Best timing to convert traditional / rollover IRA to a Roth IRA account.

[teetee]

I currently have around 200k in my rollover IRA with Fidelity after rolling it over from a 401k after I left the company. I know conversion to Roth is going to count as ordinary income and will be taxed at the max. applicable Fed. tax rate.



My current MAGI is around 100k and the job is fairly stable. Single, 20 years before I reach 59.5 years old. What would be the strategy and timing to convert to Roth and do I do it in several chunks per year? My goal is to convert it as soon as possible and minimize the tax liability.

 

[pjigar]

It is best to defer conversions until your current tax bracket is lower than you tax bracket when you turn FRA, with enough window to finish all conversions. It really depends on when you plan to FIRE.

 

[teetee]

It is best to defer conversions until your current tax bracket is lower than you tax bracket when you turn FRA, with enough window to finish all conversions. It really depends on when you plan to FIRE.

Wouldn't the wait kind of renders the tax-free growth of Roth IRA meaningless? I wish to do it as soon as possible so the growth will not incur tax.

 

[gauss]

One strategy is to convert enough to put you at the top of your current/marginal tax bracket each year.

-gauss

 

[kaneohe]

One basic idea is that you compare the tax rate of converting now (or whenever) vs what your tax rate would be if you didn't convert in retirement and taking RMDs. You want to convert if the rate at conversion is less than later on.

 

[teetee]

One basic idea is that you compare the tax rate of converting now (or whenever) vs what your tax rate would be if you didn't convert in retirement and taking RMDs. You want to convert if the rate at conversion is less than later on.

Thanks. I have some large real-estate related passive income planned in my retirement years so the tax rate is likely to be more in my retirement years than what I have now.

 

[sengsational]

I'm not sure there's quite enough information provided to say what a good strategy would be. For instance, if you planned to "wind-down" your career and have a span of time when you were earning less by working less, then THAT would be a better time to convert than during full salary years. [Edit: cross posted with the above post so I see the above makes no sense. If you KNOW your tax rate will be higher in retirement years it does make sense to do it now. So the strategy that gauss (someone who's got a great track record in these matters) presented seems likely to be optimal.]


I've not used the i-orp online tool in it's capacity to model earning years plus retirement years (I've only used it for retirement years), but I see how you can put IRA and Roth contributions in for earning years. And it will give you a strategy for Roth conversions if conversions make sense (which they usually do if you have any tIRA funds). The thing about i-orp is it takes patience to get the inputs right, especially if you go to the "Extended ORP". And my broken-record recommendation for people who maintain asset allocation across all tax buckets is to put the SAME equity percentages in all three (tax-deferred, Roth, and taxable). This way, the optimization doesn't preferentially pull from the lower performing bond allocation.

 

[kaneohe]

Wouldn't the wait kind of renders the tax-free growth of Roth IRA meaningless? I wish to do it as soon as possible so the growth will not incur tax.

unfortunately, this is a quantitative, not qualitative decision. Suppose you are now in the 24% bracket. You convert 100K to Roth paying the 24K taxes and end up w/ 76K in Roth. Suppose the Roth doubles to 152K.

Compare w/ the TIRA which has also doubled to 200K. If you are in the 12% bracket in retirement, you pay 24K in taxes and end up w/ 176K which is better than Roth. If you were in the 24% bracket in retirement, you would pay 48K in taxes and end up with 152K after taxes, the same as the Roth.

 

[pb4uski]

Thanks. I have some large real-estate related passive income planned in my retirement years so the tax rate is likely to be more in my retirement years than what I have now.

Given this, you may want to consider converting to the top of your current tax bracket.

Before you do, do a strawman tax return as if you were retired with your expected retirement numbers to confirm that you will be in a higher tax bracket.

 

[pb4uski]

Wouldn't the wait kind of renders the tax-free growth of Roth IRA meaningless? I wish to do it as soon as possible so the growth will not incur tax.

unfortunately, this is a quantitative, not qualitative decision. Suppose you are now in the 24% bracket. You convert 100K to Roth paying the 24K taxes and end up w/ 76K in Roth. Suppose the Roth doubles to 152K.

Compare w/ the TIRA which has also doubled to 200K. If you are in the 12% bracket in retirement, you pay 24K in taxes and end up w/ 176K which is better than Roth. If you were in the 24% bracket in retirement, you would pay 48K in taxes and end up with 152K after taxes, the same as the Roth.

Yes, the whole growth argument is a popular misconception as kaneohe's example with the same tax bracket demonstrates. If you pay the taxes with taxable account money then there is a minor second order benefit of avoiding taxes on growth of the money used to pay the taxes... but it is a minor benefit in the whole scheme of things.

At the end of the day it is principally a tax rate play... today's marginal tax rate vs future marginal tax rates.

 

[teetee]

Given this, you may want to consider converting to the top of your current tax bracket.

Before you do, do a strawman tax return as if you were retired with your expected retirement numbers to confirm that you will be in a higher tax bracket.

Well it always puzzles me why people don't consider Roth as the best option. It does not have RMDs and most people in this forum will likely have some sort of net worth saved up if they retire early. Doesn't that automatically qualifies for going with Roth so we can let the money in the Roth to grow tax free and will never need to take it out only if we have to?


To me Roth account is so much attractive so I was super excited when my new company use Roth 401k instead of Traditional 401k.

 

[pb4uski]

Well it always puzzles me why people don't consider Roth as the best option. ....

I think that conventional wisdom and most people during their working years think that their marginal tax rate in retirement will be lower than their marginal tax rate while working.... which favors saving in a traditional 401k or traditional IRA.... I know I thought so while I was working and it has turned out to be that way.

