Roth Conversion Taxes - Perspective (I Needed)

[Midpack]

While everyone's plans are totally viable I decided not to give a **** about conversions - and taxes in general. I already know that however I spend my money I won't have an issue with hitting my budget AND paying taxes. So I stopped caring. No heirs to worry about so whatever happens 30 years from now is of no relevance. Given how random US laws can be when relating to retirement funds I think we should just live in the moment instead of worrying about future tax rates.

On paper we seem to have excess funds, and no heirs - but there's no way you can be certain. So I'm doing Roth conversions along with managing our nest egg to the best of my ability, just in case. It doesn't take much effort, it's kinda fun and engaging, so why not? And we do have charities we'd like to give generously too in the end. YMMV obviously.

 

[pb4uski]

True, the conventional advice is to pay the taxes from taxable funds so if you convert $100, $100 ends up in your Roth rather than $80 (or whatever).

When I had cash in taxable accounts and paid estimated taxes from that cash that is what I did.

More recently, after I turned 59 1/2, I have been using tIRA withdrawals with 100% withholdings instead of estimated tax payments.... and I used up all my taxable account cash to pay off my mortgage and car loan.... so from here on out I'll be converting $100, having $20 withheld and sent to pay taxes and $80 will go to the Roth.

If as is our plan out taxable equities pass to heirs tax-free because of stepped up basis, it shouldn't matter because to pay the tax from taxable funds I would have to sell shares and the gain would reduce my headroom for Roth conversions.

 

[Octogirl]

+1 - 2020 is our first year of FIR (not E) and I ve been doing some tax planning so this thread is helpful. One's plans really do depend on many assumptions and family.
DH and I frequently talk about "If I die first scenarios....." mostly because we want to protect the spouse left behind.

We needed to stay under IRMAA in 2019 but in 2020 have "room" for Roth conversion. We already have 20% of equities in a Roth account (opened >10 years ago).
Based on examples- we still need to stay under IrMAA limits and mentally prepare for the tax "bite"

While assumptions will vary, my assumption is that Tax rates will rise over next 10-20 years. Medical costs are rising (read An American Sickness) and more people who are living into their 90's (like my mom) will use Medicare.

Just my thoughts today

 

[Clone]

If you do NOT have cash to spare, you must pay for the taxes out of the converted money.

There is another asterisk condition that applies for some folks. If you have an inherited IRA, those funds can not be converted to a ROTH. There is also an RMD that must be taken each year. I pull money from the inherited IRA and put most of it towards federal withholding, and the balance against state withholding.

 

[CRLLS]

I am of the school that, when it comes to Roth Conversions, there is little difference between paying taxes from pretax monies or cash. That is provided paying those taxes from the pretax account doesn't bump you into the next tax bracket. From my situation, the goal is to reduce RMD's and protect a surviving spouse's tax situation. Paying taxes from the tIRA reduces the RMD's. I have to admit I haven't done a detailed analysis. Paying from a cash account (bucket strategy, if I had one) would only mean I have to take more out of tIRA to fill the bucket up again.

 

[LRDave]

I'll convert, for sure, to the top of the 12% bracket for the next 3 years - who wouldn't? I'll play it by ear as to converting more for the next 3 years and the years after that.

 

[MasterBlaster]

Our marginal rate will never, ever be less than 22%.

No doubt that we will be paying 22% or more once SS and RMDs start

It seems that the issue of average rates paid versus marginal rates isn't quite clear to some of you.

If I take SS and RMDs and other money out. My marginal rate may be 22% but that doesn't mean that I pay 22 % on everything I take out. My average tax on what I take out is quite a bit less.

Even if marginal rates in the future go up to 25 or 28 or 33 or 35 % or whatever, Your average tax paid on your IRA/401k withdrawals may likely be less than your now current 22% marginal rate.

By converting at 22% now you may not be getting the best tax rate.

 

[Gumby]

It seems that the issue of average rates paid versus marginal rates isn't quite clear to some of you.

If I take SS and RMDs and other money out. My marginal rate may be 22% but that doesn't mean that I pay 22 % on everything I take out. My average tax on what I take out is quite a bit less.

Even if marginal rates in the future go up to 25 or 28 or 33 or 35 % or whatever, Your average tax paid on your IRA/401k withdrawals may likely be less than your now current 22% marginal rate.

By converting at 22% now you may not be getting the best tax rate.

I understand quite well the distinction between marginal rate and average rate, thank you.

What I am telling you is that before I ever get to take a penny out of my tIRA, we will be in the 22% bracket due to pensions and SS. Yes, the average tax rate we pay will be less than 22% due to the fact than some income is taxed at 10% and some at 12%, but there is literally nothing I can do to prevent our tIRA withdrawals from being taxed at 22% or more. Even taking out the amount I plan, at any reasonable rate of return I will never reduce my tIRA balance before RMDs hit. In fact, it likely will be 50% higher than when I start.

So, yes, I am certain I am getting the best rate by converting now.

 

[RetireBy90]

It seems that the issue of average rates paid versus marginal rates isn't quite clear to some of you.

