How to figure out when Roth conversions are worth it?

[Retch The Grate]

Before I got married I was consistent in adding to my Roth, but post-marriage, my wife and I are way above the cut-off as a couple (my income has gone up, and she was already a cybersecurity engineer at Google when we met). Looking at Roth conversions it seems like our marginal tax rate is way too high to consider doing conversions/backdoor Roth to be worthwhile but maybe I'm looking at it the wrong way? Everybody goes on about how great it is to do backdoor contributions, but as far as I can tell my taxes are likely to be substantially lower in retirement (we don't expect to need our combined current income to support our current lifestyle and we aren't aiming for higher).

Even when I stop working at some point, DW is 9 years younger than me and will keep going for a while most likely as our FI point got raised a lot by buying our house (I miss being FI, but I like our house and love my DW feeling safe and secure and able to put down roots), and it seems like the math is likely to stay in favor of not converting? But again, maybe I'm misunderstanding something about how to figure it out, all the articles I've read over the years act like it is a no-brainer for high income earners, but when I try to estimate it, it doesn't appear to be so...

 

[karen1972]

It depends on if you are talking about pure Roth conversions (because you have money already in your traditional IRA), which usually people would wait to do those until they are in a low income bracket because its likely a sizeable amount rolled from a previous 401k, so then not likely to be cost effective to convert while working.

OR

if you are talking about purely a backdoor Roth, in which the money has already been taxed when you received it in your paycheck and now you are just trying to figure out where to save it.
A) traditional IRA (allows for tax deferral but you are not getting any tax break and all gains wiil be taxed upon withdrawal)
B) Brokerage - can get the money at any time, but any dividends will be taxed in the year distributed at your ordinary income tax rate and you may have to pay Long term cap gains on sale.
C) backdoor Roth, you don't have to pay taxes on any gains.

In the latter scenario, unless you need the money before 59.5, C gives you the most flexibility and least taxes.

 

[Midpack]

Roth conversions come down to leveling your tax bracket throughout your retirement. Most people who benefit from Roth conversions have large TIRAs/401ks and are in a significantly lower tax bracket when they begin retirement than they will be once RMDs, Soc Sec and/or pensions/annuities begin - the window to convert is before that. TCJA, state taxes, IRMAA, widow tax rates and other variables should also be factored in to the decision. There is no universal case, you have to do the math as it applies to your specific situation, and you'll have to make some assumptions regarding future tax rates, longevity, etc.

It can be very worthwhile, but the sooner you get the math done, the more likely you could benefit. I've laid our case out before, but we're projected to save almost $400K in taxes thanks to Roth conversions.

https://arnoldmotewealthmanagement.com/when-roth-conversions-make-sense/

 

[TheWizard]

The backdoor Roth thing is fundamentally a CONTRIBUTION to your Roth IRA, limited to $7000/year per person, or whatever the limit is now. It almost always makes sense provided you don't have pre-tax money in your tIRA, which a lot of folks do have.

Roth CONVERSIONS seldom make sense if you're still working and making a healthy earned income...

 

[pb4uski]

Before I got married I was consistent in adding to my Roth, but post-marriage, my wife and I are way above the cut-off as a couple (my income has gone up, and she was already a cybersecurity engineer at Google when we met). Looking at Roth conversions it seems like our marginal tax rate is way too high to consider doing conversions/backdoor Roth to be worthwhile but maybe I'm looking at it the wrong way? Everybody goes on about how great it is to do backdoor contributions, but as far as I can tell my taxes are likely to be substantially lower in retirement (we don't expect to need our combined current income to support our current lifestyle and we aren't aiming for higher).

Even when I stop working at some point, DW is 9 years younger than me and will keep going for a while most likely as our FI point got raised a lot by buying our house (I miss being FI, but I like our house and love my DW feeling safe and secure and able to put down roots), and it seems like the math is likely to stay in favor of not converting? But again, maybe I'm misunderstanding something about how to figure it out, all the articles I've read over the years act like it is a no-brainer for high income earners, but when I try to estimate it, it doesn't appear to be so...

I think that you have it right that conversions are not beneficial in your circumstances. Roth conversions are only beneficial when the effective tax rate on the conversion is lower than the rate you expect when you are subject to RMDs.

So for higher income earners, that eliminates while they are working.

The sweet spot seems to be from when you stop working until pensions and SS start because during those years where you are living off of taxable savings you are typically in a low tax bracket. That is us for now... we are filling up any headroom in the 10% and 12% tax brackets as when RMDs start we expect to be deep into the 12% tax bracket once my SS starts so RMDs will be about 18%... some at 12% and some at 22%.

