Roth Conversion (trying to keep it simple)

[chad.sfds]

I have looked around online and on this forum and have not found any "calculators" that allow you to put in criteria and have it give you your answer for roth conversions. In principle, all other things being equal I love the idea of tax free growth and passing on tax free inheritance.

This is my question for my current still employed situation (will be 50 this year) looking to retire potentially in ~ 5 years at 55. My goal is to be financially able to do that and only work because I chose to. Let's assume I am currently in my highest earning years in 24% bracket and once retired, I'd be in the 22% bracket.

If the taxable limit is (for example) 170k before I would be in the 32% bracket and (for example) my taxable income for the year was 145k, I am considering doing an in plan roth conversion in my 401k for $25k. And I would like to do this every year, atleast while I am still working, to build up my roth bucket. I have the cash to pay the taxes.

Thoughts?

 

[chad.sfds]

duplicate post by mistake.

 

[ImThinkin2019]

I have looked around online and on this forum and have not found any "calculators" that allow you to put in criteria and have it give you your answer for roth conversions. In principle, all other things being equal I love the idea of tax free growth and passing on tax free inheritance.

Thoughts?

We tried a number of calculators and were not satisfied until we bought Pralana Gold. It's an Excel spreadsheet made by a person for themselves, then much further developed for modeling. I think we paid less than $100 a few years ago. Don't hold me to this - it could be more today.

With Pralana Gold, you input your current financials and then you can test 3 different scenarios, such as Roth conversions. It lets you compare the 3 and then has a sensitivity tool that lets you adjust parameters and see their effect.

The output can be numerical or graphical. I used the graphical to show my wife what the tax burden would be if we did not do Roth conversions. That finally persuaded her. (In her family they hate to pay any more tax than they need to. Thus a "hot button" for her.)

We are now in the "lean" years between exit from minicorp and startup of SS at 70. Doing as much conversion as we are comfortable with every year. Our plan is to leave the Roths to the kids with the taxes paid, like you are thinking.

Hope this helps!

 

[mountainsoft]

If the taxable limit is (for example) 170k before I would be in the 32% bracket and (for example) my taxable income for the year was 145k, I am considering doing an in plan roth conversion in my 401k for $25k. And I would like to do this every year, atleast while I am still working, to build up my roth bucket. I have the cash to pay the taxes.

Sounds about right. If your bracket topped at 170K and you only earn 145K, you could convert 25K and still stay in the same bracket. I think there are some technicalities, such as the standard tax deduction, that would allow you to convert more in a year, but your basic plan is the simplest and easiest.

I did the same thing, converting about 20K-30K per year, while we are still working. I paid estimated taxes on the conversion from our regular savings, so the full amount was converted from traditional to Roth. I didn't have a lot in my traditional account, but after several years of conversions I am 100% Roth now.

Since we're in the 12% bracket before and after retiring, there's no big tax advantage, but it will lower our taxable income for things like healthcare, property tax deductions, social security taxes, etc. And any future growth will be tax free.

 

[SevenUp]

Let's assume I am currently in my highest earning years in 24% bracket and once retired, I'd be in the 22% bracket.

Although it is usually not effective to do Roth conversions while working, if you truly will be in the 22% bracket later, it might make sense to pay 24% to convert now due to the way “Traditional plus taxable” vs. Roth works out. See that link for more.

In general, see the rest of that wiki entry for considerations, and the Roth IRA conversion wiki, particularly the "Using a spreadsheet" section.

 

[SnowballCamper]

This calculator has an option to turn on/off Roth conversions, and when you turn it on it tells you how much in what year to convert in order to achieve maximum after tax money. It takes a bit of reading to interpret the results, but I found it worthwhile.

https://www.i-orp.com/Plans/extended.html

 

[target2019]

I have looked around online and on this forum and have not found any "calculators" that allow you to put in criteria and have it give you your answer for roth conversions. In principle, all other things being equal I love the idea of tax free growth and passing on tax free inheritance.

