Roth conversion and tax bracket

[fh2000]

The current tax bracket for MFJ is below:

10% Up to $19,750
12% $19,751 to $80,250
22% $80,251 to $171,050

So, if I do Roth conversion for the middle range, say, $120,000, for few years until RMD, does my effective tax bracket comes about the mid point, 17%? We have no other income other than small dividend.

Thanks

 

[summerblues]

Maybe I'm misunderstanding your question...as I understand it, if you have regular income that totals $120,000 then your first $19,750 is taxed at 10%, your income btwn $19,751 and $80,250 is taxed at 12% and the amount btwn $80,251 and $120k is taxed at the 22% rate.

 

[Alan]

I expect someone more knowledgeable than myself will be along shortly but the tax brackets listed in the OP refer to taxable income, after allowable deductions.


https://www.forbes.com/sites/kellyp...ax-rates-standard-deduction-amounts-and-more/

Standard Deduction Amounts.
The standard deduction amounts will increase to $12,200 for individuals, $18,350 for heads of household, and $24,400 for married couples filing jointly and surviving spouses.

 

[N02L84ER]

Maybe I'm misunderstanding your question...as I understand it, if you have regular income that totals $120,000 then your first $19,750 is taxed at 10%, your income btwn $19,751 and $80,250 is taxed at 12% and the amount btwn $80,251 and $120k is taxed at the 22% rate.

+1
It works out to just under 15%

 

[pb4uski]

The current tax bracket for MFJ is below:

10% Up to $19,750
12% $19,751 to $80,250
22% $80,251 to $171,050

So, if I do Roth conversion for the middle range, say, $120,000, for few years until RMD, does my effective tax bracket comes about the mid point, 17%? We have no other income other than small dividend.

Thanks

Close. Let's say that you did $120k Roth conversion and had $5k of qualified dividends. Yout total income would be $125k. If you used the standard deduction of $24.8k then your taxable income would be $100.2k... consisting of $95.2k of ordinary income and $5k of qualified income. (all are based on 2020 tax brackets and standard deduction).

The first $19,750 of ordinary income would be taxed at 10% ($1,975), then next $60,500 at 12% ($7,260) and the last $14,950 at 22% ($3,289) for a total ordinary tax of $22,210. The $5k of qualified income would be taxed at 15% ([-]$1,500[/-] $750).

So your total tax would be [-]$14,024[/-] $13,274.... or 11.2% of your $120k conversion. Part of the reason that it is so low is because the first $24.8k is at 0% because it is offset by the standard deduction.

 

[fh2000]

Close. Let's say that you did $120k Roth conversion and had $5k of qualified dividends. Yout total income would be $125k. If you used the standard deduction of $24.8k then your taxable income would be $100.2k... consisting of $95.2k of ordinary income and $5k of qualified income. (all are based on 2020 tax brackets and standard deduction).

The first $19,750 of ordinary income would be taxed at 10% ($1,975), then next $60,500 at 12% ($7,260) and the last $14,950 at 22% ($3,289) for a total ordinary tax of $22,210. The $5k of qualified income would be taxed at 15% ($1,500).

So your total tax would be $14,024.... or 11.2% of your $120k conversion. Part of the reason that it is so low is because the first $24.8k is at 0% because it is offset by the standard deduction.

Thanks, PB.
You are amazing. I read from a member about a Tax Calculator:
https://www.mortgagecalculator.org/calcs/1040-calculator.php

I entered the amount, and it came out: $13,849. Quite close from your hand calculation.

With your explanation, I can now use the Calculator to do some simulation run of our specific cases.

 

[pb4uski]

^^^ Found an error and edited post above... now $13,274.

Agrees to this calculator: https://www.calculator.net/tax-calc...ion4=0&cotherdeductable=0&printit=0&x=69&y=34 which uses 2020 rates rather than 2019 rates.

 

[targatom2019]

If you are in the 22% bracket then do you get more benefit to convert up 24% ? 2% more but you could convert another 90K.

 

[Alan]

If you are in the 22% bracket then do you get more benefit to convert up 24% ? 2% more but you could convert another 90K.

No, because all the extra is taxed at 24%. If you increase the amount to 210,000 in the calculator above the tax jumps to $33,357. In other words that $90k extra increases the tax by ~$20k

 

[AtlasShrugged]

I’d like to offer a different perspective on Roth conversion costs and rates, particularly for people with multiple forms of taxable income and more complex returns.

