Roth Conversion or Not

[Dash man]

The principle behind Roth Conversions is to equalize your marginal tax bracket over time - that avoids high tax brackets by also avoiding low ones. It's playing on the convexity ("progressivity") of the tax code. This is well trod ground and what you are doing doesn't sound anywhere close to optimum.



My wild guess is your tool is not figuring taxes on the taxable account correctly, perhaps taxing capital gains as ordinary income.



I suggest you invest in a commercial tool like Pralana Gold, MaxiFi or Income Strategy, spending a hundred bucks could save you hundreds of thousands.

Pralana Gold projects I’ll save $1.4M in taxes over our lifetime and I’m following the plan it provided. Income Strategy also shows significant savings. The principle behind Roth conversions is not to equalize your marginal tax bracket, but to minimize taxes over the long term. Your wild guess is wrong.

 

[target2019]

Early last year I posted two charts that I created by using Flexible Retirement Planner for the conversion amounts and result, and Excel charts to compare no conversion with 20K and 40K for 24 years or so. Of course this is just one comparison and everyone has a different set of income parameters. But you do get a general view in these charts of the effect over a longer period. YMMV.

 

[Rianne]

Ok, ok. The best of the best forum financial wisdom helped me see the light. We'll convert starting next year and are done with ACA income limits. My "C" grade in finance shows. I have confidence in your advice. ) Thanks! I start Medicare in Sept., DH starts in December this year. We have cash set aside to pay the taxes, so all is good.

 

[RunningBum]

Every year or so I do a run of future tax estimates and how much, if any, I should convert each year considering new factors that roll in at various times such as IRMA, a small pension and SS income. Trying to project income and taxes for the future is hard, so I made assumptions mostly based on current tax law and current income and I can update this every year to better tune the plan.

I was pretty aggressive before ACA which means I should be able to fully convert my IRA or leave some for QCDs. I had hoped I could do this without pushing QDivs into being taxed or hitting IRMAA, but I can't, so I need to prioritize.

From 60-65 I'll convert to the ACA subsidy cliff (if it comes back) or to where QDivs start being taxed. I'm ok with losing some subsidy at 8.5% as long as it's not combined with a 12%+15% marginal rate with QDivs taxed. Conversions will be very low.

From 65 to 70, I'll convert to the top of the first IRMAA tier. Some income is taxed at 12%+15%, a little at 22%, then a 22%+3.5% effective IRMAA rate. I can do larger conversions in these 5 years and should be able to get my IRA completely converted or down to a level that I'd use for QCDs. Tax rates might revert to pre-TCJA here but that really doesn't change much for me.

After 70 when I start SS, any extra withdrawals or conversions would have a small SS tax hump window and then pretty quickly hit IRMAA so I really want to finish my conversions before then. As a bonus I'll have a large Roth that I can tap anytime tax-free if I need extra spending money.

All of this shows that to fully optimize conversions you should look at more than just basic tax brackets, but if it's too complex you can go for "close enough". Or look to a program like Pralana Gold, which I hear covers all of this and more.

 

[TheWizard]

Every year or so I do a run of future tax estimates and how much, if any, I should convert each year considering new factors that roll in at various times such as IRMA, a small pension and SS income. Trying to project income and taxes for the future is hard, so I made assumptions mostly based on current tax law and current income and I can update this every year to better tune the plan....

I did/do something very similar with a spreadsheet going back to start of retirement in 2013.
I didn't have any ACA concerns and my taxable account was small in 2013 so no QDiv issues.

So I had a simpler job of deciding which IRMAA tier to stay in each year. Each December I would do an accurate estimate of my AGI for the year and then top up my Roth conversion amount for the year.

Having started RMDs this year, I'm on a certain plateau from here on and expect to do minimal Roth conversions in future years...

 

[Exchme]

Pralana Gold projects I’ll save $1.4M in taxes over our lifetime and I’m following the plan it provided. Income Strategy also shows significant savings. The principle behind Roth conversions is not to equalize your marginal tax bracket, but to minimize taxes over the long term. Your wild guess is wrong.

Pralana Gold is a great tool, its tax package is quite good, so we can rule out my first guess (make sure you regularly check the Pralana website, it's up to version 2022 v 2.10).

You can get some odd looking results in Roth Conversion calculations because of the many steps, humps and phase-ins in the tax code, but let's walk through another possibility.

