Roth Conversion - More Than Just the Tax on the Conversion

[clobber]

I believe that this Kitces article thoroughly covers OPs original post:
https://www.kitces.com/blog/roth-conversion-analysis-value-calculate-timing-true-marginal-tax-rate-equivalency-principle/

Then there is also the other Kitces article that is probably helpful:
https://www.kitces.com/blog/long-term-capital-gains-bump-zone-higher-marginal-tax-rate-phase-in-0-rate/

 

[donheff]

Trying to sort this out is a complicated PITA. I bought a copy of Pralana Gold (a commercial spreadsheet app) to model my situation. It is a powerful tool for Roth conversion analysis but my head is still spinning. Trying to factor in the likely tax implications for inheriting kids takes it up another notch. Ultimately, I say screw em - they will get plenty. If I leave a few bucks on the table it will help the budget deficit.

 

[pb4uski]

Yeah, I focused more on us. We have two heirs, one solidly in the 12% bracket and another in 12% but close to 22%, similar to us after we are both on SS.

Whatever happens to them it will be gravy anyway so I'm not fretting about it.

 

[COcheesehead]

The OPs situation is exactly why I have not done any conversions. It’s a house of cards and really depends on one’s own situation. I would have taken an ACA hit, an income tax hit and maybe an IRMMA hit all to MAYBE gain a tax advantage in 20+ years.
My RMDs won’t start for at least 15 years.
I have earned income in retirement so I contribute to an Roth and I max out HSAs so I am still getting the benefit of tax free investments without paying for a conversion.

 

[d.davis]

Everyone has their own unique path. The sweet spot for ROTH conversions was contributing to each 401k at a high tax rate then retiring early (55/53) on a modest cash pile while converting mfj to the top of the 12/15% bracket. No pensions. We'll each start oasi around 64. It'll work out well if the tax system stays intact. If DC ever converts to a VAT system then we'll be taxed twice. If DC ever messes with oasi we'll run for congress.

 

[street]

The RMD amount cannot go into a Roth, period.
If you decide to take the money, you'll have to pay taxes on it, of course. The other alternative would be to do it as a QCD, in which case no tax would be due.

But you can convert any amount over and above the RMD amount into a Roth, paying taxes on that amount when you do.

Thanks for the clarification for me.

 

[street]

No! You can't put the RMD in a Roth. It has to be money over and above the RMD or else it has to be money you earned that year.

Gotcha! Thanks so much.

 

[ChrisC]

Trying to sort this out is a complicated PITA. I bought a copy of Pralana Gold (a commercial spreadsheet app) to model my situation. It is a powerful tool for Roth conversion analysis but my head is still spinning. Trying to factor in the likely tax implications for inheriting kids takes it up another notch. Ultimately, I say screw em - they will get plenty. If I leave a few bucks on the table it will help the budget deficit.

I used Bigfoot's Retiree Portfolio Model over at BH several years ago to corroborate my gut conversion strategy back in 2013 that conversions up to the top of 24% bracket made sense for us. I'm not looking for mathematical precision in arriving at optimal conversions for us. So, just looking over my recent tax filing I probably had around $10K more of conversion space in the 24% tax bracket -- always difficult to be precise about this when you're considering IRMAA since IRMAA looks backward at MAGI two years ago, which as I understand from some of your prior posts you don't have to worry about.

My heirs are already in or beyond the 24% bracket on their returns and I expect, given their own financial trends, they'll likely wind up in the highest brackets in a few years from now -- so there's that too.

My CSRS pension takes care of all living expenses, including Federal tax withholding on my conversions. I pay no state taxes on my conversions using my TSP in NC where we live, so this has made me gradually rollover funds from my 401K to TSP and then rollout funds from TSP to a Roth IRA (once in Wells Fargo and now in Fidelity because Wells Fargo screwed up conversions I made in 2021 from TSP).