Roth conversions have wide ranging effects on tax returns and Medicare premiums, including:

1) Ordinary income taxes – Conversion income increases ordinary income which bumps your total ordinary income into higher tax brackets and may cause itemized deductions to be phased-out (e.g., medical expenses).

2) Qualified dividends and LT capital gains taxes – The preferential tax rate on qualified dividends and capital gains is based on total taxable income. Conversion income may push the preferential rate from 0% to 15% or from 15% to 20%, which could cause qualified dividend and capital gains income to be taxed at higher rates.

3) 3.8% Net Investment Income Tax (NIIT) – Conversion income may push AGI over the $250,000 NIIT threshold which could cause additional taxes on investment income.

4) Medicare Part B and D premiums – Medicare premiums are based on a recipient’s modified adjusted gross income (MAGI). Conversion income may push MAGI over various Medicare thresholds thereby triggering additional Medicare premiums. These premiums are known as Income Related Monthly Adjustment Amounts or “IRMAA.”

The best way to estimate the total tax cost of a Roth conversion is to calculate its marginal tax cost. This calculation requires making a “before” and “after” calculation as follows:

1) Calculate your income taxes and Medicare premiums before Roth conversion income.
2) Calculate your income taxes and Medicare premiums after Roth conversion income.
3) The difference is your total marginal tax cost of a Roth conversion.

To calculate your marginal tax rate on a conversion, divide the total tax cost from step 3 above by the Roth conversion amount. For example, if you do a $100,000 Roth conversion and your marginal tax cost is $25,000, then your marginal tax rate would be 25%.

Also, you should include state income taxes, if any, in the before and after calculation.

 

[RetireBy90]

I’d like to offer a different perspective on Roth conversion costs and rates, particularly for people with multiple forms of taxable income and more complex returns.

Roth conversions have wide ranging effects on tax returns and Medicare premiums, including:

1) Ordinary income taxes – Conversion income increases ordinary income which bumps your total ordinary income into higher tax brackets and may cause itemized deductions to be phased-out (e.g., medical expenses).

2) Qualified dividends and LT capital gains taxes – The preferential tax rate on qualified dividends and capital gains is based on total taxable income. Conversion income may push the preferential rate from 0% to 15% or from 15% to 20%, which could cause qualified dividend and capital gains income to be taxed at higher rates.

3) 3.8% Net Investment Income Tax (NIIT) – Conversion income may push AGI over the $250,000 NIIT threshold which could cause additional taxes on investment income.

4) Medicare Part B and D premiums – Medicare premiums are based on a recipient’s modified adjusted gross income (MAGI). Conversion income may push MAGI over various Medicare thresholds thereby triggering additional Medicare premiums. These premiums are known as Income Related Monthly Adjustment Amounts or “IRMAA.”

The best way to estimate the total tax cost of a Roth conversion is to calculate its marginal tax cost. This calculation requires making a “before” and “after” calculation as follows:

1) Calculate your income taxes and Medicare premiums before Roth conversion income.
2) Calculate your income taxes and Medicare premiums after Roth conversion income.
3) The difference is your total marginal tax cost of a Roth conversion.

To calculate your marginal tax rate on a conversion, divide the total tax cost from step 3 above by the Roth conversion amount. For example, if you do a $100,000 Roth conversion and your marginal tax cost is $25,000, then your marginal tax rate would be 25%.

Also, you should include state income taxes, if any, in the before and after calculation.

I would add to the list
5) Additional tax on any SS income - the amount of your SS that is taxable is dependent on your AGI
6) Phaseout of loss on rental property - if you have rental property and have a loss for tax purposes (after including in depreciation) ability to deduct that loss from regular income will phase out topping out at $150K.
7) Impact on State and Local taxes - if your state has graduated income tax rates it could push you into a higher marginal tax rate.
8) Impact on tax rates if your filiing changes to single - If you file as MFJ today, when one spouse passes your status will change to single and there are much lower brackets so any remaining RMDs would be taxed at a much higher rate.



Just lots of moving pieces when planning a conversion. Each person/couple is in a unique situation so it will vary for each.

 

[RunningBum]

I’d like to offer a different perspective on Roth conversion costs and rates, particularly for people with multiple forms of taxable income and more complex returns.

