Benefits of Roth Conversions vs Medicare Premium Surcharge

[rkser]

I am 65, am starting both Medicare & retirement.

I am planning out the Roth Conversions for the year up to top of 24% MFJ & will be paying a hefty tax in the hope of reducing taxes later in the retirement.
I do not know how to project my taxes in the future, but knowing the lowest tax rates of present, I am guessing my taxes will be higher later in the game.

In the process, I noted the resulting higher MAGI will penalize me with higher rung of Medicare Premium Surcharge to a tune of almost $3k/yr more than the standard premium 2 yrs down.

I guess you can have one or the other, not both. Is there a way to decide which way to go ?

I will appreciate any opinions/feedback, thankyou in advance

 

[RunningBum]

It's hard to say because there are so many factors like this. I would be trying to set up a spreadsheet specific to the situation and try to run it out for the rest of your life, but you have to make some assumptions for that. Maybe one of the tools people use does this for you.

Would you be paying the standard premium if you did no conversion, or would you just be in a lower tier? Just wondering if the difference is really $3K or something less.

To do a rough calculation, let's say you'd be in the 32% bracket later. That's an 8% tax rate difference. If you're talking about converting $50K now at 24% vs. taking later at 32%, that's a $4K savings ($50K * 8%). A little better than your $3K IRMAA surcharge.

 

[SecondCor521]

It's the same thing as @RB except in reverse, but I like to look at things as a tax rate. So converting puts you in the 24% rate plus whatever rate the IRMAA increase works out to be.

The math I do is to take the IRMAA tier rate (say, $462.70 per month) minus the IRMAA base rate (say, $144.60 per month), multiply by 12, then divide by my taxable income.

For my data, at age 75, that number works out to be 4.39%. So I'd add that 4.39% to the base rate of 24% and get 28.39%.

I can do this for my taxes today and my taxes later. Roughly speaking, if my conversion tax rate now is lower than it will be at age 75, I think it's a good bargain.

@RB's approach has the benefit of putting a dollar figure on the benefit, which is a good sanity check to see if it's even going to make much difference one way or the other.

 

[TheWizard]

Just levelize your AGI for starters, until age 72.
Maybe tweak it up a bit close to but not over the next higher IRMAA tier.

Then from age 72 on, hopefully in same IRMAA tier as before...

 

[rkser]

MAGI up to $330,000, the IRMAA Premium is $386.10, Standard being $148, the surcharge of $238/month x 12 = $ 2856/yr more.
Our MAGI of $326,000 (22k + AGI 304) as calculated below.

This is preliminary Sheet from - MortgageCalculator / 1040 Tax Estimator for 2021, figures are rounded off, changes will be made after playing with numbers. I use Turbo tax to file.

Income All Other Sources: $310,000
Taxable interest: $12,000
Tax-exempt interest:$22,000
Ordinary dividends (this includes any qualified dividends):$78,000
Qualified dividends (included in ordinary dividends):$70,00
Long term Capital gain or loss: $60,000
Taxable IRA distributions: $160,00
Total income:$310,000
Adjusted Gross Income: $304,000
Standard Or Itemized Deduction: $26,450
Taxable Income: $277,550
Total Tax Before Credits: $43,458
Total Tax Credits: $0
Total Tax After Credits: $45,510
Your taxes are estimated at $45,510
This Is 14.68% Of Your Total Income Of $310,000. Your Total Tax Payments For The Year Were $0. Your Outstanding Tax Bill Is Estimated At $45,510. This Puts You In The 24% Tax Bracket.

We are usually near the top of 22%, but Roth Conversions are pushing us into 24%, will pay the taxes from taxable accounts.
I have $1.4m in all Bonds IRA & want get it down to $1m if I can.

Looking at the above figures again, I know I should not be concerned too much about the irmaa surcharge of around $3 k/ yr, but I just hope it pays later in the retirement.

 

[pb4uski]

....I do not know how to project my taxes in the future, but knowing the lowest tax rates of present, I am guessing my taxes will be higher later in the game. ...

What I do is rough, but gives me a bit of an idea. I have a little different situation but I assume interest and dividends are about the same as now... and the same for my pension. I add in our estimated SS once both DW and I are collecting SS based on 2021 (IOW, not including any projected COLAs for 2021 onwards). Then I include our tax-deferred balances divided by the RMD factor for age 72 and reduce the total but the standard deduction for a MFJ couple over age 65.

And mine at 72 will definitely be higher than today.

