Roth Conversions.

[samclem]

Would you be sorry or just indifferent?

For me, I'd definitely be sorry if investment performance is lower than expected because that scenario can adversely affect my quality of life (particularly so if we're hit by negative returns just as I'm taking my RMDs).

It's the scenario where I go up in tax bracket where I'd be indifferent because in that case, I'd just have more money than I know what to do with.

+1. That describes my situation, too. Prepaying taxes now and finding our portfolio is heading toward the X-axis in 15 years and I could use the dough I gave the IRS would be a cause of regret.

IOW, in my situation the scenarios in which it will have been a bad decision are very unlikely.

Yes, it would be unlikely for us, too (thankfully). But if it happens, it'll be a doozy and I'll be looking for all the flexibility that some extra $$ in the portfolio might provide.

 

[Fedup]

My plan is to do a little bit every year until I'm 70. I'm waiting to see what's going to be after this year. Much clear picture.


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[pb4uski]

...Mind, I'm single, currently in 25% federal and 9.3% state marginal and expect to be in the same tax bracket upon retirement hence, I'm in no hurry to prepay my taxes.

If you're single and expect to be in the same tax bracket in retirement then there is no compelling reason to convert and pay earlier unless you have a strong belief that tax rates will increase.

 

[pb4uski]

....Yes, it would be unlikely for us, too (thankfully). But if it happens, it'll be a doozy and I'll be looking for all the flexibility that some extra $$ in the portfolio might provide.

I guess that I'm looking at it differently but my situation may be different.

Using the example, the "investment" made by paying taxes early is ~$75k and the potential benefits exceed the investment by a good margin. The financial return is a 13.5%/year after-tax return (the $141,501 difference in value at the end of 10 years in relation to prepayments of $7,500/year for 10 years). (Revised sensitivity table added below).

That return is only 8.7% if my nominal investment return is 0% but is 18.3% if my nominal investment return is 10%. I can't get anywhere close to that elsewhere so I'll prepay the taxes. The only way that I get screwed is if my tax rate in my 70s is lower than 10% and given potential increases in taxes, the possibility of one of us dying and our tax rate being even higher, etc. I don't see a tax rate lower than 10% as a possibility.

In any event, a $75k prepayment of taxes isn't going to lead to financial ruin in my case no matter how bad things get.

Sensitivity table
	$ extra	Financial return
0%	112,500	8.7%
2%	123,184	10.6%
3%	128,969	11.6%
4%	135,069	12.5%
5%	141,501	13.5%
6%	148,284	14.5%
8%	162,974	16.4%
10%	179,296	18.3%

 

[gauss]

If you're single and expect to be in the same tax bracket in retirement then there is no compelling reason to convert and pay earlier unless you have a strong belief that tax rates will increase.

Are you taking into account the possible effects of taxable vs non-taxable SS here?

Even if you are in the same tax bracket, your marginal tax rate can be close to twice as much due to this effect.

-gauss

 

[pb4uski]

No. There is no need to as I was commenting in response to a post where the poster indicated that they will be in the 25% tax bracket before and after retiring so if they have that much income then most likely all there SS will be 85% taxable.

But I see your point in situations where once SS starts between 1/2 your SS and RMDs you are flirting with the combined income limits.

 

[GTFan]

While I agree that if investment experience is good and RMDs pushing you into a higher tax bracket that you have the resources to pay the taxes, but I would prefer to do conversions and have those savings go to my kids than to the government.

Ignoring other choices of course, such as donating to charity to stay within the 15% bracket.

As I mentioned in other threads, this is as much a lifestyle decision as it is a financial one. You either want to leave a large legacy or you don't, given that your portfolio will be enough to live on regardless of whether you do conversions. And as sam has mentioned in the event of sequence of return risks early on you are keeping more money that can be spent in your early retirement years as needed. And you can spend down your tax-deferred money from 60-70 (staying within the bracket) and possibly avoid a lot of the torpedo.

There is no right or wrong answer here, there are a ton of variables including tax-deferred portfolio size, whether you want to max out ACA subsidies, local/state tax rates, leaving a legacy etc. Highly YMMV.

 

[pb4uski]

I wasn't necessarily ignoring charity and agree that is an option to stay in the 15% bracket. For us, whatever's left will go to our kids and charity (in the case of charity on top of what we already give), we just haven't yet decided how much is going to each. To some extent it will depend on how the kids are doing.

