Roth conversions

[joylesshusband]

Quote:

Originally Posted by Montecfo If you are paying the tax before you have to, you want to be very confident it will be at a lower rate than if paid later. And you want to try to manage the risk you pay taxes you might never have to pay.

The text I bolded above is a classic example of misunderstanding what the goal is.

It is not the tax rate that has to be lower.
It is not even the total tax amount that has to be lower.
It is the extra _value_ gained by "paying the tax before you have to" as you aptly put it.

This value is not a simple matter of tax arbitrage.
Perhaps you just prefer to see it that way, as otherwise your brain cells would have to work a little bit harder, and you don't feel like dealing with tired brain cells at the moment...

[RunningBum]

Somebody tell me if this person (I tried about 5 different words here but all of them would probably get me in trouble) ever posts anything of substance. All I see are insults, and nothing at all to back his claims. Welcome to my ignore list.

[googily]

Quote:

Originally Posted by RetireBy90 Thanks for a real example. For too long I have been playing/planning with textbook assumptions. Real sorry to hear you are by yourself, but it is very helpful for me to get a real life scenario like this.

Thanks. And don't forget the additional potential tax torpedo of selling a home and only having a $250k CG exemption rather than $500k. Even with the stepped-up value, the likely gains on my house are already well past $250k, since we bought more than 20 years ago in a neighborhood that has since become extraordinarily sought after. I'm not moving right away, but we always knew it was not going to be a house where we could age in place, so I will likely sell it at some point. That'll be a fun year tax wise.

[oldphd]

Quote:

Originally Posted by pb4uski That is the plan in our case, but if once our taxable funds are gone we might use Roth money to avoid going into the next tax bracket... IOW... if pension, SS and RMDs put us in the 12% tax bracket we would do additional voluntary tIRA withdrawals up to the top of the 12% tax bracket, then use Roth money rather than do tIRA withdrawals into the 22% tax bracket.

My thought is similar. In our case, we will have the 12% bracket almost filled with pension and SS at age 70 (works out for each of us independently, so being widowed doesn't change the bracket). We should also have depleted our taxable accounts by that point. Since I will fall into the 22% at that point, I plan to do Roth conversions prior to that point to fill the 22% for me (we currently file separately to save on state taxes). Using nominal returns over the years until 70, If I just fill the 12%, I will still have bunches of traditional IRA. If I go to 22% for us MFJ, I can deplete it a few years in advance and then have room left in the 12%, so that doesn't make sense. Like Goldilocks, the middle of the road is just right, converting to 22% for me filing separately, with DW maxing out the 12%. I would still have money in the traditional IRA but not huge amounts so RMDs would be modest.

That seems confusing as I read it, so I hope it makes sense. The point I want to make is that my plan is to do decide what I want my tax return to look like, do that, and then use the Roth as my source of funds. If I spend less than an arbitrary 4% SWD, it's still earning money in a tax free way. At that point, I don't see a reason to have more than a nominal amount in a taxable cash type account (savings, checking, whatever).

Think of your Roth as a tub filled with water. You are pouring into it at a rate you choose to fine tune your 12/22/whatever tax bracket. Independently, you are drawing out of it to spend money on life. As long as there's enough in when you start, the level goes up and down over time.

The ultimate goal whether in your lifetime, your spouse, or other heirs, is to minimize the taxes owed. This is tax deferred, and WILL get taxed at some point coming out.

Another point for our consideration, and would be for at least some others here, is IRMAA. If I would stick to the 12% conversion for those earlier years and then either of us is widowed, we'd get hit by IRMAA with RMDs. So there's a little more than just the tax bracket to consider.

[Montecfo]

Quote:

Originally Posted by joylesshusband The text I bolded above is a classic example of misunderstanding what the goal is. It is not the tax rate that has to be lower. It is not even the total tax amount that has to be lower. It is the extra _value_ gained by "paying the tax before you have to" as you aptly put it. This value is not a simple matter of tax arbitrage. Perhaps you just prefer to see it that way, as otherwise your brain cells would have to work a little bit harder, and you don't feel like dealing with tired brain cells at the moment...

I stand ready to entertain your explanation of the extra value gained by paying taxes before you have to. Understanding how tax rates and amount of tax are irrelevant will also be enlightening, no doubt.

