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Convert late in the game?
Old 10-26-2021, 07:31 PM   #1
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Convert late in the game?

For years I ignored the matter of Roth conversions, thinking it would be a lot of bother for not much benefit. Only recently did I take a look using some actual numbers and realized what a difference they could make. Iíve been ERíd ten years now so have a shorter time horizon to work with. Online calculators have given mixed results as to whether they are even worthwhile in my situation. The people here are smarter than I am so Iíll open up the question.

Age 65. Single. No kids. 12% bracket; no state income tax.
401(k) is about 600,000. Taxable account is about 500,000. Cash is about 250,000. Pension is about 18,000. No SS yet, but it will be about 29,000 in another year or so.
No debt; all expenses are easily handled. Health has been very good (now Iíve jinxed myself by saying that).

I realize this is a first world ďproblemĒ. Iíve won the game, so this will primarily affect any legacy I leave. But RMDs are looming and the taxes are distasteful to consider.
Let me know if Iím leaving anything out. Many thanks in advance.
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Old 10-26-2021, 07:42 PM   #2
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I assume your income is lower now than when it will be when you start SS, so it's probably worth converting some now. Probably just to the top of the 12% bracket. Once you start SS it makes less difference though pre-RMD you can at least move some of the tIRA into a Roth, rather than into taxable as RMDs will make you do.

Deferring SS to 70 would give you more years to convert. Whether that's enough to change your SS plans is up to you.

An alternative to converting would be to use the 0% cap gains space to take some LTCGs you might have in taxable.
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Old 10-26-2021, 07:53 PM   #3
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Assuming you get $10K/yr in qualified dividends, you could convert ~$26.5K for ~11.5% before hitting a 27% marginal rate.

That instantaneous marginal rate would drop to 22% after an additional $10K converted, and the amount between $26.5K and ~$59.8K would be subject to ~23% marginal.

Once you start SS (and assuming the same pension and qualified dividends), anything coming out of traditional accounts will be taxed at >22% (including a $5K band subject to a 50% tax).

See Roth IRA conversion - Bogleheads for general comments and links to a couple of spreadsheets that you might use to evaluate your own situation.
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Old 10-26-2021, 07:54 PM   #4
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Not too late. I suspect that once you are receiving SS and RMDs that you'll be into the 22% tax bracket, so I would consider doing Roth conversions to the top of 0% capital gains tax bracket.

You can play with your numbers at https://www.irscalculators.com/tax-calculator

I think the reality is that you are not going to be able to convert any meaningful money at less than 22%.
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Old 10-26-2021, 11:16 PM   #5
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What if you have to sell your taxable account investments to pay taxes for the conversion, and you will also incur a hefty amount of capital gains by selling the positions? My gut feel is that it is not worth doing Roth conversion if this is the case.
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Old 10-26-2021, 11:24 PM   #6
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What if you have to sell your taxable account investments to pay taxes for the conversion, and you will also incur a hefty amount of capital gains by selling the positions? My gut feel is that it is not worth doing Roth conversion if this is the case.
IN general, it depends on the definition of "hefty" (that determines the marginal rate of the conversion), the amount of tax drag avoided by reducing the taxable account balance, and the expected future marginal tax rate.

Here the OP has sufficient cash to avoid this complications.
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Old 10-27-2021, 06:57 AM   #7
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What if you have to sell your taxable account investments to pay taxes for the conversion, and you will also incur a hefty amount of capital gains by selling the positions? My gut feel is that it is not worth doing Roth conversion if this is the case.
You only pay tax on the gains, not the entire proceeds of what you sell. I would model this in a spreadsheet rather than go with gut feel.
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Old 10-27-2021, 07:12 AM   #8
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I'm in a very similar position but have convinced myself that at least some yearly conversion in the 22% bracket makes sense. There are 3 reasons: 1) reducing my tIRA balance will lead to a corresponding reduction in my RMD's 2) these are legacy accounts and my kids will likely be in a higher than 22% bracket when they get the money and 3) any growth in the money converted will be tax free to them rather than leading to larger RMD's for me.
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Old 10-27-2021, 07:44 AM   #9
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You only pay tax on the gains, not the entire proceeds of what you sell. I would model this in a spreadsheet rather than go with gut feel.
We can't / won't do it anyway as we are at 22% for this year and 24% tax bracket for next year. If the investment which I liquidate has 25% capital gains, it would add another 3.75% tax.
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Old 10-27-2021, 08:24 AM   #10
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A consideration for married people is that tax rates will likely rise significantly for a surviving spouse, and assuming you don't see marriage in the future, that takes away one advantage of a Roth conversion.