This is my question for my current still employed situation (will be 50 this year) looking to retire potentially in ~ 5 years at 55. My goal is to be financially able to do that and only work because I chose to. Let's assume I am currently in my highest earning years in 24% bracket and once retired, I'd be in the 22% bracket.

If the taxable limit is (for example) 170k before I would be in the 32% bracket and (for example) my taxable income for the year was 145k, I am considering doing an in plan roth conversion in my 401k for $25k. And I would like to do this every year, atleast while I am still working, to build up my roth bucket. I have the cash to pay the taxes.

Thoughts?

That is correct. You think of your marginal bracket, and see how much headroom you have. If this year will be very similar to last year, it's a simple calculation and decision.

But beware a large amount of unexpected income this year. You can stagger conversions throughout the year, to be sure.

 

[Al18]

In my opinion it doesn’t make sense to convert to Roth IRA if you are in a 32% tax bracket and still working. You will pay $8000 in Federal Taxes to convert $25000 Roth IRA. Many on this forum were in a higher tax bracket while working, but are in a lower tax bracket when they retired early. Once retired, we’re in the 12% tax bracket - that’s a good time to do Roth IRA conversions.

My suggestion for now is to take the $8000 you set aside for taxes and invest $5000 per year in a stock index ETF at a brokerage, and put $3000 into a 1 to 3 year CD. Continue to do so every year . This will provide you money to spend when you are retired that will be nearly tax free. FYI for Married Filing Jointly, the 0% long term capital gains rate for 2023 extends to $89,250.

 

[chad.sfds]

In my opinion it doesn’t make sense to convert to Roth IRA if you are in a 32% tax bracket and still working. You will pay $8000 in Federal Taxes to convert $25000 Roth IRA. Many on this forum were in a higher tax bracket while working, but are in a lower tax bracket when they retired early. Once retired, we’re in the 12% tax bracket - that’s a good time to do Roth IRA conversions.

My suggestion for now is to take the $8000 you set aside for taxes and invest $5000 per year in a stock index ETF at a brokerage, and put $3000 into a 1 to 3 year CD. Continue to do so every year . This will provide you money to spend when you are retired that will be nearly tax free. FYI for Married Filing Jointly, the 0% long term capital gains rate for 2023 extends to $89,250.

I am not in 32%, but rather 24%. Does that change your view?

How are you guys getting in the 12% bracket without Roth infusion? MFJ, which I venture to guess a large percentage of folks are here, limits at $83,550 for 2022.

 

[Al18]

MFJ 2022 standard deduction is $25900. So Gross income can be up to $109,450. Many early retirees are easily staying in this bracket & doing some Roth conversion by a combination of selling stock, cashing in a CD and taking some small withdrawals from their traditional.

I wouldn’t waste money by converting Roth IRA at the 24% bracket - when you can do it later at a lower tax rate.

 

[SevenUp]

How are you guys getting in the 12% bracket without Roth infusion? MFJ, which I venture to guess a large percentage of folks are here, limits at $83,550 for 2022.

That's taxable income. Need to add at least the standard deduction to reach adjusted gross income (AGI).

For MFJ both 65+ in 2023, a $120,150 AGI based on ordinary income alone stays in the 12% bracket. In the extreme, an additional $129K of qualified dividends could be added and the couple would still be in the 12% bracket for ordinary income.

 

[Exchme]

We tried a number of calculators and were not satisfied until we bought Pralana Gold. It's an Excel spreadsheet made by a person for themselves, then much further developed for modeling. I think we paid less than $100 a few years ago. Don't hold me to this - it could be more today.

With Pralana Gold, you input your current financials and then you can test 3 different scenarios, such as Roth conversions. It lets you compare the 3 and then has a sensitivity tool that lets you adjust parameters and see their effect.

The output can be numerical or graphical. I used the graphical to show my wife what the tax burden would be if we did not do Roth conversions. That finally persuaded her. (In her family they hate to pay any more tax than they need to. Thus a "hot button" for her.)

