Roth Conversions Trial Balloon

[SecondCor521]

I was referring to Gumby's post #18, not yours.

Ah, I see now. Thanks.

 

[Dtail]

Good timing thread for me.
I was just going to ask about do folks look at tax rates at 70.5 relating to Roth conversion decisions now, or look ahead at later age dates when the RMD rates will be higher.

On a related note, it appears my DGF will not be in a category higher than 12% (she already receives SSDI).
Currently she doesn't pay any Federal (or state) tax, so wondering if converting into the 10% bracket is worth it, as then an income tax return has to also be filed.

 

[pb4uski]

If her marginal tax rate once SS and RMDs are applicable will be 12%, then arguably yes but the benefit is smaller.

 

[audreyh1]

In your OP example, are you saying convert now to the top of the 22% bracket if you expect to be in the 22% bracket once you turn 70?

 

[audreyh1]

I'm not sure if IRMAA is a good reason to constrain... if we convert to the top of the 22% tax bracket in 2020 that is taxable income of $171,050 and assuming the standard deduction for 65 year olds of $27,400 that is income/MAGI of $198,450.

MAGI is before standard deductions, not after!

I agree with Midpack's premise of converting to the top of the tax bracket that you expect to be in once all your income streams have started.... mainly because of the factor that if one of you passes the surviving spouse will get thrown into a higher tax bracket.

The surviving spouse since tax rate issue: I keep finding estate tax planning ways to handle that “problem”.

 

[Dtail]

If her marginal tax rate once SS and RMDs are applicable will be 12%, then arguably yes but the benefit is smaller.

Okay, but concerning my first question when folks analyze the benefits of Roth conversions, why wouldn't one also consider future years of RMD rates and not just the 70.5 rate?
i.e. the 3.65% rate at 70.5 jumps to ~5% at 78 y.o., which is much more than just inflationary type increases and perhaps what works for 70.5 y.o. then falls short at 78 y.o.

 

[audreyh1]

I forget, do Roth conversions count toward this limit?

Yes, because they can push capital gains income up past the NIIT threshold. You’ll owe NIIT on any net investment income above that limit, not on the conversion itself. And this calc is pre-deductions.

 

[Midpack]

In your OP example, are you saying convert now to the top of the 22% bracket if you expect to otherwise be consistently in the 22% bracket once you turn 70?

Added in red.

There is no simple answer, and I laid out some caveats in the OP. I was just trying to find a better general starting point than “convert up to 12%” which seemed to be the most common advice, and may not be enough for many here. A simple statement of more use, to more people? Meant as a trigger for further investigation, not a blanket directive.

Maybe you have a better suggestion than Convert to the fill whatever bracket you’ll be in from age 70 on if you hadn’t done any conversions?

Not sure I’m following the “top” in bold. I can comment on that in several ways.

 

[pb4uski]

I'm not sure if IRMAA is a good reason to constrain... if we convert to the top of the 22% tax bracket in 2020 that is taxable income of $171,050 and assuming the standard deduction for 65 year olds of $27,400 that is income/MAGI of $198,450. ....

MAGI is before standard deductions, not after! ...

Yes, I did it that way... income/MAGI of $198,450 less $27,400 standard deductions would result in $171,050 of taxable income... the top of the 22% tax bracket for 2020. The $198,450 of MAGI would put us in the first tier of medicare surcharges.

The surviving spouse since tax rate issue: I keep finding estate tax planning ways to handle that “problem”.

Are you referring to making our kids tIRA beneficiaries rather than DW?

 

[pb4uski]

Okay, but concerning my first question when folks analyze the benefits of Roth conversions, why wouldn't one also consider future years of RMD rates and not just the 70.5 rate?
i.e. the 3.65% rate at 70.5 jumps to ~5% at 78 y.o., which is much more than just inflationary type increases and perhaps what works for 70.5 y.o. then falls short at 78 y.o.

I agree that subsequent years should be considered.... in our case the rise in RMDs isn't sufficient to kick us into a higher tax bracket... don't forget that the tax brackets increase with inflation too.

Looks like withdrawals, ignoring tIRA growth, increase 3.4% initially and grade up as one ages, with growth from 80-81 being a little over 5%.