If I take SS and RMDs and other money out. My marginal rate may be 22% but that doesn't mean that I pay 22 % on everything I take out. My average tax on what I take out is quite a bit less.

Even if marginal rates in the future go up to 25 or 28 or 33 or 35 % or whatever, Your average tax paid on your IRA/401k withdrawals may likely be less than your now current 22% marginal rate.

By converting at 22% now you may not be getting the best tax rate.

what is important to me, you may have missed from the previous poster is I have $x in my TIRA. When 72 RMDs will kick in and a percentage of that goes to taxes.

Like most (I think) I have sources of income other than IRAs. These will continue regardless of how much I take from the IRAs, so the marginal tax I have to pay on a conversion or withdraw is what matters to me.

I think it goes back to each situation is different and your goal in doing conversions is important. I'm not just trying to minimize my total tax bill (although that is one of my goals), I'm also trying to pay today rather than tomorrow as I can afford it today. I'm also trying to make life simpler for DW or my heirs after I pass. Less worry about paying taxes on anything they get from estate. Finally, and most important, I'm trying to maximize income for DW if I got before her. Rather than having to send a cut of any withdraws to IRS, she will be able to take as little or as much as she wants without having to consider the tax implications.

But then I'm a bit crazy so my logic may not be for everyone.

 

[RunningBum]

I understand quite well the distinction between marginal rate and average rate, thank you.

What I am telling you is that before I ever get to take a penny out of my tIRA, we will be in the 22% bracket due to pensions and SS. Yes, the average tax rate we pay will be less than 22% due to the fact than some income is taxed at 10% and some at 12%, but there is literally nothing I can do to prevent our tIRA withdrawals from being taxed at 22% or more. Even taking out the amount I plan, at any reasonable rate of return I will never reduce my tIRA balance before RMDs hit. In fact, it likely will be 50% higher than when I start.

So, yes, I am certain I am getting the best rate by converting now.

This is exactly right. You don't look at average tax, but rather the variable amount you are considering to convert now vs. withdraw later in the future. In other words, the marginal rate on that variable amount.

In a simple example ignoring investment gains and possible future tax rate changes, if you are $1000 from the top of the 22% bracket now, and expect to be barely in the 22% bracket come RMD time, converting $1000 today costs you the same $220 in taxes you'd pay on a later withdrawal. Comparing the overall tax rate is not a factor.

 

[pb4uski]

It seems that the issue of average rates paid versus marginal rates isn't quite clear to some of you.

If I take SS and RMDs and other money out. My marginal rate may be 22% but that doesn't mean that I pay 22 % on everything I take out. My average tax on what I take out is quite a bit less.

Even if marginal rates in the future go up to 25 or 28 or 33 or 35 % or whatever, Your average tax paid on your IRA/401k withdrawals may likely be less than your now current 22% marginal rate.

By converting at 22% now you may not be getting the best tax rate.

I'm a retired CPA and have been doing tax returns since 1977 so I think I understand the difference between average rates and marginal rates.... and I don't need any "clarity" from you on the difference between average tax rates and marginal tax rates.

Once we are on SS and RMDs start between our qualified dividends, pension and SS we will be in the 22% tax bracket before any RMDs... so RMDs and any Roth conversions on top of RMDs would all be at 22%.

On the other hand.... between now and when SS starts we are in the 10% bracket based on qualified dividends and my pension.... so our conversions are a blend of 10%, 12% and 22%... so it is better to convert now than have higher RMDs later that will be taxed at 22%. Once SS starts but before RMDs begin we'll be close to the top of the 12% bracket.... a small portion of RMDs will be taxed at 12% and the remainder at 22%.

The other reason for dong Roth conversions at 22% now is if DW or I pass prematurely that we'll be in the 22% bracket even earlier because we'll be filing single so subject to single tax brackets and will lose of half of the standard deduction.

 

[TheWizard]

What I've been doing since retirement in 2013 at age 63 is maintaining a spreadsheet which projects my income (my AGI, actually) year by year from various streams.
So for Roth conversion planning, what I do is look at my projected AGI at age 72 (formerly age 70/70.5) assuming zero Roth conversions from age 72 onwards.

I then look at my projected AGI for the current year in early December and then do a lump Roth conversion to get my AGI for the current year up close to what it will be in 2022 (age 72).

I'm in the middle of the Medicare IRMAA tiers, so I cheated one year and avoided doing a larger Roth conversion that would have bumped me up into a higher tier.
But lately, I've bitten the bullet and now am in the same IRMAA tier that I will likely be from age 72 onwards.

I'm single lately so no concern about surviving spouse tax situation.

Tax brackets *may* revert back to previous in 2026, which would change my marginal rate from 24% back to 28%, so I may continue doing "small" Roth conversions from 2022 through 2025, after completing my RMD, of course...

 

[MasterBlaster]

I don't need any "clarity" from you

No need to be snitty.

Converting at 10% marginal works out much better than at 22% - that is true.

That may not be optimal for someone converting at higher marginal rates.

