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

[SecondCor521]

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?

It is obvious to you and me.

I was just trying to explain the notion of what I thought @free2020 meant, which is what another poster was asking about, which is trying to reduce the size of the traditional IRA through conversions.

I've been Roth converting since age 46 and will probably convert every year for the rest of my life. Even so, my traditional IRA will probably continue to outgrow my conversions according to my projections and plan. Given the market returns over the last five years plus my conservative financial approach, plus a few other things, I probably - in retrospect - saved too much and deferred too much. First world problems of course.

 

[Dtail]

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.

That is where my DGF is at right now. None for me coz of heavy ACA tax subsidies.

 

[Dtail]

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.

2 other factors when not to convert could be:
1) The ACA tax subsidies generated by limiting one's MAGI can be larger than any Roth conversion benefit.
2) If one wishes to keep some monies in a TIRA to use against potential large unreimbursed long term care type medical expenses.

 

[Sue J]

I love the term "runaway" traditional IRA. I have a small one of these. It just keeps growing. I haven't done any conversions yet because in 2020 we had a few months of ACA subsidies before we started Medicare. 2021 will be the first year where I will convert to Roth and I will take 2-3 years depending on the tax impact. My goal is to leave this to my kids and have it all in Roth so they have no taxes on it.

The impact on ACA subsidies would have been larger than our Fed tax rate. We are solidly in the 12% bracket and nowhere near IRMAA.

I also have an Inherited IRA. That cannot be converted to Roth, unfortunately. I do the RMDs and the growth is more every year. Nice problem to have! This one is old enough where it's stretched out over my lifetime so the RMDS are small.

 

[Gumby]

I think a factor that few incorporate in their calculations is the tax arbitrage that has already occurred. For example, most of the money I put in my 401k was put there when my marginal tax rate was 35% or more. Some years, it was 39%. So for every $1000 I contributed, I saved $350 in taxes. So now, many years later, I take out my $1000 contribution. If I am now in the 22% marginal bracket, I pay $220 in taxes. That's $130 in free money right there, not even counting the compounded gains on the extra $350 that was in my after tax account that whole time.

 

[RunningBum]

I think a factor that few incorporate in their calculations is the tax arbitrage that has already occurred. For example, most of the money I put in my 401k was put there when my marginal tax rate was 35% or more. Some years, it was 39%. So for every $1000 I contributed, I saved $350 in taxes. So now, many years later, I take out my $1000 contribution. If I am now in the 22% marginal bracket, I pay $220 in taxes. That's $130 in free money right there, not even counting the compounded gains on the extra $350 that was in my after tax account that whole time.

Why would that be a factor in the conversion calculation? Just like there are "sunk costs", that was a "sunk benefit". You got that benefit and it was great, but now it's time to evaluate whether and how much to convert.

 

[Gumby]

Why would that be a factor in the conversion calculation? Just like there are "sunk costs", that was a "sunk benefit". You got that benefit and it was great, but now it's time to evaluate whether and how much to convert.

You are quite correct. The question for us now is: Looking ahead, what is the optimal strategy? But let us not forget that we did get a benefit when we set that money aside tax free. It may make us less cranky about paying taxes now.

 

[RunningBum]

It may make us less cranky about paying taxes now.

YES! The original deferral means you are paying taxes later, not earlier, and less of them to boot!

 

[Scuba]

2 other factors when not to convert could be:

1) The ACA tax subsidies generated by limiting one's MAGI can be larger than any Roth conversion benefit.

2) If one wishes to keep some monies in a TIRA to use against potential large unreimbursed long term care type medical expenses.

I’m curious about #2 - is there a benefit to having money for unreimbursed LTC/medical expenses in a tIRA vs a Roth?

 

[Dtail]

I’m curious about #2 - is there a benefit to having money for unreimbursed LTC/medical expenses in a tIRA vs a Roth?

My thinking was as follows:
If one has for example 100k in a tIRA and then converts 100k to a Roth, let's say they will pay 12% taxes even if from a taxable account.
If LTC expenses are 100k, they still paid 12k in taxes.
Now if they kept the monies in a tIRA and they used 100k of the tIRA to pay the 100k of LTC expenses, they would get a tax deduction of 100k less the 7.5% tax deductible and just have to pay taxes on the 7.5k which would be less than 12k.
Does that make sense?

 

[RunningBum]

The drawback to keeping some money in a tIRA for LTC is that you probably have years of RMDs before you need LTC. And you may never need LTC. But if you do it can be 100K/yr for the rest of your life. So the math can certainly work if it happens, but it's not a clear-cut advantage.

I have a lot of unrealized capital gains in my taxable account so I'll use that rather than keep some money in my tIRA in case I have very high medical expenses later.

 

[Scuba]

My thinking was as follows:

If one has for example 100k in a tIRA and then converts 100k to a Roth, let's say they will pay 12% taxes even if from a taxable account.

If LTC expenses are 100k, they still paid 12k in taxes.

