Advice on Roth Conversions

[leyland]

Hi Folks,

I am looking for advice/thoughts on how to decide whether to start converting our traditional IRAs to Roth IRAs and if so how much each year. Here are the details:

RMDs: My wife is 4 years away from having to take RMDs (66.5 years old). I am 7 years away (63.5 years old).

Income: Our only income is dividends (about 90% qualified) and capital gains from non-retirement accounts.

SS: We will both start at age 70 so no SS yet.

So, I realize that conversions are taxed as regular income and some attention to marginal tax rates is important when deciding on whether to convert and how much. For the consideration of marginal tax rates, do dividends and capital gains count towards the income level that dictates the marginal tax rate? In other words, what is the thought process on trying to decide whether to convert and how much? Thanks for any insight.

 

[kaneohe]

The basic rule is to compare the tax rate of conversion against the rate if you didn't convert and were withdrawing from the TIRA .......you can calculate the latter for now conditions and also after RMDs start. If you can convert at lower rate now than you would pay when withdrawing later if you didn't convert,that is a favorable condition to convert.

It might be best for now to use a tax calculator like this
https://www.mortgagecalculator.org/calcs/1040-calculator.php
You can do a no conversion calculation and compare w/ a conversion calculation to calculate the marginal tax rate of that conversion. Then calculate the similar models for no conversion and withdrawal from the TIRA to get the marginal tax rates for that TIRA withdrawal.

Yes, there can be some interaction so that the QDIV/CG affect the marginal rate. The calculator method will take that into account so you don't have to worry about that.

The basic idea can be understood by thinking of a stacked bar chart w/ QDIV/CG sitting on top of the ordinary income.
If your ordinary income is low enough the QDIV/CG will not be taxed. However if you add enough ordinary income at the bottom, the QDIV will be taxed at 15%. Your marginal rate then is not just the 12% on the Roth conversion but the additional 15% on the QDIV caused by the Roth conversion for a total of 27%. This rate of course is limited by the amount of QDIV/CG you have so the rate may eventually decrease to just the ordinary rate once all the QDIV/CG is
pushed above the threshold.

You can simulate these effects w/ the tax calculator.

 

[pb4uski]

Hi Folks,

I am looking for advice/thoughts on how to decide whether to start converting our traditional IRAs to Roth IRAs and if so how much each year. Here are the details:

RMDs: My wife is 4 years away from having to take RMDs (66.5 years old). I am 7 years away (63.5 years old).

Income: Our only income is dividends (about 90% qualified) and capital gains from non-retirement accounts.

SS: We will both start at age 70 so no SS yet.

So, I realize that conversions are taxed as regular income and some attention to marginal tax rates is important when deciding on whether to convert and how much. For the consideration of marginal tax rates, do dividends and capital gains count towards the income level that dictates the marginal tax rate? In other words, what is the thought process on trying to decide whether to convert and how much? Thanks for any insight.

While it is hard to say without more information, what you describe is typically a great time to do Roth conversions or alternatively, live off your tIRAs rather than taxable accounts.

From what you wrote your marginal tax rate now is much lower than your marginal tax rate once SS is online... so any tIRA withdrawals or RMDs after SS starts will be at a higher tax rate than what you would pay today.

Dividends and capital gains count.

So for example, let's say that you are living off of savings and your qualified dividends and capital gains are $20k.... your marginal tax rate is zero.

You could have as much as $103,150 of income in 2019 and still be in the 0% capital gains tax bracket. So let's say you do $83,150 of Roth conversions your tax would be $6,662 (8%). It is 8% because the first $24,400 is not taxed because it is covered by the standard deduction, then next $19,400 is taxed at 10% and the remaining $39,350 is taxed at 12% and those all blend to 8%. The $20k of preferenced income is subject to tax at 0%.

8% is a lot lower than the taxes that you saved when that income was deferred and the taxes that would be paid if you wait.

Also, the result would be the same if you do $83,150 of tIRA withdrawals or Roth conversions. My taxable accounts are mostly equities so I leave those alone to grow because if I tap them for spending money the capital gains generated reduces the amount that I can withdraw at these low tax rates. Also, if one of us passes those equities get a stepped up basis so any unrealized gains become tax-free.

Just remember: in terms of reducing RMDs, $1 of tIRA withdrawals saved or spent have the same impact as $1 of Roth conversions.

 

[SnowballCamper]

For the numerically optimal withdrawal plan (for most of us) use www.i-orp.com

On the extended tab you can specify parameters for the number and size of Roth conversions. When you allow the conversions, it will almost certainly have you do large conversions (with a hefty tax bill) early on. What I like about this calculator is that you can see the results projected through the end of your planned retirement, and how many years it takes to get back the benefit of doing the Roth conversion.

It does take some reading to be able to interpret the results, but the site has extensive documentation links.

 

[Cobra9777]

We convert to the top of the 12% bracket. I'm not willing to go higher because the benefit is comparatively tiny for our situation, and it is not without some risk. We have two pensions, dividends, and some rental income, so the annual conversions are rather small. We've been doing this since I retired at 52 and we hope to get about half our tax-deferred balances converted by 70. At that point, we'll have pensions, SS, and a balanced mix of taxable, tax-deferred, and tax-free. Tax-wise, that should provide plenty of flexibility in meeting our spending needs. And RMDs should be taxed at an incremental rate well below the rate we would have paid when the tax was originally deferred. That's good enough for me.