You can get the kind of results you are seeing if you tell the program to hold different asset allocations in different accounts while using Mode 1 instead of Mode 2. To use Mode 2, go to Financial Assets, then Management and look for the first entry at the top under the box labeled ASSET ALLOCATION MODE. It should read "User Specifies Overall Asset Allocation and Target Asset Location". Then you go to the Financial Assets - Asset Allocation screen and use the arrows on the left to set the priority order for which accounts hold the most stocks. This mode keeps the portfolio level stock/bond allocation constant while allowing you to hold more stocks in Roth and Taxable and bonds in tax deferred.

If you use Mode 1 ("User specifies asset allocation at the account level") and enter a higher stock allocation in the Roth than in the traditional IRA, then the program favors huge early conversions in order to get more money into stocks sooner. But that's not holding your overall asset allocation constant over time, so the effect of Roth conversions is being swamped by the larger impact of higher stock allocation.

Until the 2022 version, Mode 1 was the only choice and if users wanted to hold their overall portfolio asset allocation constant with different allocations in different account types, they had to manually rebalance each account every few years (which was very time consuming and tedious). Mode 2 addressed that and Pralana is one of the few programs that allows this.

 

[ncbill]

The principle behind Roth Conversions is to equalize your marginal tax bracket over time - that avoids high tax brackets by also avoiding low ones. It's playing on the convexity ("progressivity") of the tax code. This is well trod ground and what you are doing doesn't sound anywhere close to optimum.

My wild guess is your tool is not figuring taxes on the taxable account correctly, perhaps taxing capital gains as ordinary income.

I suggest you invest in a commercial tool like Pralana Gold, MaxiFi or Income Strategy, spending a hundred bucks could save you hundreds of thousands.

Why would you assume that poster had any significant amount in taxable?

I would think the norm for high-income, dual-earner households interested in early retirement would be to defer as much as possible while working.

So they might have only 5 figures in taxable but well into 7 figures in tax-deferred when they retire.

 

[Animorph]

I have two reasons for my Roth conversions:

1) Withdrawing from the tIRA at the lowest possible tax rates. You will be better off by taking advantage of your lowest marginal tax rates. This benefit is independent of the timing of your withdrawals/conversions, so don't be afraid of paying taxes now versus later. If all of the tIRA will withdrawn at a 22% tax rate, the IRS owns 22% of your tIRA balance. Then timing of withdrawals doesn't change that.

2) Roth converting $10,000 and paying the 22% tax ($2,200) from a taxable investment account is equivalent to withdrawing $10,000 from the tIRA, paying $2,200 of that to the IRS, depositing the remaining $7,800 into a Roth account, and then depositing $2,200 from your taxable account into the Roth account. Whereas you only owned $7,800 of your tIRA withdrawal, you now have $10,000 in your Roth that all belongs to you. You have effectively made an additional Roth contribution of $2,200 that will no longer be taxed.

The benefit of (2) is time dependent. The longer that $2,200 sits in the Roth account, the more it can grow tax-free. This favors maximizing Roth conversions earlier rather than later.

This benefit depends on your individual tax and portfolio accounts situation. For us, it was worth it to Roth convert above the RMD expected tax rate in order to maximize the benefits of (2). That was true up until about 10 years before our first expected Roth withdrawals. 10 years of tax free investment growth is a decent benefit. It can be enough to overcome the capital gains taxes paid to free up that taxable money and a small bump in the marginal tax rate of the last few Roth conversion dollars. One year of tax free investment growth probably won't be worth the expense of those extra hurdles.

We are now within that 10 year period before our first Roth withdrawal. Our years of jumbo Roth conversions into high tax brackets are over. We are Roth converting just enough to fill the tax brackets below our expected RMD tax rate and trying to maximize our use of the 0% capital gains tax rate.

 

[rick55]

I think this down market is a good time to do conversions. Dw starts Medicare 06/01 so we will look to start in January. 5 years to rmd.

 

[meleana]

The thing bothering me is paying the taxes out of our taxable cash accounts. I would rather just have the taxes taken out of the conversion account.

I get the concept of why to pay them out of your taxable cash accounts but I would rather have my cash. I don’t see what the big deal is.

I’m already taking RMDs on an inherited Ira and the taxes are taken out of that account. Yet- other than this year, of course, that account has always grown past what it was when I received the RMD.

The other thing is why not instead just take the money out of our traditional iras now to draw down those balances and pay the taxes on that money out of the traditional Ira accounts? Won’t that bring down the balance just the same as a Roth conversion in terms of the torpedo tax? And the Medicare premium penalty?

We are 68 and 66 and in the 12% bracket right now. We will only be doing this for 4 years anyway until we each start collecting SS at age 70.

I don’t get it.

