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My FIRE Strategy -- Roth Conversion
Old 02-04-2024, 07:24 PM   #1
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My FIRE Strategy -- Roth Conversion

Hello all,
I fear that there is some blatantly stupid blind spot to this plan, so I am hoping the posters here can quickly point out the errors of my ways. Please forgive my newbie naivete, but when I finally landed my first good job that had a savings plan, a TIAA advisor said, "Stick your money in a growth fund and forget about it," so that's what I did. 15% of my gross year since 1994. I have only been looking at retirement for the last few years and seriously, only recently.

Hear goes:
67 is my full retirement age. (spring 2030).
I am hoping to take early retirement in June of 2025 at age 62, but I could work longer.
  • I should have about $190k in liquid savings by July of 2025.
  • I have about $945,000 in a (TIAA) tax deferred retirement savings account.
  • I can receive about $18k in salary for 5 years by taking early retirement at 62.
  • House is paid off, no other debt whatsoever.
  • I can stay on the employer health plan until Medicare kicks in at 65 for about $300/yr.
  • Id like $4k/mo for expenses from 62 to 67. $3k monthly living & $1k/mo towards trips and large purchases.

Preliminary Plan:
  • I am thinking about living off of liquid savings and my early retirement income for the 5 years of early retirement. I am also are considering converting most of my retirement account to a Roth IRA over those 5 years, by converting about $170k a year so I can stay in the 24% marginal bracket.
  • At 67, I plan on accessing my SS which should pan out to $2500-$3000/mo, so I will need to start drawing at least $1000-$1500/mo from that Roth IRA at 67 so I can maintain my lifestyle. I will also have the added expense of Medicare Premiums.
  • I figure by converting it all to Roth asap, most of my taxes will be paid and I should be able to live mostly income tax free after that.

Is this a sound strategy or should I not worry so much about converting to Roth for the tax advantages?

What other strategies might you recommend?

Thanks.


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Old 02-04-2024, 08:34 PM   #2
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In general, I am a big fan of Roth conversions when it makes sense. I do not think it makes sense in the scenario you describe.

In the most basic sense, Roth coversions are useful for tax-rate arbitrage over time. Meaning, if you will pay a lower tax for converting now than you will for withdrawing the same funds later, you should convert. On the other side, if your rate for converting is higher than later, than you should defer. (There are some further considerations, but that is the nub of it.)

I cannot tell for sure from what you wrote, but your numbers do not suggest to me that you will be in a super-high tax bracket later.

Maybe convert to the top of the 22% bracket? Maybe only the 12?
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Old 02-04-2024, 10:08 PM   #3
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Welcome to the forum!

Agree with Out-To-Lunch. Paying 24% now to pay 0% later, as you describe, will probably result in less after-tax money to spend across your lifetime.

Build your own spreadsheets and project out, then try to even things out in terms of your top marginal rate. Based on your numbers, I'm betting that 22% is even too high, and you can probably do some combination of top-of-12%, top-of-an-IRMAA-bracket, and top-of-22% maybe only for a year or two.

Oh yeah, IRMAA is probably something worth putting in your spreadsheet.

You'll also have to form your own opinion on the expiration of the TCJA in 2026, and whether it is generally better to defer or accelerate taxes in edge cases (personally I choose to defer unless there is a clear win, which to me is ~5% in marginal rate difference).
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Old 02-04-2024, 10:45 PM   #4
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Originally Posted by Out-to-Lunch View Post
In general, I am a big fan of Roth conversions when it makes sense. I do not think it makes sense in the scenario you describe.

In the most basic sense, Roth conversions are useful for tax-rate arbitrage over time. Meaning, if you will pay a lower tax for converting now than you will for withdrawing the same funds later, you should convert. On the other side, if your rate for converting is higher than later, than you should defer. (There are some further considerations, but that is the nub of it.)

I cannot tell for sure from what you wrote, but your numbers do not suggest to me that you will be in a super-high tax bracket later.

Maybe convert to the top of the 22% bracket? Maybe only the 12?
Thanks for your reply.

At the 12% bracket, it would take me at least 30 years to convert to Roth, depending on return rates earned, maybe never. While I am guessing that income tax rates are likely to increase in the future, that is not why I am considering converting to Roth. The main reason for converting is so that in the future, I will not be paying tax on the interest that I earn.



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Old 02-04-2024, 11:10 PM   #5
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Originally Posted by glasswave View Post
Thanks for your reply.

