Roth Conversions and the Tax Torpedo

[RASAP]

DW and I were late to the game when it came to doing our Roth conversions. If it were not for the great people here we probably would have never started and we would still be reveling in paying little or no federal income tax.

We have been doing some small conversions (25k to 35k) for the past few years. I will be 71 (DW 68) this year so it looks like we have 2 more years to do some conversions before the RMDs start. For the sake of this discussion, let's assume all future tax rates will be the same as they are now. Our annual income is Social Security ($68k), some dividends ($15k of which about 75% are qualified) and a bit of interest ($200). When I run the numbers for Roth conversions, it looks like I can convert around $44k at a marginal tax rate of 22% before the torpedo hits. Then the MTR jumps to 50% from $45k to $55k where it then returns to 22% for well past where IRMAA would come in to play. My calculations indicate that the torpedo cost and additional $2,500 if I converted past the $55k mark (as compared to the MTR staying constant at 22%). What I can't seem to wrap my head around is whether or not to stop the conversions at $44k or blow past that to the point where IRMAA starts to play a role. I can pay the taxes with non-IRA funds. As it stands right now, if I don't do any more conversions, my RMDs will have me taking about $15k more than I need/want in 2025.

 

[Dash man]

DW and I were late to the game when it came to doing our Roth conversions. If it were not for the great people here we probably would have never started and we would still be reveling in paying little or no federal income tax.



We have been doing some small conversions (25k to 35k) for the past few years. I will be 71 (DW 68) this year so it looks like we have 2 more years to do some conversions before the RMDs start. For the sake of this discussion, let's assume all future tax rates will be the same as they are now. Our annual income is Social Security ($68k), some dividends ($15k of which about 75% are qualified) and a bit of interest ($200). When I run the numbers for Roth conversions, it looks like I can convert around $44k at a marginal tax rate of 22% before the torpedo hits. Then the MTR jumps to 50% from $45k to $55k where it then returns to 22% for well past where IRMAA would come in to play. My calculations indicate that the torpedo cost and additional $2,500 if I converted past the $55k mark (as compared to the MTR staying constant at 22%). What I can't seem to wrap my head around is whether or not to stop the conversions at $44k or blow past that to the point where IRMAA starts to play a role. I can pay the taxes with non-IRA funds. As it stands right now, if I don't do any more conversions, my RMDs will have me taking about $15k more than I need/want in 2025.

Look out about 10-15 years to see what your RMDs will be. That’s where it really hurts.
Also consider the impact of one of you passing and having to file as an individual.
Those two things made me decide to convert aggressively for a few years.

 

[SevenUp]

In 2023, you could convert a little over $50K (assuming the $68K SS is for 2023) before the jump from 22.2% to a 50% marginal rate.

If you believe paying a 22.2% marginal rate is worthwhile, then do the $50K conversion.

Having made that choice, now you have a new choice: how much more, if any, to convert? The marginal rate on the new choice depends on how much you are willing to convert, and drops to ~24% if you convert ~$86K more, up to but not over the first IRMAA tier.

Does paying a 24% marginal rate to convert look desirable or undesirable to you?

 

[JBTX]

https://www.bogleheads.org/w/images/6/6a/SSHeatMapMFJ2023.png

This graph seems to generally confirm your assumptions.

 

[Exchme]

I get that you could do about $10K of conversions and owe zero taxes.

The next $12K Roth Conversion ($22K 10% bracket size/1.85) is at 10*1.85 = 18.5%, so total conversion so far is $22K.

The next $29K Roth Conversion is at 12% x 1.85 = 22.2%, total conversion so far is $51K.

The bad juju is the next $5K that will be at 37.2% since LTCG's are taxed at 15% while SS taxation is also still being phased in. The extra tax (above the 22.2% rate) is about $750. Total Conversions so far are $56K

At that point, the maximum 85% of SS is taxed. There is another $7K of rough sailing at 27% until all your LTCGs are taxed. The extra tax (above 22%) in that range is $350. Total Roth Conversions so far are $63K.

Conversions above that are taxed at 22% until you hit the top of the IRMAA tier.

 

[pb4uski]

.... As it stands right now, if I don't do any more conversions, my RMDs will have me taking about $15k more than I need/want in 2025.

But what tax bracket would that put you in for 2025 and beyond... and more specifically, what would be the tax rate on your RMDs [(tax after RMD less tax before RMD) divided by RMD]?

 

[RASAP]

But what tax bracket would that put you in for 2025 and beyond... and more specifically, what would be the tax rate on your RMDs [(tax after RMD less tax before RMD) divided by RMD]?

As best as I can tell, I'll still be at 22%.

 

[pb4uski]

So then arguably it is a tossup to pay 22% today to avoid paying 22% later... actually a slight benefit since you are using taxable funds to pay the RMD taxes.

However, some reasons to do more conversions now might be if one of you dies then the surviving spouse may be in a much higher bracket when RMDs happen (assumes you surviving spouse is your beneficiary), if your beneficiaries are in high tax brackets, the likelihood of higher tax rates in the future, etc.

 

[Al18]

According to the CBO: https://www.cbo.gov/budget-options/58634
Through calendar year 2025, taxable ordinary income earned by most individuals is subject to the following seven statutory rates: 10, 12, 22, 24, 32, 35, and 37 percent. At the end of 2025, the rates will revert to those in effect under pre-2018 tax law. Specifically, beginning in 2026, the rates will be 10, 15, 25, 28, 33, 35, and 39.6 percent.

 

[RetireBy90]

Like many, I also run spreadsheet to help decide how much to convert. Last 2 years I blew through IRMAA limits to pay an extra $170*2 or $340 per month. I was upset at myself first year we had to pay the extra but looking at it from a distance $340*12 months =$4,080 which is less than extra tax I hope to avoid with taxable RMDs. 2 years allowed me to get a big part moved, about $300K. Now I’m back to smaller conversions of $70K or so to avoid that level of IRMAA. My point is one or 2 years of extra $4K I needed to take in view of tax savings from RMDs and that single taxpayer rate later. Just one case, each is individual.

 

[sengsational]

If you haven't done it, you can run i-orp. Use the nerd version (this has more inputs, but more accurate). It will probably be aggressive in conversion. It's not got detailed federal tax calculations, so just take it as one data point. I use it with Roth conversions "unlimited" and "off" and get an idea of the magnitude of the tax play. In my case, it's not very significant if we both live a while longer, but worth the trouble, for sure, if there's only one of us knocking around after an early departure.