Planning for this year's Roth conversion, hit a wall, stumped!

[Telly]

For the last X years, we have been doing Roth conversions. Will have higher tax bracket in future, due to RMDs at 72 stacking onto taking SS at 70. Doing conversions up to the top of the 12% bracket, expecting 22% bracket at 72. A no-brainer. But I did feel like I was just chipping off little bits of TIRA each year, as the TIRA was still growing.

However... doing preliminary 2020 taxes this week, found that with much higher cap gains this year in taxable, plus DW Covid-related OT, we have headed into the 22% bracket now, and don't think we will be leaving it.

I did a simple tax look at the future at age 72:
Using 2020 figures as a base, removed DWs wages, added DWs pension when she retires, reused my little pension I'm taking already, reused 2020 Ordinary Dividends and Cap Gains, added my future age 70 SS (I have the estimate for that), took present TIRA amount and used 3.65% as first RMD. Reused the basic 2020 deductions. Running all that as if I was age 72 now in 2020. Result was Taxable income about 2/3rds the way up the 22% bracket.
So first issue, does it really make any sense to do conversions and still end up in the same tax bracket?

On to an IRMAA check -- I then added 2020 tax-exempt interest onto my "age 72" AGI to get MAGI. Then compared MAGI to 2018 IRMAA brackets. Result, right at the beginning of Tier 1 IRMAA! I also looked at the IRMAA $ penalties for DW and me on an annual basis, about $1,700 for us two combined in Tier 1.
So second issue, piled on top of the first issue, does IRMAA avoidance really add any reasonable kick to do conversions from 22% to 22%?

So far, I have come up with two choices:
#1 - Do nothing, no more Roth conversions, it's over. Just pay the increased taxes in future when due.
#2, - Do Roth conversions up to the top of 22% bracket this year and next two years, then cut waaay back for last two years, to avoid triggering IRMAA look-back the two years before age 72. My gut feel doesn't feel right about this one, or maybe it was the Burrito...

A few other thoughts, but I don't think they are going to pull a rabbit out of the hat -- 85% of my SS will be taxed, not 100%, so numbers drop by some thousands there. We know we need to make changes in the coming year to make our taxable more tax-efficient. Wellington is kicking out CG every year, and we also have a long-running growth fund (managed) that was a super star for many years, but now is pouring out CGs. But I don't think redoing our taxable equities to more tax-advantaged is going to create big magic with respect to Roth conversion abilities.

So I'm stalled, brain hurts, year-end clock is ticking.

 

[SecondCor521]

You're doing a number of things oddly. I'm not sure if it'll make your head hurt less, though, to know about them to try to make a decision.

1. The brackets for both taxes and IRMAA adjustments go up by inflation every year. Since you appear to have six years between now and age 72, that will affect your analysis.

2. IRMAA is a Medicare adjustment. Most people go on Medicare at 65, not 72. IRMAA has a two year offset / lookback, so your IRMAA analysis should start looking at your age 63 tax return.

3. Depending on how your IRA is invested, it might grow between now and 72.

4. Are you accounting for your SD going up at your age(s) 65? It's not clear to me how old you and your DW are.

As to the answer to your question, I'd figure out if converting more this year would perhaps keep you in the 22% and out of the 24% bracket longer. The spreadsheet I built for this purpose seems to tell me that converting to the top of the 22% bracket for as long as possible then converting to the top of the 24% bracket as long as possible gives me the most after tax spending. There may even be a more optimal path of converting to the top of the IRMAA brackets in stepwise fashion, but this is harder to do because people don't know what the IRMAA brackets will be two years in advance.

 

[RunningBum]

found that with much higher cap gains this year in taxable, plus DW Covid-related OT, we have headed into the 22% bracket now,

Capital gains don't affect your regular income tax bracket.

A couple of things to consider why converting at 22% might be beneficial. If you or your spouse dies, the other will be filing single, which very likely pushes them to a higher tax bracket. And in 2025 tax cuts expire unless action is taken, so you might wind up in the 25% bracket, not 22%.