At the 12% bracket, it would take me at least 30 years to convert to Roth, depending on return rates earned, maybe never. While I am guessing that income tax rates are likely to increase in the future, that is not why I am considering converting to Roth. The main reason for converting is so that in the future, I will not be paying tax on the interest that I earn.



~~~~~
You need to look into the commutative law of multiplication. If the tax rate is the same, it makes no difference if you enjoy gains first, and then pay taxes; or if you pay taxes first, then enjoy tax-free gains. You should be instead focussing on getting your money out at the lowest possible tax rate. (I am using "tax rate" here broadly, including regular taxes, losses of subsidies, IRMAA surcharges, NIIT, etc.)

Here is a good resource for you: https://www.bogleheads.org/wiki/Traditional_versus_Roth
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Old 02-04-2024, 11:23 PM   #6
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Quote:
Originally Posted by Out-to-Lunch View Post
You need to look into the commutative law of multiplication. If the tax rate is the same, it makes no difference if you enjoy gains first, and then pay taxes; or if you pay taxes first, then enjoy tax-free gains. You should be instead focussing on getting your money out at the lowest possible tax rate. (I am using "tax rate" here broadly, including regular taxes, losses of subsidies, IRMAA surcharges, NIIT, etc.)

Here is a good resource for you: https://www.bogleheads.org/wiki/Traditional_versus_Roth
+1
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Old 02-04-2024, 11:32 PM   #7
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Originally Posted by SecondCor521 View Post
Welcome to the forum!

Agree with Out-To-Lunch. Paying 24% now to pay 0% later, as you describe, will probably result in less after-tax money to spend across your lifetime.

Build your own spreadsheets and project out, then try to even things out in terms of your top marginal rate. Based on your numbers, I'm betting that 22% is even too high, and you can probably do some combination of top-of-12%, top-of-an-IRMAA-bracket, and top-of-22% maybe only for a year or two.

Oh yeah, IRMAA is probably something worth putting in your spreadsheet.

You'll also have to form your own opinion on the expiration of the TCJA in 2026, and whether it is generally better to defer or accelerate taxes in edge cases (personally I choose to defer unless there is a clear win, which to me is ~5% in marginal rate difference).
Thanks for the reply.

I am a computer graphics guy who has tried to avoid spreadsheets most of my life. But I just ran a scenario using a Simple Savings Calculator where I started in "Calculator 1" with 1 mil and earned 10% for 5 years. Then in "Calculator 2" I started with 750k and earned 10% for 5 years, when I multiply the total of Calc 1 by .75 it comes out nearly identical to Calc 2. Same for 10, 20 and 30 years.


I can't help but think my math scenario is wrong. I see videos that demonstrate how Roth conversion can save you 100s of 1000s.

I should have a low enough income that I won't be boosted up due to high income Medicare charges.

My guess is that taxes will have to increase in the future if the nation is to avoid bankruptcy.




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Old 02-04-2024, 11:35 PM   #8
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Be aware at age 63 , the IRMAA penalty will exist if your income crosses the line.

I think it's unnecessary to convert all your retirement money , as RMD's won't start until age 73. Even then having a $100K in an IRA will only require a withdrawal of less than $4K, which adds to income.

What will your income be when fully retired at age 67 in today's dollars ? How much in taxes if that was now will you pay ?
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Old 02-05-2024, 05:11 AM   #9
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Originally Posted by Sunset View Post
Be aware at age 63 , the IRMAA penalty will exist if your income crosses the line.

I think it's unnecessary to convert all your retirement money , as RMD's won't start until age 73. Even then having a $100K in an IRA will only require a withdrawal of less than $4K, which adds to income.

What will your income be when fully retired at age 67 in today's dollars ? How much in taxes if that was now will you pay ?
Actually at OP's age, RMD's won't start until age 75.
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Old 02-05-2024, 05:55 AM   #10
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Originally Posted by glasswave View Post
I am a computer graphics guy who has tried to avoid spreadsheets most of my life. But I just ran a scenario using a Simple Savings Calculator where I started in "Calculator 1" with 1 mil and earned 10% for 5 years. Then in "Calculator 2" I started with 750k and earned 10% for 5 years, when I multiply the total of Calc 1 by .75 it comes out nearly identical to Calc 2. Same for 10, 20 and 30 years.


I can't help but think my math scenario is wrong.
It is not wrong if your tax rate on that amount is always 25%.


Quote:
Originally Posted by glasswave View Post
...converting to Roth for the tax advantages
It's only an advantage if you convert up front at a marginal tax rate lower than you would pay to withdraw later. For example, converting at 24% when you could have paid only 12% later would be a disadvantage.
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Old 02-05-2024, 08:51 AM   #11
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I agree with most of the others that it's quite unnecessary to Roth convert all of a fairly large tax-deferred account. Ignore Ed Slott's ravings on this matter.

What's pretty close to optimal for most folks, especially those of us filing Single, is having a relatively level AGI from start of retirement onward, increasing maybe 3% per year.
You accomplish this by doing larger Roth conversions in years prior to SS and RMDs, and then smaller or zero Roth conversions once both of those start.

I also have significant funds with TIAA and recommend you consider annuitizing a portion of your accumulation for lifetime income with a ten year guaranteed period. This assumes your health is generally good.

Also, your projected retirement income of $4000 per month seems a bit modest. What is your net monthly income now, when working full-time, after subtracting FICA and retirement plan contributions? I wouldn't target too much less than that in retirement, if possible, given all the free time available then.

I have quite a bit in my Roth IRA now, after doing conversions each year since 2013. I don't withdraw money from my Roth on a regular basis. I keep that tax-free money for occasional large purchases, like buying a new car. Just something to consider...
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Old 02-05-2024, 09:11 AM   #12
