Age 65/$3.3M IRA - Deflate it before RMDs?

[JeKa]

There's nothing sketchy about doing a Roth conversion. The only reason you might get help is to try to come up with the right about to convert for best tax/wealth management. It's as simple as moving money from one account (your tIRA) to another (your Roth). I'd have both accounts with the same holding company to keep it that simple.

If you don't need the money, I would absolutely convert money to a Roth rather than just withdraw the money and keep it in taxable, for the simple reason that all growth in the Roth is tax-free.

Unless there is something you have not disclosed about your situation, I would be converting up to top of the 24% tax bracket, or possibly to the top of one of the IRMAA tiers.

+1

 

[BaseballDad1618]

I think the lesson for our younger members is to keep some money in after tax accounts. If I could do it all over again, I would only contribute to the 401k to: 1) get any match (I never had one) and 2) get us down to the next lower tax bracket, but not more. And I most certainly would not make non-deductible IRA contributions. What a tax preparation nightmare that is.

I was a bit foolish (in hindsight, brilliant) when I was fresh out of college as I just created a taxable account to fund all my investments, aside from 401k. I certainly missed out on 3-4 years of Roth contributions during those first few years being a young, dumb ‘finance’ major, but it’s funny coming back full circle now where my wife and I are almost phased out of any Roth contributions due to income limits.

My 401k has quickly accelerated to over 50% of my inv portfolio (less than 25% a year ago) due to some generous matching & profit sharing contributions, but I’m finding tax implications and reducing them in both current and future scenarios to be quite the arduous task. Roth 401k vs Trad401k? Contribute to a 457b or Backdoor Roth? Or just after tax investments, all have different outcomes on current and/or future tax liability. I suppose as I read in another thread that’s why it’s called ‘personal’ finance.

It’s probably worth a post to get some thoughts on structure, but again I just love the commentary on a thread like this as there is so much to learn and not one answer is correct, or at least different answers can be rationalized.

 

[tulak]

I think the lesson for our younger members is to keep some money in after tax accounts. If I could do it all over again, I would only contribute to the 401k to: 1) get any match (I never had one) and 2) get us down to the next lower tax bracket, but not more. And I most certainly would not make non-deductible IRA contributions. What a tax preparation nightmare that is.

Good advice.

I’m still contributing max to 401k to stay out of the next tax bracket. Same as your advice, but from a different perspective.

I’m hoping I can convert a majority - or all - of tax sheltered accounts before RMDs. This is an area I haven’t modeled yet. I have time, but should do this soon to make sure I won’t have any unexpected surprises in the future.

 

[Koolau]

Good advice.

I’m still contributing max to 401k to stay out of the next tax bracket. Same as your advice, but from a different perspective.

I’m hoping I can convert a majority - or all - of tax sheltered accounts before RMDs. This is an area I haven’t modeled yet. I have time, but should do this soon to make sure I won’t have any unexpected surprises in the future.

Yeah, I started too late. Still a bunch in the 401(k) and RMDs are out of my control. Convert early and often!

 

[Alan]

I started Roth conversions for myself and my wife from the first year after retiring and one bit of advice I would give, that I may have missed in this particular thread is as follows. My wife and I each had non-deductible IRAs which, as Gumby points out above, are a pain to track the basis, so I what I did was not to rollover my zero-basis 401k into an IRA until I had done a Roth conversion of my IRA. Reason being that a Roth conversion takes into account all the non-deductible contributions from one's IRAs but 401ks are not included. My IRA had a lot more basis than taxable gain so in a single year I converted the lot and then had zero basis going forward.

 

[brokrken]

Maybe I'm missing something, but I did some math and if your income need at 70 is more than the RMD there is no benefit to doing the early conversions unless the return on the IRA is super low (like 2% or less). Not stating this as fact, perhaps I did a calculation wrong, just throwing it out there for discussion.

 

[Out-to-Lunch]

Maybe I'm missing something, but I did some math and if your income need at 70 is more than the RMD there is no benefit to doing the early conversions unless the return on the IRA is super low (like 2% or less). Not stating this as fact, perhaps I did a calculation wrong, just throwing it out there for discussion.