 

[Sunset]

Roth conversions are only valuable if a person/couple has too much in IRA's. or has a really low tax rate to convert into.

(IMHO)
Too much in IRA's is when the taxes due from (0.0377 x IRA amounts) + SS + Pension = Higher tax rate than when working.

When a person starts getting close to that, they can just contribute to a Roth or buy tax efficient ETFs in a regular brokerage account.

 

[NgineER]

Yeah - conversions won't make sense to you whereas backdoor contributions and mega backdoor contributions likely will make sense for you if you have additional money to invest after living expenses.

backdoor is just a conversion from non deductible IRA's (when your income is too high to allow for tax deductions).
Mega back door is the after tax contribution to your 401(k) which then are rolled over into a Roth IRA.

Both options will give you access to tax free growth, something I've prioritized ahead of regular brokerage contributions.

 

[Retch The Grate]

Thanks all, that makes me feel better about my inability to understand where the benefits were with my finances. If my wife didn't make so much money, and wasn't 9 years younger so keeping our income high even when I decide to retire, that would be one thing, but I guess this is just a "we are doing great, no special tricks for us" thing which is nothing I feel bad about.

 

[Rianne]

Yeah - conversions won't make sense to you whereas backdoor contributions and mega backdoor contributions likely will make sense for you if you have additional money to invest after living expenses.

backdoor is just a conversion from non deductible IRA's (when your income is too high to allow for tax deductions).
Mega back door is the after tax contribution to your 401(k) which then are rolled over into a Roth IRA.

Both options will give you access to tax free growth, something I've prioritized ahead of regular brokerage contributions.

When you convert from the tIRA making 6 - 8% to the Roth, you're buying a new index fund, stock, CD, etc. so you start at the bottom, right? We'd be buying into a high-stock market or can you take the existing index fund, CD to the Roth? When you say growth, you mean starting from the point you convert, not where you are already in the tIRA, correct?

Edit: you could lose the gains you have in the tIRA or am I understanding incorrectly?

 

[Exchme]

When you convert from the tIRA making 6 - 8% to the Roth, you're buying a new index fund, stock, CD, etc. so you start at the bottom, right? We'd be buying into a high-stock market or can you take the existing index fund, CD to the Roth? When you say growth, you mean starting from the point you convert, not where you are already in the tIRA, correct?

Edit: you could lose the gains you have in the tIRA or am I understanding incorrectly?

I don't have any CDs, so speak to those, but I have converted other investments in-kind from my IRA to my Roth without needing to sell.

Of course you need to pay taxes on the converted amount, but optimally that money comes out of taxable.

 

[anothercog]

Since your both still working check to see if your 401k plans offer a mega back door roth option. I found out that our plan does. You can contribute quite a bit to a roth this way on top of maxing out your 401k contributions.

Conversions likely won't be beneficial for you.

 

[TheWizard]

When you convert from the tIRA making 6 - 8% to the Roth, you're buying a new index fund, stock, CD, etc. so you start at the bottom, right? We'd be buying into a high-stock market or can you take the existing index fund, CD to the Roth? When you say growth, you mean starting from the point you convert, not where you are already in the tIRA, correct?

Edit: you could lose the gains you have in the tIRA or am I understanding incorrectly?

Start at the bottom?
Not sure I understand your point.
All equity investments, index funds and otherwise, are subject to fluctuations in value. There's no guarantee what $1000 I put into VOO (S&P 500 ETF) will be worth a year from now, no matter if it's in a Roth, tax-deferred, or taxable account.

So what was your point?

 

[SevenUp]

When you convert from the tIRA making 6 - 8% to the Roth, you're buying a new index fund, stock, CD, etc. so you start at the bottom, right? We'd be buying into a high-stock market or can you take the existing index fund, CD to the Roth? When you say growth, you mean starting from the point you convert, not where you are already in the tIRA, correct?

Edit: you could lose the gains you have in the tIRA or am I understanding incorrectly?

Presumably the same investment options are available in the Roth IRA account as in the traditional IRA account. Thus the gains or losses will be the same going forward from today, regardless of which account has the investments.

 

[Rianne]

Start at the bottom?
Not sure I understand your point.
All equity investments, index funds and otherwise, are subject to fluctuations in value. There's no guarantee what $1000 I put into VOO (S&P 500 ETF) will be worth a year from now, no matter if it's in a Roth, tax-deferred, or taxable account.

So what was your point?

Not a point, a question. For example, I have a 5-year CD earning 5.5% in my tIRA. Do I have to sell that CD to convert and purchase a new one at a lower rate? Or can I transfer that CD to the Roth? If I sell an index fund in tIRA to purchase the same fund in Roth? This answered that question from Exchme:
I don't have any CDs, so speak to those, but I have converted other investments in-kind from my IRA to my Roth without needing to sell.