 

[SecondCor521]

MAGI up to $330,000, the IRMAA Premium is $386.10, Standard being $148, the surcharge of $238/month x 12 = $ 2856/yr more.
Our MAGI of $326,000 (22k + AGI 304) as calculated below.

This is preliminary Sheet from - MortgageCalculator / 1040 Tax Estimator for 2021, figures are rounded off, changes will be made after playing with numbers. I use Turbo tax to file.

Income All Other Sources: $310,000
Taxable interest: $12,000
Tax-exempt interest:$22,000
Ordinary dividends (this includes any qualified dividends):$78,000
Qualified dividends (included in ordinary dividends):$70,00
Long term Capital gain or loss: $60,000
Taxable IRA distributions: $160,00
Total income:$310,000
Adjusted Gross Income: $304,000
Standard Or Itemized Deduction: $26,450
Taxable Income: $277,550
Total Tax Before Credits: $43,458
Total Tax Credits: $0
Total Tax After Credits: $45,510
Your taxes are estimated at $45,510
This Is 14.68% Of Your Total Income Of $310,000. Your Total Tax Payments For The Year Were $0. Your Outstanding Tax Bill Is Estimated At $45,510. This Puts You In The 24% Tax Bracket.

We are usually near the top of 22%, but Roth Conversions are pushing us into 24%, will pay the taxes from taxable accounts.
I have $1.4m in all Bonds IRA & want get it down to $1m if I can.

Looking at the above figures again, I know I should not be concerned too much about the irmaa surcharge of around $3 k/ yr, but I just hope it pays later in the retirement.

Yeah, so my way may be a bit sloppy, but I would take the $2856 / $277,550 and conclude that IRMAA is about a 1% additional tax, so you'd be in the 24% +1% = 25% bracket. You'd have to decide if you'll be in a higher bracket in the future either due to the 2026 tax changes, or new tax law, or growth in your tIRA, or decreasing RMD divisors, or the loss of a spouse or multiple of these.

It all gets a bit fuzzy because the IRMAA surcharge is two years later, and it's adjusted for inflation (both the brackets and the surcharges), and the IRMAA surcharges are a series of mini cliffs, and you don't know what's going to happen in the future. But it's a rough way of looking at it that I think is reasonable.

 

[SevenUp]

We are usually near the top of 22%, but Roth Conversions are pushing us into 24%, will pay the taxes from taxable accounts.

You might want to go to the top of the 24% bracket, because you are actually paying higher marginal rates for most of the first $250K in Roth conversions.

See the chart below, from the case study spreadsheet using the numbers you provided. The spikes are IRMAA tiers.

 

[Dash man]

We did a large conversion last year and will take the IRMAA hit next year because of it. But in the following years things will be manageable to the second IRMAA tier. I honestly don’t know if it was worth it for IRMAA purposes, because we did it primarily to make filing taxes at the single rate more tolerable should one of us pass early on. We will never completely dodge IRMAA.

 

[Dash man]

One thing to consider if you itemize your taxes. IRMAA is tax deductible as a medical expense and your total healthcare expenses exceed 7.5% of your income.

 

[TheWizard]

One thing to consider if you itemize your taxes. IRMAA is tax deductible as a medical expense and your total healthcare expenses exceed 7.5% of your income.

Correct, but the stick holding that carrot gets longer the deeper into IRMAA one gets...

 

[teej1985]

One thing to consider if you itemize your taxes. IRMAA is tax deductible as a medical expense and your total healthcare expenses exceed 7.5% of your income.

You're better off reimbursing from your HSA. No 7.5% floor to worry about.

 

[rkser]

You might want to go to the top of the 24% bracket, because you are actually paying higher marginal rates for most of the first $250K in Roth conversions.

See the chart below, from the case study spreadsheet using the numbers you provided. The spikes are IRMAA tiers.

