Question about which account to draw funds from

[N02L84ER]

Gotcha. Thank you so much your input. So you're a little older than me, but you are doing a similar thing?

I am 60 and plan to do conversions thru age 72.

Regarding pb4uski's post, my traditional IRAs are 100% bonds and money market, so I expect my growth to be between 2% and 3% per year but I agree the balance doesn't fall as fast as you might expect. My conversions are into total stock market index funds in the Roths causing a rising glide path in equities.

 

[FREE866]

I would go to the top of the 0% qualified income tax bracket... which for 2020 is $40,000 for a single... then add in the standard deduction of $12,400 and that is $52,400 of total income.... then subtract out your non-Roth conversion income to get your Roth conversion amount. At that amount, all your qualified income would be at 0% tax and you would be converting the maximum amount possible at 12% or less.

What you'll find it that these Roth conversions might not reduce your Roth as much as you think because of growth... sort of like a dog chasing its tail.

So for example, let's say you have $500k in a Roth and convert $30k a year for 16 years... if the Roth grows at 5% a year even if your conversions increase 3% a year beacuse tax brackets increase with inflation, after 16 years you would still have over $200k.

Earnings @ 5% Roth conversions Balance
0 500,000
1 24,250 -30,000 494,250
2 23,940 -30,900 487,290
3 23,569 -31,827 479,032
4 23,132 -32,782 469,382
5 22,625 -33,765 458,242
6 22,043 -34,778 445,506
7 21,380 -35,822 431,064
8 20,631 -36,896 414,799
9 19,790 -38,003 396,586
10 18,851 -39,143 376,293
11 17,807 -40,317 353,782
12 16,651 -41,527 328,906
13 15,376 -42,773 301,510
14 13,974 -44,056 271,428
15 12,437 -45,378 238,487
16 10,756 -46,739 202,504

Just to clarify, so if I have $22, 400 in Dividends and long term gains then $30,000 would be the appropriate amount to convert to Roth right?


and in your last paragraph you mean I would have 200K+ left in the tradition IRA right?

 

[FREE866]

and where do you see 0% tax rate up to 40K?
I see rates of 10, 12 , and 22 percent when income is 40K and below

 

[N02L84ER]

Assuming your total income is 22,400 + 30,000 = 52,400
For 2020 taxes, subtract the standard deduction for singles, 12,400 from your total income. 52,400 - 12,400 = 40,000. This is your taxable income.

40,000 is within the 12% tax bracket. If all your dividends and long term gains are qualified dividends, then all 22,400 is "taxed" at the 0% capital gains tax rate. If your qualified dividends and capital gains push your taxable income over 40,000, every CG+Div dollar above 40,000 in taxable income will be taxed at 15%.

The tax calculations works like this:
30,000 - 12,400 = 17,600 taxable income using normal tax bracket rates.

The 10% tax bracket for the conversion is the first $9,875. The tax is 9,875*10% = 987.50
Subtract out the 10% income that has already been calculated. 17,600 - 9,875 = 7,725 left to be taxed at the 12% tax rate. 7,725 * 12% = 927.00

So the tax on the conversion is 987.50 + 927.00 = 1,914.50
Your taxable income was 40,000. Your taxable Roth conversion income was 17,600.
40,000 - 17,600 = 22,400 of dividends and capital gains which is "taxed" at 0%.
So, your total tax is 1,914.50 for an effective tax rate of 1,914.50/52,400 = 3.65%

 

[FREE866]

Assuming your total income is 22,400 + 30,000 = 52,400
For 2020 taxes, subtract the standard deduction for singles, 12,400 from your total income. 52,400 - 12,400 = 40,000. This is your taxable income.

40,000 is within the 12% tax bracket. If all your dividends and long term gains are qualified dividends, then all 22,400 is "taxed" at the 0% capital gains tax rate. If your qualified dividends and capital gains push your taxable income over 40,000, every CG+Div dollar above 40,000 in taxable income will be taxed at 15%.

The tax calculations works like this:
30,000 - 12,400 = 17,600 taxable income using normal tax bracket rates.

The 10% tax bracket for the conversion is the first $9,875. The tax is 9,875*10% = 987.50
Subtract out the 10% income that has already been calculated. 17,600 - 9,875 = 7,725 left to be taxed at the 12% tax rate. 7,725 * 12% = 927.00

So the tax on the conversion is 987.50 + 927.00 = 1,914.50
Your taxable income was 40,000. Your taxable Roth conversion income was 17,600.
40,000 - 17,600 = 22,400 of dividends and capital gains which is "taxed" at 0%.
So, your total tax is 1,914.50 for an effective tax rate of 1,914.50/52,400 = 3.65%

I had to read this literally like 6x to grasp it all, but I think I get it. My head hurts!
Are you or were you an accountant? you're very good at all this--thank you!