I may be missing something in your calculation. I agree that the impetus for doing conversions is blunted if your withdrawal is greater than the RMD. However, it is still conceivable that your tax rate at that time would be greater than the tax rate on conversions now.

 

[Dtail]

I may be missing something in your calculation. I agree that the impetus for doing conversions is blunted if you withdrawal is greater than the RMD. However, it is still conceivable that your tax rate at that time would be greater than the tax rate on conversions now.

Agree that this aspect is also a piece of the decision making process.

 

[Out of Steam]

I think the lesson for our younger members is to keep some money in after tax accounts.

Agree with this one; in our first two years of retirement, lack of funds outside of retirement accounts has proven to be at least an annoyance.

 

[RunningBum]

Maybe I'm missing something, but I did some math and if your income need at 70 is more than the RMD there is no benefit to doing the early conversions unless the return on the IRA is super low (like 2% or less). Not stating this as fact, perhaps I did a calculation wrong, just throwing it out there for discussion.

Might you be conflating income with spending? I don't ever have an "income need". I have a need for cash available to spend, which might come from a tIRA (which would be 100% income), or a taxable account (only the capital gains are income) or a Roth (0% income).

With that in mind, if you still think you are onto something, please show your math calculations.

 

[brokrken]

My assumptions:
$2.2M Traditional, $100K Roth to start. I started converting as soon as I FIRE. I'll be 48, but wife will be 53, so I used 53 as the starting age. From 53-60, I have no income except for the conversions up to 22%, as I will be living off of taxable accounts. At 60, I start taking my income either from the ROTH or the Traditional. I ran both scenarios to compare. It seems at a 3%+ real return, all I'm doing is trading taxes for market gains. At 2% there is a benefit, which starts at age 72. I also have assumed tax rates do not change. And again, my income needs exceed the RMD. For instance, in the "do not convert" scenario with 4% average return at age 70, after withdrawals the value of the Traditional would be $2.032M. So, the RMD would be $2.032/27.4 or about $74K. I assume I need $125K income, net of taxes. So, if it's coming out of tIRA I have to withdraw roughly $150k.

 

[RunningBum]

OK, I think I see what you are saying, though I haven't tried putting this in a spreadsheet to decide how market return rate affects this decision.

How does SS factor into this? My income will unavoidably increase at 70 or whatever age I start SS. So I'm doing conversions while my income is lower without SS. Once I start SS I think I run into your situation where there's probably no benefits to converting. Many people talk of converting between ER and when RMDs start, but really I think it is between ER and when SS & perhaps any pension starts.

 

[brokrken]

If I wait until 70 to start SS the estimate at that time is around $75K, so to meet my income needs of $150k I'd need another $75K, which is about equal to the RMD. I did this high level just to get an idea of how it would go. Looks like the next step is for me to split the IRAs into hers and mine to see how that impact the calculations. Again, if anyone sees a fatal flaw, please let me know.

 

[pb4uski]

What is your assumed tax rate in retirement?

If you cash need exceeds your RMD why wouldn't you use tax-free Roth withdrawals for the excess rather than additional high tax cost tIRA withdwawals?

 

[brokrken]

What is your assumed tax rate in retirement?

If you cash need exceeds your RMD why wouldn't you use tax-free Roth withdrawals for the excess rather than additional high tax cost tIRA withdwawals?

Sorry, I thought I mentioned, 22% and that's based on the amount I would need to pull out of the tIRA.

For your second question, I only start with $100k in Roth. In the convert case, I do take out of Roth first and there is very little left in the tIRA after all those years of converting when I'm 70 (only $229k) so the RMDs are miniscule. In the do not convert case, I also do, but the ROTH it's gone after the 1st year.

 

[ERPRECY]

If that $3.3m tIRA today when you are 65 grows at 4% real, then it would be worth $4.3m in today's dollars. [$3.3m*(1+4%)^72-65)] I use today's dollars because tax brackets are adjusted for inflation.