Roth conversions have wide ranging effects on tax returns and Medicare premiums, including:
...

The best way to estimate the total tax cost of a Roth conversion is to calculate its marginal tax cost. This calculation requires making a “before” and “after” calculation as follows:

1) Calculate your income taxes and Medicare premiums before Roth conversion income.
2) Calculate your income taxes and Medicare premiums after Roth conversion income.
3) The difference is your total marginal tax cost of a Roth conversion.

To calculate your marginal tax rate on a conversion, divide the total tax cost from step 3 above by the Roth conversion amount. For example, if you do a $100,000 Roth conversion and your marginal tax cost is $25,000, then your marginal tax rate would be 25%.

Also, you should include state income taxes, if any, in the before and after calculation.

All of these things also have to be factored into the comparison tax rate that you'd be paying later if you don't make the conversion and are faced with RMDs. And many of us are converting now before starting SS, Medicare (IRMAA factor) and pensions (additional ordinary income).

 

[pb4uski]

All of these things also have to be factored into the comparison tax rate that you'd be paying later if you don't make the conversion and are faced with RMDs. And many of us are converting now before starting SS, Medicare (IRMAA factor) and pensions (additional ordinary income).

+1

 

[pb4uski]

I would add to the list
5) Additional tax on any SS income - the amount of your SS that is taxable is dependent on your AGI
6) Phaseout of loss on rental property - if you have rental property and have a loss for tax purposes (after including in depreciation) ability to deduct that loss from regular income will phase out topping out at $150K.
7) Impact on State and Local taxes - if your state has graduated income tax rates it could push you into a higher marginal tax rate.
8) Impact on tax rates if your filiing changes to single - If you file as MFJ today, when one spouse passes your status will change to single and there are much lower brackets so any remaining RMDs would be taxed at a much higher rate.



Just lots of moving pieces when planning a conversion. Each person/couple is in a unique situation so it will vary for each.

5-7 are implicitly included in Atlas's "income taxes".

8 is an interesting reference point and supercharges the benefit of Roth conversions in many situations.

 

[fh2000]

OP is here.

Thanks for all the input. I am a typical case of analysis paralysis. I see two other factors that will tip the balance: ACA subsidy, and IRA account rate of return.

DW (58) and I (64) have combined pre-tax IRA amount of $1.8M. We have another 2.3M after tax amount. We have no Roth IRA at this point. No income source other than small dividend. We both plan to receive SS at age 70. Our withdraw rate this year is about 3%.

Year 2020, ACA subsidy amount is $21,000 for a family of 2.
Year 2021-2027, DW's single person ACA estimated subsidy: up to $10,000.

I have a spreadsheet with RMD calculation, Social Security payment, and tax calculation (thanks to PB's detail math), doing small amount of Roth does not move the pre-tax total amount very much.

The question is, do we do Roth conversion up to 22% starting in 2020, and give up subsidies in order to save future taxes? Or do we do small amount of Roth conversion just enough to receive all or some subsidy (we have to do some Roth, in order to meet ACA income requirement)?

Even if I do Roth conversion for half of pre-tax amount and lose all subsidies, and pay the taxes for the next few years, if I put in future rate of return for more than 2%, the RMD amount and total of IRA account will continue to climb for the subsequent 15 years before downward trend starts. The I-ORP tool uses default 7% rate of return, and the tax in later years is even more dramatic, so its recommendation is start Roth with about $120,000 a year for 12 years.

Either way, we pay the taxes now, or later.

 

[Winemaker]

Either way, we pay the taxes now, or later.

Exactly. I gave up trying to move things around; especially now after the SECURE provisions are now in place. We're gonna pay 22% now, and/or 24% after one of us croaks. I am grateful to have the problem, but feel helpless that I can't engineer myself out of the situation.

 

[pb4uski]

.... Either way, we pay the taxes now, or later.

That's a foregone conclusion.

I hate to further complicate your deliberations, but another factor to consider is what happens to her marginal tax rate if one of you dies prematurely.

At first blush it seems to be a push if you pay 22% now or later (or 24%, not that the 2% difference is a big deal). But what happens if one of you dies and the survivor files single instead of married filing jointly?

I decided to prioritize Roth conversions over ACA subsidies, but ours was a unique situation where the savings from subsidies was not all that great and the tax savings were much better.

