Roth Conversions for Childless Couple

[Packman]

It seems like the majority of folks here recommend converting taxable IRA's to Roth's. In our case I haven't found good reasons to do so. We do not have children. Our parents are deceased. Our remaining siblings are all older than us and okay, financially. So our heirs are mostly nieces and nephews, of which we are not real close to. DW and I are in our mid 60's and in the 12% tax bracket. We are retired and withdrawing some funds from our IRA's now to the top of the 12% bracket. I am knowledgeable of the tax laws on inherited IRA's. I am thinking that I would rather let our heirs pay the IRA taxes upon our deaths than for us to pay the tax, except on future RMD's. Plus we continue to invest and grow the funds that would be used to pay taxes now.

Am I missing something?

 

[Midpack]

A majority are/should not be recommending Roth conversions for all. Everyone has to run their own numbers and make some assumptions re: future tax rates among other things.

No one could give you a meaningful answer based on your OP. Depends entirely on your numbers, not that I am asking you to share. It’s all about keeping your tax rate about the same throughout retirement, e.g. if passive income (dividends, STCG), RMDs, Soc Sec, pensions/annuities will force you into a higher tax bracket once they all hit - Roth conversions might be (very) beneficial to you.

Roth conversions will save us a ton in Fed and state taxes, so it makes sense for us. We’d be paying at 12% marginal for 7 years and 25% for 23 years without Roth conversions. With conversions we’re paying 22% for 7 years and 15% for the remaining 23. Obviously based only on what we expect tax rates to do over our projected retirement years, etc.

That does not mean it’s a good idea for everyone. It makes no sense whatsoever for some.

 

[pb4uski]

It seems like the majority of folks here recommend converting taxable IRA's to Roth's. In our case I haven't found good reasons to do so. We do not have children. Our parents are deceased. Our remaining siblings are all older than us and okay, financially. So our heirs are mostly nieces and nephews, of which we are not real close to. DW and I are in our mid 60's and in the 12% tax bracket. We are retired and withdrawing some funds from our IRA's now to the top of the 12% bracket. I am knowledgeable of the tax laws on inherited IRA's. I am thinking that I would rather let our heirs pay the IRA taxes upon our deaths than for us to pay the tax, except on future RMD's. Plus we continue to invest and grow the funds that would be used to pay taxes now.

Am I missing something?

Seems sensible unless once you start collecting SS or pensions that income along with RMDs will push you into the 22% tax bracket.

One other reason is that if one of you were to die, would the surviving spouse be in the 22% tax bracket. If so, it might be better to pay 12% now vs the surviving spouse paying 22% later.

Another oft cited reason is a view that tax rates will increase if Congress does not act to make the current tax rates permanent or if Congress just increases income tax rates generally.

The last part, about investing and growing the funds that would be used to pay taxes now is a falacy... in fact, it is lightly untrue. Take a hypothetical taxpayer that has $10,000 in a tIRA and $2,000 in taxable funds and will pay 20% on any tIRA withdrawals. Further, over the next 10 years any investment would double. If they do a Roth conversion today and use the taxable funds to pay the $2,000 of taxes due, in 10 years they will have $20,000 that can be withdrawn tax fee. If they don't do a Roth conversion, in 10 years they'll have $20,000 in the tIRA and $4,000 in the taxable account and if they withdraw the tIRA and pay the taxes then they still end up with $16,000 available to spend.

You may ask, how is it slightly untrue. That would be because the growth of the $2,000 would be subject to tax annually so it might not really double to $4,000.

 

[JoeWras]

We have no kids.

We have no income for the last 5, and next 5 years, except for investment income.

Why not fill up to the 12% bracket, and bit a bit into the 22% bracket? It just makes sense. It isn't all about heirs. It also helps us for longevity, should that occur. I think that is the reason, OP, we are doing it.

That said, since we're going to be making more investment income in 2023 with higher interest rates, we won't be doing as many conversions this year as years previous.

OP says they are withdrawing to 12% bracket. Well, that's another way too. We have no need to withdraw right now. I guess what I'm saying is it depends on the mix of dough you have in tax advantaged accounts or not. If all your dough is in tax advantaged accounts, perhaps just withdrawing (now, before RMDs) is the way to go.

BTW: most of our nieces and nephews are bums. Seriously, our legacy plan puts most to charity.

 

[SecondCor521]

I might also take a SWAG at what the nieces and nephews would pay on their inherited IRAs during their 10 year SECURE Act withdrawal window. It would be ordinary income on top of the rest of their taxable income, which might push one or more of them into the 22% bracket.