It's probably not going to be much of a difference either way.

 

[pb4uski]

Telly, sorry to say this but I'm going to make you head hurt even more.

Another significant factor that you need to consider is your actual marginal rate for that Roth conversion into the 22% tax bracket if you have significant preferenced income (qualified dividends and LTCG). What happens is that once you start converting into the 22% tax bracket, if you have qualified income, your marginal tax rate is actually 27% rather than 22% for the amount of your preferenced income, and then drops down to 22% for the remainder.

For example, let's say that you have converted to the top of the 12% tax bracket but also have $50k of qualified income (and $55,050 of ordinary income) and you are considering additional Roth conversions into the 22% tax bracket and decide to conver another $50k.

Before that additional $50k your tax is $3,276. After the additional $50k of Roth conversion your tax is $16,741, and increase of $13,465 (26.9% of the $50,000)! What is happening is that each $1 of Roth converision above the 0% preferenced income tax bracket adds $1 of ordinary income that is taxed at 12% but also pushes $1 of preferenced income from the 0% bracket into the 15% bracket... with the combined effect of a 27% marginal tax rate until no preferenced income is taxed at 0%.

https://www.kitces.com/blog/long-te...one-higher-marginal-tax-rate-phase-in-0-rate/

In fact, the interrelationship between ordinary income and long-term capital gains creates a form of “capital gains bump zone” – where the marginal tax rate on ordinary income can end out being substantially higher than the household’s tax bracket alone, because additional income is both subject to ordinary tax brackets and drives up the taxation of long-term capital gains (or qualified dividends) in the process.

For instance, individuals with as little as “just” $30,000 of income (after deductions) and some capital gains on top who would normally be in the 12% tax bracket may face marginal tax rates as high as 27% due to the capital gains bump zone. And upper-income households eligible for the 35% tax bracket may face a marginal rate of 40% as the top capital gains tax bracket phases in. The effect can be even worse for retirees who also claim Social Security benefits, where the combination of phasing in Social Security benefits, and driving up long-term capital gains to be subject to the 15% rates, can trigger a marginal tax rate of nearly 50%(!) for a household otherwise in the 12% ordinary income tax bracket!

You can play with https://www.dinkytown.net/java/1040-tax-calculator.html to see the impact. Open two windows and put MFJ and in one window input $55,050 of pension income and $50,000 of taxable IRA distributions and in the other window input $55,050 of pension income and $100,000 of taxable IRA distributions.

 

[Ole Red 29]

Another significant factor that you need to consider is your actual marginal rate for that Roth conversion into the 22% tax bracket if you have significant preferenced income (qualified dividends and LTCG). What happens is that once you start converting into the 22% tax bracket, if you have qualified income, your marginal tax rate is actually 27% rather than 22% for the amount of your preferenced income, and then drops down to 22% for the remainder.

This hasn't even been on my radar. This is why I read this forum. Thanks for the tidbit. I have some more studying to do.

 

[pb4uski]

They sure don't make it easy or straightforward.

 

[Gotadimple]

Telly,
Go to Costco - buy the double bottles of aspirin. Get some antacid while you there too.

You said "Do Roth conversions up to the top of 22% bracket this year and next two years, then cut waaay back for last two years, to avoid triggering IRMAA look-back the two years before age 72."

IRMAA applies to Medicare Part B and Part D, and you are eligible for those programs starting at age 65. You can delay Social Security, but not Medicare. Well, you can delay it but then you pay an increased Medicare premium forever - unless you are still working at age 65 and have employer coverage.

So, when doing conversions do them up to age 63, then stop. That's option 1.
Option 2 is manage your AGI (including any Roth conversions) to just short of the IRMAA limit - you are still at the 22% bracket. For 2021, IRMMA is under $176,000 for MFJ, while the 22% bracket ends at 172,750 for MFJ.
Option 3 includes option 2 and adds - when taking RMDs consider funding a major part of your charitable contributions using RMDs (which means lower taxes but no deduction for that part of the RMD distributed to charities).