We are now in the "lean" years between exit from minicorp and startup of SS at 70. Doing as much conversion as we are comfortable with every year. Our plan is to leave the Roths to the kids with the taxes paid, like you are thinking.

Hope this helps!

Pralana Gold is $99 the first year and $49 renewal. For Roth Conversions, it has matrix covering 20 years, where you select which spouse to prioritize (or neither), the tax bracket, whether to limit to the top of the 0% LTCG bracket, the IRMAA tier, the ACA MAGI FPL. You make whatever selections you want to test year by year and watch the total savings at end of life go up or down. To account for heir's taxes on inherited IRAs, you enter the assumed taxes on the remaining IRA balance.

You do have to go back and forth a bit on your plan as it may be better than nothing to convert to a high bracket the first year, but generally it's better to convert to moderate brackets for more time.

 

[target2019]

I am not in 32%, but rather 24%. Does that change your view?

How are you guys getting in the 12% bracket without Roth infusion? MFJ, which I venture to guess a large percentage of folks are here, limits at $83,550 for 2022.

There are different opinions on what you should do. My gut tells me that your situation is very different, as you point out, from married folks.

Staying in the 12 was a 2-year opportunity for us. Just like that, we are now in the 22...and will not be able to go back.

In your situation the question is converting now, at 22%, or converting after 2025 when your rate goes back to 27% (or doesn't). If you're retired in 5 years, maybe you'll be in the 15% marginal bracket? Conversion in that scenario makes sense. But we don't know what the future brackets will be.

There are other threads where Roth conversions are discussed in much detail.

 

[pb4uski]

I have looked around online and on this forum and have not found any "calculators" that allow you to put in criteria and have it give you your answer for roth conversions. In principle, all other things being equal I love the idea of tax free growth and passing on tax free inheritance.

This is my question for my current still employed situation (will be 50 this year) looking to retire potentially in ~ 5 years at 55. My goal is to be financially able to do that and only work because I chose to. Let's assume I am currently in my highest earning years in 24% bracket and once retired, I'd be in the 22% bracket.

If the taxable limit is (for example) 170k before I would be in the 32% bracket and (for example) my taxable income for the year was 145k, I am considering doing an in plan roth conversion in my 401k for $25k. And I would like to do this every year, atleast while I am still working, to build up my roth bucket. I have the cash to pay the taxes.

Thoughts?

I don't think it is a good idea to do Roth conversions while you are working because Roth conversions would be taxed at high marginal rates. The optimal time to do Roth conversion is between early retirement and once pensions and SS start since that is the time when one would typically be in lower tax brackets.

I'm a good example of that. When I was working, my earnings put us in a high tax bracket (28% marginal as I recall). When I retired (technically resigned) we were living off of our savings and absent Roth conversions our taxes would be $0. At the same time, I projected that once we were receiving SS and my pension that we would be near the top of the 12% tax bracket before RMDs and that RMDs would push us into the 22% tax bracket, so the effective tax on RMDs would be about 17%. Meanwhile, I could do Roth conversions to the top of the 12% tax bracket and only pay about 9% on the conversion amount. If one of us dies the surviving spouse would be in an even higher tax bracket and one of our two heirs is in a high tax bracket.

So in our case, I thought it made sense to pay 9% today to avoid paying 17% or more later. So in short, I think it is suboptimal in most cases to do Roth conversions while working.

 

[chad.sfds]

That's taxable income. Need to add at least the standard deduction to reach adjusted gross income (AGI).

For MFJ both 65+ in 2023, a $120,150 AGI based on ordinary income alone stays in the 12% bracket. In the extreme, an additional $129K of qualified dividends could be added and the couple would still be in the 12% bracket for ordinary income.

I do understand that is taxable. A couple under 65 in 2022 that made 125k gross income with only standard ded would be in the 22% bracket so that is what I was basing my example on. Playing around with that a little more now that you pointed out the 2023 example, I see its not a big reduction to get down to the 12%.

Can you please elaborate on that last sentence I bolded?

 

[mountainsoft]

I don't think it is a good idea to do Roth conversions while you are working because Roth conversions would be taxed at high marginal rates.

