Monster Roth Conversions - How big to go and for how long?

[DawgMan]

I am finally coming around to the idea that it will be prudent for me to do a significant amount of Roth conversions if I want to save significant taxes come RMDs and also make life a little more tax friendly for the surviving spouse. I have been in a semi-retired state and expect to make too much money this year for it to make sense in 2021, but am anticipating no earned income starting 2022, when both DW & I will turn 58. While I have posted around the question of Roth conversions/RMDs in the past, I am struggling to find the right answer for someone in my situation. I frankly don't know how to get some solid suggestions other than to share some real numbers. This is something I generally don't like to do as in the past I find there are some judgmental people on this board who like to comment "how could you spend that much?" type remarks. So, I would ask only those who have constructive suggestions to reply.

Background...
- $6M+ After Tax/$6M Tax Deferred (no Roth)
- Plan to keep my AA between 50/50 - 60/40
- Plan on $300K/yr gross spend, including taxes (a good 50%+ discretionary). Will I spend it all every year... who knows, planning allot of "go go" year spending and gifting.
- DW & turn 57 here within the next few months (empty nesters, 4 kids & 3 grandkids)
- Everything paid for, staying in house for the time being
- No pensions, will take SS at 70 (whatever that ends up being/budgeting 75% of benefit)

Questions...
- Using the current tax code, starting 2022, should I take my first $300K as 1) naturally occurring dividends/CGs from after tax accts (estimate $125K - $150K/yr currently) + 2) a 401K withdrawal up to the total, then fill up the balance of the 24% bracket (up to $418K currently) in Roth conversion, rinse and repeat every year until I see my RMDs drop into the 24% tax bracket (based on today's tax code) or keep going?
- Take a 401K withdrawal (after deducting income from after tax acct) up to the top of the 24% bracket, no Roth conversions, rinse & repeat year after year as above?
- How should I really look at the effects of AMT, IRMAA, NIIT, changes in my capital gains rate in picking how much I convert each year?

I have run the math using only my after tax $$ until RMDs (paying very little tax) and then paying significant taxes in RMDS. The math still works to fund my life, priority 1. Paying little taxes for the next 14 years also begs the question should I weigh the NPV of paying little taxes today compared to higher taxes in the future? However, while I don't have hard legacy goals, I realize there will be a boat load of $$ if I am reasonably prudent here.

Yes, real first world problems, not complaining, just want to be a good steward of what I have been fortunate to accumulate.

[RetireBy90]

I think your approach is reasonable, that is dividends and 401K and then some Roth conversions paying taxes from after tax funds. You will probably not make a dent in the 401K balance but you will have some funds in your Roth so you will have some flexibility later if you need to dodge income limits. I don’t see you position changing much unless you are able to convert sums in hundred of thousands over next 12 years. If you get a 6% return on 401K that will be $360K each year in gain. With $100K conversions what will you do to the balance ? However you will have over $1M in tax free.

[RunningBum]

First, a correction, the top of the 24% bracket is $329,850, not $418K. $418K is the top of the 32% bracket.

Given a choice between converting or withdrawing from tax deferred accounts, I would always convert. Your money grows tax free in a Roth, while in taxable it generates taxable dividends, and when liquidated, capital gains. Roth is a clear winner.

Given that, I would use my taxable account to supplement dividends/CGs for the $300K desired spending. If you withdraw from the 401K for living expenses, you are leaving more in taxable. If you use taxable for living expenses and convert rather than withdraw from tax-deferred, you get more in your Roth.

I would definitely convert to the top of the 24% tax bracket. I would continue to convert even once your RMDs drop into the 24% bracket because if one of you dies, the other probably will be in a higher bracket. This will take a few years so you can reevaluate then.

AMT, I don't know enough about. Run your numbers thru a 2020 tax program to get an idea of what happens.

IRMAA, I'll bet you'll be in the second to highest bracket no matter what. And saving $1000 or so by trying to get down another rung is peanuts with your numbers. Being as tax efficient as you can is most likely worth more.

NIIT, you're probably going to hit that no matter what, aren't you?

A possibly change in cap gains rate would favor should not impact how much to convert, but it would favor using your taxable account for living expenses because taking cap gains now would be better than taking them later. Of course you could probably never have to take cap gains so your heirs would get stepped up basis, but that could certainly change too.