 

[nvestysly]

This thread is very timely for DW and me. Last year (2019) I completed a 72(t) SEPP plan so now I'm free to consider Roth IRA conversions. I've looked at other "conversion" threads over the past few years just to keep my eye on the topic but never really figured out a strategy. Midpack's thread and many of the responses have been very helpful as I give this topic my version of a deep dive.

DW and I find ourselves currently in the 22% marginal bracket. When SS kicks in and RMD's start in just over 10 years it's not likely the rates will be lower.

We may very well utilize Qualified Charitable Distributions to further minimize the impact of RMD's when the time comes.

The topic of Roth IRA's and IRA Conversions makes me think of Ed Slott - the IRA guru seen periodically on PBS during fundraising drives. Has anyone hired a professional like Ed (or other CPA) to help them on the subject or is everyone taking a DIY approach?

 

[target2019]

Midpack's thread will help you understand whether or not the professional knows their stuff.

IMO, the TurboTax What-If worksheet will get you there.

We're in the 22% bracket for 2019, and will drop to 12% bracket in 2020. I'm taking this one year at a time, and just staying within 12% for conversions, for now.

 

[pb4uski]

No need to be snitty. ...

WADR, you started it. I think that Gumby and I had similar reactions.

It seems that the issue of average rates paid versus marginal rates isn't quite clear to some of you. ...

 

[MasterBlaster]

OK:

My post was not meant as a slight on anyone. Apologies to anyone who may have been offended.


By the way, I did read through much of Midpacks thread on getting a handle on optimal tax strategy and found it to be outstanding. (https://www.early-retirement.org/forums/f28/retirement-tax-planning-income-optimization-99854.html)

 

[RetireBy90]

+1 on excellent work by midpack. I started this journey not even knowing what I didn’t know, but reading his posts and working through my somewhat unique situation I did conversions for the first time last year and started converting full force this year.

Many thanks to those that have contributed.

 

[rmprescott]

I've found this optimizer very insightful in pondering these issues: https://i-orp.com/ZERO/index.html

 

[Scratchy]

The other reason for dong Roth conversions at 22% now is if DW or I pass prematurely that we'll be in the 22% bracket even earlier because we'll be filing single so subject to single tax brackets and will lose of half of the standard deduction.

And unfortunately the reality is that this will occur at some point for most couples.

 

[Perryinva]

I understand quite well the distinction between marginal rate and average rate, thank you.

What I am telling you is that before I ever get to take a penny out of my tIRA, we will be in the 22% bracket due to pensions and SS. Yes, the average tax rate we pay will be less than 22% due to the fact than some income is taxed at 10% and some at 12%, but there is literally nothing I can do to prevent our tIRA withdrawals from being taxed at 22% or more. Even taking out the amount I plan, at any reasonable rate of return I will never reduce my tIRA balance before RMDs hit. In fact, it likely will be 50% higher than when I start.

So, yes, I am certain I am getting the best rate by converting now.

+1 exactly. Pensions and SS come in at about $120k with 40% of our pensions and all SS both COLA, so I don’t even see bracket increases ever getting US below the current 22%(25%). So before I file for SS, and still have even ANY 12% to use, I will use all that and much of the 22%, but below IRMAA through 2025. I’m not AS concerned with RMD reduction, as I am with growing the Roth as large as possible for the surviving spouse, but every little reduction from what might have been, helps, since most all RMDs will end up in an after tax account, growing and generating more taxes.

 

[MichaelB]

The link was reviewed, not working for some systems so it was updated and is otherwise fine.

Edit to add - the link is to I-ORP. Multiple posts questioning the link have been removed, as the link is perfectly normal.

 

[The Onceler]

Late to the party but i-orp lets you change the Roth conversion ceiling and then you can see the projected outcome differential in the total portfolio value. There are a few glitches in that, at higher levels of projected pension/SS income, i-orp won’t solve for lower ceilings. It basically refuses to compute an outcome if it thinks you should be doing more (even though it is quite content to compute a “no conversion” outcome). It seems to default into massive early conversions, which looks a bit risky if one thinks tax laws might change in the direction of penalizing Roths somehow (directly or indirectly). This might be offset by the risk that brackets will creep up if you don’t convert.

 

[atmsmshr]

Kitces on Roth conversions and drawdown

I may have missed it - but did not see anyone previously post this very good article on Roth conversions (with capital gains consideration).

Kitces nicely describes and uses graphs to illustrate advantages and disadvantages.

https://www.kitces.com/blog/tax-eff...strategies-to-fund-retirement-spending-needs/

 

[Dave J]

I may have missed it - but did not see anyone previously post this very good article on Roth conversions (with capital gains consideration).

Kitces nicely describes and uses graphs to illustrate advantages and disadvantages.

https://www.kitces.com/blog/tax-eff...strategies-to-fund-retirement-spending-needs/

This is an excellent article and thanks for posting it. I stumbled into this strategy a few years ago on my own, but I do wish I had read it when I was first early retired. A must read for anyone with sizeable IRA/401K assets that will have to have tax paid someday.