Your family overall would pay less in taxes if you paid 12% on Roth conversions or IRA withdrawals now than them paying 22% later. I would only do this if I knew I had enough to take care of myself and my spouse for the rest of our lives.

As an aside, if you're not spending those extra funds you're withdrawing from your IRAs to top off the 12% bracket and are just investing them in taxable, it's probably better to Roth convert those dollars instead of withdrawing them. The tax impact is exactly the same but the money grows tax free inside the Roth rather than taxed every year in taxable.

 

[JBTX]

It’s really impossible to tell what is best from the limited information given. All else equal, if you are already liquidating to the top of the 12% bracket I probably wouldn’t do them into the 22%. But I probably would do conversions to the top of the 12%, if it turns out your distributions take you to something less than the top of the 12%.

 

[RunningBum]

The way I would view it is to handle your tIRA the most efficient way assuming you are going to live a very long time, and you are going to eventually spend all of it.

I don't think the "let them pay the taxes" mentality makes a great deal of sense because that means you are restricting your own access to your tax deferred money. You can't use that money until you pay the taxes. If you pay taxes at, say 22%, the point isn't that you used 22% of your money to pay taxes, it is that you are making 78% of money newly available for you to spend.

My advice based on only a snippet of information about your situation given here, is to keep in the tIRA what you might later spend on assisted living or other tax deductible LTC so that you can use those expenses to reduce tax on withdrawing that money. And keep money earmarked for charities here too, and give to them via QCDs. Any other money besides that, find the most tax efficient way for you to withdraw or convert it in your lifetime, especially while both of you are around with MFJ tax status.

 

[Packman]

OP here. Maybe I wasn't clear on my original post.

First, as it relates to inheritances I understand people with children want to leave them tax free money. We don't care about that.

Second, we are taking full advantage of the 12% tax bracket now. Our tax deferred vs taxable accounts are roughly split 50/50 so we have lots of flexibility. The next dollar we take out of an IRA today will be at 22%. When we get to age 73 we will be in a higher tax bracket with SS and RMD's but not more than 22%, if the brackets remain the same (yes, most believe taxes will increase but no one knows that, and maybe SS will decrease or end ?). So, if I assume taxes stay the same, I pay 22% now or 22% later.

I guess I've answered my own question. It's all about guessing future tax rates and not much else. By the way, aren't tax rates lower today than 25 years ago?

I do understand the significance of increased taxes if one spouse dies. That needs to be considered. Thanks for the feedback.

 

[SevenUp]

...withdrawing some funds from our IRA's now to the top of the 12% bracket.
...
Am I missing something?

Maybe, maybe not.

If you are already taking SS, what marginal tax rate are you paying on those withdrawals?

If you aren't already taking SS, what marginal tax rate do you expect to pay on RMDs (or other traditional withdrawals/conversions)?

The marginal tax rate is probably higher than the bracket number, due to the way Taxation of Social Security benefits works.

 

[Montecfo]

I think guessing what nextegg you might leave, what your tax rates will be and what tax rates heirs might be subject to decades from now and 10 years following is beyond the reasonable scope of accurate estimation.

I certainly do not worry about my son's inheritance being taxable to him. Nor does he.

Doing a Roth conversion is like making an investment. An investment in lower taxes. And like most investments it makes the most sense if the savings are large, such as the difference between the 12% and 22% brackets.

But paying taxes now that would not be owed until decades in the future, if at all, in order to save say 3% does not seem like a very attractive "investment" to me.

I have much more lucrative ways to "invest".

So I Roth convert with that in mind.

 

[Montecfo]

OP here. Maybe I wasn't clear on my original post.



First, as it relates to inheritances I understand people with children want to leave them tax free money. We don't care about that.



Second, we are taking full advantage of the 12% tax bracket now. Our tax deferred vs taxable accounts are roughly split 50/50 so we have lots of flexibility. The next dollar we take out of an IRA today will be at 22%. When we get to age 73 we will be in a higher tax bracket with SS and RMD's but not more than 22%, if the brackets remain the same (yes, most believe taxes will increase but no one knows that, and maybe SS will decrease or end [emoji2962]). So, if I assume taxes stay the same, I pay 22% now or 22% later.



I guess I've answered my own question. It's all about guessing future tax rates and not much else. By the way, aren't tax rates lower today than 25 years ago?



I do understand the significance of increased taxes if one spouse dies. That needs to be considered. Thanks for the feedback.