Hope that helps!
- Rita

 

[PhrugalPhan]

I just did a more thorough analysis this past month and realized that contributing 100% to Roth in my retirement account (as I have for 3 years already) and then doing conversions to the top of the same tax bracket in retirement will still not be enough to avoid hitting a higher bracket and getting IRMAA surcharges starting at 72 just like you have found out . In my case I am getting pushed from 22% to 24% (or 28% when the time comes) Fortunately for me I have 5 years before IRMAA becomes an issue, so I hope to do 22% plus limited 24% bracket conversions to keep this at bay. But another year or two of crazy market growth like we've been having and well... higher taxes here I come.

Anyway to your question, I would accept that option #2 is the right choice, no matter how painful it looks.

 

[TheWizard]

Roth converting to the top of the XX% bracket was never an optimal concept.
Depending on your starting point, your additional Roth conversion amount to top of current bracket could be a small amount or a quite large amount.

Better concept is to approximately "levelize" your AGI for the years before and after age 72. You'll need a spreadsheet to project that age 72 AGI, updated yearly.

When planning those Roth conversions, keep an eye on the next higher IRMAA tier threshold, to avoid going just over...

 

[cat4ever]

Am I crazy for wanting to avoid all this complication and spreadsheets and just plan to convert ~50K per year until 65 (i.e. for 10 years) and let the chips fall where they may? I didn't retire to pore over spreadsheets, and none of us really have any idea what brackets will be in 10 years anyway. My only guess is they'll be higher, which is why I'd do them at all.

 

[FREE866]

Capital gains don't affect your regular income tax bracket.

Question--example:
I thought if one has---not including dividends, interest or factoring in standard deduction--- 40K in income and 10K in capital gains the total income for tax purposes is considered to be 50K?

 

[CardsFan]

Am I crazy for wanting to avoid all this complication and spreadsheets and just plan to convert ~50K per year until 65 (i.e. for 10 years) and let the chips fall where they may? I didn't retire to pore over spreadsheets, and none of us really have any idea what brackets will be in 10 years anyway. My only guess is they'll be higher, which is why I'd do them at all.

You are not crazy, and many (most?) of us here have had the same headache as Telly. There is no RIGHT answer.

Anything you convert can help. IMHO, converting to the top of the 12% bracket is a no brainer. In our case, these conversions had an overall effective tax rate of 7-8%.

This year we went into the 22% bracket, staying below IRMAA as we are 65. Effective tax rate will be about 15%.

That said, the tIRA is still growing faster than I can drain it. Will I go higher next year? Maybe.

Bottom line: If we have this problem, our odds of running out of money are extremely low to non-existent

 

[RunningBum]

Question--example:
I thought if one has---not including dividends, interest or factoring in standard deduction--- 40K in income and 10K in capital gains the total income for tax purposes is considered to be 50K?

On 1040 there is a line that says "Total Income" and it would be $50K in your example. But to compute the taxes you are sent to the "Qualified Dividends and Capital Gains" worksheet which separates the QDiv+LTCG tax from the regular income tax. This keeps LTCGs and QDivs from affecting your regular income tax bracket.

 

[RunningBum]

Am I crazy for wanting to avoid all this complication and spreadsheets and just plan to convert ~50K per year until 65 (i.e. for 10 years) and let the chips fall where they may? I didn't retire to pore over spreadsheets, and none of us really have any idea what brackets will be in 10 years anyway. My only guess is they'll be higher, which is why I'd do them at all.

What do you think about plugging your numbers into i-orp and following it's recommendations?

 

[FREE866]

On 1040 there is a line that says "Total Income" and it would be $50K in your example. But to compute the taxes you are sent to the "Qualified Dividends and Capital Gains" worksheet which separates the QDiv+LTCG tax from the regular income tax. This keeps LTCGs and QDivs from affecting your regular income tax bracket.

Hmm..not sure if I did mine right then. Like the OP I'm trying to stay in 12% bracket--to the top. Filing Single I have:


$6125 in LTCG
$8777 In dividends
$37498 in Roth conversions
$52400 total



take out $12400 for standard deduction


Puts me at $40,000 total
0% capital gains tax




Is this right?

