Roth conversion study surprised result

[DawgMan]

Yes, in your situation I would be probably convert to the top of the 24% bracket.

There is the see-saw effect to watch out for. As you convert and pay some taxes now, does it eliminate or reduce your tIRA enough that you won't be in that higher tax bracket later? You don't want to convert at 24% only to find out that you're down to 22% because you have little or no RMD. OTOH, that 22% bracket may revert back to 25% in 2026. And a 2% difference in either direction isn't going to amount to that much.

You talk about the inflation effect and a dollar now being worth more. That is offset by the fact that your Roth grows tax free, but your tIRA doesn't. Run that through a spreadsheet to see for yourself.

Based on my modeling, I stay in the 24% bracket starting with conversions thru RMD years (until 1 spouse passes). Of course, all of this is based on the assumptions I noted.

My comment on regarding truly comparing the lifetime tax savings is that in Test 1 (no conversions) all of my taxes are paid starting at age 72+, whereby for the first 15 years I can pay arguably no taxes. So, if my analysis says I will pay a total of $6 in lifetime taxes in Test 1 and $4 in taxes in Test 2 (annual Roth conversions), but I start paying a part of the $4 at age 57 (2022), am I really saving $2 in taxes or should I really be discounting the $2 at some factor? Am I making sense here?

 

[RunningBum]

I understand what you are saying, and I think you can compare the two directly but I'm not coming up with a quick way to prove that.

I look at it a slightly different way: Which way will give me more money to spend? That's pretty much the equivalent of asking which gives me the higher net worth, but without getting in the troublesome discussion of how to treat deferred tax liabilities.

I evaluate this as if I will spend all of the money, which means my tIRA will be zero at death. If that means I calculate out to beyond 100, so be it. If I die earlier, my heir gets it, with whatever tax implications. I'm not optimizing for my heir, I'm doing it for me.

So if converting to a Roth gives me more money in the end, I convert. Fully, if that's what my numbers say, partially or not at all if that works out best.

There's clearly no breakeven point here. If I'm looking at spendable dollars, anything in my tIRA is not spendable until I pay the taxes. So it's not meaningful to look at the larger tIRA balance if I don't convert, because I can't touch it in that form. But I can get at the Roth.

Access to converted money has the extra advantage of having more flexibility if I need a large amount of money in an emergency or special situation. If I've chipped away at the tIRA with conversions and now have a big chunk in the Roth, I can get to all of that in an emergency, if I'm 59.5+. But if I didn't convert, and I have need for a large amount out of my tIRA, I'm likely going to get hit with a very large tax bill so I'll net less money available to spend.

I hope that answers your question.

 

[Montecfo]

You talk about the inflation effect and a dollar now being worth more. That is offset by the fact that your Roth grows tax free, but your tIRA doesn't. Run that through a spreadsheet to see for yourself.

Unless tax rates change, the Roth and regular IRA are equivalent. I'm not sure I see the "offset" you are referring to. A dollar today is always worth more than a dollar in the future. That is true even if inflation is zero.

 

[Montecfo]

Legacy, as in the kids will not have taxable RMDs with inherited Roth accounts.

Frankly, I look at anything my kids get (which will be plenty) as of little concern as they should look at it as found money. My main focus is the benefits it provides for my DW & me.

Whether larger taxable distributions are better than smaller tax-free ones depends on tax rates. The benefit should be in the form of more money after taxes.

But I certainly agree with you on any bequests to the kids being found money. I can't imagine anyone bellyaching about an inheritance because they owe taxes on it.

 

[Exchme]

One important thing to consider about conversions is how it impacts your ACA subsidies, assuming you are using this insurance. Makes the calc even more complicated.

Yes, I have a window of a couple years where Pralana Gold suggests I go for ACA subsidies. That restricts the amount of conversions that could be done in the 22% bracket, but there is still room in the 24% bracket for conversions in other years and the analysis says don't bother to use it. I probably will go into the 24% bracket this year and next before thinking about trying to get subsidies the following couple of years, regardless of the analysis. The future has a lot of uncertainties and I want to get the Roth off to a good start.