 

[grasshopper]

TurboTax Taxcaster is online for 2018 and soon to be up for 2019. Easy to input Income including QD and tIRA as pension adjust until you find your sweet spot.

https://turbotax.intuit.com/tax-tools/

 

[sengsational]

For the numerically optimal withdrawal plan (for most of us) use www.i-orp.com

+1
My usual warning is in order to have it use exclusively tax "levers" to optimize, report your stock/bond allocation the same across all tax buckets. So if your overall stock allocation (including taxable, pre-tax, roth) is 60%, put 60 across the board. Otherwise, it will use the expected rate of return to help decide which bucket to pull from, which is invalid (presuming that you reset to target asset allocation across all tax buckets).



Then also look at the magnitude of the difference between doing aggressive Roth conversions and not (do a run with Roth conversions 'off'). Some people see that the long-term plan is just a tiny bit better with Roth conversions (but requires them to pay lots of tax right now), and decide against it because the improvement isn't enough to justify paying tax early (kind of a 'bird in the hand' thing).

 

[SnowballCamper]

Some other criteria I consider:

1. We are at a [-]historical[/-] relative low for income taxes now. The marginal rates have trended down since WWII. I doubt this continues for another 50 years. I-ORP increases the tax bracket cutoffs with inflation, and that is surely not how they will actually increase. Overall, I think the historical low supports the case for conversion to Roth.

2. I have significant pension income that puts any conversion of more than a few thousand into the 22% tax bracket. Given my current income, known SS estimate, and what my RMD would be if I were 70 now, I would still be in the 22% tax bracket, or have just a few thousand in the 24% bracket. So the amount of tax is about the same, assuming tax rates stay the same, and I can choose to pay it now or later.

3. I'm early in retirement (45), and don't have a desire to blow that dough yet. I expect that we'll have some serious medical expenses (hopefully later and not sooner). The medical expense deduction is hopefully still there to offset the tax on larger withdrawals when I have to make them.

4. Finally,

Then also look at the magnitude of the difference between doing aggressive Roth conversions and not (do a run with Roth conversions 'off'). Some people see that the long-term plan is just a tiny bit better with Roth conversions (but requires them to pay lots of tax right now), and decide against it because the improvement isn't enough to justify paying tax early (kind of a 'bird in the hand' thing).

And for me the up front expense of an aggressive conversion strategy is too much for a gain of maybe a couple thousand a year.

 

[Senator]

I convert to the top or slightly over my tax bracket. It is hard to tell just how much, so I do ~$10K early in the year, and domore later is I need to.

Tax rates will likely go up, exponentially, for anyone that has any sort of wealth. Do as much as you can now.

 

[googily]

I convert to the top or slightly over my tax bracket. It is hard to tell just how much, so I do ~$10K early in the year, and domore later is I need to.

Tax rates will likely go up, exponentially, for anyone that has any sort of wealth. Do as much as you can now.

I'm still working (53), but am converting into the 24% bracket along with maxing out the mega backdoor Roth. As a widow, the potential tax torpedo is large, and I'll have two pensions and will start survivor SS at 60 and mine at 70. So really this is probably as good a tax situation as I'll be in, especially with the assumption that tax rates are going to rise.

I also have access to DH's 401k without penalty, so I want to try to lower that balance--and might as well dump it into a Roth since I still have money in taxable that I can spend until the conversions season.

 

[sakowitzm]

+1 this ^

Like googily, I am a widow(er), so the 22% bracket comes quickly, with 24% not far behind. Especially as I am receiving a hefty survivor's benefit. I expect to be in the 24% bracket when I finally start my own SS at 70, with significant RMDs. So am converting into the 24% bracket now. I like that this will give me flexibility down the road, to draw from taxable and non-taxable. And if I kick off sooner than expected, my adult kids will inherit more that is non-taxable.

 

[googily]

+1 this ^



Like googily, I am a widow(er), so the 22% bracket comes quickly, with 24% not far behind. Especially as I am receiving a hefty survivor's benefit. I expect to be in the 24% bracket when I finally start my own SS at 70, with significant RMDs. So am converting into the 24% bracket now. I like that this will give me flexibility down the road, to draw from taxable and non-taxable. And if I kick off sooner than expected, my adult kids will inherit more that is non-taxable.

Sorry you are in the same spot, but glad to hear there's at least one other person who came to this conclusion. There's not much guidance for younger widows on such things.

And don't forget that the 24% bracket is scheduled to go away after 2025, and it's more likely we'll be in the 28% bracket if the previous setup returns (which I actually doubt, I think someone with my nest egg will definitely take a big hit the next time the tax codes are revised).

 

[Octogirl]

+1 on Roth conversion

I need to review these posts in Jan. 2020

 

[SecondCor521]

+1 on Roth conversion

I need to review these posts in Jan. 2020

I do my Roth conversions in December, after doing a proforma tax return to figure out what I want my taxes to look like.

Try it, it's fun!

 

[pb4uski]

+1 on Roth conversion

I need to review these posts in Jan. 2020

No, January 2020 would be too late to do Roth conversions for 2019.

 

[Octogirl]

Roth conversion

Thanks. Yes, I already know that I won't convert in 2019, because I am still working full time. But I'll be retiring in 2020 and do tax planning in January for the year.