The RMD factor at age 72 is 25.6 so your RMD would be $168k... bringing your total income to $268k. If all is ordinary income the RMD would increase your federal income tax from ~$8k to ~$46k.... 23% of the RMD. MFJ both over 65.

Plus, tax rates are scheduled to increase in 2026 unless Congress intervenes which is unlikely and if one of you dies then the surviving spouse would likely be in an even higher income tax bracket.

I would take a hard look at doing Roth conversions to the top of the 22% or even 24% tax bracket. YMMV.

One point of confusion though... at one point you state that your income stream is $100k a year and at the end you say your gross income is $120k a year... can you elaborate on that?

Our numbers are almost the same as this OP, except we’re 66 this year. Thank you for this recommendation. While it’s hard to swallow the amount of taxes we need to pay (from the t-IRAs since we don’t have other source), this makes the most sense to us.

 

[patela6]

What an insightful thread and comments!
Given RMD start age seems to be going up each decade, I wonder how that would play into calculations. E.g. 72 --> 75?

Bottom line seems, its an absolute no Brainer to let any Roth conversion opportunity at or under 12% to be missed *any* year its possible.

 

[free2020]

My assumptions:
$2.2M Traditional, $100K Roth to start. I started converting as soon as I FIRE. I'll be 48, but wife will be 53, so I used 53 as the starting age. From 53-60, I have no income except for the conversions up to 22%, as I will be living off of taxable accounts. At 60, I start taking my income either from the ROTH or the Traditional. I ran both scenarios to compare. It seems at a 3%+ real return, all I'm doing is trading taxes for market gains. At 2% there is a benefit, which starts at age 72. I also have assumed tax rates do not change. And again, my income needs exceed the RMD. For instance, in the "do not convert" scenario with 4% average return at age 70, after withdrawals the value of the Traditional would be $2.032M. So, the RMD would be $2.032/27.4 or about $74K. I assume I need $125K income, net of taxes. So, if it's coming out of tIRA I have to withdraw roughly $150k.

I find your post quite insightful. Especially the bolded line. Well said. I'll use that!
Also, "income needs" is the best approach to take as you are doing.

Irony is that careful chiseling as with the Roth conversion over a decade or longer only works with very mediocre returns. Our situation has mirrored yours, I was 52 (now 62) when I started thinking about all of this, RMD, Roth, after-tax savings etc. I did convert opportunisticaly in 2010. Ten years into it, my conclusion is similar to yours. I don't intend on converting to Roth anymore, except if the market tanks 10+%, I may do some again.

 

[Curmudgeon44]

Please let me ask an elementary question: What does it mean when it "works"? Seriously I am getting confused by this and wanted to re-focus on the goal... Maybe we aren't all on the same page.

Thank you.

 

[SecondCor521]

Please let me ask an elementary question: What does it mean when it "works"? Seriously I am getting confused by this and wanted to re-focus on the goal... Maybe we aren't all on the same page.

Thank you.

In context, I think @free2020 is saying that you can only reduce the size of your traditional IRA if the conversions you're doing by taking money out exceeds the growth inside the traditional IRA on average over time.

Some people have "runaway" traditional IRAs, where they're converting $50K a year to a Roth and the traditional IRA grows by $100K, then you're not gaining ground on the goal of reducing the size of the traditional IRA.

The reason some people try to reduce the size of their traditional IRAs is that with RMDs and SS, one can face very high tax rates. Better to convert some now and pay 22% of the conversion to the IRS, then take out the money as an RMD later and pay 35% of the conversion to the IRS.

(Of course, I'm not @free2020 and they're certainly more than welcome to correct me if I've misconstrued or misrepresented.)

 

[CardsFan]

Please let me ask an elementary question: What does it mean when it "works"? Seriously I am getting confused by this and wanted to re-focus on the goal... Maybe we aren't all on the same page.

Thank you.

I am by no means an expert on this, but I have been doing Roth conversions.

IT works when:

- you can convert at a tax rate much lower than you will pay when SS and RMD's kick in. In our case, we will be solidly in the current 22% bracket. So converting to the top of the 12% bracket is a no brainer. Last year we converted into the 22% bracket, but the effective tax rate on the conversion was about 16%. Still a benefit.