 

[Exchme]

I have to admit, as I start to play with some different Roth conversion strategies, my head spins. You guys are all much smarter than me. A tool I have used to help with this is New Retirement Planner Plus. I would be curious to get everyone's feedback on the results I have gotten so far...

Macro Modeling Assumptions
- Start withdrawals 2022 (no earned income), age 57 (both me and DW)
- Using current tax brackets (married, file jointly), which stay "as is" growing 2% annually
- Higher than typical annual planned withdrawal amount (FatFire- very discretionary spend), growing 2% annually
- 2% annual inflation
- 60/40 AA averaged across all retirement accounts, ideally positioned to minimize taxes, underwriting 5% annual returns
- Current retirement accounts: 55% after tax/45% Tax deferred, 0% Roth
- Planning on 75% of current SS benefit. Current WR in low 2% range before SS.

Test 1: No Roth Conversions, live off after tax $$ until RMDs (no tax deferred acct withdrawals), upon age 72 (RMDs) results in hitting the 32% tax bracket until age 78, then goes to 35%+.

Test 2: Do larger Roth Conversions starting in 2022 (age 57) into the 24% tax bracket through age 71 and then stop (no withdrawals other than conversions from tax deferred accts), then RMDs kick in resulting in me staying in the 24% tax bracket until one of us passes. Lifetime tax savings save me over 31% from Test 1, which relates to real $$ in my case.

So, aside from legacy concerns (ideally transferring Roth vs tax deferred accounts to kids) and future single spouse tax issues, should that not be a strong enough argument alone to do Roth conversions into a tax bracket that in theory is the same as it would be in RMDs? The only counter argument I would make to my 31% tax savings is that it is in real $$, and probably should be somewhat discounted since I can effectively pay no taxes until RMDs hit (a dollar today is worth more than a dollar tomorrow)? What discount rate should I use and what does it do to the 31% (is it really 20%?), I'm not sure?

So, based on my analysis, it seems Roth conversions are worth it, even into the 24% tax bracket. Throw in the legacy and single spouse benefits, even more beneficial. Assume high probability of even higher taxes in the future, they become even more more beneficial.

What say you?

If you are giving away your estate to charity, the metric that matters is NW, if you care about how much your heirs get, then the value after heir liquidation is what matters. I don't have a methodology for caring about heirs, but only sort of. maybe look at both and then decide?

That's a big tax bite difference between the 24% bracket and the 32% or higher. Your situation certainly won't get better if TCJA expires, so my guess is you should be converting at the top of the 24% bracket for the next few years. Then once IRMAA starts to matter, the math might change a bit, but you will get the privilege of paying a lot of taxes either way.

The tax rate doesn't need to be discounted for time and because of the progressive tax code, the best way to avoid high tax rates is to avoid low tax rates too and try fill the lower rate years with Roth Conversions to make the tax rates closer to level throughout life. My conundrum was that for me, it didn't take as much as I thought.

 

[SevenUp]

One important thing to consider about conversions is how it impacts your ACA subsidies, assuming you are using this insurance. Makes the calc even more complicated.

TheFinanceBuff blog has a good description of a tool for just this situation: Roth Conversion and Capital Gains On ACA Health Insurance

 

[chassis]

@Exchme thanks for this thread and posting your results.

Did you note the age of neutrality, or breakeven age, when comparing Roth conversions vs no Roth conversions?

For scenarios where Roth conversions were helpful, what % net worth difference at end of plan did you calculate? I'm didn't see how to form a conclusion on that question using the charts in the original post.

 

[CardsFan]

And here we go again.

 

[skyking1]

For us the #1 reason is helping the surviving spouse dodge the single filing tax torpedo. That is plenty enough reason. I see mention of avoiding the 32% bracket. Now look at it from single filing tax rates.

 

[corn18]

I think it's worth it for everyone to at least take a look at Roth conversions. Results and benefits will vary widely for each individual case. I tend to look at corner cases to see if it is beneficial to my situation.