Sevenup,

Please help me understand this graph, I am confused. I redid the Tax Estimation at the Top of 24% Tax Bracket -

In above given Tax Estimation-
After converting $ 160k
Taxable income is $277550
MAGI = $ 326k
Taxes due $ 45510
Irmaa Medicare Premium $ 2856/yr more in 2023

As per Tax Estimation Sheet given below, to the top of 24% Bracket -
After converting $ 205k i.e $45k more
Taxable Income is $32250
MAGI is $371k
Taxes due $ 57516, i.e $12k more
Irmaa Medicare Premium around $ 3900/yr more i.e $1000 more in 2023

1040 Tax Estimator for 2021
Income All Other Sources: $355,000
Taxable interest: $12,000
Tax-exempt interest:$22,000
Ordinary dividends (this includes any qualified dividends):$78,000
Qualified dividends (included in ordinary dividends): $70,000
Long term Capital gain or loss: $60,000
Taxable IRA distributions: $205,000
Total income:$355,000
Adjusted Gross Income: $349,000
Standard Or Itemized Deduction: $26,450
Taxable Income: $322,550
Total Tax Before Credits: $53,754
Total Tax After Credits: $57,516
Your taxes are estimated at $57,516
Your Taxes Are Estimated At $57,516.
This Is 16.2% Of Your Total Income Of $355,000. Your Total Tax Payments For The Year Were $0. Your Outstanding Tax Bill Is Estimated At $57,516. This Puts You In The 24% Tax Bracket.

Bottom Line is if I convert $205000, i.e Roth convert $45k more than prior & go to top of 24%, taxes will be $57516 , i.e $12k more,

I am trying to get my mind wrap around these numbers.

 

[walkinwood]

I am 65, am starting both Medicare & retirement.

I am planning out the Roth Conversions for the year up to top of 24% MFJ & will be paying a hefty tax in the hope of reducing taxes later in the retirement.
I do not know how to project my taxes in the future, but knowing the lowest tax rates of present, I am guessing my taxes will be higher later in the game.

In the process, I noted the resulting higher MAGI will penalize me with higher rung of Medicare Premium Surcharge to a tune of almost $3k/yr more than the standard premium 2 yrs down.

I guess you can have one or the other, not both. Is there a way to decide which way to go ?


I will appreciate any opinions/feedback, thankyou in advance

This decision is very complicated and software can help. I can't remember if i-orp (extended) takes medicare premium surcharges into account or not, but if it does, that's an option.


https://www.early-retirement.org/forums/f28/retirement-tax-planning-income-optimization-99854.html



This thread discussed a few options to help with ROTH conversion decisions & you may benefit from reading through it. Good luck.

 

[qwerty3656]

Just a minor question/clarification. You don't use MAGI for tax brackets, right. You subtract deductions first (either standard or calculated), right? So if MFJ 12% tax bracket goes upto $80,250, you really can earn $105,000 and still be in the 12% bracket, right?

 

[RunningBum]

Just a minor question/clarification. You don't use MAGI for tax brackets, right. You subtract deductions first (either standard or calculated), right? So if MFJ 12% tax bracket goes upto $80,250, you really can earn $105,000 and still be in the 12% bracket, right?

Right

 

[SevenUp]

In above given Tax Estimation-
After converting $ 160k
Taxable income is $277550
Taxes due $ 45510
Irmaa Medicare Premium $ 2856/yr more in 2023

After converting $ 205k i.e $45k more
Taxable Income is $32250
Taxes due $ 57516, i.e $12k more
Irmaa Medicare Premium around $ 3900/yr more i.e $1000 more in 2023

Bottom Line is if I convert $205000, i.e Roth convert $45k more than prior & go to top of 24%, taxes will be $57516 , i.e $12k more,

I am trying to get my mind wrap around these numbers.

Including the IRMAA increase, your marginal rate on that $45K is ($57,516 + $3,900 - $45,510 - $2,856)/($205,000 - $160,000) = $13,050/$45,000 = 29%. The extra $45K includes the last IRMAA spike shown on the chart.

The chart was done with a couple of assumptions:
1) There was some $6K adjustment to reduce your AGI.
2) Your spouse is either 63 or 64 - too young for a higher standard deduction, but old enough that IRMAA effects apply. The IRMAA numbers given seem different from the ones used by the chart tool.

The tax calculations (ignoring IRMAA) agree exactly between the two tools.

Does that help with the wrapping?

 

[Dash man]

You're better off reimbursing from your HSA. No 7.5% floor to worry about.

That’s true if it’s an option. I’ve never had that option, but my son takes advantage of it.

 

[rkser]

Including the IRMAA increase, your marginal rate on that $45K is ($57,516 + $3,900 - $45,510 - $2,856)/($205,000 - $160,000) = $13,050/$45,000 = 29%. The extra $45K includes the last IRMAA spike shown on the chart.

The chart was done with a couple of assumptions:
1) There was some $6K adjustment to reduce your AGI.
2) Your spouse is either 63 or 64 - too young for a higher standard deduction, but old enough that IRMAA effects apply. The IRMAA numbers given seem different from the ones used by the chart tool.

