roth conversions - age related question

[perinova]

I have seen that some of you do yearly Roth conversions (while keeping below the ACA cliff). Can you explain why I would want to do that? Is it to mitigate the RMD of the traditional IRA over age 70 1/2? Is is to reduce taxes ina later year?
Another question comes to mind: Do you think it makes sense to put money in Roth IRA above age 70 1/2? For example reinvest the RMDs into a Roth?
Thanks!.
Perinova.

 

[SevenUp]

Last question first: RMDs are ineligible for Roth conversions, so that's that.

The strategy that provides the largest after-tax spendable income often is to take traditional withdrawals (converted to Roth or spent) when the marginal tax rate on the conversion amount is lowest.

It further often works out that approximately constant income leads to the lowest lifetime tax rates, so yes "mitigating RMDs" can be a good reason to convert earlier.

You pretty much have to evaluate things for you specific situation.

 

[kaneohe]

Last question first: RMDs are ineligible for Roth conversions, so that's that.

.......................................

also the first withdrawals from the TIRA are considered RMDs. If your RMD is 10K, you must withdraw 10K first. Then you could withdraw an extra 5K and convert that. You cannot withdraw the first 5K first and convert that into a Roth and then withdraw your 10K RMD later.

 

[mountainsoft]

I have seen that some of you do yearly Roth conversions (while keeping below the ACA cliff). Can you explain why I would want to do that? Is it to mitigate the RMD of the traditional IRA over age 70 1/2? Is is to reduce taxes ina later year?
Another question comes to mind: Do you think it makes sense to put money in Roth IRA above age 70 1/2? For example reinvest the RMDs into a Roth?

You can only contribute "earned" income (from a Job) to an IRA, so you can't use RMD's for Roth contributions. Of course, you could reinvest the RMD into a taxable savings or brokerage account, you don't have to spend it.

By the way, the RMD age has now been increased to 72.

As for converting a traditional IRA to a Roth in your 70's, it could be a benefit if tax rates increase in the future (likely). You would pay taxes at today's rate when you convert, instead of the new higher tax rate when you would otherwise withdraw from your traditional IRA.

If you convert before you start taking RMD's (or above your RMD requirements), you might be able to reduce or eliminate future RMD's.

I believe it's also easier to pass a Roth IRA to your heirs than a traditional, but I'm not clear on the details so you may want to research that. Someone else might be able to offer more info on that aspect.

 

[Out-to-Lunch]

The other big reason is if you are married, and filing taxes jointly now (MFJ). Upon the demise of one of you, the survivor will (likely) be filing taxes single, and regular withdrawals and/or RMDs could place the survivor in a high tax bracket.

 

[Time2]

I have seen that some of you do yearly Roth conversions (while keeping below the ACA cliff). Can you explain why I would want to do that? Is it to mitigate the RMD of the traditional IRA over age 70 1/2? Is is to reduce taxes ina later year?
Another question comes to mind: Do you think it makes sense to put money in Roth IRA above age 70 1/2? For example reinvest the RMDs into a Roth?
Thanks!.
Perinova.

I see the Roth Conversion as a we to reduce the amount you have in IRAs, thus 'mitigating" the taxes due on RMDs. Many can also keep there tax bracket lower when doing the Roth, than after they have SS and RMDs added to their income.

 

[VanWinkle]

You can only contribute "earned" income (from a Job) to an IRA, so you can't use RMD's for Roth contributions. Of course, you could reinvest the RMD into a taxable savings or brokerage account, you don't have to spend it.

By the way, the RMD age has now been increased to 72.

As for converting a traditional IRA to a Roth in your 70's, it could be a benefit if tax rates increase in the future (likely). You would pay taxes at today's rate when you convert, instead of the new higher tax rate when you would otherwise withdraw from your traditional IRA.

If you convert before you start taking RMD's (or above your RMD requirements), you might be able to reduce or eliminate future RMD's.

I believe it's also easier to pass a Roth IRA to your heirs than a traditional, but I'm not clear on the details so you may want to research that. Someone else might be able to offer more info on that aspect.