[pb4uski]

Quote:

Originally Posted by joylesshusband No one questioned the general reasoning for doing Roth conversions. What was questioned was the precision of the criteria applied to how much, and when to convert. My point of contention is that a simple tax arbitrage oversimplifies the picture, as it ignores opportunity costs. What you suggested is the most simplistic model, which is hardly applicable to anyone’s actual situation. It is understood that all models (all and any model well beyond the Roth conversion subject) are imperfect, being skewed limited replicas of the real thing, but I don’t see a reason to use the most simplistic one due to its obvious inaccuracy, and make decisions based on it. If I had in mind an acceptable way of quantifying the opportunity cost of paying extra income tax due to conversions, I would have presented it herein. I am still working on it.

Nice solilioquy. Specifically what opportunity costs does it ignore? In your opinion, what complications are lacking?

Seems to me like you are asserting that there are other things that need to be considered with no earthly idea of what they are. So put up....

And BTW, that model is quite applicable to many of our situations, specifically mine.

[pb4uski]

Quote:

Originally Posted by RunningBum Somebody tell me if this person (I tried about 5 different words here but all of them would probably get me in trouble) ever posts anything of substance. All I see are insults, and nothing at all to back his claims. Welcome to my ignore list.

+1 All hat.....

[bigcmagor]

Quote:

Originally Posted by pb4uski +1 All hat.....

As someone who has previously been accused of having more hat than herd, methinks this comparison is disrespectful to hats.

[CardsFan]

Getting back on topic.

In our case, converting to the top of the new 12% bracket is a no-brainer, at least before taking SS.

We avoided about 25% in taxes when we invested, and we can now pay an effective tax rate of 12% (or less) when we convert, and let the balance grow tax free. Whether we use it, or our DS does when we pass (which is the likely use of the money), there is a net benefit of over 13% .

If we take SS at FRA, as we plan, then the conversion benefits may go away if they increase the amount of SS that is taxed. So we will re-evaluate in 3 years when we get there.

As far as converting in the 22% bracket, that is a lot more iffy in terms of tax savings. I am not inclined to simply pre-pay taxes for DS.

That said, we will likely get hit with the tax torpedo at RMD age no matter what we do. We may decide to increase our charitable donations. But when all is said and done, if one or both of us is in the 35% tax bracket due to RMD's, well, we won the game .

FWIW, in the case of SCUBA, with no heirs, it may make perfect sense to NOT convert, and then use charitable contributions to minimize the effect of of RMD's on taxes.

[harley]

Quote:

Originally Posted by Scuba My CPA said that because Roth money grows tax free, many investors never tap into it, especially if they have enough assets from other sources to live their desired lifestyle. So Roths are often left for heirs.

This is a feature, not a bug. If it doesn't fit in your plans, don't do it. But for us the ability to pass on our hard earned money at a lower tax penalty is a significant bonus. Even f we end up drawing against it ourselves having the money available at the much lower overall rate would feel great.

Quote:

Originally Posted by RunningBum Somebody tell me if this person (I tried about 5 different words here but all of them would probably get me in trouble) ever posts anything of substance. All I see are insults, and nothing at all to back his claims. Welcome to my ignore list.

The self proclaimed (I read his profile when he first started posting) troll is a waste of space. I wish you would all quit quoting him. Then I could truly ignore him.

[samclem]

Quote:

Originally Posted by CardsFan As far as converting in the 22% bracket, that is a lot more iffy in terms of tax savings. I am not inclined to simply pre-pay taxes for DS. That said, we will likely get hit with the tax torpedo at RMD age no matter what we do. We may decide to increase our charitable donations. But when all is said and done, if one or both of us is in the 35% tax bracket due to RMD's, well, we won the game .

This is a point that I think sometimes gets overlooked. DW and I won't be converting (i.e. pre-paying taxes) if the projected advantage isn't quite significant. For us that means we won't go beyond the top of the 15% 12% bracket. We've got a long road to travel on this retirement path, and keeping that extra $$ in our accounts rather than using it to pay taxes could provide an important cushion. If our investments do poorly, then our "take" will be lower in $$ every year and the proportion of withdrawals at low tax rates will be even higher. And if our investments do great and we pay more taxes as we near the finish line when we know our money will not run out anyway, then that's okay.

[RetireBy90]

Quote:

Originally Posted by samclem This is a point that I think sometimes gets overlooked. DW and I won't be converting (i.e. pre-paying taxes) if the projected advantage isn't quite significant. For us that means we won't go beyond the top of the 15% 12% bracket. We've got a long road to travel on this retirement path, and keeping that extra $$ in our accounts rather than using it to pay taxes could provide an important cushion. If our investments do poorly, then our "take" will be lower in $$ every year and the proportion of withdrawals at low tax rates will be even higher. And if our investments do great and we pay more taxes as we near the finish line when we know our money will not run out anyway, then that's okay.