 

[RunningBum]

Hmm..not sure if I did mine right then. Like the OP I'm trying to stay in 12% bracket--to the top. Filing Single I have:


$6125 in LTCG
$8777 In dividends
$37498 in Roth conversions
$52400 total



take out $12400 for standard deduction


Puts me at $40,000 total
0% capital gains tax




Is this right?

You're good.

Assuming all dividends are qualified, you have 25,098 regular income and 14,902 QDivs+LTCG.

Those two numbers combined being at 40,000, you pay no tax on any part of it that is QDivs or LTCGs.

The 25,098 regular income is taxed as follows:
10% on the first 9874
12% on the 15,224 remaining

In fact you're more than good, you are perfect. Had you converted another $100, that $100 would have been taxed at 12%, plus you would've pushed $100 of the Qdivs/LTCGs into being taxed at 15%, for a total of 27%. Your effective rate would have stayed at 27% with more conversions until you pushed all QD/CGs into being taxed. At that point the next $124 would be taxed at 12%, and after that you'd be into the 22% tax bracket.

You can verify this using an online tax calculator like https://www.dinkytown.net/java/1040-tax-calculator.html

Sorry if my previous answer put a scare into you. I tried to answer the question you asked, but maybe I misunderstood or you didn't quite ask the question you intended to.

 

[FREE866]

You're good.

Assuming all dividends are qualified, you have 25,098 regular income and 14,902 QDivs+LTCG.

Those two numbers combined being at 40,000, you pay no tax on any part of it that is QDivs or LTCGs.

The 25,098 regular income is taxed as follows:
10% on the first 9874
12% on the 15,224 remaining

In fact you're more than good, you are perfect. Had you converted another $100, that $100 would have been taxed at 12%, plus you would've pushed $100 of the Qdivs/LTCGs into being taxed at 15%, for a total of 27%. Your effective rate would have stayed at 27% with more conversions until you pushed all QD/CGs into being taxed. At that point the next $124 would be taxed at 12%, and after that you'd be into the 22% tax bracket.

You can verify this using an online tax calculator like https://www.dinkytown.net/java/1040-tax-calculator.html

Sorry if my previous answer put a scare into you. I tried to answer the question you asked, but maybe I misunderstood or you didn't quite ask the question you intended to.

Thank you so much! You and others on here are amazing, seriously!

 

[pb4uski]

Hmm..not sure if I did mine right then. Like the OP I'm trying to stay in 12% bracket--to the top. Filing Single I have:


$6125 in LTCG
$8777 In dividends
$37498 in Roth conversions
$52400 total



take out $12400 for standard deduction


Puts me at $40,000 total
0% capital gains tax




Is this right?

Looks right... and further, assuming that the dividends are all qualified you have $14,902 of qualified income that is taxed at 0% and $25,098 of ordinary income.... the first $9,875 will be taxed at 10% and the remainder at 12%.

If you have made $300 of charitable contributions in 2020 you can do another $300 of Roth conversion and offset it with an additional $300 chartiable contribution deduction and pay an additional $0 in tax on the added $300 Roth contribution.

ETA: See now that I crossposted with RB.

 

[cat4ever]

What do you think about plugging your numbers into i-orp and following it's recommendations?

Sorry, that falls under the category of complication, as well as assuming whatever I-orp is, it knows what actual future rates may be, and assumes i can trust whatever math lines behind it, without having to take the time and effort to understand it.

 

[Telly]

Telly was last seen running up over a hill with hands on side of head, yelling "Cap gains, Qualified dividends, RMDs, Roth conversions, IRMAA, Social Security, Brackets and Brackets, nyaaaaaaah!"

I so rarely multi-quote here, I forgot how to do it, sorry.

