Pulling back MAGI via Roth conversions? (ACA)

[GoodbyeYellow]

I read about this somewhere on this forum but now cannot find it. It was a late night read so hoping it wasn't a dream

DW is planning retirement at 59, just a few months away, when I will be 62 (already retired). As this will mean the loss of her health plan, we plan to go on ACA to tide us over till Medicare and are looking for ways to make MAGI as low as feasibly possible. At the same time, we need to generate cash from our sizable Traditional IRAs, which generally means increased income.

The thread I saw noted something like this: one can convert Trad IRA to Roth IRA to lower MAGI, as said conversion reduces AGI to arrive at MAGI.

Of course, AGI increases when taking tIRA (and is taxable), but then this gets subtracted if converted to Roth, to arrive at MAGI. So the net effect is/should be zero.

However, to my thinking (which could be screwy, looking for more seasoned people to chime in), this has the potential to generate cash for the next year. As in:

Yr 1: Take say $10K distribution from tIRA, then convert it to Roth, pay taxes as needed. (However with low enough AGI, taxes are either very low or zero).

Yr 2: Convert $11K (increased it just to differentiate between buckets) to Roth and pay taxes, but withdraw Year 1's $10K to use as cash for year 2. (leave the non-distributable growth, if any, to remain there as necessary)

Yr 3: Repeat Year 2 etc.

Of course, the withdrawals don't need to be done and that's also a possibility, depending on things. In that case we get to grow Roth balances.

I get a feeling this may be too simplistic and there must be a gotcha somewhere.

PS: There are/will be other sources of funds in these years (including cash on hand); I just haven't mentioned them as they are not directly relevant here.

 

[pb4uski]

... The thread I saw noted something like this: one can convert Trad IRA to Roth IRA to lower MAGI, as said conversion reduces AGI to arrive at MAGI.

Of course, AGI increases when taking tIRA (and is taxable), but then this gets subtracted if converted to Roth, to arrive at MAGI. So the net effect is/should be zero. ...

No... Roth conversions increase MAGI, not decrease MAGI.... IOW, if you do a $10k conversion then your MAGI goes up $10k, your tIRA goes down $10k and your Roth goes up $10k (assumes no taxes withheld, which is the best way to do it).

...However, to my thinking (which could be screwy, looking for more seasoned people to chime in), this has the potential to generate cash for the next year. As in:

Yr 1: Take say $10K distribution from tIRA, then convert it to Roth, pay taxes as needed. (However with low enough AGI, taxes are either very low or zero).

Yr 2: Convert $11K (increased it just to differentiate between buckets) to Roth and pay taxes, but withdraw Year 1's $10K to use as cash for year 2. (leave the non-distributable growth, if any, to remain there as necessary)

Yr 3: Repeat Year 2 etc. ...

That works fine as long as your are over 59 1/2 when you do the withdrawal... but is really not any different from just taking a tIRA withdrawal for spending after the first year.

 

[SevenUp]

...but then this gets subtracted if converted to Roth, to arrive at MAGI.

Would be nice for your situation if true, but that's not how MAGI for Affordable Care Act purposes works.

Those with MAGI that would otherwise be too low for ACA purposes may use Roth conversions to increase that MAGI.

 

[RunningBum]

It must have been a dream. Along with the tax you pay on the conversion, you should factor in the reduction of subsidy with a conversion. It's probably more than you think, so it's worth figuring the actual numbers.

Compare this combined rate with your projected future tax rate. Try to factor in what you might face in extra SS taxation (which can also have a far greater impact than you might think) and IRMAA tier increases if you take that income later, especially with RMDs. Also consider investment gains over inflation could also push you into the next tax bracket.

For both cases factor in whether a conversion or RMD/withdrawal will also push QDivs/LTCGs into being taxed.

Sounds complicated, but I try to do a realistic estimate without going into gory details. In many cases there is a pretty obvious level at which one should convert, a grey area past that, and an obvious level beyond that where you should not convert. But each case is different so run your own numbers. If it's close, I convert to take the bird in the hand rather than guess what taxes will do later. Plus if I have a large expense later, I have that tax-free account to take from, and don't have to make a larger than usual tIRA withdrawal that might put me in a yet higher tax bracket.

 

[pb4uski]

What is your withdrawal rate for the first few years and what is your mix of taxable/tax-deferred and tax-free? Percentages are fine... for example, WR if 6% for the first few years and mix is 20/70/10.

 

[GoodbyeYellow]

Thanks all, yeah too good to be true. But at least it wasn't a dream, rather a misreading; see Worksheet 2.1 (line 2) in this publication, which I did manage to find:
https://www.irs.gov/publications/p590a

The error I made is not to read through, that this is for MAGI for purposes of computation of Roth. Oh well, and thanks for the head-straightening.

pb4uski, we haven't done this quite using the "withdrawal rate" method and I do intend to start a new thread with a bit of numbers included. But in broad strokes, we will be needing some 1/7th of the 'portfolio' over the first six years. We are funding this through a combination of dividends (15%), sale of equities (~30%), Cash (~30%), Roth IRAs (~15%), and IRA drawdowns (~15%). Bit over 100% in sum, but it will be tweaked as we go along.

Of course, 6 years times 7 is 42, and neither of us expects to make it that long. And that's not counting SS or any growth. Which is why I'm looking for additional eyes on this. We meet with a Fidelity guy in a few days (free) and perhaps another fee-based planner. I will also post a thread here in a day or two, am a bit confused as to how to best leverage the portfolio, which I don't think I am doing with the above plan.

RunningBum, I'll need to work on what you wrote. Some of it I already have, some needs clarity (from me).

 

[SevenUp]

Thanks all, yeah too good to be true. But at least it wasn't a dream, rather a misreading; see Worksheet 2.1 (line 2) in this publication, which I did manage to find:
https://www.irs.gov/publications/p590a

The error I made is not to read through, that this is for MAGI for purposes of computation of Roth.

Yes, unfortunately there are at least the ten different definitions of MAGI listed on that Bogleheads' wiki.

 

[mountainsoft]

The thread I saw noted something like this: one can convert Trad IRA to Roth IRA to lower MAGI, as said conversion reduces AGI to arrive at MAGI.

You may have read one of my posts. In my case I am converting my traditional IRA to a Roth while I'm still working. I didn't have a huge balance to start with, but have converted about 25K-30K per year to stay in the 12% tax bracket. Come January I will be able to convert the last of my traditional IRA to my Roth.

Once we retire I won't have my traditional IRA anymore. When we lose my wife's employer healthcare, any withdrawals I make from my Roth account won't count as income for ACA, allowing us to qualify for subsidies.

"Don’t include qualified distributions from a designated Roth account as income."
https://www.healthcare.gov/income-and-household-information/income/

By keeping our taxable income low, it will also allow us to qualify for reduced property taxes. And we will pay less taxes in retirement due to the lower taxable income.