When to convert Roth while managing ACA subisidy?

[guitarguy]

New guy here, long time lurker... love this site. I've read a lot but I'm still a little confused as to what the right answer for me is.

I'm 59, retired at age 54. No pension, just investments. I know I want to convert a good chunk of my IRA to a Roth... done all the math and checked with my accountant. I can convert almost $100k/year and stay in the 25% bracket. I'd be happy if I can get at least $300k into a Roth, just as a hedge against future changes in tax laws.

I also receive a very good subsidy from the ACA; it saves me about $5k/yr. (I know I don't need to apologize and I don't want to offend anyone, but as a small business founder I paid a gazillion dollars in taxes during my life, so this is simply getting the ONLY $ benefit back from the govt that I've ever received... just playing by the rules the idiots in Washington created). And I do use small Roth conversions to keep me in the ACA income sweet spot.

The best plan I've seen so far is doing Roth conversions in alternating years. Seems that allows you to rebalance, tax harvest, and most importantly convert Roth. But I've also read that you should convert after you sign up for medicare...? Or before SS? I'll probably start SS around age 64, but I could easily wait, as long as I don't screw up my portfolio.

Here's my best guess:
Start by converting 100K next year and use the alternating years method... when I'm 64 I'll have converted $300k. Better to start now and take advantage of these incredibly low tax rates and ACA subsidies while they last... because who knows what the politicians will do next (probably nothing at least for 2 more years).

Then at 65 I'll probably take SS... and by then the laws will probably have changed anyway.

Am I off-base? Is there a better method?

Of course, know one knows what the future holds. But I am planning these conversions because I'm convinced on the following assumptions:
-Tax rates and eligibility for ACA subsidies won't be getting better for my situation. This is a pretty good opportunity... it's only going to get worse, and when I take SS and then RMDs my taxable income will go up anyway.
-At some point the govt is going to have to get their hands on more of our money. Who has the money? The baby boomers and others who have accumulated assets. Demographics and the shrinking working population will have a pronounced effect in coming years.
-They won't do serious damage to IRA or Roth rules (i.e. Roth RMD) for a while... there's too much voting power in boomers. But they will tinker with it.

Most important, since I'm just hedging with the Roth anyway, and the Roth will still be much less than half of my qualified portfolio, this seems to be a safe approach.

Am I crazy?
Many thanks!

 

[GrayHare]

That's the general approach used by many. Don't convert up to the 25% bracket unless you believe post Social Security you'll be in that bracket or higher. Starting during you age 63 tax year be careful of converting so much that your high income subjects you to the IRMAA surcharge once Medicare begins.

 

[pb4uski]

Just curious about how you can convert $100k a year and/or be in the 25% tax bracket and still qualify for ACA subsidies... do you still have kids at home?

Also, if the value of your ACA subsidies is only $5k, you may be better off in the long run converting more to Roth and paying the additional $5k.

The epiphany that I had recently was living off of taxable equities the last couple years since we were 59 1/2. I was too focused on the sweet 0% tax rate on LTCG and qualified dividends. Instead, I should have been living off tax-deferred to reduce the amount subject to the tax torpedo on SS begins since the taxable equities will eventually get a stepped up basis.

 

[guitarguy]

No kids, that's why I'm lloking at alternating years. The years I convert, I won't get the subsidy. But the 24% bracket is 84k-$168k so that's where I'll be.

I too have been living off taxable equities... but i'm curious what you mean about the tax torpedo and stepped up basis? I thought that was just for inheritance... maybe that's your situation? I'm living off the taxable account not solely due to the low tax rate, but because my accountant and my own research suggests I should spend down the taxable account first and let the IRA and Roth grow. Plus, I'm still cash heavy in taxable accounts, waiting for the bear and also cost averaging, so I don't need to sell anything for annual income for a while. The low tax rate is gravy, but it's not my primary focus at this point.

And yes, I hear you on the $5k point... starting to think about that plus the Medicare IRMAA... always have to keep the bigger picture in mind.
Thanks!

 

[pb4uski]

The tax torpedo refers to the increase in tax rates for early retirees once SS and pensions start. We are a good example. Currently, our only income is my small ~$18k a year pension and interest and dividends. Absent any Roth conversions we would pay no federal income tax. However, once SS starts we will pay taxes, but even then only a small portion of our SS will be taxable. But then add RMDs and ont only do we have tax on the RMDs but the additional income also makes more of our social security taxable.

The marginal tax rate of the added SS is only 2.6%... but the marginal tax rate on RMDs is 25% and we'll be solidly in the 22% tax bracket for the rest of our lives.

So the objective is to reduce tax-deferred as much as possible at low tax rates between ER and when SS starts and more importantly when RMDs start by either IRA withdrawals or Roth conversions.

My prior practice of living off of taxable accounts thwarted that goal because 50% or so of every sale was LTCG. While there was no tax on those LTCG, the incidious thing was that it reduced the amount of low cost Roth conversions that we could do.

Our tax-deferred is over half of our retirement savings... so from now (currently 63) until RMDs start we will live off of tax-deferred and leave taxable and Roths alone.... later, once SS and RMDs start, my pension, SS and RMDs will still be plenty to live on. Most likely the taxable accounts and Roths will not be used and will pass to our kids tax-free... they get a stepped up basis for the taxable accounts and the Roths are tax-free too.

To me, it doesn't make sense to use the taxable accounts for spending even at 0% LTCG if those capital gains restrict doing low cost tax-deferred withdrawals or Roth conversions... especially when the kids will get a stepped up basis on those holdings, which currently have ~50% unrealized gains (current value is about double my basis).

So in our case, the conventional wisdom of taxable, then tax-deferred and then Roth was clearly suboptimal. Luckily, I only squandered $120k of headroom before I figured it out.

 

[lhamo]

If you are only aiming to convert 300k, why not wait until you go on Medicare at 65 and don't have to worry about keeping the ACA subsidy? You could then do 60k a year or so and still be in a lower tax bracket, even if you start taking SS at 65.