It really depends on your current and future tax rates.

We are in the 12% tax bracket now, and will be in the same bracket after retiring. There was no advantage to waiting to make the conversions. Also, it's easier to come up with the money to pay the taxes while working than it will be when we're retired.

 

[pb4uski]

I'm not sure what SevenUp meant by that last sentence, but in 2023 a married couple over 65 taking the standard deduction could have $[-]118,350[/-] 119,750 of qualified dividends and long-tem capital gains and pay $0 in tax.

 

[pb4uski]

It really depends on your current and future tax rates.

We are in the 12% tax bracket now, and will be in the same bracket after retiring. There was no advantage to waiting to make the conversions. Also, it's easier to come up with the money to pay the taxes while working than it will be when we're retired.

If it is 12% now vs 12% later, then I agree and I could see that being likely where the retiree has a significant pension that starts right away when they retire early.

 

[chad.sfds]

I'm not sure what SevenUp meant by that last sentence, but in 2023 a married coup over 65 taking the standard deduction could have $118,350 of qualified dividends and long-tem capital gains and pay $0 in tax.

OK, but your example is still something I am just beginning to learn about. Is that 118,350 straight from the capital gains tax table? I assume that the value is higher for 65 and over which is why you guys keep saying "over 65". The 2023 capital gains tax table I see for MFJ for 0% is $89,250 max. Forgive my ignorance here, I am 15+ years away from 65 and trying to learn all the operating parameters for future years.

Also, I get a stock sale (for example) that constitutes capital gains, but can you elaborate on the qualified dividend part? You're saying these qualified dividends are treated in the capital gains tax bucket, not taxable income bucket? Can you give an example?

 

[JBTX]

I have looked around online and on this forum and have not found any "calculators" that allow you to put in criteria and have it give you your answer for roth conversions. In principle, all other things being equal I love the idea of tax free growth and passing on tax free inheritance.

This is my question for my current still employed situation (will be 50 this year) looking to retire potentially in ~ 5 years at 55. My goal is to be financially able to do that and only work because I chose to. Let's assume I am currently in my highest earning years in 24% bracket and once retired, I'd be in the 22% bracket.

If the taxable limit is (for example) 170k before I would be in the 32% bracket and (for example) my taxable income for the year was 145k, I am considering doing an in plan roth conversion in my 401k for $25k. And I would like to do this every year, atleast while I am still working, to build up my roth bucket. I have the cash to pay the taxes.

Thoughts?

It really depends on how much you currently have in traditional IRAs and what your income and tax bracket will be going forward. If you have substantial traditional Ira assets and are pretty sure you will be in the 22% bracket going forward, even if you aren’t working, then yes I’d probably do conversions up to top 24% bracket. That’s only 2% more than22%, and 22% is scheduled to go back to 25% in 2026 unless congress extends current brackets.

 

[SevenUp]

That's taxable income. Need to add at least the standard deduction to reach adjusted gross income (AGI).

For MFJ both 65+ in 2023, a $120,150 AGI based on ordinary income alone stays in the 12% bracket. In the extreme, an additional $129K of qualified dividends could be added and the couple would still be in the 12% bracket for ordinary income.

I do understand that is taxable. A couple under 65 in 2022 that made 125k gross income with only standard ded would be in the 22% bracket so that is what I was basing my example on. Playing around with that a little more now that you pointed out the 2023 example, I see its not a big reduction to get down to the 12%.

Can you please elaborate on that last sentence I bolded?

The taxation of ordinary income gets separated from the taxation of qualified dividends and long term capital gains. See the worksheet on p. 36 of https://www.irs.gov/pub/irs-pdf/i1040gi.pdf. How that worksheet applies to your situation should be visible in whatever tax software you use.

The point of the (as mentioned, extreme) example is that 2023 MFJ age 65+ filers with $129K of qualified dividends will still be subjected to only a 12% marginal rate on the $200 between $119,950 and $120,150 of ordinary income.