- when your conversions, even if they are the same as your future tax rate, lower your RMD's to keep you out of IRMAA, or at a lower bracket.

- when your conversions help the remaining spouse stay in a lower bracket upon the death of one.

The first one above is fairly easy to quantify. The other 2 are, at least in our case, hoped for benefits. While some folks have spreadsheets to calculate these, IMHO, there are too many moving parts for any kind of accuracy. I just look at them as potential upside.

 

[Curmudgeon44]

A Working Plan

Thank you that is something I can get my mind around. Our family situation is one of those "runaway" pre-tax accounts, though I would have worded it "we deferred certainly enough, possibly too much". First world problems hahaha.

We were concerned about having enough for retirement, and the pre-tax 401K was just sitting there with an immediate tax benefit... in hindsight I would urge a young person to diversify between pre-tax and after-tax accounts, on the general principle you never know what the future will bring.

I have a definition of the plan "working" that perhaps is idiosyncratic. From my point of view, a Roth Conversion Plan "works" if it can get me to RMD age with a pre-tax balance amount which does not jump me up into an unfamiliar tax bracket. That's the best I can hope for.

Good luck with whatever works for you.

 

[RunningBum]

Please let me ask an elementary question: What does it mean when it "works"? Seriously I am getting confused by this and wanted to re-focus on the goal... Maybe we aren't all on the same page.

It's a good question. Ultimately, it comes down to how to make the most money available to you (and possibly your heirs or charities) in the end. You have to realize that your tIRA is not money available to you until you pay your taxes, except to make QCD donations. If you die with a balance, your heirs will be paying the taxes before they can use the money.

There's almost no way to know for certain that a Roth conversion will "work", so you make your best estimations and projections.

When does it work?

• When you can pay lower taxes now than you expect to be paying when you are forced to take RMDs. Most of us have this opportunity if we retired and have years without that income and before SS starts.
• When you project taxes will be even, but you can pay the taxes out of a taxable income source outside of the IRA.
• If one spouse dies and would leave the other with a large RMD and filing at the higher Single tax rate.
• If you find later that you need a large sum for a special expense, you can take it out of your Roth. If it came out of your tIRA would could be putting yourself in an even higher tax bracket for that year.

When does it not work? Meaning you should not convert at this point.

• When you are paying higher taxes now than you expect in retirement. This is common if you are still working or have some other income coming in now but not later. Or perhaps you plan to move to a lower or no tax state and this will give you a lower overall tax rate later. Or if your heirs are in a lower tax bracket and you want to optimize for them. But remember you have to pay taxes on RMDs and if you live a long time you'll be paying most of the taxes. Also they have to withdraw the entire amount within 10 years so their tax situation might not work out as well as you'd think.
• When you lose money. It would've been better to defer the conversion so you could convert a lower balance after losses. Of course you don't know you will lose money, and if you did, why wouldn't you invest in something else? It's also unlikely you will lose money in the long run.
• When it's money you plan to donate. Instead of converting, hold that money out for QCDs or make the charity a definition. Neither you nor the charity pays taxes.
• If you are under 59 1/2 and do not have enough money to pay the conversion tax from a taxable account. If you pay the tax out of the converted money, it is treated as an early withdrawal so you are penalized, 10% if I recall correctly.

I probably missed another factor or two.


Don't be misled by talk of a breakeven point. Someone is going to be paying the taxes. Always keep in mind that you can't touch that tax deferred money until you pay the taxes! People tend to focus on the sting of paying taxes now, but don't seem to grasp that the money isn't available until they pay the tax.

 

[RunningBum]

Some people have "runaway" traditional IRAs, where they're converting $50K a year to a Roth and the traditional IRA grows by $100K, then you're not gaining ground on the goal of reducing the size of the traditional IRA.

I've read posts from people that get discouraged by this, but isn't it obvious that if you are not converting at all, your tIRA would be growing even more?

 

[CardsFan]

^^ This.

RunningBum said it clearer than I, with more detail.

Edit to add: actually the one above.