The tax calculations (ignoring IRMAA) agree exactly between the two tools.

Does that help with the wrapping?

SevenUp,

I am sorry, I am lost in the calculations.

Yes DW is 60, you thought I might as well convert to top of 24% marginal tax bracket.
Can you please help me understand how converting the additional $45k will help me.

Thanks

 

[TheWizard]

Converting to the top of the 24% bracket is probably not the best idea unless you expect to have retirement income (AGI) up to that level (or higher) from age 72 onward, doing zero Roth conversions after age 72.

I do Roth conversions in the 24% bracket but stop short of getting my MAGI into the next higher IRMAA tier...

 

[SevenUp]

SevenUp,

I am sorry, I am lost in the calculations.

Understood - there are a lot of calculations! Perhaps we could start with one or two of the most puzzling - which are those?

Yes DW is 60, you thought I might as well convert to top of 24% marginal tax bracket.

If you are comfortable with $160K conversion being a good deal, note that the marginal rate on that $160K is about 27%. The 27% comes from [(tax+IRMAA when the $160K is included) - (tax+IRMAA without the $160K)] / $160K.

If, instead of $160K, you convert $340K (which would put you a few thousand dollars under the top of the 24% bracket), the marginal rate on the extra $180K = [(tax+IRMAA with $340K converted) - (tax+IRMAA with $160K converted)] / ($340K - $160K) = 26.5%.

In other words your marginal rate on the extra $180K conversion amount that would take you to the top of the 24% bracket is lower than your marginal rate on the first $160K converted. Does that make sense?

Can you please help me understand how converting the additional $45k will help me.
Thanks

Going from $160K only to $205K (an additional $45K) is not so favorable. The marginal rate on that $45K is about 29.5%.

 

[Lstansbury]

Iorp

This decision is very complicated and software can help. I can't remember if i-orp (extended) takes medicare premium surcharges into account or not, but if it does, that's an option.


https://www.early-retirement.org/forums/f28/retirement-tax-planning-income-optimization-99854.html



This thread discussed a few options to help with ROTH conversion decisions & you may benefit from reading through it. Good luck.

IORP extended does take IRMA into account. Ive been testing out various roth conversion scenarios and an IRMA report is included

 

[Exchme]

IORP extended does take IRMA into account. Ive been testing out various roth conversion scenarios and an IRMA report is included

I-orp is a great tool. I would give a word of caution about IRMAA handling. Last I checked, i-orp didn't look back 2 years for IRMAA taxes, it used the current year. Over a lifetime, that won't make a significant difference, but for ages 63 and 64, it won't recognize that income in those years might trigger IRMAA two years later. So it might suggest Roth Conversions in those years that you don't really want to do.

 

[rkser]

Understood - there are a lot of calculations! Perhaps we could start with one or two of the most puzzling - which are those?

If you are comfortable with $160K conversion being a good deal, note that the marginal rate on that $160K is about 27%. The 27% comes from [(tax+IRMAA when the $160K is included) - (tax+IRMAA without the $160K)] / $160K.

If, instead of $160K, you convert $340K (which would put you a few thousand dollars under the top of the 24% bracket), the marginal rate on the extra $180K = [(tax+IRMAA with $340K converted) - (tax+IRMAA with $160K converted)] / ($340K - $160K) = 26.5%.

In other words your marginal rate on the extra $180K conversion amount that would take you to the top of the 24% bracket is lower than your marginal rate on the first $160K converted. Does that make sense?

Going from $160K only to $205K (an additional $45K) is not so favorable. The marginal rate on that $45K is about 29.5%.

SevenUp,

Thankyou Sir for your help & patience, it is becoming sort of clear.
Is that pesky NIIT of 3.8 included in these calculations or is it on top of this ?

With my best

 

[SevenUp]

SevenUp,

Thankyou Sir for your help & patience, it is becoming sort of clear.
Is that pesky NIIT of 3.8 included in these calculations or is it on top of this ?

With my best

NIIT is included. The Excel tool that I've been using, downloadable from Case Study Spreadsheet updates, doesn't follow every single paragraph, clause, etc., in the US tax code, but it covers the vast majority of items that a typical individual would encounter. E.g., IRMAA and ACA effects are also included.

Looking at the marginal rate charts it generates, I often think "can that be correct?" but when I look at the details, sure enough that's our tax code at work.