I am working on that now.

 

[boilerman]

One other thing I am considering is doing a 2nd helping of conversions this year with markets down. My plan calls for doing conversions of about $120K each year. I’ve done my conversion for 2020, but thinking of doing another helping while markets are troubled. If I do, I’ll try to do 4 conversions of equal amount so I don’t try (and for sure) fail to pick the bottom. ;-)

Yes, I had originally planned to look my Roth conversions later this year but with the market down, I'm thinking of accelerating that.

 

[boilerman]

"NIIT charges 3.8% on your net investment income or the amount of it above 250K AGI which ever is less. You don't mention interest, dividends..........just the CGs so you could figure it out."

probably best to just do some simple examples: note CG stacked on top of ordinary income.
1)CG: 100K, AGI:250K.3.8% on CG=3.8K; 3.8% on CG above 250K=0; min=0
NIIT=0

2)CG=100K,AGI:251K; 3.8% on CG=3.8K; 3.8% on CG above 250K=3.8% of 1K=38; min=38; NIIT=38

3)CG=100K; AGI 400K; 3.8% on CG= 3.8K; 3.8% on CG above 250K=3.8% of
100K = 3.8K; min =3.8K, NIIT= 3.8K

at first NIIT will be limited by amount of CG> 250K; later it will be limited by
amount of CG as ordinary income increases. Also not taken account in 3), as
amount subject to NIIT increases, you may get a deduction for state taxes attributable to the CG ...........only, however, if you itemize those state taxes.

https://www.irs.gov/newsroom/questions-and-answers-on-the-net-investment-income-tax

That helps, thanks

 

[SecondCor521]

And as I said above, my DW is in poor health...but even if she wasn't, unless both people in a marriage pass in the same year, filing single is a big hit. My spreadsheet shows a $16K per year increase in taxes at (my) age 70, if filing single.

Since I'm single, I kinda glossed over this point. I think you're right to try to weigh it in somehow, and it can point to more aggressive conversions.

The other unfortunate part tax-wise about losing a spouse is that two years later, the remaining spouse can have a higher IRMAA because they're looking at the single IRMAA "brackets" rather than the MFJ IRMAA "brackets".