My model calculates taxes and includes everything. I model taxes on SS, MFJ vs Single if one of us dies and CG/dividend taxes. So a fairly comprehensive look at taxes. I am retired, age 55 and in the 12% tax bracket. My model assumes that goes up to 15% in 2025. Once SS kicks in @ 70, I will be in the 22% tax bracket just with my COLA pension and SS. So on the face of it, I should maximize conversions between 55 and 72. Let's take a look (first number is total Federal and State taxes paid from now until age 95):

374,160 No conversions
365,445 100% to top of 12%/15% bracket

Not a huge difference there.

358,149 No conversions, me dead @ 73
297,714 100% to top of 12%/15% bracket, me dead @ 73

Hmm, this corner case shows that Roth conversions are more impactful, but not life changing.

I didn't run a scenario for my heirs inheriting a tIRA vs Roth, but they should benefit from inheriting a Roth vs traditional IRA, so the nod goes to conversions.

So I agree there is nothing life changing. We are going to do conversions to the top of the 12% bracket from 56-70 just because it's not hard to do.

 

[Exchme]

@Exchme thanks for this thread and posting your results.

Did you note the age of neutrality, or breakeven age, when comparing Roth conversions vs no Roth conversions?

For scenarios where Roth conversions were helpful, what % net worth difference at end of plan did you calculate? I'm didn't see how to form a conclusion on that question using the charts in the original post.

Let me start with my preface that net worth at death is a useful measure if you are giving your tax deferred money to charity as the assets transfer without taxes. But I am willing money to individuals and am interested in estate planning that will optimize their assets after heir liquidation, so that's the measure I used, rather than unadjusted NW. From other discussions, you seem to be in the middle, giving your estate to private individuals but not interested in estate planning that would optimize their inheritance. To each his own.

But rather than rehash that tired subject, the short answer is there was very little change in net worth during our lifetimes. Here are equivalent graphs to the original post, but this time using the present value of the change in NW/Roth conversion value.

The curve shapes (though not the scale) look very close to the original and the optimum point is still the same at 35% conversions, corresponding to the 22% bracket prior to IRMAA and staying within the 176K IRMAA tier.

 

[Exchme]

I think it's worth it for everyone to at least take a look at Roth conversions. Results and benefits will vary widely for each individual case. I tend to look at corner cases to see if it is beneficial to my situation.

My model calculates taxes and includes everything. I model taxes on SS, MFJ vs Single if one of us dies and CG/dividend taxes. So a fairly comprehensive look at taxes. I am retired, age 55 and in the 12% tax bracket. My model assumes that goes up to 15% in 2025. Once SS kicks in @ 70, I will be in the 22% tax bracket just with my COLA pension and SS. So on the face of it, I should maximize conversions between 55 and 72. Let's take a look (first number is total Federal and State taxes paid from now until age 95):

374,160 No conversions
365,445 100% to top of 12%/15% bracket

Not a huge difference there.

358,149 No conversions, me dead @ 73
297,714 100% to top of 12%/15% bracket, me dead @ 73

Hmm, this corner case shows that Roth conversions are more impactful, but not life changing.

I didn't run a scenario for my heirs inheriting a tIRA vs Roth, but they should benefit from inheriting a Roth vs traditional IRA, so the nod goes to conversions.

So I agree there is nothing life changing. We are going to do conversions to the top of the 12% bracket from 56-70 just because it's not hard to do.

Agreed, the 12% bracket is a gift. If you have enough money to even worry about Roth Conversions at all, that's probably a given unless you want an ACA subsidy, then you will need to keep it within the subsidy limit. If you optimize asset location, you can get a lot of movement in your accounts in those years.

 

[corn18]

Agreed, the 12% bracket is a gift. If you have enough money to even worry about Roth Conversions at all, that's probably a given unless you want an ACA subsidy, then you will need to keep it within the subsidy limit. If you optimize asset location, you can get a lot of movement in your accounts in those years.

That's a good point about AA. All my fixed income is in my 401k in my stable value fund which is yielding 2.2%. That's better than bonds so I'll keep it there. And it minimizes growth in my 401k so I have to convert less. My taxable and Roths are 100% stock, which will maximize growth there. As I convert, I will have to find another fund for my fixed income allocation in my Roths.