NPV of paying little taxes today, No. Your tax deferred accounts continue to grow so the longer you defer converting or withdrawing, the more you have to pay taxes on later.

I would run i-orp. People find it's very aggressive, but I think they don't account for how much the tax-deferred accounts grow if you don't take from it.

As mentioned under AMT, I would run my numbers under a tax program and try to extrapolate future numbers, and look for surprises like AMT.

I would also consider hiring a tax accountant for a few hours to analyze your situation and give you a plan. A good one should know more than you or I about all this. If it were me I'd try to figure it all out so that if they come up with a different strategy I'll know to ask them why and see if their answer makes sense. That would help identify a good tax advisor from bad.

[DawgMan]

Quote:

Originally Posted by RunningBum First, a correction, the top of the 24% bracket is $329,850, not $418K. $418K is the top of the 32% bracket. Given a choice between converting or withdrawing from tax deferred accounts, I would always convert. Your money grows tax free in a Roth, while in taxable it generates taxable dividends, and when liquidated, capital gains. Roth is a clear winner. Given that, I would use my taxable account to supplement dividends/CGs for the $300K desired spending. If you withdraw from the 401K for living expenses, you are leaving more in taxable. If you use taxable for living expenses and convert rather than withdraw from tax-deferred, you get more in your Roth. I would definitely convert to the top of the 24% tax bracket. I would continue to convert even once your RMDs drop into the 24% bracket because if one of you dies, the other probably will be in a higher bracket. This will take a few years so you can reevaluate then. AMT, I don't know enough about. Run your numbers thru a 2020 tax program to get an idea of what happens. IRMAA, I'll bet you'll be in the second to highest bracket no matter what. And saving $1000 or so by trying to get down another rung is peanuts with your numbers. Being as tax efficient as you can is most likely worth more. NIIT, you're probably going to hit that no matter what, aren't you? A possibly change in cap gains rate would favor should not impact how much to convert, but it would favor using your taxable account for living expenses because taking cap gains now would be better than taking them later. Of course you could probably never have to take cap gains so your heirs would get stepped up basis, but that could certainly change too. NPV of paying little taxes today, No. Your tax deferred accounts continue to grow so the longer you defer converting or withdrawing, the more you have to pay taxes on later. I would run i-orp. People find it's very aggressive, but I think they don't account for how much the tax-deferred accounts grow if you don't take from it. As mentioned under AMT, I would run my numbers under a tax program and try to extrapolate future numbers, and look for surprises like AMT. I would also consider hiring a tax accountant for a few hours to analyze your situation and give you a plan. A good one should know more than you or I about all this. If it were me I'd try to figure it all out so that if they come up with a different strategy I'll know to ask them why and see if their answer makes sense. That would help identify a good tax advisor from bad.

I stand corrected on the $418K... buzz kill!

Am I understanding you correctly, you are suggesting take my first $300K from after tax first, then do only Roth conversions to top of 24%?

To your point, knowing my planned spend is $300K and the top of the 24% is $329K leaves very little room to move the needle. Jumping conversions to 32% really seems unappetizing, but perhaps that needs some consideration.

Yes, I will be planning to sit with my CPA on this. I was hoping for a silver bullet from someone...

[CardsFan]

^^ What RunningBum said.

Take all your spending from after tax, and then convert to the top of the bracket you feel comfortable with.

The bad news: No matter what you do, you will pay a bunch in taxes.

The good news: You will pay a bunch in taxes because you are all set.

[DawgMan]

Quote:

Originally Posted by CardsFan ^^ What RunningBum said. Take all your spending from after tax, and then convert to the top of the bracket you feel comfortable with. The bad news: No matter what you do, you will pay a bunch in taxes. The good news: You will pay a bunch in taxes because you are all set.

Do conversions into the 32% make any sense? It still feels like I am not moving the needle much. In some ways, I go back to my earlier point... if the math works w/o Roth conversions as a couple and single, despite the higher taxes, how much gymnastics should I do year after year to "maximize"? Again, want to be prudent, but where does it stop moving the needle?