 

[Fedup]

I agree with previous poster that it's a lifestyle choice. I will have 3 pots of money when I'm in my 80s and 90s, IRA, Roth IRA and taxable account. The longer my husband and I live as a couple, the larger the taxable account. We no longer contributing to IRA, so that pot will be getting smaller as we age, with RMDs and all. My IRA account will not be used for 15 years so it's best to convert to Roth as much as it makes sense. The taxable account, there is not much I can do about it. I have to look for ways to invest to minimize tax. But eventually it will be the largest pot.


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[trapperjohn]

Beside the reasons already mentioned, you may also want to consider any effect on any money left over once you're gone.

If your heirs inherit a tIRA, they will be required to withdraw AND PAY TAXES ON required RMDS. The RMD schedule will be longer than your original RMD schedule, but they will still have RMDs and will have to pay those additional taxes.

If your heirs inherit a Roth, their withdrawals will be tax free


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[heyyou]

So far, delayed gratification has worked well in my life, so I'm delaying SS and converting tIRA to RIRA from retirement day until RMDs start. At the top of the 15% bracket, for Married Filing Jointly, the effective tax rate is 10.8%. Probably won't get any better than that, although the tax brackets do rise with the level of inflation.

Look at the amount of extra tax paid, it is not much in the big picture. Consider how much your portfolio value fluctuates daily. Since it is tax, retirees are hyper sensitive about it, but it is not large amounts of money if converting in the 15% bracket. The goal is to have plenty of money in the long run, not necessarily paying less tax for two in their 60s then her paying substantially more tax in her 80s as a widow filing as a single taxpayer.

Sent from my tin can on a string.

 

[pb4uski]

I couldn't agree more. Exactly what my strategy is but I concede that it does not fit all.

 

[hnzw_rui]

Ignoring other choices of course, such as donating to charity to stay within the 15% bracket.

Donating to qualified charitable organizations as a tax strategy probably means increasing expenditures/withdrawal rate, too. Possibly by significantly more than what taxes would have otherwise cost if someone doesn't have a lot of other itemized deductions.

Another thing, as a single filer you need considerably less income to be in the 25% bracket compared to married filing jointly. Reducing taxable income to $38K gets you down to the 15% bracket but if planning to do Roth conversions of, say, $20K a year at 15%, that leaves you with just $18K of income available for expenses. You would need to make up the shortfall using taxable savings or liquidation of assets with high cost basis.

As I've previously mentioned, I don't plan on doing any oversized Roth conversions. At most, I'd likely do conversions up to the top of the 25% bracket for the purpose of tax smoothing. If returns are good enough that RMDs push me into 28% and get hit by IRMAA then that's fine. If returns are extremely good that yield from taxable accounts and RMDs are high enough to push me into the 33% bracket or higher, then I'll just thank my lucky stars and probably give a huge chunk of the excess RMDs as charitable donations and gifts.

 

[GTFan]

That is incorrect, you can use qualified IRA charitable distros to satisfy RMDs. You don't have to force them up to the itemized bracket to get tax reductions.

IRA Qualified Charitable Contributions Reinstated, Made Permanent

 

[hnzw_rui]

That is incorrect, you can use qualified IRA charitable distros to satisfy RMDs. You don't have to force them up to the itemized bracket to get tax reductions.

IRA Qualified Charitable Contributions Reinstated, Made Permanent

That's at age 70 1/2 though. I don't think that's an option for someone retiring at 55 and planning to do Roth conversions in order to reduce RMDs.

 

[Frankie1926]

At 55 there are many years of risk that the tax treatment of roths will not be as lucrative. I think 1 candidate is already looking at creating rmd rules for roths.


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[hnzw_rui]

At 55 there are many years of risk that the tax treatment of roths will not be as lucrative. I think 1 candidate is already looking at creating rmd rules for roths.

Yeah, that too. Hence, I'm only planning on doing Roth conversions for tax smoothing.

Oh well, I'm just 32 right now. I'm likely gonna have to adjust plans in response to changes in tax law.

 

[2017ish]

At 55 there are many years of risk that the tax treatment of roths will not be as lucrative. I think 1 candidate is already looking at creating rmd rules for roths.