Although the non-spouse heir will be required to take withdrawals, they will be tax free. That is the advantage of using a Roth to pass assets to your heirs. A spouse can take the inherited Roth and combine it with their own so no required withdrawals.

 

[Markola]

Here’s how the blogger Darrow Kirkpatrick thought it through for his particular situation and decided there was no advantage. He links to Roth conversion calculators. https://www.caniretireyet.com/roth-iras-roth-conversions-needs/

 

[Out-to-Lunch]

Here’s how the blogger Darrow Kirkpatrick thought it through for his particular situation and decided there was no advantage. He links to Roth conversion calculators. https://www.caniretireyet.com/roth-iras-roth-conversions-needs/

That was a useful article, and I don't disagree with his thoughts. Note, however, that it was written before the TCJA. This changes the calculus of how likely it is that rates will change.

 

[pb4uski]

That was a useful article, and I don't disagree with his thoughts. Note, however, that it was written before the TCJA. This changes the calculus of how likely it is that rates will change.

From the article:

... Assuming that my tax bracket stays constant in retirement (more on that later), both of them report that I would be able to generate about 3% greater annual income if I convert our Traditional IRA to a Roth. That is provided I pay the conversion tax from non-IRA assets. If I pay the tax from IRA funds, there is no difference in the net value to me of doing a conversion.

... My spreadsheets show us maintaining our current 15% tax bracket, with headroom to spare, and project only a 2-3% benefit to net worth from doing Roth conversions. ...

That makes sense... the 2-3% benefit is probably the second order effect of avoiding tax on growth in the taxable account money used to pay taxes on the Roth conversion.

As I've said many times, Roth conversions are principally a tax rate arbitrage play... paying less now rather than more later... in our case, paying about 9% now (a blend of 0%, 10% and 12%) vs 22% or more later once SS and RMDs start... so in our case the saving have been substantial.

It sounds like in the author's case that his marginal tax rate in ER is the same as his expected marginal tax rate later in retirement, so there is no tax rate arbitrage to play.

 

[Out-to-Lunch]

As I've said many times, Roth conversions are principally a tax rate arbitrage play...

Yup! And I have agreed with you every time you said it!

It sounds like in the author's case that his marginal tax rate in ER is the same as his expected marginal tax rate later in retirement, so there is no tax rate arbitrage to play.

Yes. He makes this statement:

It makes little sense, in my opinion, for most near-retirees to assume their tax rates will rise.

And my point is that this may have been true in 2015, but in 2020, an increase in tax rates in 2026 is the current law of the land. It may or may not come to pass, but, I would say that it currently makes a lot of sense to think ones tax rates will rise.

 

[pb4uski]

It makes little sense, in my opinion, for most near-retirees to assume their tax rates will rise.

That makes no sense to me. There are thousands of early retirees who are similarly situated to us... living off of savings with reinforcements of pensions and SS coming later... that are in low marginal tax rates now but will be in higher tax brackets once pensions and SS start... for who Roth conversions are really compelling.

He's a pretty smart guy... why would he have not thought of such situations?

 

[Out-to-Lunch]

That makes no sense to me. There are thousands of early retirees who are similarly situated to us... living off of savings with reinforcements of pensions and SS coming later... that are in low marginal tax rates now but will be in higher tax brackets once pensions and SS start... for who Roth conversions are really compelling.

He's a pretty smart guy... why would he have not thought of such situations?

Yes, good points. (I am grateful to be in that position, too.)

I know I mentioned this already upthread, but I want to recast it in a slightly different way. We agree that Roth conversion is primarily a play on arbitraging tax rates, so higher rates in the future argue for converting now. Well, MANY people WILL assuredly find themselves in a higher bracket later than they are now, as a result of the demise of their spouse.

 

[RunningBum]

That makes no sense to me. There are thousands of early retirees who are similarly situated to us... living off of savings with reinforcements of pensions and SS coming later... that are in low marginal tax rates now but will be in higher tax brackets once pensions and SS start... for who Roth conversions are really compelling.

He's a pretty smart guy... why would he have not thought of such situations?

He says:

It makes little sense, in my opinion, for most near-retirees to assume their tax rates will rise.