[RetireBy90]

Quote:

Originally Posted by DawgMan I stand corrected on the $418K... buzz kill! Am I understanding you correctly, you are suggesting take my first $300K from after tax first, then do only Roth conversions to top of 24%? To your point, knowing my planned spend is $300K and the top of the 24% is $329K leaves very little room to move the needle. Jumping conversions to 32% really seems unappetizing, but perhaps that needs some consideration. Yes, I will be planning to sit with my CPA on this. I was hoping for a silver bullet from someone...

I’m really stepping out on a ledge here, RunningBum is one of a few I really listen to in these matters. However, if you earn $150K in taxable account, it doesn’t matter how much you spend, for taxes. You could then convert to top of 24% bracket or about $180K in 24% bracket. Won’t move the needle much on you RMDs but will get around $2M into Roth.
Ok, go ahead and correct me

[RunningBum]

Quote:

Originally Posted by DawgMan Am I understanding you correctly, you are suggesting take my first $300K from after tax first, then do only Roth conversions to top of 24%?

Not quite. You said you could get $125-$150K from divs/CG distributions. Taking the rest from taxable means liquidating some holdings. You would only pay capital gains tax on the gains, so pick holdings that don't have large unrealized gains. If you sell $150K and the basis was $140K you only pay tax on $10K of gains. And, this is separate from your regular income so it doesn't affect how much you can convert to the top of the 24% bracket. In fact, of that $125-150K, much of that should be qualified dividends and long term CG distributions, and they wouldn't count towards the 24% bracket either.

Quote:

Yes, I will be planning to sit with my CPA on this. I was hoping for a silver bullet from someone...

There isn't a silver bullet. The income was tax DEFERRED. You have to pay the tax sometime. The way I'd look at it, you are paying tax and liberating the money in your tIRA/401K that you can't touch until you pay the tax.

[DawgMan]

Quote:

Originally Posted by RunningBum Not quite. You said you could get $125-$150K from divs/CG distributions. Taking the rest from taxable means liquidating some holdings. You would only pay capital gains tax on the gains, so pick holdings that don't have large unrealized gains. If you sell $150K and the basis was $140K you only pay tax on $10K of gains. And, this is separate from your regular income so it doesn't affect how much you can convert to the top of the 24% bracket. In fact, of that $125-150K, much of that should be qualified dividends and long term CG distributions, and they wouldn't count towards the 24% bracket either. There isn't a silver bullet. The income was tax DEFERRED. You have to pay the tax sometime. The way I'd look at it, you are paying tax and liberating the money in your tIRA/401K that you can't touch until you pay the tax.

Yes, I think we are saying the same thing regarding taking after tax $$ and yes, tax deferred means just that.

I really appreciate everyone's comments here. It's kinda like buying a car... you know it's going to depreciate, but you sure would like to have the highest residual the day you sell.

Like many here, I was so wound up in maximizing my earning/minimize taxes/savings years that I never thought I would be angst-ing over paying taxes in retirement.

[CardsFan]

Quote:

Originally Posted by DawgMan Do conversions into the 32% make any sense? It still feels like I am not moving the needle much. In some ways, I go back to my earlier point... if the math works w/o Roth conversions as a couple and single, despite the higher taxes, how much gymnastics should I do year after year to "maximize"? Again, want to be prudent, but where does it stop moving the needle?

In your case, I think they might, at least now before IRMAA (though I am not sure you can dodge that bullet).

They may have a very nominal impact, but not likely a negative one.

[Whisper66]

Quote:

Originally Posted by DawgMan Do conversions into the 32% make any sense? .....

To get a feel for the answser, you might consider running https://www.i-orp.com/Plans/extended.html . Make sure to check off the option of "IRA to Roth Conversions = 7 Unlimited". The program will suggest optimum Roth conversions if you spent the maximum allowable amount that your savings allow for the life time you input.

I took a shot with my interpretation of your numbers. I-ORP suggests you could spend of~ $590,000 per year (adjusted up each year for cost of living) excluding taxes for the rest of your life. If you actually spent that much yearly and wanted to optimize lifetime conversions, ORP suggests convering into the 37% tax bracket for a couple years, and the 35/33% tax brackets for another 6-7 years.

From your comments, I expect you won't spend 590k / yr so optimum Roth conversions may be higher. Also I expect (IMHO) that tax rates in the future will be higher than the current tax laws so higher Roth conversions today may be beneficial. Note: I-ORP takes into account the current tax rates and the changes when they expire in 2025.