 

[N02L84ER]

No, I was a high school math teacher. You are welcome.

 

[lordjust]

No, I was a high school math teacher. You are welcome.

PB or NO

will the pro-rata rule apply here ? I guess I should ask how is he getting around it ? I didn’t think you could pull from a tira to convert a small percent without that rule applying ? I’m asking for myself and how I get around it unless I misunderstand the rules.

 

[pb4uski]

The pro-rata rule only applies where one has had non-deductible IRA contributions. Most people have never had non-deductible tIRA contributions so the pro-rate rule would not typically apply. Of course, if you don't know or don't remember or don't have recorded of how much your non-deductible tIRA contributions were then the IRS is happy to conside all withdrawals as income... essentially assuming that all contributions were deductible.

 

[pb4uski]

Assuming your total income is 22,400 + 30,000 = 52,400
For 2020 taxes, subtract the standard deduction for singles, 12,400 from your total income. 52,400 - 12,400 = 40,000. This is your taxable income.

40,000 is within the 12% tax bracket. If all your dividends and long term gains are qualified dividends, then all 22,400 is "taxed" at the 0% capital gains tax rate. If your qualified dividends and capital gains push your taxable income over 40,000, every CG+Div dollar above 40,000 in taxable income will be taxed at 15%.

The tax calculations works like this:
30,000 - 12,400 = 17,600 taxable income using normal tax bracket rates.

The 10% tax bracket for the conversion is the first $9,875. The tax is 9,875*10% = 987.50
Subtract out the 10% income that has already been calculated. 17,600 - 9,875 = 7,725 left to be taxed at the 12% tax rate. 7,725 * 12% = 927.00

So the tax on the conversion is 987.50 + 927.00 = 1,914.50
Your taxable income was 40,000. Your taxable Roth conversion income was 17,600.
40,000 - 17,600 = 22,400 of dividends and capital gains which is "taxed" at 0%.
So, your total tax is 1,914.50 for an effective tax rate of 1,914.50/52,400 = 3.65%

Just to add to this... while the taxable income is $40,000 ($22,400 dividends and LTCG + $30,000 Roth conversion - $12,400 standard deduction) it is two components

• $22,400 of qualified income that is taxed at 0% since taxable income is $40,000 or less and
• $17,600 of ordinary income ($30,000 Roth contribution - $12,400 standard deduction) that is subject to the ordinary tax brackets of 10% and 12%.

 

[lordjust]

The pro-rata rule only applies where one has had non-deductible IRA contributions. Most people have never had non-deductible tIRA contributions so the pro-rate rule would not typically apply. Of course, if you don't know or don't remember or don't have recorded of how much your non-deductible tIRA contributions were then the IRS is happy to conside all withdrawals as income... essentially assuming that all contributions were deductible.

Thanks PB. I didnt understand that important piece.

 

[N02L84ER]

I am one of the people that has non-deductible IRA contributions and I fill out the 8606 form every year for my conversions to determine how much of it is taxable. The first year I did a conversion over 4% was tax free. This year, thanks to growth in the IRAs, only 1.24% will be tax free. It is an extra form, but not too hard to fill out.

 

[MasterBlaster]

I skimmed this thread and I didn't see the mention of this

The other Big reason to spend down the Qualified money (401ks, IRAa) is that once you start taking Medicare you can get hit with highly punitive IRMAA means-tested taxes on your (and spouses) Medicare per your income level.

Early Roth conversions are a great way around this.

I also concur with spending some time with the advanced version of the Optimal retirement Planner (I-Orp.com) to model the outcome.

 

[LastBoomer]

Congress can change rules, so beware of assuming Roth advantages are fixed for all time. I think some folks, who were playing the Roth conversion game, got burned after the Trump tax cut.
I think it only makes sense to pay taxes NOW if you can predict the future—and nobody can.

 

[pb4uski]

..... I think some folks, who were playing the Roth conversion game, got burned after the Trump tax cut. ...

Care to elaborate how people were burned?

 

[N02L84ER]

My guess is the reference is to when the 15% tax rate became 12%, the 28% rate became 25%, etc. I realized some LTCG the last year the lowest tax rate was 5%, the next year it was 0%. Not a huge tax bill, but it could have been smaller. I still would have paid state taxes regardless.

 

[aja8888]

My guess is the reference is to when the 15% tax rate became 12%, the 28% rate became 25%, etc. I realized some LTCG the last year the lowest tax rate was 5%, the next year it was 0%. Not a huge tax bill, but it could have been smaller. I still would have paid state taxes regardless.

How does one get burned by tax rates being reduced? That's a new one on me!

 

[pb4uski]

I find it hard to imagine tax rates being reduced from the current tax brackets given the deficits that we currently have.