In tax year 2025 I turn 72 and start RMDs. Will start SS at 70. I used 2020 tax rules to simulate what it would be like at 72, as if I turned 72 this year. I expect that between now and 2025, tax brackets and other rules will increase by inflation. What other tax rule changes may come, and what my IRA actually does by then, I can not predict, so simulating this way seemed the best.

I did mess up in one area, as was pointed out to me, regarding Roth Conversions vs. IRMAA. Any conversions in the 2020 through 2024 tax years I need to keep an eye out for IRMAA, that I don't run into it due to too-large conversion amount. In 2025 and beyond, I need to watch that RMD plus other income doesn't hit IRMAA, as that would hike Medicare up two years later. Though once I get to 2025, if RMDs nonetheless put me into IRMAA, or tax brackets like 24%, there's not much I can do about it then, it's like giving a train driver a steering wheel, heading down that track regardless. Really, only charitable contributions from the IRA can reduce it.

pb4uski, thanks for the Kitches and Dinkytown links. Been spending time looking at them. I vaguely now remember you talking about how regular income can push up CG and QDiv out of the zero tax range, and the tax bump thereof, some years ago.

I went through the basics, now corrected, with DW. When she heard about losing the zero tax rate on CG and QDiv and the tax bump, by us adding Roth conversion, she said let's skip the conversion. But that creates a "come what may" in the future, and no way in the future to really make any adjustment. Locking in a path in the present, for the future. We will be working this issue more, I'm reluctant to give up too quick. It IS possible that no matter what we do, since there aren't many years left to do Roth conversions, that the IRA growth cancels our efforts. But even then, taking no effort now might make us hit IRMAA Tier 2, etc., really don't know.

A good problem to have, I guess, but one thing I think about is our self-insuring for LTC. That high taxes could gobble a lot of that corn up. As far as one spouse dying, and the big wham of filing single instead of MFJ, single IRMAA bracket, etc., I don't think we can take any reasonable action to avoid that drastic tax effect now.

I got started on this too late this year, I did not expect the big Cap Gains this year!

 

[RunningBum]

Sorry, that falls under the category of complication, as well as assuming whatever I-orp is, it knows what actual future rates may be, and assumes i can trust whatever math lines behind it, without having to take the time and effort to understand it.

OK. It's your money, you can do with it what you want. I tend to forget that not everyone enjoys developing spreadsheets like I do.

You seem to have at least a vague notion that taxes will be higher later, so converting something is probably going to be the right move. And if it's not obvious what to do, there's probably not a big difference how much you convert, as long as it's not a total conversion and a huge tax bill in one year.

Another option is to hire a tax expert to run the numbers for you, but you may consider the work of getting your information and working out your assumptions on growth and tax rate with them too complicated, and they might not save you any more money than they'll charge.

It's also possible you'll notice something when doing your taxes (or having them done) that signals you should change your conversion amount for future years.

So, no, not crazy at all. Probably not optimal, but also possible you'll do better than people like me who try to get it perfect, only to find reality doesn't match assumptions.

 

[TheWizard]

Not crazy, no, just ordinary, perhaps.

Lots of regular folks just take it as it comes, rolling with the punches. These folks often pay someone to do their taxes, not because they're incredibly complicated, but due to lack of interest and learning.

So, yeah...

 

[Trooper]

If you have made $300 of charitable contributions in 2020 you can do another $300 of Roth conversion and offset it with an additional $300 chartiable contribution deduction and pay an additional $0 in tax on the added $300 Roth contribution.

Good point on the one-time ability to deduct cash contributions, even for those that itemize.

Another way to increase Roth conversion ability is through an HSA contribution. This is only available to folks insured in an HSA-eligible plan (normally high-deductible plans). The OP said his DW was still working, so perhaps her plan is eligible.

 

[FREE866]

If you have made $300 of charitable contributions in 2020 you can do another $300 of Roth conversion and offset it with an additional $300 chartiable contribution deduction and pay an additional $0 in tax on the added $300 Roth contribution.

\

I have...and thank you for reminder!!!

 

[MarieIG]

Thinking of converting approx. 50k per year between 2021-2025 and letting the chips fall where they may . . .