 

[RunningBum]

Exactly. I gave up trying to move things around; especially now after the SECURE provisions are now in place. We're gonna pay 22% now, and/or 24% after one of us croaks. I am grateful to have the problem, but feel helpless that I can't engineer myself out of the situation.

You know what rate you could pay now. In the future it's uncertain, even while both of you are alive. Do you stick with the current rates? Or how about the current law, which has the lower tax rates expiring soon? Or what?

 

[AtlasShrugged]

I would add to the list
5) Additional tax on any SS income - the amount of your SS that is taxable is dependent on your AGI
6) Phaseout of loss on rental property - if you have rental property and have a loss for tax purposes (after including in depreciation) ability to deduct that loss from regular income will phase out topping out at $150K.
7) Impact on State and Local taxes - if your state has graduated income tax rates it could push you into a higher marginal tax rate.
8) Impact on tax rates if your filiing changes to single - If you file as MFJ today, when one spouse passes your status will change to single and there are much lower brackets so any remaining RMDs would be taxed at a much higher rate.



Just lots of moving pieces when planning a conversion. Each person/couple is in a unique situation so it will vary for each.

Thanks for the amendments to my list. Your #8 item is particularly insightful. I never thought about that before. Great addition!

 

[Winemaker]

You know what rate you could pay now. In the future it's uncertain, even while both of you are alive. Do you stick with the current rates? Or how about the current law, which has the lower tax rates expiring soon? Or what?

I am in the camp that says tax rates won't rise. The current tax rates are there for 9 more years; do you remember all the kerfuffle when the Bush tax cuts were about to expire? They were extended for two more years, then made permanent for those under $400,000. I'm feel the present tax structure is good for everyone, and will keep the economy moving positive. No politician in their right mind will vote to raise taxes if the economy stays humming along; however if a domestic event occurs, that will change things. Getting elected/ re-elected is the most important thing those power hungry, smarter than everyone else people are.

I am already pulling my inflation adjusted 4% withdrawal, it will be retirement year #6 in a week. I have 11 more to go before I take my required at 72. Instead of converting to a Roth, we're spending it.

They have also discovered that the Fed can buy back trillions of treasuries to fund the deficit spending without ratcheting up inflation.

 

[target2019]

Tax cuts expire 12-31-2025.
https://taxfoundation.org/look-ahead-expiring-tax-provisions/

 

[RunningBum]

And nobody has to go on record to "vote for a tax increase." They can just let the tax cuts expire without action, right?

 

[SecondCor521]

No, because all the extra is taxed at 24%. If you increase the amount to 210,000 in the calculator above the tax jumps to $33,357. In other words that $90k extra increases the tax by ~$20k

It may be a rare case, but converting now at 24% to avoid converting (or RMDs) later at 32% or more could be a thing.

 

[I am He]

But what happens if one of you dies and the survivor files single instead of married filing jointly?

I decided to prioritize Roth conversions over ACA subsidies, but ours was a unique situation where the savings from subsidies was not all that great and the tax savings were much better.

After seeing my Mom's tax rate go up, I'm opting to move now. I have to keep repeating the mantra (so I'll truly adapt) "the enemy of a good plan is a perfect plan." I ran numerous scenarios and finally just did it, knowing I did my best and nothing is truly perfect.

I just pulled the trigger and wrote the second largest check in my life by choosing to convert 1/2 of the tIRA which put us at the top of the 24% bracket and needing to repay 7 months of ACA subsidy.

Future years will be 12 months of ACA and we'll convert to the top of the tax free and ACA eligible zone, around $83,000 for we three (which is basically taxing us marginally at 9.8% for the ACA subsidy and "medicaid" for the minor).

If we have to do anything else taxable (preventing a future conversion such as deciding to take capital gains to rebalance in the taxable account) and there's money left in the tIRA by the time RMDs hit, I plan to withdraw them all for QCDs unless truly necessary to live off them.

 

[Alan]

It may be a rare case, but converting now at 24% to avoid converting (or RMDs) later at 32% or more could be a thing.

I and DW have been converting in the 24% band for the last few years. This is because we will move up a band from 20% to 40% in the UK with RMDs. Fortunately the tax treaty allows Roth conversions to be taxed only in the USA whereas IRA distributions are taxed in the UK. I am now 100% Roth and DW has about 3 years of conversions ahead of her.