If you're near to the top of a tax bracket when 70.5 then that is a valid concern, but if your near the bottom or middle of a tax bracket then much less so.

 

[googily]

Here are my projected numbers, from my nutso spreadsheet. Widowed, no direct heirs who I care about massaging taxes for. Working a couple more years, maxing Roth 401k/after-tax conversions, plus pensions, SS (survivor at 60, mine at 70), and a possible inheritance included, and a very generous yearly spend in my HCOL area without adjusting for slow-go and no-go years. About 85% of my money is in tax-deferred.

This includes RMDs, but not QCDs, and is assuming brackets will revert at the end of 2025. This means that while the top of the 24% bracket now is ~ $162k, the top of the 25% bracket will only be ~ $94k. All in today's numbers, and of course very very approximate. Assuming about 3% growth.

No conversions:
Now to age 70: ~ $280k in fed taxes paid overall
70 to 80: ~ $455k
80 to 90: ~$507k
Total to 90: ~$1.24m

Converting to the top of the 22% bracket and then 25%:
Now to age 70: ~ $360k
70 to 80: ~ $370k
80 to 90: ~ $735k
Total to 90: ~$1.23m

Converting to the top of the 24% bracket and then 25%:
Now to age 70: ~ $465k
70 to 80: ~ $310k
80 to 90: ~ $382k
Total to 90: ~$1.16m

It's sort of fascinating. There just isn't that much of a difference in the three scenarios--it's all about when I want to pay.

Though if I believe taxes are going to get higher (and I do), this could change a lot. But if I have the money to have to be paying high taxes when I'm older, then yay for me. (and probably yay for charities)

So, after being all "I'm maxing out conversions!" I'm now "no more conversions for me." Let old me deal with it.

 

[Dtail]

I agree that subsequent years should be considered.... in our case the rise in RMDs isn't sufficient to kick us into a higher tax bracket... don't forget that the tax brackets increase with inflation too.

Looks like withdrawals, ignoring tIRA growth, increase 3.4% initially and grade up as one ages, with growth from 80-81 being a little over 5%.

If you're near to the top of a tax bracket when 70.5 then that is a valid concern, but if your near the bottom or middle of a tax bracket then much less so.

Yes agree. I guess if inflation starts increasing closer to the RMD withdrawal rates, that would be another little twist.

 

[SecondCor521]

Good timing thread for me.
I was just going to ask about do folks look at tax rates at 70.5 relating to Roth conversion decisions now, or look ahead at later age dates when the RMD rates will be higher.

When I did my RMD tax spreadsheet, I ran it out to age 85.

In my case, even with my planned conversions through 70.5 and RMD's from then on, it looks like I could have a sort of runaway situation on my hands: At age 70.5, my RMD (plus 85% SS minus standard deduction) will put me into the 24% bracket. About six years later, I'll be in the 32% bracket. Four years after that, I'll enter the 35% bracket.

Two comments:

1. As some Youtube financial guy pointed out to me (and @pb4uski mentioned here as well), there are differences that probably matter and differences that don't as much. 10% to 12% or 22% to 24%, meh. 12% to 22% or 24% to 32%, well I may pay attention to that a bit more.

2. From where I sit, it looks like I would have to approximately double my current conversion amount in order to get my age 85 bracket down to top of the 24% bracket. That's probably something I should look at in a few years once my FAFSA EFC era is over (I believe I have a large FAFSA cliff at $50K AGI for SNT).

 

[Dtail]

When I did my RMD tax spreadsheet, I ran it out to age 85.

In my case, even with my planned conversions through 70.5 and RMD's from then on, it looks like I could have a sort of runaway situation on my hands: At age 70.5, my RMD (plus 85% SS minus standard deduction) will put me into the 24% bracket. About six years later, I'll be in the 32% bracket. Four years after that, I'll enter the 35% bracket.

Two comments:

1. As some Youtube financial guy pointed out to me (and @pb4uski mentioned here as well), there are differences that probably matter and differences that don't as much. 10% to 12% or 22% to 24%, meh. 12% to 22% or 24% to 32%, well I may pay attention to that a bit more.

2. From where I sit, it looks like I would have to approximately double my current conversion amount in order to get my age 85 bracket down to top of the 24% bracket. That's probably something I should look at in a few years once my FAFSA EFC era is over (I believe I have a large FAFSA cliff at $50K AGI for SNT).