While my marginal tax rate in retirement is indeed lower than when I was working it is higher than I expected that it would be when I started tax deferred saving.... so the tax savings are positive but just not as much as I thought they would be. First class problem I guess.

 

[REWahoo]

I think that conventional wisdom and most people during their working years think that their marginal tax rate in retirement will be lower than their marginal tax rate while working.... which favors saving in a traditional 401k or traditional IRA....

Yep. My marginal rate in retirement is less than half what it was the last year I worked. A Roth would have cost me almost triple in taxes vs what I'm currently paying on my withdrawals.

 

[kaneohe]

Well it always puzzles me why people don't consider Roth as the best option. It does not have RMDs and most people in this forum will likely have some sort of net worth saved up if they retire early. Doesn't that automatically qualifies for going with Roth so we can let the money in the Roth to grow tax free and will never need to take it out only if we have to?


To me Roth account is so much attractive so I was super excited when my new company use Roth 401k instead of Traditional 401k.

again this is the qualitative side of the brain taking over.....tax free growth/no RMDs. The tax free growth is with the expense of the tax haircut up front instead at the end so you have less growing tax free than the TIRA. The counter to the no RMD is that the RMD funds don't disappear.......they just get the tax haircut at the end and you don't have to spend the remainder. The decision maker again in the end is how much pay for taxes on the front end for the Roth vs how much you pay on the back end for the TIRA. It's a quantitative decision in the end.

more than you ever wanted to know
https://www.bogleheads.org/wiki/Traditional_versus_Roth

 

[Cobra9777]

Agree with kaneohe and pb4uski.... the conversion decision is almost entirely a question of tax rate differences. There is an additional small benefit related to paying conversion tax from a taxable account. But chasing tax free growth in the Roth is not a factor at all in the conversion decision.

Generally, Roth contributions are a better option early in your career when income and marginal rates are low. Once you get up to a rate that you think is higher than what you'll pay when distributions start, then tax-deferred makes more sense.

For us, Roths did not exist until we were already in the 28%-33% brackets, even higher for a few years. So at ER, we only had 401Ks that we rolled into tIRAs. But from ER to 70, we expect to be in the 12% bracket (was 15%). So we are doing Roth conversions to the top of the 12% bracket. We expect to be well into the 22% bracket when SS and RMDs start.

So we deferred at 28-33%. We'll pay tax at 12% on conversions, and 22% on whatever portion we don't convert.

 

[teetee]

Agree with kaneohe and pb4uski.... the conversion decision is almost entirely a question of tax rate differences. There is an additional small benefit related to paying conversion tax from a taxable account. But chasing tax free growth in the Roth is not a factor at all in the conversion decision.

Generally, Roth contributions are a better option early in your career when income and marginal rates are low. Once you get up to a rate that you think is higher than what you'll pay when distributions start, then tax-deferred makes more sense.

For us, Roths did not exist until we were already in the 28%-33% brackets, even higher for a few years. So at ER, we only had 401Ks that we rolled into tIRAs. But from ER to 70, we expect to be in the 12% bracket (was 15%). So we are doing Roth conversions to the top of the 12% bracket. We expect to be well into the 22% bracket when SS and RMDs start.

So we deferred at 28-33%. We'll pay tax at 12% on conversions, and 22% on whatever portion we don't convert.

That is extremely helpful. Thanks. My living expense is too low to need any RMDs that I can forsee and that's why I want to avoid RMDs to become my ordinary income and get taxed during my retirement.



I understand things can change. I may have health issues that requires long term treatment which can bump up my expense need in the future. It's good to know I really don't have to think that conversion now is the sure way to save money on tax.

 

[retired1]

I've been converting in small chunks (5K - 15K) last few years. I feel it's better to pay tax on it now than wait for the "right time". Once in Roth, I feel comfortable knowing it'll grow tax-free and upfront tax payments are worth it. I think you've to keep the funds in Roth for atleast 5 years before you can withdraw.

 

[kaneohe]

........................Thanks. My living expense is too low to need any RMDs that I can forsee and that's why I want to avoid RMDs to become my ordinary income and get taxed during my retirement.
.......................................

if you convert to Roth, you will have no RMDs later.........just don't forget that you got there by paying taxes to convert. It's not that there is no tax..........you just paid it years earlier.

Another logical trap.........if you convert now, you will pay less tax. True in a way but the real test is not what you pay in taxes but what you end up with after tax:

convert 10K now at 24% tax rate and pay 2.4K in taxes. 7.6K goes to Roth.
In N yrs, it has gone up by 10x to 76K.

Alternatively..........leave 10K in TIRA. In N yrs it has gone up to 100K. If you withdraw it at 24% rate, you pay 24K in taxes........10X what you paid to convert.........so what..........you have 76K after taxes which is the real test.
The results are the same because the tax rates were the same to convert and to withdraw from TIRA. If the tax rates were different, the conclusions would be different so that should be the focus.

 

[pjigar]

That is extremely helpful. Thanks. My living expense is too low to need any RMDs that I can forsee and that's why I want to avoid RMDs to become my ordinary income and get taxed during my retirement.



I understand things can change. I may have health issues that requires long term treatment which can bump up my expense need in the future. It's good to know I really don't have to think that conversion now is the sure way to save money on tax.

If you have excess savings and really want to build Roth bucket then utilize mega backdoor or backdoor IRA contributions. Balance them with taxable savings so will have something to live on when you ER.

 

[Cessna152]

If you ever wish to move to a different state near or after retirement, and you wish to minimize taxes on income from retirement funds, you'll have a greater number of destination options with zero state income taxes with those funds in a Roth than a traditional IRA. So in a sense a Roth allows greater retirement mobility when all other factors are equal.