Packman, I think you have got it!

 

[RunningBum]

If your heirs aren't a priority, then why not optimize the money available for you to spend, rather than try to minimize taxes you pay? And why does it matter if you are leaving them tax free money? That's not your priority.

I think too many people look at $500K (or whatever) in a tIRA and think they have $500K. You don't. You have $500K less whatever tax you owe on the deferred income.

 

[RunningBum]

btw that tax free inheritance is reduced by the tax you paid, so it's not like your giving them any big benefit at your expense, once you grasp the concept of deferred income not being available to you until you pay the tax. Your just leaving them the leftovers of whatever you didn't spend in your lifetime.

 

[LateToFIRE]

Thanks all, this discussion very useful, clarifies some thinking around Roth conversions. I did not ask the original question, but profile very similar to OP's, only a bit younger and still generating earned income for the next little while. I've got all kind of taxable income and asset sales that will be making us look high-income for a couple years after I pull the trigger - that's the "bad" news. The good news is that after the pain of paying taxes and friction costs on all this lumpy "income", my taxable account is projected to be sufficient to meet our retirement budget needs. Of course, there is the future problem of RMD's from our t-IRA's. Still, when I model conversion scenario vs no-conversion, the difference in ending total portfolio balance is negligible. I think I'm just in too high of a tax bracket for it to make much difference - a first class problem to have for sure. Don't worry, I will absolutely consult a tax expert before making any final decisions.

P.S. One thing I noted when handling my in-law tax returns towards in final years. As medical expenses like in-home care, nursing home care, etc. ramped up, the tax-deductions became quite extraordinary. It should have occurred to me to do some Roth conversions at the time to minimize the inherited IRA portion of the estate. Ah well, none of the heirs, including DW, is complaining. At least there were no capital gains taxes on the other property. If they do away with the capital gains write-up (i.e. stepped up basis) for estates, THAT will be extremely painful for heirs.

 

[COcheesehead]

We are in a similar position as the OP. For a variety of reasons, we are not doing conversions. One has to look at their own situation and decide how much tax arbitrage they want to do based on a guess on tax rates 20+ years down the road. Our RMD age is 75. That may even get pushed further out by that time as well too.
Almost all the money we have in deferred accounts was placed there in avoidance of the top two tax brackets. I feel we have won already, even if I pay whatever the future equivalent is of today’s 22% bracket. There are also options, QLACs and QCDs, for not paying any taxes if we so chose.

 

[Taco]

.... So, if I assume taxes stay the same, I pay 22% now or 22% later....

That's how I look at it also. If nothing changes, it makes no difference.

But, what if something does change?
Do potential changes favor the now or the later?
And are changes likely to occur?

As already alluded to, the death of a spouse and the smaller 12% tax bracket is one possible change. And the 22% tax bracket reverting to 25%, barring new legislation passing, is another possible change.

It is also possible the 22% bracket could be lowered in the future, but I think that is pretty unlikely.

So at least for me and my situation, it seems like any possible change would tip the balance in favor of the paying some extra 22% now. And if no changes, it was a wash anyway.

 

[LateToFIRE]

That's how I look at it also. If nothing changes, it makes no difference.

But, what if something does change?
Do potential changes favor the now or the later?
And are changes likely to occur?

As already alluded to, the death of a spouse and the smaller 12% tax bracket is one possible change. And the 22% tax bracket reverting to 25%, barring new legislation passing, is another possible change.

It is also possible the 22% bracket could be lowered in the future, but I think that is pretty unlikely.

So at least for me and my situation, it seems like any possible change would tip the balance in favor of the paying some extra 22% now. And if no changes, it was a wash anyway.

Not to be morbid, but I'm thinking a premature death of a spouse might significantly worsen tax situation with respect to RMD's, but also might significantly lower expenses (ex. smaller or shared home with relatives, no further need to plan for spouse LTC, etc.). I doubt either of us would stay in our current family-sized spread in that event.

 

[Midpack]

Thanks all, this discussion very useful, clarifies some thinking around Roth conversions. I did not ask the original question, but profile very similar to OP's, only a bit younger and still generating earned income for the next little while. I've got all kind of taxable income and asset sales that will be making us look high-income for a couple years after I pull the trigger - that's the "bad" news. The good news is that after the pain of paying taxes and friction costs on all this lumpy "income", my taxable account is projected to be sufficient to meet our retirement budget needs. Of course, there is the future problem of RMD's from our t-IRA's. Still, when I model conversion scenario vs no-conversion, the difference in ending total portfolio balance is negligible. I think I'm just in too high of a tax bracket for it to make much difference - a first class problem to have for sure. Don't worry, I will absolutely consult a tax expert before making any final decisions.