So since one typically would not convert after 70.5, then if one takes into account future larger withdrawals into the RMD process and converts as such in their 60's, then one might be paying too much tax in their 60's as it relates to their 70's RMD situation, but might be correct for their 80's and beyond RMD situation.
Not sure that makes sense.

 

[SecondCor521]

So since one typically would not convert after 70.5, then if one takes into account future larger withdrawals into the RMD process and converts as such in their 60's, then one might be paying too much tax in their 60's as it relates to their 70's RMD situation, but might be correct for their 80's and beyond RMD situation.
Not sure that makes sense.

Well, maybe my graphs will help?

One is with "small" conversions which is current plan of record and reflects the "runaway" situation. The other is with "large" conversions, which reflects the comment I made in my second point in the previous post.

The jump in the blue line is when I turn 70.5 and switch from conversions to RMDs. The other lines are the top of various tax brackets, increasing by inflation over time so all dollar amounts are in 2019 dollars.

My spreadsheet is pretty simple now in terms of planning, because it is set up for constant dollar conversions between now and 70.5, and then RMDs based on the IRS formula after that. Other strategies, such as withdrawing more than RMD amounts in my 70s, may be reasonable but I haven't built the spreadsheet to handle gracefully.

 

[Paulz]

Don't you think the tax advantages of Roth conversions are misleading if they do not advise you to consider the amount of state taxes when making the decision? Like in Maryland, even though I am in 12% bracket, I must add on another 7.75% in state/local taxes. It does make converting less attractive because it is only 2.25% savings over a 22% bracket.
Or I am wrong?

Thats kind of where I am. My state\local charges 5.65%, but I know I'm moving to a no state tax location in retirement. By doing the Roth now I'm paying 5.65% more than I would in retirement, but I know after 2026 the Federal taxes are going up 4% for me so I'm worrying over 1.65%

 

[SevenUp]

And remember that, if the conversion tax is paid from cash on hand, converting now in the 22% or higher federal brackets beats converting later, even if the marginal rate later is identical to the marginal rate now.

Removing the tax drag on the taxable funds is what breaks the tie.

 

[Ronstar]

I went up to 22% last year and probably will this year. One of my reasons to convert to this level or higher is that we are thinking of moving from Illinois to Arizona. Illinois has no state tax on IRA withdrawals. So it makes sense for us to escalate conversions while Illinois residents.

 

[On My Own]

Can anyone direct me to a tax planning optimization spreadsheet similar to those referenced, please?

I have attempted one of my own ; however from this thread I see there are many complexities to consider.

 

[tenant13]

Here are my projected numbers, from my nutso spreadsheet. Widowed, no direct heirs who I care about massaging taxes for. Working a couple more years, maxing Roth 401k/after-tax conversions, plus pensions, SS (survivor at 60, mine at 70), and a possible inheritance included, and a very generous yearly spend in my HCOL area without adjusting for slow-go and no-go years. About 85% of my money is in tax-deferred.

This includes RMDs, but not QCDs, and is assuming brackets will revert at the end of 2025. This means that while the top of the 24% bracket now is ~ $162k, the top of the 25% bracket will only be ~ $94k. All in today's numbers, and of course very very approximate. Assuming about 3% growth.

No conversions:
Now to age 70: ~ $280k in fed taxes paid overall
70 to 80: ~ $455k
80 to 90: ~$507k
Total to 90: ~$1.24m

Converting to the top of the 22% bracket and then 25%:
Now to age 70: ~ $360k
70 to 80: ~ $370k
80 to 90: ~ $735k
Total to 90: ~$1.23m

Converting to the top of the 24% bracket and then 25%:
Now to age 70: ~ $465k
70 to 80: ~ $310k
80 to 90: ~ $382k
Total to 90: ~$1.16m

It's sort of fascinating. There just isn't that much of a difference in the three scenarios--it's all about when I want to pay.

Though if I believe taxes are going to get higher (and I do), this could change a lot. But if I have the money to have to be paying high taxes when I'm older, then yay for me. (and probably yay for charities)

So, after being all "I'm maxing out conversions!" I'm now "no more conversions for me." Let old me deal with it.