 

[Sunset]

The thing bothering me is paying the taxes out of our taxable cash accounts. I would rather just have the taxes taken out of the conversion account.

I get the concept of why to pay them out of your taxable cash accounts but I would rather have my cash. I don’t see what the big deal is.

I’m already taking RMDs on an inherited Ira and the taxes are taken out of that account. Yet- other than this year, of course, that account has always grown past what it was when I received the RMD.

The other thing is why not instead just take the money out of our traditional iras now to draw down those balances and pay the taxes on that money out of the traditional Ira accounts? Won’t that bring down the balance just the same as a Roth conversion in terms of the torpedo tax? And the Medicare premium penalty?

We are 68 and 66 and in the 12% bracket right now. We will only be doing this for 4 years anyway until we each start collecting SS at age 70.

I don’t get it.

People that want to pay cash have lots extra lying around and want to optimize the amount in the ROTH due to it's tax free status.

But if you don't have the cash lying around, then paying the taxes from the IRA at conversion time the next best thing.

I've done it both ways.

 

[RunningBum]

The thing bothering me is paying the taxes out of our taxable cash accounts. I would rather just have the taxes taken out of the conversion account.

I get the concept of why to pay them out of your taxable cash accounts but I would rather have my cash. I don’t see what the big deal is.

I’m already taking RMDs on an inherited Ira and the taxes are taken out of that account. Yet- other than this year, of course, that account has always grown past what it was when I received the RMD.

The other thing is why not instead just take the money out of our traditional iras now to draw down those balances and pay the taxes on that money out of the traditional Ira accounts? Won’t that bring down the balance just the same as a Roth conversion in terms of the torpedo tax? And the Medicare premium penalty?

We are 68 and 66 and in the 12% bracket right now. We will only be doing this for 4 years anyway until we each start collecting SS at age 70.

I don’t get it.

It's not that huge of a deal. It sounds like you understand that taking $100K out of your tIRA and moving all of it to your Roth,paying taxes from your taxable account, is better than taking $100K out of the IRA and moving $88K to your Roth. $12K growing tax free is better than 12K which is taxed on growth and distributions, right? And don't forget state taxes.

If you're saying, I'll just move the full $100K to my Roth and take an extra $12K out of my tIRA to pay taxes, that $12K also gets taxed now at 12%. Most people plan their conversions to some income limit, so planning for $100K but actually taking $112K out of your tIRA blows that plan.

The numbers aren't huge, but it is something. It's a tie breaker if you are paying 12% taxes now and would be paying 12% on MRDs.

If that $12K doubles before you use sell it at 15% LTCG, that's an $1800 difference, or 1.8% on $100K. If you don't care about that, don't do it. I project that I may start spending from my Roth in my late 60s. If that happens, I might as well just have taxes withheld on the conversion.

For those under 59.5, they don't have a choice unless they want to face an early withdrawal penalty on the tIRA money that goes to taxes.

 

[meleana]

It's not that huge of a deal. It sounds like you understand that taking $100K out of your tIRA and moving all of it to your Roth,paying taxes from your taxable account, is better than taking $100K out of the IRA and moving $88K to your Roth. $12K growing tax free is better than 12K which is taxed on growth and distributions, right? And don't forget state taxes.

If you're saying, I'll just move the full $100K to my Roth and take an extra $12K out of my tIRA to pay taxes, that $12K also gets taxed now at 12%. Most people plan their conversions to some income limit, so planning for $100K but actually taking $112K out of your tIRA blows that plan.

The numbers aren't huge, but it is something. It's a tie breaker if you are paying 12% taxes now and would be paying 12% on MRDs.

If that $12K doubles before you use sell it at 15% LTCG, that's an $1800 difference, or 1.8% on $100K. If you don't care about that, don't do it. I project that I may start spending from my Roth in my late 60s. If that happens, I might as well just have taxes withheld on the conversion.

For those under 59.5, they don't have a choice unless they want to face an early withdrawal penalty on the tIRA money that goes to taxes.

Thanks. No state taxes in our state. What I’m saying is when doing the conversion just have the investment company pay the taxes out of it and the rest convert.

We of course would be mindful of how much we totally convert and withdraw ( for the taxes) so we stay under the income limit.

We are living on cash and have been for a few years now so we have a lot of it, but it has to last until I collect SS at least. ( I’m the “ younger” one) Plus I am very conservative. What if we unexpectedly need or want a big amount of cash for something?

I don’t want to feel strapped because I have to pay the IRS for several years out of our cash account.