Many have limits on how much tax they are willing to pay today and don't convert as much as I-ORP suggests. I personally have come around to accepting I have to pay sooner or later and might as well try to optimize it as much as I can.

You have a great problem to have, congrats.

[SecondCor521]

Quote:

Originally Posted by RunningBum And, this is separate from your regular income so it doesn't affect how much you can convert to the top of the 24% bracket. In fact, of that $125-150K, much of that should be qualified dividends and long term CG distributions, and they wouldn't count towards the 24% bracket either.

This is a bit misleading. Roth conversions are treated as ordinary income. Qualified dividends and capital gains are taxed at preferenced income brackets and rates. But if you Roth convert enough, then it can push those qualified dividends and capital gains into higher brackets. I like this visualizer, although it doesn't account for AMT or NIIT:

https://engaging-data.com/tax-brackets/

The key point to understand is that your capital gains income brackets are first filled up by your ordinary income (i.e. Roth conversions) - you don't get to start over at zero. So as an extreme example, if you have $10,000 in LTCG income and no ordinary income, then your LTCG tax federally will be zero. But if you Roth convert, say, $100,000, then that $10,000 gets pushed out of the 0% tax bracket and into the 15% bracket by the Roth conversion.

In the graph above, the standard deduction is at the bottom, the remaining ordinary income is in the middle, and the preferenced income is at the top.

...

@DawgMan, after going around and around on the same questions myself after several years, here's what I do:

1. Figure out what my IRA (or 401(k) I guess in your case) will be worth when I'm 72. So in your case you'd basically take your 401(k) balance and add 15 years of growth.
2. Figure out the RMD on that amount.
3. Figure out what my Social Security will be when I'm 72.
4. Figure out what the total of #2 plus 85% of #3 is minus what the standard deduction will be. This is a rough proxy for my AGI at that point.

5. I then figure out what income tax bracket I'll be in at that point.
6. I also figure out what IRMAA bracket I'll be in at that point.
7. In your case you'd also want to figure out if NIIT applies to that amount (probably).
8. Then add in the effects of AMT.

You can then add up 5, 6, 7, and 8 to come up with an age 72 marginal rate if you do nothing. With your numbers, it wouldn't surprise me to see you ending up in the 32% or even 35% bracket, plus IRMAA of maybe 10% plus NIIT of 3.8% for a total of right around 50%.

If you can Roth convert some now below whatever that rate works out to be, then I think you're coming out ahead. Since Roth conversions now reduce your age 72 401(k) balance then, you'll also reduce your future RMDs and thus your age 72 tax rate.

So it's a bit of a see-saw that you want to balance - if you over-convert now into the 35% bracket, you might only end up in the 24% bracket later, which would mean paying more taxes than necessary and also sooner than necessary. I've extended my spreadsheet to assume Roth conversions every year from now on, so I can see how my Roth conversion plan affects that age 72 IRA balance and thus RMD and thus tax bracket.

...

Oh, and in general, I take and spend my taxable income and dividends first, top off spending by selling in taxable, then Roth convert up to my target AGI based on the approach outlined above. I do not cap gain harvest; I prefer Roth conversions over cap gain harvesting. I also have a monotonically increasing stair step plan - I essentially stay at 400% FPL until Medicare, then stay at the 22% bracket for as long as I can, then stay at the 22% bracket for a while, and so on.

[RunningBum]

Quote:

Originally Posted by SecondCor521 This is a bit misleading. Roth conversions are treated as ordinary income. Qualified dividends and capital gains are taxed at preferenced income brackets and rates. But if you Roth convert enough, then it can push those qualified dividends and capital gains into higher brackets. I like this visualizer, although it doesn't account for AMT or NIIT:

That's true. I didn't intend to be misleading, but I did ignore that because I think with the OP's numbers they will have all of their QDivs/CGs taxed as well as the full 85% SS. Sure, they could keep ordinary income low until RMDs and keep some of the QDivs/CGs taxed at 0%, but they'll pay a bigger price having so much taxed at higher rates when RMDs start.

[Animorph]

What RunningBum said. That's what I've been doing for many years now. Pay for everything from the taxable account and Roth convert to a target tax level.