I'm keeping some funds in my TDAs for charitable donations or long term care expenses, though, like you, I have Federal LTCi.

We completed converting all of my wife's TDAs to her Roth IRA in 2020. And I began the process in 2020, and will likely have most of my funds in TSP as opposed to my Roth IRA.

I'm grateful that Secure 2.0 gave me an additional year before RMDs kick in for me as well as removing the RMD requirement for Roth TSP or Roth 401 funds, of which I do have a small portion.

I'm not a spreadsheet guy so I don't try to precisely calculate everything; I just need to be accurate in the landing zone. Good luck with modeling your situation.

 

[SevenUp]

For anyone who can use Excel and is interested in this subject, Roth Conversion with Social Security and Medicare IRMAA is worth a read.

Not so much for any precise calculation, but for the general picture of marginal rates that could apply for a range of Roth conversion amounts for a given individual's situation.

 

[niven]

If in the same above scenario, you do a $100,000 Roth conversion the same year, not only would you pay the tax on the Roth conversion, but then that $89K of qualified dividends that were in essence tax free now becomes taxable at the 15% qualified dividend rate and I believe the Obamacare investment tax of 3.8% would kick in (because now your MAGI is above $250,000). So, the total tax on the Roth conversion is much more than just the tax liability on the $100,000 that I convert, it pushes some qualified dividends into high brackets and kicks in the 3.8% tax on ALL of the investment income.

Am I correct, or am I completely missing the boat here? Thanks.

Incorrect on the NIIT calculation - the 3.8% tax is on the lower amount of the total investment income OR the AGI minus the $250,000 threshold for MFJ. So in your example, the NIIT tax would be ($300,000 - $250,000) * 3.8% or $1,900. See form 8960.

EDIT: In OP's example, the MAGI would be the same as the AGI.

 

[lawman]

All this makes my head hurt. I am 67 years old..I want to try to avoid IRMAA once I have to take my RMD. I want to take money from my IRA every year until then and put it in my Roth hoping to get my RMD low enough so that once I have to take it it will not put me into IRMAA..Can I do this and is their a limit as to how much I can move? I don't care about the tax implications..

 

[orbops]

I am 56, and luckily was able to retire at 50. I am currently taking an RMD on an inherited Roth, and doing Roth conversions each year, and I am in the ACA for insurance. The key decision with taking a Roth conversion is to map out what your AGI will be as each year progresses and determine which tax bracket you will be in towards the end of the year based on totals of dividends & interest & capital gains. When December rolls around, that determines how much of a Roth conversion I will be making to stay within a specific tax bracket (in my case 10% or 12%).

I take my RMD for the inherited IRA the 1st week in January, and my Roth conversion is done in December when I have a really good idea of what my AGI will be.

In terms of the ACA premiums, you just need to decide how much you're willing to pay each month. There are sites that give you an estimated cost for bronze, silver, and gold plans based on AGI. After about 67K, there are no subsidies. You can target your year end premium during the enrollment period.

 

[orbops]

All this makes my head hurt. I am 67 years old..I want to try to avoid IRMAA once I have to take my RMD. I want to take money from my IRA every year until then and put it in my Roth hoping to get my RMD low enough so that once I have to take it it will not put me into IRMAA..Can I do this and is their a limit as to how much I can move? I don't care about the tax implications..

There's no limit on how much you can move in a Roth conversion. You just have to treat any Roth conversion as the same as interest income, so it has the biggest impact on AGI.

 

[Out-to-Lunch]

All this makes my head hurt. I am 67 years old..I want to try to avoid IRMAA once I have to take my RMD. I want to take money from my IRA every year until then and put it in my Roth hoping to get my RMD low enough so that once I have to take it it will not put me into IRMAA..Can I do this and is their a limit as to how much I can move? I don't care about the tax implications..

I am a bit confused, lawman. If you are 67, you are already in the IRMAA timeframe. If you do a large Roth conversion now, it may help you in the future; however, it could/will raise your IRMAA tier two years hence. (IRMAA depends on your AGI two years prior.)