Since there are many different people on the list, once we get past basic textbook answers, past the math, we can have different conclusions. Reading just this thread, there are different objectives, so different answers.

Sounds like it works for you, so it is the right answer. I try to make sound financial decisions, but sometimes sleeping at night tells me to do something different. Each decision is personal and what is right for you may not be right for anyone else. Drive on !!

[Scuba]

Quote:

Originally Posted by RunningBum OK, if you think you'll leave a lot for heirs, AND they will be in a lower tax bracket then you are now, then maybe it makes sense to not convert. It sounds like this may be your case. If they aren't going to be in a lower tax bracket, I don't see why you wouldn't go ahead and convert if it's favorable to you, and go ahead and spend some from that Roth. Just because your CPA says many investors don't tap into it doesn't mean you can't. I'll probably tap my Roth before I sell my highly appreciated taxable assets, so I can avoid paying LTCG taxes that my heirs won't have to because of step-up basis on inheriting taxable accounts. Also consider that after 70 you start paying MRDs, so you may wind up paying a good part of those taxes anyway. I don't put any importance in delaying paying taxes vs. paying them now. What I look at is, if I wind up draining all of my assets, how will I get the most out of them, considering taxes paid, and return on investments, including the extra return on taxes deferred. If you want to consider heirs, you can look at the same scenario for how to maximize you money assuming they will drain those assets, which they likely will have to due to inherited RMD rules. It could be, that if their prospects for making income aren't good, that it's better to let them inherit a tIRA and let them pay the taxes at their lower rate, but if they decide to take it as a lump sum they'll get hit hard. If it comes out better for myself or my heirs to pay some taxes now, I'll do it. It doesn't bother me in the least if I'm spending my money to pay taxes for my heirs, because I'm going to spend whatever I'm going to spend, and with pre-paying taxes I may leave them a little less, but in a better tax situation. So they'll still win, and not at my expense. If you think you simply won't spend from your Roth because it's tax free growth, then I can't help you. You are no longer making a financial decision. If I'm missing something, I'd like to learn what. Wait! You said in post 26 you don't have heirs, and now you're saying you do. I think I just wasted my time. I guess it gave me time to think through the inheritance angle, but I don't think my son will be in a lower tax bracket than I'm in now so I don't think it changes my plan.

I suppose it depends on what you mean by heirs. We don’t have children, nor is there anyone in our lives we feel obligated to leave money for when we die. However, our estate does have designated beneficiaries. We were willing to pay a small four figure amount to set up a trust to maximize the after-tax inheritance they will get. However, we aren’t willing to pay five or six figures of income tax from our portfolio in order to do Roth conversions so that our beneficiaries won’t have taxes on their inheritance when we’re dead.

And as I said previously, so far since our ER, our tax bracket has not been at a lower level than we expect it to be in the future, so there has not been any reason to convert. We’ll see if that changes in the future.

[MrLoco]

One thing folks may not be aware of:


On Sept. 21, 2016 the Senate Finance Committee voted 26-0 to "kill the stretch IRA" provision on inherited non-spousal IRA's. Thankfully, this was not voted into law at the time, but could in the future. Why is this important?


Like many, my wife and I have worked hard and squirreled away enough thru 401k's and IRA's that the amount is more than we could have anticipated. And like many, we would like to leave some to the children.



If the stretch IRA provision is ever done away with this leave two options. Heirs can take the money all at once or over a 5 year period. And there is a $450,000 exemption (which is paltry). So if a parent leaves a $2 million Trad. IRA to a child/grandchild....$1.5 million would need to be taken over a 5 year period no later than Dec. 31 the year following the original IRA owner's death. This would place most heirs of the inherited IRA in the highest (or close to it) tax bracket.Obviously, a money grab by Uncle Sam. And even if all the money was in A ROTH IRA....no taxes would be due, but the heir would still be required to liquidate the IRA within 5 years.....giving up perhaps decades of additional tax free growth.


Just another wrinkle.

[pb4uski]

^^^^^ I would have no problem with tamping down the stretch IRA... the original intent was to provide tax benefit to the worker/saver... not to their heirs.... and a $450k exemption is pretty generous. Hardly a "money grab".

If I were king I would make it $250k exemption and the rest over up to 10 years.