Early on it may indeed be worth it to go into the 32% tax bracket. That's because you're effectively moving some some of your taxable account into the Roth account. That will accumulate tax free until you start Roth withdrawals. If the time until Roth withdrawals is shorter than that tax savings may not be much.

AMT will depend on your mix of regular, qualified, and capital gains income. You'll have to figure that out. I generally tried to avoid it, but I think it surprised me once or twice.

NIIT has been my limit the past few years, kind of late in the process. I'm within about 10 years of taking Roth withdrawals. The remainder in my tIRA will be taxed at 22% if everything stays the same, with a fairly robust margin for tIRA inheritance or filing as a single. So at this point it isn't worth exceeding the 22% bracket for Roth conversions.

Since I'm closer to taking Roth withdrawals, my planning now favors 0% capital gains over large Roth conversions. I will still Roth convert to the top of the 10% bracket. I'll still have some 15% capital gains taxes, but I'm going to be low enough in AGI to try to avoid IRMAA to some extent. I'll be trying to manage the capital gains over the next few years to stay out of the top IRMAA bracket at least.

State taxes can also impact the benefit of Roth converting, so be aware if you are close to the top of a state bracket.

It is worth Roth converting in general, about 7% increased yearly spending for us I think. However, with all the potential tax hits for larger conversions, the benefits of converting large amounts are easily diminished. There seems to be a pretty broad "optimal" range of conversions. So if you are converting close to the top of your expected RMD tax bracket you're 90% of the way there.

[RetireBy90]

DawgMan, I was having heartburn at converting above the 22% bracket until I added a line to my spreadsheet so I see total in tIRA and then a line that shows 72% of the total (22% for fed tax and 6% for state). Now I see how much is really there for us and how much the man has in our accounts. I’ve done well for him. He should be paying me

[2017ish]

Dawgman, a couple of points that I don't believe have been mentioned yet.

First, remember that you have $25,100 standard deduction (or greater itemized) in addition to the top of each bracket. (And if you and/or wife do HDHP in retirement, the amount contributed to HSA effectively can come right out of tax deferred.)

Second, either you or your spouse almost surely will have a future of filing as a single taxpayer while still having essentially the same RMDs that are assessed against a couple MFJ. Those tax years are likely to be ugly.

We retired with about half your stash, but with only 3ish years of spending outside of deferred accounts. The first three years, we spent down the taxable accounts and converted to top of 24% bracket, but remain uncertain about the wisdom of stopping there. (Remember what rates are presently supposed to snap back to in 2026.)

Now that we are living off IRA money, I'm leaning more towards converting sums that we don't spend in a given year so as to exhaust the 32% bracket. With the account allocation of your holdings, it would be an easier call for me (if in your shoes). Nothing is certain, but that seems to maximize the odds over the long term by reducing the deferred accounts.

Finally, you might want to look at making your taxable accounts (and Roths) 100% equity, and put sufficient bonds in your deferred accounts to reach your allocation goal. This would maximize growth in the most tax efficient buckets, and help to tame the deferred accounts without sacrificing your desired allocation percentages.

Congrats on positioning yourselves for an excellent retirement!

[DawgMan]

Thanks everyone! I will dig into all the suggestions. I guess I may need to make peace with the 32% bracket, as unappealing as it sounds!

[newellcr]

DawgMan, Congrats. In middle 50's here, ERed, and have been doing 5 figure conversions for about 6 years. Last year, I finally figured out that I wasn't making much headroom and converted about a quarter Mil. I am seeing the light at the end of the tunnel now and will continue with some version of these 'big' conversions until the Roth/rollover holds something like 85/15. It is pretty hard to make peace with the 32% bracket and I have only a small piece that falls there for 2020. I am seriously considering going big(er) for 2021. I am actually eyeballing the 35% bracket, mostly because we will have capital gains to contend with in the out years. Every story is so different... Good luck.



You mention that you don't have any pension. DW and I have been considering a 6 figure gift to old state U. You can donate rollover chunks and get lifetime earnings and a current year deduction. The deduction can help with additional Roth conversions. There are limits, the rules are interesting, and the returns are generally awful. We have considered laddering a couple of larger donations. The sweet spot for this starts at age 59.5 so we aren't there yet for lots of reasons. The 'return' might not be the goal, but it is pension like and the gifts might help tame your large IRA and bump up Roth conversions sooner. The charity manages the donation/investment and gets the residual in the end...