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It sounds like this would be going overboard on Roth conversions. The good thing this plan does is to avoid taxation of SS benefits. The SS taxation phase-in creates higher than expected marginal tax costs. But I doubt that it's worth going to the top of the 24% bracket and paying IRMAA surcharges (which are another ~5%) to get there.

My wild guess is that conversions to the top of the base IRMAA tier might be worthwhile, but that's about it.

There are consumer grade models you could use to make estimates of this - I've used a free spreadsheet at Bogleheads.org called the Retiree Portfolio Model that would work but is very manual on Roth conversions. My favorite is a paid Excel sheet called Pralana Gold (web version to be released in a couple months). I've heard of folks using a web based program called NewRetirement, I haven't used it, I understand it doesn't have all the nuances of the tax code that Pralana Gold has, but those nuances feel unnecessary in this case.
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Old 02-05-2024, 09:14 AM   #13
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Glassware - you don't mention whether you have a Roth IRA already in place. If not, why not open one up and fund 2023 while you still have a chance - and ponder your conversions . . .
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Old 02-05-2024, 10:29 AM   #14
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Glassware - you don't mention whether you have a Roth IRA already in place. If not, why not open one up and fund 2023 while you still have a chance - and ponder your conversions . . .
+1. I see no mention of an existing Roth IRA. If you don't have one already, you should make contributions for 2023 and 2024.
I agree with the others; converting to the 24% rate seems too much for someone with your assets. Since you have around $10K of interest and $18K of earned income in retirement, you should be able to convert around $30K at the 12% rate in addition to the annual Roth contributions. That seems reasonable.
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Old 02-05-2024, 10:37 AM   #15
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I know you dislike spreadsheets, but check out I-orp.com which helped guide me some with conversion planning.
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Old 02-05-2024, 11:44 AM   #16
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I’m reading on my phone so may have missed. Is there a pension in this picture? Is the $18k an annual “salary” for 5 years or a one-time payment?
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Old 02-05-2024, 11:58 AM   #17
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Originally Posted by glasswave View Post
Thanks for your reply.

At the 12% bracket, it would take me at least 30 years to convert to Roth, depending on return rates earned, maybe never. While I am guessing that income tax rates are likely to increase in the future, that is not why I am considering converting to Roth. The main reason for converting is so that in the future, I will not be paying tax on the interest that I earn.
Your goal should be to maximize your wealth over your lifetime. Paying at a much higher tax rate now to avoid taxes later will probably not optimize your wealth. If you are paying tax out of the conversion money than you are only getting 76% converted for the income in the 24% range. You won't pay tax on the future interest, but you're only earning interest on that 76% base. The numbers really won't work out for you unless you are forecasting much higher future tax rates.

Many of us here are Roth conversion proponents when the tax arbitrage works--converting as the same or lower rate than you expect to be paying when you have SS and RMDs adding to your retirement income. There's a reason you aren't getting agreement on your plan here. You appear to be converting at too high of a rate.
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Old 02-05-2024, 12:12 PM   #18
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I tend to see Roth conv (in my own situation) as less an optimization, more a preservation of options, since none of us knows exactly when we’ll die - a key determinant of the final tally. I will do a few years of conversions up to the 22-24% bracket which is at least where I’ll be living in the post-RMD future. I like the idea of having a “tax-free” stash for lumpy expenses. IF all goes well, both tIRA401k and Roth funds will grow to excessive amounts which would make the question of optimal strategy fairly moot. Looking forward to these kinds of problems (but of course planning for the worst as is my nature).
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Old 02-05-2024, 12:39 PM   #19
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Congrats on having built up substantial savings, having a paid off house and near retirement. Your current plan leads me to believe you want to pay absurdly high tax rates now to avoid them in the future. The only one happy is the government. Throw out your plan and start again. There is no rule of thumb for RothIRA conversions. You need a detailed tax plan showing every year for the rest of your life. If you don’t understand spreadsheets, considering paying a fee only CFP to make a plan for you.
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Old 02-05-2024, 12:53 PM   #20
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I tend to see Roth conv (in my own situation) as less an optimization, more a preservation of options, since none of us knows exactly when we’ll die - a key determinant of the final tally. I will do a few years of conversions up to the 22-24% bracket which is at least where I’ll be living in the post-RMD future. I like the idea of having a “tax-free” stash for lumpy expenses. IF all goes well, both tIRA401k and Roth funds will grow to excessive amounts which would make the question of optimal strategy fairly moot. Looking forward to these kinds of problems (but of course planning for the worst as is my nature).
Slightly amending the above, I will have significant after-tax funds generated from some liquidity events next couple years (think RSU’s, deferred income, real estate sales, etc) for which taxes will (painfully) be paid upfront. But , once the net proceeds are reinvested, could still generate significant taxable income (ex. dividends, cap gains distributions, etc.) So stashing some dollars in Roth would help with that since the growth would be tax-free. Again, maybe not optimal, but I like creating lots of options for the future so can pull from whatever assets make the most sense in whatever the prevailing conditions will be.

Also, thinking I will hang onto low rate jumbo mortgage, which will begin to adjust in several years - want to have a big enough tax-free stash to pay-off without triggering nasty cap gains, if that move makes sense down the road.
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