Now if they kept the monies in a tIRA and they used 100k of the tIRA to pay the 100k of LTC expenses, they would get a tax deduction of 100k less the 7.5% tax deductible and just have to pay taxes on the 7.5k which would be less than 12k.

Does that make sense?

Yes it does. Thanks!

 

[free2020]

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.

Long post warning. Thanks for reading, understand if not read fully.

Thanks to all posters for chiming in about what "works" and "doesn't work" mean. Most of the reasons are covered.

That said, thought some elaboration of what "works" for me is in order. I'm an infrequent poster but keep an eye out for threads on outsized tIRA(relative to networth) and Roth conversions on this outstanding message board. This particular topic caught my eye and especially the views of @brokrken.

Here's what @brokrken is doing really well,

- Planning for RMD at 48!
- Considering rate of return scenarios
- Not making future tax rate the top consideration
- Having a healthy nest egg already!

Here's my situation, @ 62 (numbers)
- Low probability of anything less than a 22% tax rate from now to RMD age
- Roth is 25% of net worth currently - opportunistic conversion in 2010 + supercharging via workplace Roth with 26K contribution limits during 2018-20
- Have little in after tax savings
- Rate of return over 10% since 2005 (model for less from here on)
- Retirement planning since 50; exactly mirrors @ brkrken - based on income needs versus cash on hand or tax rate or inheritance
- Plan to empty out tIRA by around RMD age- spend it down & QCD
- Live off ROTH post- RMD

Here's my approach to investing and everything else
- Rate of return primary focus - make what American Business makes
- Buy and hold investing in stocks
- Try very hard to pay close to zero in fees
- Zero belief in modern portfolio theory - asset allocation, balancing etc.
- Mentally prepared for a 50% temporary decline in net worth with a repeat of 2008-09, hold cash to live and ride out 2 years. Will always do.

- Taxes:
- Will cheerfully pay taxes, having done well, especially in retirement years.
- QCD and taxes are in one bucket for me.

- Inheritance:
Used to not even think about this 15 years ago or earlier. Because I was obsessed with the thought "Don't have enough" to get through our own lives! Slowly as the investment approach started to work out, it went to "May have enough"; to "Have enough" and recently(cautiously optimistically) "Will have more than enough". So, passing on what's left to family is a recent consideration. I'm trying to learn from the most rational people on this subject. Both of us got nothing from our parents. We did okay on our own.

My own thoughts are that, given that I myself was living under "don't have enough" until about age 50, squirreled away every penny that we could, during our prime years (my age 30-50, spouse 25-45, kids 0-15). We were postponing spending on little luxuries like the nicer vacation, running cars to the junk yard, buying that jewelry for the spouse etc. All in order to overcome my own fear of "not having enough". For ex. we always maxed out on 401K's to the fed limit etc. What is the inheritance going to be worth to my family when they are 50 to 70 years of age after a life of postponing consumption at 0-45 ages

TL DR version, I really don't worry about leaving a large pile, let alone the tax implications for heirs. Based on my numbers outlined above, best outcome is that it's likely to be in Roth money, which allows (my best understanding), 10 years for heirs to draw down. That's good enough for me to stop breaking my head over this. If one of us passes before RMD, we increase QCD, pay taxes etc.

I post this with respect to all points-of-view around "What works". Each person's situation is unique and generalizations should not be attempted.

 

[SecondCor521]

@free2020, are you really able to empty your traditional IRA via spending and QCDs by RMD age without exceeding that 22% rate?

It seems from your description that you may be draining your traditional IRA too fast and paying more in taxes than is necessary. But since you have more than enough and don't care about taxes, I suppose that's OK.

 

[free2020]

@free2020, are you really able to empty your traditional IRA via spending and QCDs by RMD age without exceeding that 22% rate?

It seems from your description that you may be draining your traditional IRA too fast and paying more in taxes than is necessary. But since you have more than enough and don't care about taxes, I suppose that's OK.

Good question. Honestly don’t know if I can empty it out by 72. I believe it is likely but, it depends on how well the investment approach works out.

Would love to,
a) live to RMD
b) deal with the smaller, remnant tIRA which should..
c) lengthen the Roth runway

Frugality is natural for us and perhaps easier in our 70’s. And there’s the Roth. Preaching to the choir here, but I tell all youngsters to supercharge their Roth in their younger days. Fund 401k to co match-Roth contribution-and then all other savings. Put it in an index fund and forget about it!

 

[Koolau]

And there’s the Roth. Preaching to the choir here, but I tell all youngsters to supercharge their Roth in their younger days. Fund 401k to co match-Roth contribution-and then all other savings. Put it in an index fund and forget about it!

Yes, this is the "old me" talking to the "young me." Too bad the old me wasn't able to cross that time chasm. As we typically say now: A First World problem!

 

[a60dan]

Yes, this is the "old me" talking to the "young me." Too bad the old me wasn't able to cross that time chasm. As we typically say now: A First World problem!

Amen to that!