[Ready-4-ER-at-14]

I tried to look beyond the numbers to net benefits of massive conversions at a higher tax bracket that I was used to.

By moving a lot I made sure almost all the capital gain would be in the roth with fixed income and annuities in the regular iras.

Currently the distribution from the lifetime annuities are considered my Required Minimum Distributions and the fixed income is in a laddered time sequence so some come due each year to take care of other withdrawals or taxes. Roth's are near or beyond the 5 year existence withdrawal rules so trappable when we will need them.

Moving a lot hurt our Medicare costs for only one year. It hurt to see the net worth decline when the tax money went out, but have made almost all of that back this year alone.

I had also looked at how many years of investing it would take to cover that tax and minimized the estimated taxes in the future compared to the likely hood that at least one of us might live another 20 years. I suspected it would be less than 3-5 years at the time I started it.

Finally I looked at tax rates in other countries for what could be the tax on withdrawals in the future if a wealth tax is imposed on regular ira withdrawals directly.

[DawgMan]

Quote:

Originally Posted by SecondCor521 This is a bit misleading. Roth conversions are treated as ordinary income. Qualified dividends and capital gains are taxed at preferenced income brackets and rates. But if you Roth convert enough, then it can push those qualified dividends and capital gains into higher brackets. I like this visualizer, although it doesn't account for AMT or NIIT: https://engaging-data.com/tax-brackets/ The key point to understand is that your capital gains income brackets are first filled up by your ordinary income (i.e. Roth conversions) - you don't get to start over at zero. So as an extreme example, if you have $10,000 in LTCG income and no ordinary income, then your LTCG tax federally will be zero. But if you Roth convert, say, $100,000, then that $10,000 gets pushed out of the 0% tax bracket and into the 15% bracket by the Roth conversion. In the graph above, the standard deduction is at the bottom, the remaining ordinary income is in the middle, and the preferenced income is at the top. ... @DawgMan, after going around and around on the same questions myself after several years, here's what I do: 1. Figure out what my IRA (or 401(k) I guess in your case) will be worth when I'm 72. So in your case you'd basically take your 401(k) balance and add 15 years of growth. 2. Figure out the RMD on that amount. 3. Figure out what my Social Security will be when I'm 72. 4. Figure out what the total of #2 plus 85% of #3 is minus what the standard deduction will be. This is a rough proxy for my AGI at that point. 5. I then figure out what income tax bracket I'll be in at that point. 6. I also figure out what IRMAA bracket I'll be in at that point. 7. In your case you'd also want to figure out if NIIT applies to that amount (probably). 8. Then add in the effects of AMT. You can then add up 5, 6, 7, and 8 to come up with an age 72 marginal rate if you do nothing. With your numbers, it wouldn't surprise me to see you ending up in the 32% or even 35% bracket, plus IRMAA of maybe 10% plus NIIT of 3.8% for a total of right around 50%. If you can Roth convert some now below whatever that rate works out to be, then I think you're coming out ahead. Since Roth conversions now reduce your age 72 401(k) balance then, you'll also reduce your future RMDs and thus your age 72 tax rate. So it's a bit of a see-saw that you want to balance - if you over-convert now into the 35% bracket, you might only end up in the 24% bracket later, which would mean paying more taxes than necessary and also sooner than necessary. I've extended my spreadsheet to assume Roth conversions every year from now on, so I can see how my Roth conversion plan affects that age 72 IRA balance and thus RMD and thus tax bracket. ... Oh, and in general, I take and spend my taxable income and dividends first, top off spending by selling in taxable, then Roth convert up to my target AGI based on the approach outlined above. I do not cap gain harvest; I prefer Roth conversions over cap gain harvesting. I also have a monotonically increasing stair step plan - I essentially stay at 400% FPL until Medicare, then stay at the 22% bracket for as long as I can, then stay at the 22% bracket for a while, and so on.

I like the visualizer, although, as you said it does not take into account NIIT. Kitces digs into this here in more detail, illustrating the complexity of where to draw the line, particularly with larger Roth conversions, https://www.kitces.com/blog/navigati...h-conversions/

As you suggested, the best you can do is make certain projections and run different "what if" scenarios, making the best decision you can.