Same for SS delay (for the spousal benefit). But I think I'd still delay SS (and pension if possible), and convert to the top of the 12% bracket. It can't really hurt, and rates may go up.

The bigger question for me is:
Why so much cash?!

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Old 10-27-2021, 08:26 AM   #11
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We can't / won't do it anyway as we are at 22% for this year and 24% tax bracket for next year. If the investment which I liquidate has 25% capital gains, it would add another 3.75% tax.
I've heard a few people make the comment that the money used for the conversion tax has to be taxed and that makes conversions not work. I have never seen anyone actually prove this with math. Thus my comment, which I meant to be taken generally, model this rather than go by gut feel.

I'm also not aware of any 25% capital gains rate.
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Old 10-27-2021, 08:42 AM   #12
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My usual answer is to take the time to understand i-orp extended version, then run it with and without conversions to get an idea of the magnitude of benefit. Just compare the annual spend available from one scenario to the other. Are you getting 1% more spend? Meh. Are you getting 5% more spend? Hmm. Then you can go from unlimited conversion down to something you'd actually be able to stomach, and see where that puts you. The bird in the hand psychology hits hard here when the mantra has always been delay paying, and now you're being told to "get it over with".
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Old 10-27-2021, 09:04 AM   #13
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My usual answer is to take the time to understand i-orp extended version, then run it with and without conversions to get an idea of the magnitude of benefit. Just compare the annual spend available from one scenario to the other. Are you getting 1% more spend? Meh. Are you getting 5% more spend? Hmm. Then you can go from unlimited conversion down to something you'd actually be able to stomach, and see where that puts you. The bird in the hand psychology hits hard here when the mantra has always been delay paying, and now you're being told to "get it over with".
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Old 10-27-2021, 09:10 AM   #14
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I've heard a few people make the comment that the money used for the conversion tax has to be taxed and that makes conversions not work. I have never seen anyone actually prove this with math. Thus my comment, which I meant to be taken generally, model this rather than go by gut feel.

I'm also not aware of any 25% capital gains rate.
Yeah I thought the top was 20% and that requires a pretty high income(over $440,000) to get there.
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Old 10-27-2021, 10:05 AM   #15
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I'm also not aware of any 25% capital gains rate.
Here's what she meant: 25 percent of the position is gain. Tax on that at 15 percent equals 3.75 percent of the entire position.
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Old 10-27-2021, 11:12 AM   #16
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Here's what she meant: 25 percent of the position is gain. Tax on that at 15 percent equals 3.75 percent of the entire position.
Thanks, that makes sense. That should be factored into the conversion calculations, though if you ever plan to spend that money yourself you will eventually pay tax on it anyway.
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Old 10-27-2021, 02:42 PM   #17
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Quote:
Originally Posted by RunningBum View Post
I've heard a few people make the comment that the money used for the conversion tax has to be taxed and that makes conversions not work. I have never seen anyone actually prove this with math. Thus my comment, which I meant to be taken generally, model this rather than go by gut feel.

I'm also not aware of any 25% capital gains rate.
I am saying that if I have to sell $100k of taxable investments and that investments had appreciated by 25%, then 15% capital gains on 25K will add 3.75 percent taxes to cover the conversion.
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Old 10-27-2021, 03:11 PM   #18
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Quote:
Originally Posted by RunningBum View Post
I've heard a few people make the comment that the money used for the conversion tax has to be taxed and that makes conversions not work. I have never seen anyone actually prove this with math. Thus my comment, which I meant to be taken generally, model this rather than go by gut feel.

I'm also not aware of any 25% capital gains rate.
25% could include state tax.

Appears the math has been done in the case study spreadsheet. See row 164 (and others in that section) in the 'Misc. calcs' tab.
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Old 10-27-2021, 07:05 PM   #19
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Thanks for all the feedback. Looks like I’ll be playing with numbers for awhile.
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