 

[lawman]

I am a bit confused, lawman. If you are 67, you are already in the IRMAA timeframe. If you do a large Roth conversion now, it may help you in the future; however, it could/will raise your IRMAA tier two years hence. (IRMAA depends on your AGI two years prior.)

My plan is to roll over as much as I can each year without putting me over the first tier....($194,000.00 for 2023)..

 

[Doc0]

I emptied my TIRA down to about 450K. 450K RMD's in a way that keeps me in the 12% bracket for about 15 years when I include age 70 SS. My TIRA is presently in bonds, I add dividend stock when it's fortutitious to add a little risk. I withdraw enough to try and keep my TIRA at about 450K but my total ordinary income in the 12% bracket.

I have brokerage that lives in tax efficint stock that throws off little yearly taxable income so it just sits there accruing capital gain (in general) I have Roth which presently is in bonds and accrues interest tax free. My yearly taxes are therefore well controlled. If I need money for an extrodinary expense lke a car or a roof I take it from first TIRA or second the ROTH. Roth is my most prized money becaue it is 100% mine. There are no goverment strings. My second is my brokerage since I don' pay taxes till I sell. MY TIRA is my lease prized money. It is only partially owned by me, and partially owned by the government, which has pretty severe rules regarding disbursement starting at age 73. At 73 the money MUST come out at an ever increasing yearly rate AND that RMD is liable to a potetially increasing marginal income tax. Your "tax free IRA" is actually a tax deferred government piggy bank. You are going to pay the TIRA taxes. That money already belongs to the government, but you have the leeway before RMD to pay them in a defined way now, or in an undefined way (since future tax law is undefined) later. That is the advantage of the ROTH. It allows you to extricate your portion of your TIRA in a way that minimizes and clearly defines your tax hit BEFORE you become under the rule of RMD.

My 450K TIRA is designed to act as an annuity. It provides a predictable yearly income at a relatively predictabe marginal tax rate, for a relatively predictable # of years of retirement. If I live past maybe 85 my tax rate will baloon. I'll deal with that at 85. In addition I can play with the amount I disperse. If I'm in stocks and the market does good and my 450K baloons to say 480K and my RMD is 20K, I can take out 30K in the good year and have a litle exta dough. If the market is down and my 450K is 420K my RMD is actually less because RMD is just a % of the actual yearly value of the TIRA.

My brokerage is a store of wealth. If I took an extra 10K out of my TIRA it would go into my brokerage. My ROTH is self insurance. If I or my wife needed say assisted living, my Roth insures we won't have to live in some hell hole of a nursing home. It also provides ready money to pay the bump up in taxes that happens when one spouse dies.

For me therefore Roth conversion was a way to rationalize future tax liability while maintaining an annuity like income in retirement. I figured living on SS plus a small RMD from a 450K TIRA would keep me solidly in middle class tax bracket for the first 15 years of my retirement post RMD. Almost all of the taxes (like 97%) are paid by the top 50%. In my analysis the break between middle and upper tax liability is the top of the 12% bracket, so my goal is to keep ordinary income below but close to that threshold.

 

[pb4uski]

...Your "tax free IRA" is actually a tax deferred government piggy bank. You are going to pay the TIRA taxes. That money already belongs to the government, but you have the leeway before RMD to pay them in a defined way now, or in an undefined way (since future tax law is undefined) later. ....

WADR Doc, it was never claimed that a traditional IRA was tax-free, it was always tax-deferred and has been from day 1.

If that came as a surprised to you then you weren't paying attention.

 

[CRLLS]

Gotcha! Thanks so much.

Street, one more thing that I have not heard mentioned yet in this thread regarding the Roth conversion. The first $ out of your IRA each year is considered the RMD. i.e. you have to withdraw your RMD first, before you can do a Roth conversion.