 

[N02L84ER]

I wasn't agreeing that it was a burn, just guessing what the reference was.

 

[Dtail]

I wasn't agreeing that it was a burn, just guessing what the reference was.

Agree with your guess.

 

[tenant13]

This whole discussion makes perfect sense from the mathematical angle but only if you believe that having more money in the future is preferable than spending more now.

So first, we must assume that we will live long enough to even see RMDs kicking in. That's very personal: with my crappy genes and the first heart attack in March I'm safer to assume that I will die early rather than at 95. Which is actually preferable given the history of dementia in my family (did I mention crappy genes? lol). So time right now has for me a lot more value than time in the future and 10k I can spend on myself this year makes more sense than a potential 20k tax liability 20 years from now.

Secondly, a lot depends on the amount of money you start this retirement journey with. I already know that whether I'm in this or that tax bracket I'll have enough to live the life I want. And if the travel doesn't come back, I'll have way more than I could ever need.

Then there's the issue of estate. If one of your objectives is to leave a substantial one, then conversion math makes perfect sense. I have no heirs and can't even figure out my will so leaving behind a large pile of cash is not my prerogative.

Lastly - and this will be controversial for some of you - when I stopped working I ended up on Medicaid (I had no income except for some dividends and interest). It came as a surprise but I ended up liking it a lot so I structure my income to stay on it. ROTH conversions would pushed me into marketplace and those plans are simply awful compared to what Medicaid offers. For everyone that thinks it's free: when I'm dead my state will go after my estate and will handsomely reimburse itself for every tylenol they pay for right now. To the tune of thousands of dollars. So it's simply a deferred payment.

 

[FREE866]

This whole discussion makes perfect sense from the mathematical angle but only if you believe that having more money in the future is preferable than spending more now.

So first, we must assume that we will live long enough to even see RMDs kicking in. That's very personal: with my crappy genes and the first heart attack in March I'm safer to assume that I will die early rather than at 95. Which is actually preferable given the history of dementia in my family (did I mention crappy genes? lol). So time right now has for me a lot more value than time in the future and 10k I can spend on myself this year makes more sense than a potential 20k tax liability 20 years from now.

Secondly, a lot depends on the amount of money you start this retirement journey with. I already know that whether I'm in this or that tax bracket I'll have enough to live the life I want. And if the travel doesn't come back, I'll have way more than I could ever need.

Then there's the issue of estate. If one of your objectives is to leave a substantial one, then conversion math makes perfect sense. I have no heirs and can't even figure out my will so leaving behind a large pile of cash is not my prerogative.

Lastly - and this will be controversial for some of you - when I stopped working I ended up on Medicaid (I had no income except for some dividends and interest). It came as a surprise but I ended up liking it a lot so I structure my income to stay on it. ROTH conversions would pushed me into marketplace and those plans are simply awful compared to what Medicaid offers. For everyone that thinks it's free: when I'm dead my state will go after my estate and will handsomely reimburse itself for every tylenol they pay for right now. To the tune of thousands of dollars. So it's simply a deferred payment.

I don't think its really a choice between "more money now or later", rather it's just financial planning. If I end up paying out 5K a year in taxes for conversion it's not a decision to spend now or later as I have a chunk in a "cash bucket" if you will for my expenses.

 

[tenant13]

I don't think its really a choice between "more money now or later", rather it's just financial planning. If I end up paying out 5K a year in taxes for conversion it's not a decision to spend now or later as I have a chunk in a "cash bucket" if you will for my expenses.

Whether you call it "financial planning" or "money now or later" it's about making decisions how to spend what we have. I think ROTH conversions are great and I'm not advocation for not doing them. It's all about the objectives and priorities.

 

[FREE866]

Whether you call it "financial planning" or "money now or later" it's about making decisions how to spend what we have. I think ROTH conversions are great and I'm not advocation for not doing them. It's all about the objectives and priorities.

I hear you, but not to sound like a jerk 5K isn't a lot of money to "spend now" in the big picture. It's coming from my "cash bucket" in my portfolio that I have for total expenses. If I can most likely save myself a decent amount on taxes in future by using this strategy why not? I won't be affecting my lifestyle now whatsoever.

 

[FREE866]

So I finally bit the bullet and did a conversion of 30 K from my reg IRA to my Roth IRA. It definitely stinks having to pay taxes on this next year , but I think in the big picture it makes sense and I intend to do so every year going forward. Thank you to everyone who provided salient information and guidance.

 

[LastBoomer]

My opinion is that unless one can predict what future tax rates will be, there is a risk one will be better off NOT doing the conversion, and not paying taxes today. Alternatively, one could get “burned” by paying taxes on the conversion today, then having Congress decide in the future—with a vote and stroke of a pen—to tax Roth IRAs, nullifying the move. Only two things are certain in life, Death & Taxes, right?