 

[Exchme]

For us the #1 reason is helping the surviving spouse dodge the single filing tax torpedo. That is plenty enough reason. I see mention of avoiding the 32% bracket. Now look at it from single filing tax rates.

Yep, a factor that will favor the Roth includes early death of one spouse and long life of the other.

Also, in planning, most folks use conservative returns and the market often gives happy surprises, so quite often folks end up in high brackets and wish they had done some conversions sooner.

 

[CRLLS]

Let me start with my preface that net worth at death is a useful measure if you are giving your tax deferred money to charity as the assets transfer without taxes. But I am willing money to individuals and am interested in estate planning that will optimize their assets after heir liquidation, so that's the measure I used, rather than unadjusted NW. ..... .

I have a related question regarding your "optimizing" one's heirs' assets. Doesn't this require you entering their current financial data into some sort of spreadsheet and knowing their plans? I have always said that anything left is a gift. Given that and our plan goes to age 100, there is a very high likelihood that our estate will have some dollars left to distribute. I would not want to get into their shorts now in order to "optimize" their financial assets that they may get anytime between tomorrow to 30 years in the future. Our situation is somewhat complicated. One is a gov't employee and the other is a teacher, Their retirement programs are foreign to me. Plus their spouses have traditional jobs under SS. I am unfamiliar with the detailed workings of their retirement plans, tax situations or their spending budgets and have no interest in doing so. It is hard enough planning/managing our own situation.

How do you do it? Just curious.

 

[DrBrisket]

One important thing to consider about conversions is how it impacts your ACA subsidies, assuming you are using this insurance. Makes the calc even more complicated.

Yes it does.

Yes, I have a window of a couple years where Pralana Gold suggests I go for ACA subsidies. That restricts the amount of conversions that could be done in the 22% bracket, but there is still room in the 24% bracket for conversions in other years and the analysis says don't bother to use it. I probably will go into the 24% bracket this year and next before thinking about trying to get subsidies the following couple of years, regardless of the analysis. The future has a lot of uncertainties and I want to get the Roth off to a good start.

TheFinanceBuff blog has a good description of a tool for just this situation: Roth Conversion and Capital Gains On ACA Health Insurance

@Exchme-->

I have Pralana Gold. It is a very useful tool. Despite the apparent complexity, only a handful of entries provided surprisingly close NW forecasts relative to my convoluted-multi-decade-evolved personal spreadsheet. I need to take the time to take it to the next level as you have.

One question I want to look at carefully is the results of Pralana Gold's recommended Roth Conversions when ACA subsidies are potentially available? What concerns me is the Finance Buff blog entry shows a marginal tax rate of up to 30+% even though the couple under analysis should be firmly in the 12% MFJ Tax Bracket. The loss of ACA subsidies is very expensive for this couple. Would be good to have an independent verification that Pralana's Roth Conversion Optimization takes such complexities into account.

 

[SevenUp]

One question I want to look at carefully is the results of Pralana Gold's recommended Roth Conversions when ACA subsidies are potentially available? What concerns me is the Finance Buff blog entry shows a marginal tax rate of up to 30+% even though the couple under analysis should be firmly in the 12% MFJ Tax Bracket. The loss of ACA subsidies is very expensive for this couple. Would be good to have an independent verification that Pralana's Roth Conversion Optimization takes such complexities into account.

The marginal tax rates are real.

Does Pralana ask for your ACA information? If not, it's almost certain ACA effects aren't included. If it does ask, one would expect something in its output about Premium Tax Credits....

 

[DrBrisket]

The marginal tax rates are real.

Does Pralana ask for your ACA information? If not, it's almost certain ACA effects aren't included. If it does ask, one would expect something in its output about Premium Tax Credits....

100% agree the marginal rates are real. Painfully real in my own case.

WRT to Pralana Gold, it does allow you to input ACA information. You input SLCSP and the premium cost for your chosen ACA plan along with what years in your analysis to use ACA insurance. The manual states that when running its Roth conversion optimization, it will avoid The Dreaded Cliff if you are eligible for PTC. And, output tables show the projected PTC and out of pocket ACA premium costs. Pralana Gold gives a value to end of plan NW increase due to the recommended Roth Conversions.