The larger point is that it is the marginal tax rate that matters in Roth conversion decisions, and people shouldn't assume that their "bracket" is the same as their marginal rate.

There are various ways to determine the applicable marginal tax rate. My personal preference is to use the case study spreadsheet but for those who don't know Excel more laborious methods also work.

 

[pb4uski]

OK, but your example is still something I am just beginning to learn about. Is that 118,350 straight from the capital gains tax table? I assume that the value is higher for 65 and over which is why you guys keep saying "over 65". The 2023 capital gains tax table I see for MFJ for 0% is $89,250 max. Forgive my ignorance here, I am 15+ years away from 65 and trying to learn all the operating parameters for future years.

Also, I get a stock sale (for example) that constitutes capital gains, but can you elaborate on the qualified dividend part? You're saying these qualified dividends are treated in the capital gains tax bucket, not taxable income bucket? Can you give an example?

go to https://www.irscalculators.com/tax-calculator

Select 2023 for the year in upper left corner, then joint over 65 for filing status, then enter $119,750 in the capital gains box. The tax will be zero. Change the $119,750 to $119,751 and the tax will be 15c.

The top of the 0% capital gains tax bracket for 2023 is $89,250. Add the $30,500 of standard deductions for MFJ both over 65 and you get $119,750.

It is different from the $118,350 that I posted before because I had carelessly selected MFJ but one over 65 rather than MFJ both over 65.

Both long-term capital gains (over 1 year) and qualified dividends (generally domestic stock dividends or the stock portion of balanced fund/ETF dividends qualify). Check your tax return.

If you're anal like me you can do the same math using the What-If Worksheet on TurboTax.

 

[troutnut1]

We tried a number of calculators and were not satisfied until we bought Pralana Gold. It's an Excel spreadsheet made by a person for themselves, then much further developed for modeling. I think we paid less than $100 a few years ago. Don't hold me to this - it could be more today.

With Pralana Gold, you input your current financials and then you can test 3 different scenarios, such as Roth conversions. It lets you compare the 3 and then has a sensitivity tool that lets you adjust parameters and see their effect.

The output can be numerical or graphical. I used the graphical to show my wife what the tax burden would be if we did not do Roth conversions. That finally persuaded her. (In her family they hate to pay any more tax than they need to. Thus a "hot button" for her.)

We are now in the "lean" years between exit from minicorp and startup of SS at 70. Doing as much conversion as we are comfortable with every year. Our plan is to leave the Roths to the kids with the taxes paid, like you are thinking.

Hope this helps!

Thank you for this idea! I've struggled with coming up with Roth Conversion numbers and made a rather costly mistake last year that resulted in a bigger bill and a higher bracket than I initially planned. A simple math error is irreversible once you've pulled the trigger on a conversion. This planning tool is brilliant and well worth the small cost (which was $99). This was probably the best tip ive gotten here in terms of saving me time and money. The developer Scott Matthews is certainly brilliant to have come up with this. Very easy to use. You do need excel on a windows pc or a Mac but I was able to get that for my Mac on a 30 day free trial and then $6.99 a month if I want to keep it. There are a couple of cautions about using this on some macs but my older MacBook pro did great.

 

[ImThinkin2019]

Thank you for this idea! I've struggled with coming up with Roth Conversion numbers and made a rather costly mistake last year that resulted in a bigger bill and a higher bracket than I initially planned. A simple math error is irreversible once you've pulled the trigger on a conversion. This planning tool is brilliant and well worth the small cost (which was $99). This was probably the best tip ive gotten here in terms of saving me time and money. The developer Scott Matthews is certainly brilliant to have come up with this. Very easy to use. You do need excel on a windows pc or a Mac but I was able to get that for my Mac on a 30 day free trial and then $6.99 a month if I want to keep it. There are a couple of cautions about using this on some macs but my older MacBook pro did great.

Hi Troutnut,

Glad this worked out for you!

One thing I forgot to mention - that you probably noticed - Pralana Gold lets you input varying income and withrdawal amounts each year. Some of the other calculators required that certain streams be constant.