...

Death, Taxes, and Legislative changes to the tax code....

I'm a year older and am planning (after retirement) to convert fairly aggressively in early retirement--with an aspirational goal of getting as close to 50/50 as is reasonable. 100% Roth conversions is, in my mind/situation, trusting too much in the current Code provisions continuing.

 

[GTFan]

That's at age 70 1/2 though. I don't think that's an option for someone retiring at 55 and planning to do Roth conversions in order to reduce RMDs.

The point was that you can use IRA QCDs to satisfy RMDs with no tax consequences, not that it's better than conversions before RMD time. If you don't want to convert and take the upfront tax hit before you turn 70 1/2 this is a way to have no tax hit when you do reach that age.

And of course there are other ways to minimize RMDs without conversions so you don't have to donate a big chunk every year, such as spending down your tax-deferred accounts between the ages of 60-70. Like I said before, this is a personal call not strictly a financial one.

 

[hnzw_rui]

The point was that you can use IRA QCDs to satisfy RMDs with no tax consequences, not that it's better than conversions before RMD time. If you don't want to convert and take the upfront tax hit before you turn 70 1/2 this is a way to have no tax hit when you do reach that age.

And of course there are other ways to minimize RMDs without conversions so you don't have to donate a big chunk every year, such as spending down your tax-deferred accounts between the ages of 60-70. Like I said before, this is a personal call not strictly a financial one.

Ah, I agree. Personally planning on spend down and/or small conversions of tax deferred from 55-70. If returns are so good and portfolio becomes so large that my RMDs still exceed desired spending, then I'll just do QCDs. I'm loathe to prepay a lot in taxes because 15 years is a pretty long time and portfolio survival will be a concern during the earlier years. I definitely have no plans of Roth converting to the point where RMDs become zero.

 

[rayvt]

Another thing to know is that just because you design your conversion to bring you to the top of the 15% tax bracket does not mean that you pay 15% tax on the conversion.

Actually, yes it does. The tax brackets are marginal rates. Which means that each additional dollar of income you get is taxed at 15% (or whatever). If you are in the 15% bracket, $1000 of Roth conversion will cost $150 of income tax.

 

[GrayHare]

If one's first dollar of conversion fits below the 15% bracket then converting up to the top of the 15% bracket will not incur 15% tax on the entire conversion.

 

[pb4uski]

Actually, yes it does. The tax brackets are marginal rates. Which means that each additional dollar of income you get is taxed at 15% (or whatever). If you are in the 15% bracket, $1000 of Roth conversion will cost $150 of income tax.

If one's first dollar of conversion fits below the 15% bracket then converting up to the top of the 15% bracket will not incur 15% tax on the entire conversion.

No rayvt, it doesn't work that way - GrayHare is right. Let's say a married couple is in ER, living off their taxable accounts (no pension and SS yet) and have $20k of dividend income and capital gains and are doing Roth conversions to the top of the 15% tax bracket and take the standard deduction. The tax on their 2016 $76k Roth conversion is 9.7% because some of the conversion is covered by exemptions and deductions (effective rate of 0%), $18,550 is taxed at 10% and the remainder is taxed at 15% and the effective tax rate on the conversion is a blend of these 3 rates. IF their ordinary income before any Roth conversions was $39,250 or more then what you wrote would be correct.

		2016
TI at top of 15% tax bracket		75,300
Standard deduction		12,600
2 exemptions	4,050	8,100
		96,000
Qualified dividends and LTCG		(20,000)
Roth conversion		76,000
Deductions and exemptions	0%	20,700	-
$0-$18,550	10%	18,550	1,855
$18,551-$75,300	15%	36,750	5,513
		76,000	7,368
Effective tax on conversion				9.7%
Qualified income	0%	20,000	-
Total tax			7,368
Total effective tax rate				7.7%
Total income		96,000
Deductions		(12,600)
Exemptions		(8,100)
Taxable income		75,300

 

[GTFan]

Yep, it's always a blended rate because of the tax tiers. At least for federal, that is - many states are flat rate.

 

[samclem]

It just depends on your "regular" income before doing any conversions. If that other income already puts you in the 15% bracket, then it's very true that every dollar of Roth conversion is taxed at 15% (or higher, if you go into the next bracket).