So, there is a possibility that the Roth Conversion recommendations may be optimal given the user input that Pralana Gold is provided. However, with the depth of analysis the OP has done, is the OP truly satisfied Pralana Gold's recommended Roth conversions are actually optimal? Or, has the OP accepted Pralana Gold's Roth Conversion recommendations as correct without independent verification?

 

[SevenUp]

The manual states that when running its Roth conversion optimization, it will avoid The Dreaded Cliff if you are eligible for PTC.

One would hope the software has been modified such that the 400% cliff is eliminated for 2021 and 2022. There's a phase-out starting at 400% but not a cliff - in 2021 and 2022, according to current law....

 

[Doc0]

I'll use my example. What I used as a set point to see how much to remove from the tIRA was to analyze what my tax environment would be like post RMD. 12% is the best tax environment. I ran across some data I think at Fidelity that the median tIRA had about 500k meaning 500K is the most common amount. RMD + SS would provide the bulk of my ordinary income and I'm married FJ. 500K RMD's $19K at 72 combined SS is $54K of which 85% is taxable or 46K to net a taxable . If we take standard deduction our ordinary income is around 62K. The top end of standard deduction MFJ income is around 103K so I have about 41K of ordinary income to pay with before crossing into 22%. If SS inflates at 2.5% and I keep my tIRA at 500K my income will be 97K. (.85%*62K) + 34K)) still below the 22% threshold. About age 87 is when I will cross into 22%. So how do you keep the tIRA at 500K? RMD is required minimum, you can take more, so my tIRA is risked at about a 7% return. In good years I can take >RMD. In bad I can take just RMD. RMD is calculated on the total value of the tIRA's at the end of the year. I use this calculator. I estimate my taxes using this calculatorTax Plan Calculator by Maxim Lott

I did an analysis on taxes and in the main soak the rich starts at 22%, so the longer you can avoid 22% the better you are. This strategy keeps you in 22% ordinary income around 15 years.

To fund my Roth, I used some tax loss harvest and cashed in some brokerage stocks for a net 0% tax, basically turning my brokerage into a partial Roth. I live on cash. Therefore my only ordinary income is my Roth conversion. I have converted to the top of the 24% but find it much cheaper to keep conversions < $250K for various cliff and surcharge reasons. This gives you the greatest conversion for the least taxes.

In my case I retired at 65 which gave me 5 years of conversion which has now increased to 7 with CARES passage. The bulk of my conversions will be converted by this year. Next year I commence SS and so my conversion will take that income into account. The way I look at it is the government tends to leave the middle guy alone and soak the rich, so your job is to look like a middle guy. There is plenty of leeway to pull money out of other accounts as needed. My Roth money is most sacred as it provides the basis of self insurance in case someone strokes or needs memory care. tIRA + SS pays for hamburgers and electricity. It has a bonus variable based on how the market does. Other needs, like a new car or travel are provided by brokerage since cap gains are relatively low. After you've been to Europe of Asia a couple times it looses its luster.

The government already owns those taxes in the tIRA and you're going to have to pay. The way the the system is rigged as you age taxes go up and RMD goes up, so each year more for Sam and less for you. Also once I die, my wife will likely kick up only one tax bracket instead of 3.

 

[Exchme]

100% agree the marginal rates are real. Painfully real in my own case.

WRT to Pralana Gold, it does allow you to input ACA information. You input SLCSP and the premium cost for your chosen ACA plan along with what years in your analysis to use ACA insurance. The manual states that when running its Roth conversion optimization, it will avoid The Dreaded Cliff if you are eligible for PTC. And, output tables show the projected PTC and out of pocket ACA premium costs. Pralana Gold gives a value to end of plan NW increase due to the recommended Roth Conversions.

So, there is a possibility that the Roth Conversion recommendations may be optimal given the user input that Pralana Gold is provided. However, with the depth of analysis the OP has done, is the OP truly satisfied Pralana Gold's recommended Roth conversions are actually optimal? Or, has the OP accepted Pralana Gold's Roth Conversion recommendations as correct without independent verification?