 

[TheWizard]

Not a point, a question. For example, I have a 5-year CD earning 5.5% in my tIRA. Do I have to sell that CD to convert and purchase a new one at a lower rate? Or can I transfer that CD to the Roth? If I sell an index fund in tIRA to purchase the same fund in Roth? This answered that question from Exchme:
I don't have any CDs, so speak to those, but I have converted other investments in-kind from my IRA to my Roth without needing to sell.

Ok, I see now.
No idea how a CD transfer to Roth would work. Most of us don't have CDs in IRAs, especially Roth IRAs...

 

[ncbill]

I do convert in-kind from traditional IRA to Roth IRA but all those are ETFs.

Check with your financial institution to see if you can o the same for CDs.

 

[rkser]

Roth conversions are only valuable if a person/couple has too much in IRA's. or has a really low tax rate to convert into.

(IMHO)
Too much in IRA's is when the taxes due from (0.0377 x IRA amounts) + SS + Pension = Higher tax rate than when working.

When a person starts getting close to that, they can just contribute to a Roth or buy tax efficient ETFs in a regular brokerage account.

Thanks Sunset for the formula, let me take a shot at it with our numbers,

In our case, money in the taxable brokerage accounts is more than our tax deferred accounts,

Our both IRAs of - 1,146,161 X 0.0377 = $ 43210

Our both SS at age 70 = $ 60,948 /yr

No pension

We do get dividends + interest from Brokerage + interest of $125000 /yr
(Thanks in part to VXUS in Taxable accounts)

We both are retired at 67 + 62,

We are in 24% tax bracket now, thanks in part to Roth Conversions,

Should I continue with Roth Conversions ?

Thanks for your opinion & thoughts

 

[SevenUp]

We do get dividends + interest from Brokerage + interest of $125000 /yr

How much is qualified dividends, vs. interest + non-qualified dividends?

 

[rkser]

Qualified Dividends - $ 74228. VS $ 50411

(Int 10237+Non Q Div 40174)

(Tax Exempt Interest 10,237)

 

[pb4uski]

When you convert from the tIRA making 6 - 8% to the Roth, you're buying a new index fund, stock, CD, etc. so you start at the bottom, right? We'd be buying into a high-stock market or can you take the existing index fund, CD to the Roth? When you say growth, you mean starting from the point you convert, not where you are already in the tIRA, correct?

Edit: you could lose the gains you have in the tIRA or am I understanding incorrectly?

Wouldn't you execute the conversion by just transferring assets from a tIRA to the Roth so there is no restarting all? That's what I do when I do a Roth conversion. No gains are lost.

 

[SevenUp]

Our both IRAs of - 1,146,161 X 0.0377 = $ 43210

Our both SS at age 70 = $ 60,948 /yr

No pension

We both are retired at 67 + 62,

We are in 24% tax bracket now, thanks in part to Roth Conversions,

Should I continue with Roth Conversions ?

Qualified Dividends - $ 74228. VS $ 50411

(Int 10237+Non Q Div 40174)

(Tax Exempt Interest 10,237)

With those dividend and interest amounts, you won't pay 24% on any amount of Roth conversion.

Instead, your marginal rates will look like this for 2024:

You could use the case study spreadsheet in Excel to confirm your situation, then add SS benefits to see how things might look when taking those.

 

[rkser]

In year 2023 I did $159,305 of Roth Conversion,

Our AGI came to $295,138

Taxable Income was $265,431, which comes in 24%, for MFJ

I do not understand the graph in the above post,

In my understanding (limited) my roth conversion brought me up to 24% marginal tax bracket,
although my effective tax rate is around 13% &

I will pay $329/month for medicare B supplement including the IRMAA in yr 2025

What am I missing ?
Does making the planned further serial Roth Conversions makes sense in this case ?

Thanks a lot

 

[SevenUp]

In year 2023 I did $159,305 of Roth Conversion,

Our AGI came to $295,138

Taxable Income was $265,431, which comes in 24%, for MFJs

That's the "bracket rate", but that is not the marginal tax rate you paid. Take a look at that wiki article and see if it makes sense to you. The Roth conversion choice comes down to a comparison between current and future marginal tax rates.

I do not understand the graph in the above post,

There are 500 individual points in the grey curve, each corresponding to an additional $440 in conversion amount. The y-values are (change in tax)/$440 for each point. The three spikes are when IRMAA tiers kick in, with the extra IRMAA treated as a tax.