[samclem]

Quote:

Originally Posted by pb4uski ^^^^^ I would have no problem with tamping down the stretch IRA... the original intent was to provide tax benefit to the worker/saver... not to their heirs.... and a $450k exemption is pretty generous. Hardly a "money grab". If I were king I would make it $250k exemption and the rest over up to 10 years.

I would think it most equitable to make this and other changes in such a way that folks don't get penalized for making decisions based on the old rules. So, say, the ability to pass along unlimited IRA holdings and proceeds from them that exist on the date the legislation passes would remain in place, new monies could be passed along under the new, more restrictive rules. Or, at very least, give people a significant window to adjust to the new rules. One person's "money grab" is another's "fair and reasonable adjustment," but making the rules "prospective" rather than affecting dough that has already been committed in a certain way under the old rules has merit, IMO. Nobody truly knows what the "intent" of the government was when the original law was passed, every legislator surely had a slightly different intent. All we can do is look at the law and the implementing rules and try to work with them.

[joylesshusband]

ignore at will, but I suspect you might agree with the simple concept that the more you spend, the less is left to compound.
It is hardly incomprehensible or "of no substance".
The amount of X paid today in annual tax is much more important than the same amount paid some 15 years later. It kind of hurts today's portfolio while it would barely move the needle later on.

samclem gets it (see post #71). He has drawn a line on how much to convert, as higher annual conversions (and tax paid on these) reduce the utility of the current portfolio to a uncomfortable level, while in later years (after starting the RMDs) the tax rate may be higher, but the overall utility of the portfolio is lessened (due to its increased size and retiree's lower needs) and the tolerance to spending a bit more in income tax at that stage is much more relaxed.
This utility (or value as I called it earlier) of keeping more money in the portfolio is much more pronounced during the first few years in retirement, as those years carry the highest exposure to the sequence of returns risk.
samclem's decision is not based merely on the tax rate arbitrage criteria, but also on factors like portfolio size and chances of survivability (in the military sense of remaining "mission capable")
So is mine.
Quantifying this though is a bear, and I admit I'm having hard time with the details.

[MrLoco]

Quote:

Originally Posted by pb4uski ^^^^^ I would have no problem with tamping down the stretch IRA... the original intent was to provide tax benefit to the worker/saver... not to their heirs.... and a $450k exemption is pretty generous. Hardly a "money grab". If I were king I would make it $250k exemption and the rest over up to 10 years.

Well....ummmm...of course you have no problem with it because most likely it does not affect you or your family. Just like I have no problem if welfare benefits are cut since I don't collect welfare ( but I do pay for them). We are all concerned primarily with those financial scenarios that most affect our own situation.


And I disagree. A $450,000 exemption is paltry if one has millions in an IRA. Should be more.

[pb4uski]

Actually, it may affect me and my family depending on how long I live.

I doubt that many here expected the tax deferral benefit to extent beyond the grave to future generations... that is why they called it an individual retirement account. While I expected that tax deferral benefits would extend to my spouse, I didn't expect it ti extnd to my kids or grandchildren.

Pigs get fat, hogs get slaughtered. Don't be a hog.

[Dtail]

Quote:

Originally Posted by joylesshusband ignore at will, but I suspect you might agree with the simple concept that the more you spend, the less is left to compound. It is hardly incomprehensible or "of no substance". The amount of X paid today in annual tax is much more important than the same amount paid some 15 years later. It kind of hurts today's portfolio while it would barely move the needle later on. samclem gets it (see post #71). He has drawn a line on how much to convert, as higher annual conversions (and tax paid on these) reduce the utility of the current portfolio to a uncomfortable level, while in later years (after starting the RMDs) the tax rate may be higher, but the overall utility of the portfolio is lessened (due to its increased size and retiree's lower needs) and the tolerance to spending a bit more in income tax at that stage is much more relaxed. This utility (or value as I called it earlier) of keeping more money in the portfolio is much more pronounced during the first few years in retirement, as those years carry the highest exposure to the sequence of returns risk. samclem's decision is not based merely on the tax rate arbitrage criteria, but also on factors like portfolio size and chances of survivability (in the military sense of remaining "mission capable") So is mine. Quantifying this though is a bear, and I admit I'm having hard time with the details.

I have a question for you.
Would you say conceptually that if one believes they will at least be in the 22% future bracket, then one should fill at least the 12% bucket now?
I guess assigning a ROR to the taxes saved by not converting now vs. the 10% tax differential brackets in the future would be difficult to quantify?
Of course, this assumes that tax rates remain the same (can't imagine them going lower in the future).