My knowledge of Pralana Gold is much better than my knowledge of ACA subsidies. Pralana Gold does limit Roth Conversions to get the ACA subsidies it calculates for you and if you ask for big Roth Conversions. I have not verified that it is doing it optimally.

Their web page says they have implemented the SECURE act changes, which would include the 2021/2022 cliff change to slope.

 

[Exchme]

I'll use my example. What I used as a set point to see how much to remove from the tIRA was to analyze what my tax environment would be like post RMD. 12% is the best tax environment. I ran across some data I think at Fidelity that the median tIRA had about 500k meaning 500K is the most common amount. RMD + SS would provide the bulk of my ordinary income and I'm married FJ. 500K RMD's $19K at 72 combined SS is $54K of which 85% is taxable or 46K to net a taxable . If we take standard deduction our ordinary income is around 62K. The top end of standard deduction MFJ income is around 103K so I have about 41K of ordinary income to pay with before crossing into 22%. If SS inflates at 2.5% and I keep my tIRA at 500K my income will be 97K. (.85%*62K) + 34K)) still below the 22% threshold. About age 87 is when I will cross into 22%. So how do you keep the tIRA at 500K? RMD is required minimum, you can take more, so my tIRA is risked at about a 7% return. In good years I can take >RMD. In bad I can take just RMD. RMD is calculated on the total value of the tIRA's at the end of the year. I use this calculator. I estimate my taxes using this calculatorTax Plan Calculator by Maxim Lott

I did an analysis on taxes and in the main soak the rich starts at 22%, so the longer you can avoid 22% the better you are. This strategy keeps you in 22% ordinary income around 15 years.

To fund my Roth, I used some tax loss harvest and cashed in some brokerage stocks for a net 0% tax, basically turning my brokerage into a partial Roth. I live on cash. Therefore my only ordinary income is my Roth conversion. I have converted to the top of the 24% but find it much cheaper to keep conversions < $250K for various cliff and surcharge reasons. This gives you the greatest conversion for the least taxes.

In my case I retired at 65 which gave me 5 years of conversion which has now increased to 7 with CARES passage. The bulk of my conversions will be converted by this year. Next year I commence SS and so my conversion will take that income into account. The way I look at it is the government tends to leave the middle guy alone and soak the rich, so your job is to look like a middle guy. There is plenty of leeway to pull money out of other accounts as needed. My Roth money is most sacred as it provides the basis of self insurance in case someone strokes or needs memory care. tIRA + SS pays for hamburgers and electricity. It has a bonus variable based on how the market does. Other needs, like a new car or travel are provided by brokerage since cap gains are relatively low. After you've been to Europe of Asia a couple times it looses its luster.

The government already owns those taxes in the tIRA and you're going to have to pay. The way the the system is rigged as you age taxes go up and RMD goes up, so each year more for Sam and less for you. Also once I die, my wife will likely kick up only one tax bracket instead of 3.

Yes, the 12% tier is super attractive and people should really try to fill it up. Most of us do our planning assuming lower than average market returns to make sure we aren't too optimistic, but if the market delivers just its average of 7% real return on stocks, folks that missed out on filling the 12% bracket will kick themselves.

 

[jldavid47]

As we have often discussed, if you're converting today at 22% to avoid 24% later then there isn't much punch to Roth conversions, but if you're converting and paying 12% today to avoid 22% later then it is a whole different story.

Or, in our case, I can make a partial conversion and pay ZERO income tax this year and every year until RMDs kick in where we'd probably pay 12%. Is it life changing? No. Is it worth it? Hell, yes. It's free money.


As for asset allocations, unless you are doing something esoteric it is quite simple to maintain nearly identical asset allocations in a tIRA and a Roth IRA. I don't see a problem.

 

[skyking1]

That is where we are at. Fill the 12% bracket till it goes away. if it doesn't, we can convert 90% of tIRA to Roth by the time I get to max SS at 70. Then we won't have the income headroom any more. All the tIRAs are my wife's who is younger.
It truly is a gift and a no brainer for us.