I'm in a similar situation that you are (just with a smaller number to work with) and this is pretty much where I ended up with my calculations as well! The numbers do add up but for me retirement (and life in general) is not only about the numbers. In US we tend to measure our "success" by assessing our finances and we extend this way of thinking into our retirement. I'd rather maximize my enjoyment over time than the overall amount of money I'll have at my disposal. So I start with my budget per year and run the simulations making sure I'll be able to cover my expenses until more or less 90. It turns out that whatever I do, I'll have enough disposable income to live the way I want. The only difference is the amount of money I'll pay in taxes. Yes, it'll be more if I don't maximize ROTH conversions but those tax payments will occur later in life leaving me with more to play now. And I'm not sure about you guys but I'd rather take advantage of my late fifties than count on having as much fun in my early 70s (as a gay dude I've just graduated to a hot daddy category but how long is that going to last? You get my drift...) I will still convert - just to diversify my income streams in the future but not as aggressively as the pure math would have me do it.

We all have to predict our end of life situation and guess our eventual demise but there are a lot of steps along the way that require much less guessing and can affect financial decisions. When to start taking SS is a major one and features prominently in all the simulation softwares but if I'd like to move to Panama and take advantage of their pensionado program I'd need a monthly paycheck in excess of $1000. That would push me towards 62. On the other hand if I'd like to die in one of the countries where currently end of life care costs around $1500/month I might consider delaying SS and treat it as insurance against inflation etc.

 

[Midpack]

Can anyone direct me to a tax planning optimization spreadsheet similar to those referenced, please?

I have attempted one of my own ; however from this thread I see there are many complexities to consider.

There isn’t a free one that I know of other than one by a member on Bogleheads. I won’t provide a link because there’s no way to verify how accurate it is, it was revised 20 times IIRC (mostly not errors) and has some hidden and very difficult to follow calculations. I spent several sessions of several hours with it and decided I wasn’t satisfied.

Many here like i-ORP, and I agree it’s incredible for free, though donations are encouraged and well deserved if you plan to use it. I wanted a little more info and flexibility, but I-ORP is pretty complete.

For low cost, a moderately savvy investor can use Income Strategy as I did for as little as $20 for a month, my journey is well documented in a thread I started I gather Right Capital is about the same quality and price for as little as $150. Neither is suitable for someone who doesn’t understand the major moving parts related to Roth conversions IMO.

IMO spending $20 to $150 seems like a very small price to pay when considering a 6-7 digit financial decision - bargain actually.

 

[SevenUp]

Can anyone direct me to a tax planning optimization spreadsheet similar to those referenced, please?

I have attempted one of my own ; however from this thread I see there are many complexities to consider.

For a single year, the best publicly available spreadsheets seem to be the case study spreadsheet and https://sites.google.com/site/excel1040/.

The latter is "prettier" while the former (when using Excel) will show actual marginal rates (not just nominal bracket rates) in chart form. Which will be better for anyone is probably in the eye of the beholder.

Optimal Retirement Planner - Extended Parameter Form and Retiree Portfolio Model - Bogleheads are two tools that do multi-year calculations but without some details of actual tax calculations.

 

[jollystomper]

And remember that, if the conversion tax is paid from cash on hand, converting now in the 22% or higher federal brackets beats converting later, even if the marginal rate later is identical to the marginal rate now.

Removing the tax drag on the taxable funds is what breaks the tie.

Interesting. We have a large amount of cash set aside before retirement to satisfy our planned SWR before we choose to take SS and not to be forced to sell equities during a market downturn. After almost 18 months of retirement It looks like our actual withdrawal rate will be about half of what we planned. So perhaps using some of the "excess" cash to pay Roth conversion taxes might be a good use (we really do not need to blow any more dough). We are currently in the 22% bracket and will be in at least that same bracket at age 70.

 

[On My Own]

Midpack, thanks for the references and willingness to share all of the reserach you are doing on this topic. Definitley agree a minor subscription cost considering the decisions being made.

Any idea how long it takes to enter one's personal data into Income Strategy ?

Has anyone else used the Right Capital system?

 

[On My Own]

Seven up, thanks for the additional references on this topic. I have been using the Google sites 1040 form in conjunction with my own spreadsheet.

Will investigate the other options you shared.