We have a lot of $ in a stable value account in a 401k, and some cash in traditional iras, but we wouldn’t want to tap that if we needed a lot of money for something because then that blows the whole idea of doing the Roth conversions and staying under the income limit.

 

[meleana]

People that want to pay cash have lots extra lying around and want to optimize the amount in the ROTH due to it's tax free status.

But if you don't have the cash lying around, then paying the taxes from the IRA at conversion time the next best thing.

I've done it both ways.

Thanks.

What do you think about just taking withdrawals out of traditional IRA’s now instead of doing Roth conversions to bring the balances down to avoid some of the tax torpedo? Isn’t it pretty much the same concept?

( We already have Roth accounts as well)

 

[RunningBum]

We are living on cash and have been fir a few years now so we have a lot of it, but it has to last until I collect SS at least. ( I’m the “ younger” one) Plus I am very conservative. What if we unexpectedly need or want a big amount of cash for something?

I don’t want to feel strapped because I have to pay the IRS for several years out of our cash account.

We have a lot of $ in a stable value account in a 401k, and some cash in traditional iras, but we wouldn’t want to tap that if we needed a lot of money for something because then that blows the whole idea of doing the Roth conversions and studying under the income limit.

My Roth is my emergency account. I've converted a lot already, and if I need more cash unexpectedly, I won't hesitate to use it, and then figure out how to get my AA back in sync. But if I don't have such an emergency, I'd rather feed the Roth rather than holding out some extra cash in taxable "just in case". I think it's very easy to see that two cases could be similar but different enough that one pays taxes out of the conversion and the other uses taxable money.

 

[meleana]

My Roth is my emergency account. I've converted a lot already, and if I need more cash unexpectedly, I won't hesitate to use it, and then figure out how to get my AA back in sync. But if I don't have such an emergency, I'd rather feed the Roth rather than holding out some extra cash in taxable "just in case". I think it's very easy to see that two cases could be similar but different enough that one pays taxes out of the conversion and the other uses taxable money.

I see. I guess I’m looking at it that we have all stock funds in our Roths so if the market was down like now we would not want to take money out of them.

We also have an adult son beneficiary so our Financial Planner told us the Roths would be the last things we ever tapped if we even have to tap them at all.

 

[RunningBum]

I see. I guess I’m looking at it that we have all stock funds in our Roths so if the market was down like now we would not want to take money out of them.

We also have an adult son beneficiary so our Financial Planner told us the Roths would be the last things we ever tapped if we even have to tap them at all.

So in that case I'd sell some stock in the Roth and buy the same amount elsewhere, especially with the market down, so it wouldn't change my AA.

As long as stepped up basis on inheritance doesn't change, I feel like I'm better off keeping the long term big winners (20 some years of VTSAX) and spending the Roth. That way neither of us pays the cap gains tax on VTSAX. I am a little leery of that going away though.

 

[SevenUp]

We are 68 and 66 and in the 12% bracket right now.

What if we unexpectedly need or want a big amount of cash for something?

If you have had a Roth IRA for more than five years, then given your ages there is neither tax nor penalty for withdrawing whatever you want from a Roth IRA at any time.

 

[oldtimer]

I see. I guess I’m looking at it that we have all stock funds in our Roths so if the market was down like now we would not want to take money out of them.

We also have an adult son beneficiary so our Financial Planner told us the Roths would be the last things we ever tapped if we even have to tap them at all.

Right, only tap them in a real emergency.

 

[almost there]

To me, this is one of the most difficult things to calculate.

Will Congress vote to extend the 2017 TCJA tax rates? Or will it revert back on January 1 2026. 12% tax rate goes back up to 15% 22% to 25%, 24% to 28%.

Will the $25,900 personal exemption for married/jointly still be around?
As most of my write offs are no longer available. Aside from one rental property.

Have been doing small Roth conversions to the top of the 12% bracket the past several years. And have yet to draw from my trad. IRA. But plan to do so in 2024. As well as SS. I did get my IRA down to 530k over the past 8 yrs with conversions. So RMD is not an issue. But am seriously thinking about larger conversions into the next bracket for 2022 and 2023. Again, not at all easy to calculate. As there are so many unknowns. But have a gut feeling taxes will be higher in the future. Based on the way things have been handled.

My prev. plan was to drain the trad IRA from 62 to 82 with smaller / annual distributions. $3000 / month for 20 yrs. But am now thinking a couple larger conversions might be the way to go 2022 & 2023. To get the IRA down further. While not a huge IRA. Am now wishing I had done more over the years. And as before, pay the tax from savings. To boost the Roth further. Its a tough call.