Ignoring the IRMAA spikes, around the $50,000 amount you are paying 27% on each extra dollar of Roth conversion because you pay 12% on that dollar, plus 15% on the dollar of qualified dividends that gets kicked out of the 0% bracket on QD.

Then your marginal rate drops to 22%, which happens to be the same as the bracket rate. Then it goes up to 25.8% when NIIT kicks in on top of the 22%, and 27.8% when in the 24% bracket plus NIIT.

Is that making more sense?

What am I missing ?
Does making the planned further serial Roth Conversions makes sense in this case ?

You current marginal tax rate is half the story. The other half is the marginal rate you expect to pay when taking SS and RMDs.

Are you comfortable enough with Excel to add those to your current income and see what you get?

 

[rkser]

SevenUp, I appreciate your time & explanation, no I am not comfortable with Excel so I never used it.

Thank you sir, for correcting my Bracket rate vs Marginal rate confusion,

I think the marginal rate is calculated as the tax on the next dollar of income, when one adds the NIIT, IRMAA etc...

I am UNABLE to calculate accurately our future marginal tax rate,

but calculating my RMDs of approximately 4% of initial value of my IRA at age 70 (presently my total IRA is $733,767) of $29350 & going up each year &+

With my SS of $3279/mo or $39348/yr at age 70

So say adding another $70 k, before DW's RMD income is added,

IF ANYTHING our future income will be more, so our marginal Tax Rate will be MORE than what it is today.

The Tax Rates are not coming down in the future in my opinion.

In my rudimentary understanding I need to keep doing the Roth Conversions & get the money out of these tax infested IRAs into ROTHS.

Our all Stock Taxable accounts will probably be going up in future as they have been & will probably add more to taxes.

In my way of thinking/calculating, I need to be comfortable with the present MFJ 24% tax bracket & KEEP ROTH CONVERSIONS going every year as our future marginal taxes will not be less & will probably be more.

Not even talking about paying jumbo taxes for the survivor.

 

[Exchme]

SevenUp, I appreciate your time & explanation, no I am not comfortable with Excel so I never used it.

Thank you sir, for correcting my Bracket rate vs Marginal rate confusion,

I think the marginal rate is calculated as the tax on the next dollar of income, when one adds the NIIT, IRMAA etc...

I am UNABLE to calculate accurately our future marginal tax rate,

but calculating my RMDs of approximately 4% of initial value of my IRA at age 70 (presently my total IRA is $733,767) of $29350 & going up each year &+

With my SS of $3279/mo or $39348/yr at age 70

So say adding another $70 k, before DW's RMD income is added,

IF ANYTHING our future income will be more, so our marginal Tax Rate will be MORE than what it is today.

The Tax Rates are not coming down in the future in my opinion.

In my rudimentary understanding I need to keep doing the Roth Conversions & get the money out of these tax infested IRAs into ROTHS.

Our all Stock Taxable accounts will probably be going up in future as they have been & will probably add more to taxes.

In my way of thinking/calculating, I need to be comfortable with the present MFJ 24% tax bracket & KEEP ROTH CONVERSIONS going every year as our future marginal taxes will not be less & will probably be more.

Not even talking about paying jumbo taxes for the survivor.

Your current path seems to me to be in the range of reasonable answers, though you ended up in the middle of an IRMAA tier in 2023 and could have tried harder to fill the tier up.

Aside from raw numbers, there are too many factors at play for general discussion to be very insightful. For instance, a tax deferred account is very valuable for long term care as care would be tax deductible, so after paying your marginal rate on the first 7.5% of AGI, the money could come out tax-free. Since we all have a non-trivial chance of needing care, going out of your way to save a couple percentage points on taxes may go up in smoke if the need for care arises.

If you have heirs that have different brackets or live in states with different taxes, that can affect the decision too.

QCDs and charitable bequests are another possible consideration if you are charitably inclined.

While it doesn’t sound like you have a cash flow pinch, if you did and had to sell highly appreciated assets to pay the taxes on Roth Conversions, those are new lifetime taxes and subtract from the value of doing conversions.

If you hold only bonds in IRA, their inherently slower growth reduces the urgency of conversions.

I would guess that at age 67 and with “only” $1.15M in your IRA, there’s up to low six figures of benefit left for doing conversions, certainly enough to spend a few $ to get one of the high fidelity modeling programs and spend a few hours learning the program to look into it. My favorite is Pralana Gold, excellent on taxes, with tremendous power and flexibility. It’s currently a paid Excel sheet, but will be converting to a web app soon-ish (they had hoped for the web version rollout to be end of March, but just announced they are slipping).