I should have posted this clearer shortcut earlier, a good starting point for anyone would be:

1. Note your current effective and marginal tax rates. Next couple years if "lumpy" - that's your base.
2. Then project taxes once Soc Sec, RMDs are in full force, along with any passive income (dividends, STCG), pensions/annuities. LTCG as well if planned. I'd use the post TCJA tables, but whatever you decide.

If the effective marginal rates for 2) are higher you should look into it further. Relying on any of the quick and dirty Roth conversion calculations isn't enough.

If future rates are the same or lower, you're probably fine without Roth conversions.

The difference can be substantial, especially if you have a large chunk in TIRAs or other tax deferred.

Our marginal rate 1) was 12% for 7 years, and our marginal rate 2) was 25% for 23 years! Thank goodness I analyzed in detail and we're well into converting our TIRAs into Roth IRAs. We're paying 22% for 7 years, and 15% for 23 years now...

 

[pb4uski]

.... So, if I assume taxes stay the same, I pay 22% now or 22% later.
...

True, but if one of you dies, will the "pay 22% later" still hold?

 

[Phroig]

It's a short hop (about $6K) from the top of the 12% income bracket for MFJ to the 24% bracket for singles. The higher rates obviously only apply to incremental income, but still.

 

[harllee]

We have no children or other family members that we want to leave a large inheritance to. But we have several charities we support. We do QCDs from our IRAs every year which substantially reduces our RMDs. Roth conversions do not make sense for us.

 

[Fotodog]

I’m 69 and have a few years where I could do some Roth conversions, trying to decide if it would be beneficial. If I didn’t need the RMD’s when they start, it would be an easy decision. But I will need that money for living expenses. Doesn’t that fact alone mean that it will make no difference?

The only reason I can think of where converting would help would be the likely upcoming tax increases if congress doesn’t act. I could convert for the next few years to the top of the 22% bracket. My tIRA balance would be reduced, assuming no growth. So if the RMD’s (which would then be taxed at 25%) don’t cover my expenses, I could withdraw the rest from the Roth account which was taxed at 22%. But it seems like this scenario would hardly make a dent in overall taxes.

Is my thinking about this correct? Thanks!

 

[SecondCor521]

I’m 69 and have a few years where I could do some Roth conversions, trying to decide if it would be beneficial. If I didn’t need the RMD’s when they start, it would be an easy decision. But I will need that money for living expenses. Doesn’t that fact alone mean that it will make no difference?

No, because you'd be paying the higher tax rate whether you spend the RMD or not.

The only reason I can think of where converting would help would be the likely upcoming tax increases if congress doesn’t act. I could convert for the next few years to the top of the 22% bracket. My tIRA balance would be reduced, assuming no growth. So if the RMD’s (which would then be taxed at 25%) don’t cover my expenses, I could withdraw the rest from the Roth account which was taxed at 22%. But it seems like this scenario would hardly make a dent in overall taxes.

Is my thinking about this correct? Thanks!

So far, yes. Saving 3% possibly on a few years of Roth conversions may not work out to all that much money in your case.

I would make sure the other reasons to convert don't apply, such as having beneficiaries who would be subject to higher tax rates than 22%, or dying and leaving a spouse in a higher tax bracket, or moving to a state with lower or no income taxes, or IRMAA considerations, or taxes in your 80's being higher.

 

[skyking1]

We have some headroom to the top of the 15% bracket when we retire. We will have a 6 year gap to do conversions before I start SS, and mostly eliminate that headroom. it makes sense to use that headroom up to protect a surviving spouse from the next higher bracket if at all possible.

 

[karen1972]

Its all dependent on what your accounts look like. Like I wanted to do conversions for two reasons
1. I wasn't 59 1/2, so by converting allowed the 5 year rule to start ticking as I think I will run short in my brokerage and have to tap tax deferred.
2. Having money in the Roth allows for tax free withdrawals in years I have lumpy expenses, ie I replaced my car this year, if I didn't have enough free cash I would have used my Roth to avoid pushing into the higher tax bracket.

Neither of those have to do with RMDs which I assume will be small as I draw down from 59 1/2 to 70 thus delaying SS.

Lots of moving components so one size certainly doesn't fit all.