 

[pb4uski]

The thing bothering me is paying the taxes out of our taxable cash accounts. I would rather just have the taxes taken out of the conversion account.

I get the concept of why to pay them out of your taxable cash accounts but I would rather have my cash. I don’t see what the big deal is.

I’m already taking RMDs on an inherited Ira and the taxes are taken out of that account. Yet- other than this year, of course, that account has always grown past what it was when I received the RMD.

The other thing is why not instead just take the money out of our traditional iras now to draw down those balances and pay the taxes on that money out of the traditional Ira accounts? Won’t that bring down the balance just the same as a Roth conversion in terms of the torpedo tax? And the Medicare premium penalty?

We are 68 and 66 and in the 12% bracket right now. We will only be doing this for 4 years anyway until we each start collecting SS at age 70.

I don’t get it.

Whatever, just so you know the implications. Let's use an example where someone has $10,000 in a tIRA and $2,000 in a taxable account and the tax rate is 20%. A 10 year time horizon and a 7% annual investment earnings rate.

If you convert and pay the tax from taxable fund then you end up with $10,000 in the Roth and 10 years later if is worth $19,672 and can be spent.

If you convert and pay the tax from the conversion then you end up with $8,000 in the Roth and 10 years later the Roth is worth $15,737. Meanwhile, over 10 years the $2,000 taxable account has grown to $3,449 and you have a total of $19,186 to spend.

So at the end of 10 years would you rather have $19,672 or $19,186?


The $485 difference is the taxes over the 10 years on the income from the taxable account.

$10,000*(1+7%)^10 = $19,672
($10,000*(1-20%))*(1+7%)^10 = $15,737
$2,000*(1+(7%*(1-20%)))^10 = $3,449

 

[target2019]

Thanks.

What do you think about just taking withdrawals out of traditional IRA’s now instead of doing Roth conversions to bring the balances down to avoid some of the tax torpedo? Isn’t it pretty much the same concept?

( We already have Roth accounts as well)

We have a set of guidelines that were developed to balance out our needs, and try to avert 10% of tax now, within reason.

I think at one time someone here developed a flowchart, to show the logic of the many possibilities of Roth conversions.

Unless someone knows all of my details, they probably can't make a 100% optimum decision for me. I think the same goes for your question. Well, yes, you can take from your IRA now, but without knowing your details it would not be right for me to say.

 

[Perryinva]

Exactly. While it makes sense to have equities in the Roth to maximize tax free growth, there is no reason at all not to pay the taxes from cash and invest that portion the same way in the Roth, if you are concerned about price drop. (Obviously assuming over 59 1/2 and 5 years of Roth). At least then the earnings in that “cash” portion grow tax free instead of taxed where it resides now. Roth can always be taken out any time with no consequences. Win-win-win. Unless someone sees themselves in a lower tax bracket later after conversions, then there is no reason not to convert. Except that some people have an aversion to paying more, even lower, taxes early. We only have about $1M in tIRA, and even converting to the first IRMAA it continues to be the same or larger the next year (maybe not 2022, LOL) while the Roth just gets larger and larger. My calcs show by the time we have to take RMDs, the IRMAA level should have risen to about where our income will be.

 

[MarkiePippo]

The normal reasons for investing in a 401k/IRA is that your tax rate will be lower when you retire than it is now. But that is not always the case. In my world my income currently is just my pension, dividends and interest at the bank. So at this moment in time my tax rate is lower than when I was working. Since when I start taking RMDs at 72 or 75 my account will have over 10 years to grow. So an 401k/IRA of $1 Million could easily grow to at least double or more. So when I am 75 my RMDs will be significantly greater than they are now. Also because of this more and more of my Social Security benefits will be taxed. So now is this time for me to convert some of this amount to Roths.

 

[Sunset]

Thanks.

What do you think about just taking withdrawals out of traditional IRA’s now instead of doing Roth conversions to bring the balances down to avoid some of the tax torpedo? Isn’t it pretty much the same concept?

( We already have Roth accounts as well)

I've done that as well, simply withdraw from the IRA (over age 60) to have cash to spend. After all I will be forced to do it when RMD's start, so taking some early to either spend or roth convert has the same effect as you say on the tax torpedo.

I prefer to roth convert, but when I had a cash flow shortage, I used my IRA to fill up my cash account by selling things that were high in value inside the IRA.

I could have sold some LTCG stocks instead, however, IL does not tax IRA withdrawals and in the back of my mind is the thought we will move to a zero income tax State and I can sell the LTCG and save 5% State taxes on them.