tIRA->Roth conversion vs. 0% LT Capital gains

[anethum]

Hi, everyone. I've posted a few times but I haven't started a thread until now. I FIRE'd early last year when I was 57. My taxable and tIRA accounts are roughly equal at present. My Roth is relatively small. My taxable accounts have some fairly significant LT Capital Gains at this time. Running the numbers through TurboTax, I harvested some LTCG at the end of 2012 to take advantage of the 0% federal tax rate which I thought was going away. Turns out it didn't go away.

I had some earned income in 2012 that I presumably won't have going forward, so I'll have a larger amount of 0% federal-taxed LTCG I can harvest in the upcoming years.

One problem I see is that I won't know until near the end of each year how much my CG distributions and dividends will be from mutual funds. OTOH, if there are major dips in the markets during the year, that would be the best time to do tIRA->Roth transfers. Of course, you never know when the bottom is anyway.

No pension, and at this time, I don't plan on taking Social Security until I'm at least 66. Longevity runs in the family.

The i-orp planner showed me the advantages of gradually moving tIRA funds to a Roth. But I like the idea of harvesting some tax-free LTCG each year, in addition to whatever annual CG distributions I get from mutual funds. Of course, I have no idea how long the 0% LTCG rate will remain in existence, as well as the low 15% tax rate. I'm inclined to do a mix of both at least as long as these rates exist and I'm not yet receiving social security. (I will have to pay state income tax for both LTCG & tIRA transfers.)

Any thoughts about how I should best balance the 0% LTCG harvesting vs. Roth conversions? I haven't figured out any way to model this with either Firecalc or the i-orp planner. I suspect that the best path will largely depend on what happens with tax rates in the future, and that's unknowable. Thanks.

 

[haha]

I have the same interest, though because of my age I don't have much room each year.

My preference would be to do the conversions up to the amount of 15% bracket that is not obligatory used with RMD, SS, interest, partnership and other sources ot non-privileged income. Actually, I also will take whatever qualified dividends I can get in that space. If any space is left I'll use it for Roth conversions in preference to deliberately realizing capital gains. IOW, the only time capital gains will use any of this space is if I take one for reasons to do with the indivdual position, not for tax planning.

Right now I am trying to work out some efficient ways to do what I can on the conversion front.

Ha

 

[grasshopper]

Don't forget to see if your MF's throw off Qualified Dividends vs Ordinary. Maybe I am wrong, but I believe the Bush tax cuts are now permanent.

 

[GrayHare]

If your other sources of ordinary income are small, or will be during retirement, leaving some in the tIRA may be wise as tIRA withdrawals will provide taxable income against which deductions can be taken.

If you convert too much to Roth in any one tax year, but don't realize it until tax time, you have a window during which you can recharacterize back to tIRA. Drawbacks include more paperwork, and if you should wish only a partial recharacterization, I'm not sure if one is permitted (never tried it myself).

Recharacterization is not available for taxable sales that generate LTCG, so "cap gain washing" must be done with more care and precision.

 

[karluk]

Any thoughts about how I should best balance the 0% LTCG harvesting vs. Roth conversions? I haven't figured out any way to model this with either Firecalc or the i-orp planner. I suspect that the best path will largely depend on what happens with tax rates in the future, and that's unknowable. Thanks.

It strikes me that finding the best path could be quite complex, even assuming no changes in the tax law. It's highly desirable to make enough Roth conversions in the years before you turn 70 1/2 in order to avoid extremely large mandatory withdrawals that might kick you into a higher tax bracket. So for extremely large 401k balances, the preference figures to be strongly in favor of Roth conversions over 0% LTCG harvesting. For small 401k balances, there is little or no danger of mandatory withdrawals pushing you into a higher tax bracket, so you can put more emphasis on generating 0% LTCG. For medium size 401k balances, there is probably some middle ground at which it would be best to evenly weigh Roth conversions and 0% LTCG harvesting. This balance point figures to be dependent on multiple factors, such as the initial 401k balance, the initial taxable balance, the number of years before mandatory withdrawals begin and your estimation of likely stock market returns in the years during which you are making Roth conversions.

 

[pb4uski]

I'm in a very similar position to the OP. In 2012, I chose to take capital gains rather than Roth conversions because I was unsure how long the 0% capital gains opportunity would last. In retrospect, since both parties seemed committed to keeping rates the same for middle income, perhaps my concern was misplaced.

I have about another year and a half's worth of capital gains harvesting available in my taxable portfolio. I "think" I will harvest those first and then I'll have about 10 years or so of Roth conversions before RMDs start. I'm thinking that the 0% LTG rate is too good to last long (even though it is allegedly "permanent") so I'm prioritizing LTCG ahead of Roth conversions.

I'm thinking if pensions, SS and RMDs force me into higher taxes in my 70s and beyond that is probably not a hugely bad problem to have.

 

[RunningBum]

I agree with Karluk that the 401K/IRA balance is a factor. I also look at LTCG at 0% being a 15% savings, while a Roth conversion at 15% might only be a 10% savings over a 25% bracket later.

A drawback to the LTCG sale is if you are making a bad sell decision based solely on taxes. Also, if you were to die, your heirs would get a new tax basis on your stocks, and also have more favorable distribution rules on a Roth IRA, so in that aspect converting to a Roth is better.

 

[Animorph]

I agree with Karluk that the 401K/IRA balance is a factor. I also look at LTCG at 0% being a 15% savings, while a Roth conversion at 15% might only be a 10% savings over a 25% bracket later.QUOTE]

I'm thinking the LTCG 15% savings would be worth more than the potential 10% Roth conversion savings as well. So my first inclination would be to do all LTCG first and then Roth conversions. If you have enough time, which you may, the ordering may not make much difference if you are able to get it all done within the 15% bracket eventually. If SS or pensions get in the way, the question may be more difficult, and the balanced approach may be better. I would want at least some of the portfolio converted to Roth.

You'll should use a spreadsheet to get a better answer.

 

[anethum]

Thanks for all of the thoughtful comments. I'm somewhat reassured that there is no obvious answer. karluk, I would characterize my tIRA balance as "moderate", so by your thinking I can do a mix. That has been my general thinking, too, and I was curious whether anyone would present a strong case for doing all one or the other. I realize that I left out numbers which makes it more difficult for everyone to assess.

One thing I think I will do this year is combine harvesting specific gains with making my investments more efficient. Some assets which are presently in tax-deferred accounts I now realize would be better off in taxable accounts, and vice versa.

There's one thing the i-orp planner spits out which I haven't been able to figure out. If I tell it I won't start collecting social security until I'm 66, it has me do sizeable tIRA->Roth conversions from now until I'm 62. Then it reduces by more than half my conversions for 3 years from age 63 to 65 (and reduces my taxes to almost nothing). Then it resumes large Roth conversions from age 66 to 70. If I tell it I won't start social security until I'm 70, it does something similar.

 

[devans0]

I tried working this out from tax tables, finding the efficient top earnings amount for 15% rate, then subtracting out income sources until I was left with tIRA.

I divided out that amount with what I had left in the 15% tIRA 'bucket' to find a withdrawal rate. At 5% (for me) it is high, but I have the cushion of taxable and Roth funds as a buffer. Any amount between my spending needs and $72500 is fair game for conversion to Roth.