That is likely true, if you haven't yet retired, your tax bracket is probably higher now that later.

But then he does on to talk about his own situation when he did retire early. In which case I agree fully with pb4's quote above.

Then again, maybe he's making as much money from blogging as he was before, though some might not call this retirement.

This part turned me off pretty quickly:

But first, be forewarned that I have a strong distaste for adding complexity and paperwork to my life just to save a few bucks. Especially if that payoff involves parting with my money sooner than later, or requires predicting the future accurately.

The author seems to scoff at increasing net worth only a few percent when they are older. That sounds like a great gain to me, for doing nothing more than a little paperwork to do the transfer and account for it in my tax return. Does he need something to double his net worth before he'll lift a finger?

And the parting with his money now argument is flawed too. You CANNOT access tax deferred money until you pay a tax on it. It is not all yours. Paying now vs. later is all baked into the conversion analysis.

You have to predict the future accurately? No, you just want to make a calculated estimate, really, just a direction of your tax rates. Given the national debt, do you think tax brackets in the future will be higher or the same? Will adding social security and RMDs put you in a higher bracket, or at least the same? If you're married, and one of you dies, will filing single for close to the same amount of taxable income put you in a higher or same bracket?

Note that even if you answer "same" to all questions, a Roth conversion won't lose you money. If you answer "higher", you'll do better. The only time you lose is if you answer "lower" to one or more of those questions, without balanced by a "higher" to another question. It doesn't require accuracy, just an idea of your personal tax situation with respect to questions like this.

The difficulty might come in trying to decide whether to go to the top of the 12%, 22%, 24%, or higher bracket with your conversion. Just because that's a harder question to answer doesn't mean you should do nothing. If you're pretty sure that conversions are a good idea, but not sure how much, you could be conservative and convert to the top of 12% or whatever bracket you are pretty certain to be worthwhile.

 

[karen1972]

Yes fundamentally it always about tax mitigation.

One example I always come back to is for me the Roth is there to smooth out the lumpiness. OP talks about the ACA Cliff and say I was managing up to the Cliff, everything was fine and then someone goes ahead and totals my car. So I need to go out and replace it immediately and maybe I dont' have cash on hand as it wasn't scheduled to be replaced for years. IF I have to dip into any account that creates a taxable event, I risk going over the ACA Cliff and it costs me a steep penalty (aka losing the subsidy). However, I have been doing conversions and have this huge sum of money sitting in my Roth readily available for withdrawal whenever I need it (assuming the 5 years has passed). Problem overted.

 

[Midpack]

If you expect lower rates after RMD/SS kicks in, they you probably don't need to convert, at least not over the 12% bracket threshold. If you expect higher rates once RMD/SS kicks in with passive income - I think everyone should consider doing Roth conversions to level your marginal tax rate ***. Then when/if tax rates increase, as I believe they have to in the long run, you'll save some. And it's also worth it to reduce taxes to surviving spouses, heirs/charities.

*** In my case I was paying at a 12% marginal rate for the next 7 years, and 25% for 23 years thereafter (assuming 30 year lifespan, and TCJA expiration in 2026). I am doing conversions now so I'll pay to the top of the 22% bracket for the next 7 years, and 15% for 23 years thereafter. It was a pretty easy decision for me once I had ALL the numbers in great detail, there was a long thread about it last Fall.

 

[CRLLS]

Quote:
It makes little sense, in my opinion, for most near-retirees to assume their tax rates will rise.

It makes little sense in my opinion, for most near-retirees, early retirees or even those already retired, to assume their tax rates will stay the same or go down. Giving the author the benefit of doubt, the detail is in the word "most" which is often overlooked. Each person's situation is different. Too many individual intertwined factors are out there for anyone to assume one is in the "most" category.

Personally, I have decided that if I don't do Roth conversions at least in the amount that my IRA grows each year, provided I watch out for the cliffs and such, I am not making enough progress to control my RMD's in the future, I will not stay out of the next tax bracket. When one of us passes and has to file Single, that adds yet another tax bracket situation. But as I say, that is my situation, not "most".