Roth Conversion Vs. ACA Subsidy

[karl404]

Since the ACA subsidy cliff has been removed for 2021 and 2022, Roth IRA conversion planning has become more complicated. I'm posting my thoughts here to see if this makes sense and / or am I missing something.

If one makes Roth conversions while keeping taxable income below $80,000 (capital gains 0% bracket), AGI could be $105,000 (with the standard deduction)

Taxes are paid at 12% on the converted dollars.

At that income range, every extra dollar of income loses $0.085 in subsidy, essentially an extra 8.5% tax paid on the conversion.

Adding these two together = 20.5%. If you expect to be in the 22% bracket or higher when traditional IRA withdrawals kick-in, then converting up to this amount makes sense, albeit within a slim margin.

With the unknowns about future tax rates and policy changes, it also makes sense to me to diversify the tax status of one's investments.

Thoughts?

 

[pb4uski]

I agree with one caveat. Depending on your income without any Roth conversions, the effective rate on the conversions could be a blend of 0% (covered by deductions), 10% and 12%... if you had no income other than Roth conversions a MFJ couple over 65 who donates $600 could do as much as $109,350 of Roth conversion and pay $9,328... 8.53% of the amount converted.... so depending on the situation the effective rate on the conversions would be between 8.53% and 12%.

Then add the 8.5% for lost ACA subsidies... though it might be best to do a proforma return using TT's What-If Worksheet to validate the total impact.

 

[karl404]

Good point. I was focused on what happens at the margin. Thanks for clarifying what happens at the 0% and 10% brackets.

 

[RunningBum]

In addition, the subsidy rate under 400%FPL is greater than 8.5%, so some of those early dollars are being taxed as high as 18%. That's what I found for 2021, by using a subsidy calculator and increasing income $1000 at a time to see what the subsidy loss was for that $1000. For a single, for $49K, $50K, and $51K each $1000 of additional income cost me $180 of subsidy. Once over 400%FPL it dropped back to $85 per thousand.

You can verify this using 2022 subsidy number for your household size. If you're already very close to 400%FPL it is probably worth it to go way over since you'd only have a small amount with subsidy loss > 8.5%.

 

[RunningBum]

https://www.healthedeals.com/obamacare-calculator/ is a calculator you can use for both 2021 and 2022.