Roth Conversions IRMAA, SS Tax

[Woodman53]

Hi Everyone,

I have been reading the forum for many years and finally joined today. This is a great forum and is always very interesting. Love all the topics that are presented.

Let me tell you about myself. I took a buy out and retired in 2014 at age 61 from a mega corporation and then they called me back in 2016 for a three-month assignment that ended up lasting until December 2022. It was all good as they paid me well and I got to make my own hours. Sometimes I worked from home and sometimes I went in. Worked about 20 hours per week. This allowed me to bridge to Social Security and I will not take it until I reach 70 in October of this year.

My question is about Roth Conversions.

I would like to do about a $750,000 in Roth Conversions. But as I do the math it gets very complicated because of the IRMAA, Federal Tax Brackets and the taxing of Social Security Income. I always thought that 85% of my Social Security income would be taxed. My income is composed of a $60,000 Non-Cola Pension and $73,000 Social Security Income (spouse and myself) for a total of $133,000. I always assumed that 85% would be taxed as my pension income was over $45,000. But I found out this is not actually the case after running it through an online calculator and completing the IRS form found in the 1040 instructions. If these are my only two sources of income, then approximately 69% of my Social Security will be taxed. So that means instead of $62,050 (85%) only $50,370 (69%) will be taxed. A tax savings of ($62,050 - $50,370) * 22% = $2569. So, the faster I can complete the conversions the faster I can start to receive this tax savings because when I am doing the conversions 85% of my Social Security will be taxed.

I originally ran two scenarios;

No.1 - Convert to just below the first IRMAA limit $194,000. This would take 11 years.

No. 2 - Convert to the top of the first IRMAA limit $246,000. This would take 7 years.

I also assumed that the IRMAA limits would increase by 2.5%/year, in Scenario No. 2 some of the income would be taxed at 24% and I would be doing RMDs starting at 72.

Not factoring the impact on taxable Social Security Income Scenario No. 1 was better.

Taking in account how Social Security will be taxed scenario No. 1 and 2 seem to be about equal or No. 2 looks slightly better.

Many of you have run these numbers. Does this sound correct. Any direction you can give me will help.

Why do they make this so complicated. I did not think there would be math in retirement.

Thanks for reading.

 

[Time2]

I don't know where you have your $750k, but if it is in the stock market, have you factored in that the money could grow faster than you can convert it, in your tax bracket of choice? A problem, but a nice one to have. Other than that, I can't be of any help.

 

[Woodman53]

Thanks for reading. I factored in that the 750K would grow by 5.1%. It is in traditional IRA.

I also factored in that IRMAA brackets, tax brackets and IRMAA penalties would grow by 2.5%.

 

[RunningBum]

Have you factored in that the SS taxation numbers are not inflation indexed? As inflation increases your SS benefit, more of it will be taxed. If you want to take advantage of having less than 85% of your SS taxed, you might want to skip Roth conversions and wait until RMDs hit since you aren't too many years from that, right? I bet RMDs alone push SS into the full 85% tax, won't they?

Once RMDs start, it's not clear that conversions really help, since your taxable income and rate will probably never be lower. Maybe converting up to the top of a tax bracket or IRMAA tier will help some.

Are their heirs who will be in a higher tax bracket, such that conversions help them? If they will be in a lower bracket, consider letting them pay the tax.

You will also be able to do charitable giving via QCDs at 70.5, which is a very tax efficient way to give.

Also consider that if either or both of you have high medical costs later, perhaps with assisted or memory care, you can write off a lot of tax deferred withdrawals with the medical expense deduction.

Don't get me wrong, I'm usually a big fan of conversions. One big advantage to converting is it gives you flexibility to take a large withdrawal for whatever purpose you need it, and not pay additional taxes. If you had to take it from deferred income you would pay a higher rate with the income spike.

It looks like you are doing a good analysis and not just trying to let SS taxation rule your strategy, right?

Weyers Cave, eh? I might be one of the few here who know exactly where it is without looking at a map. Howdy, neighbor, I'm about an hour south of you.

 

[RetiredHappy]

I just to make sure that I am clear. In 2014 and you were 61. Right now you are already 70 and RMD will kick in a couple of years' time.

https://www.ssa.gov/benefits/retire...and $34,000, you,your benefits may be taxable.

85% of your Social Security income is taxable when you and your spouse have a combined income of $44K or more when filing jointly. Not to mention, when you do RMD or conversions, those are counted as income.

I cannot help on your ROTH conversion. I see it as a personal choice. If we were to convert now, we pay 24%. Pay now or pay later makes no difference to us. So we pick status quo.

 

[SevenUp]

...they called me back in 2016 for a three-month assignment that ended up lasting until December 2022. It was all good as they paid me well....

...and now you have the problem of too much income.

I would like to do about a $750,000 in Roth Conversions. But as I do the math it gets very complicated because of the IRMAA, Federal Tax Brackets and the taxing of Social Security Income.

Roth Conversion with Social Security and Medicare IRMAA has instructions for using a tool that considers all of those.

I originally ran two scenarios;
No.1 - Convert to just below the first IRMAA limit $194,000. This would take 11 years.
No. 2 - Convert to the top of the first IRMAA limit $246,000. This would take 7 years.

Worth pushing through the Social Security hump and/or IRMAA cliffs? addresses this issue.

You can thus calculate your marginal tax rates for different conversion amounts. You'll have to do that piece by piece.

E.g., converting $5000 costs 22.2%. Let's say you decided to do that much.

Now, a separate decision is needed for converting more than that. The first $8000 extra costs 40.7%, so doing only that much is almost certainly not worthwhile, but an extra $86K (to just below that IRMAA tier) costs "only" ~24%.

Let's say you decided to do that much. Then you need to check the marginal rate for converting through that IRMAA tier up to the next one. And so forth.

You now come to what may (or may not) be the trickiest part of the whole process: estimating what marginal rate you (or the surviving spouse, or the heirs) will pay on future withdrawals, so you can compare current vs. future rates and make your choice.

Does that make sense?

 

[Woodman53]

Hi Retired Happy,

Thank you for your response.

I also though "85% of your Social Security income is taxable when you and your spouse have a combined income of $44K or more when filing jointly." If you look closely, it says may be taxed. If you run the calculation with my scenarios only 69% is taxed and as the Social Security income increases because of inflation and the taxable brackets for the Social Security income do not the actual amount that is taxed goes down.

 

[SevenUp]

https://www.ssa.gov/benefits/retire...and $34,000, you,your benefits may be taxable.

85% of your Social Security income is taxable when you and your spouse have a combined income of $44K or more when filing jointly.

That's not necessarily true. As the linked document says, up to 85% is taxable in that case.

Taxation of Social Security benefits - Bogleheads goes into more details.

 

[Exchme]

I checked OP's SS taxation and he is correct, only 69% is taxed, he can stand another $13,440 before SS is taxed at 85%. Put differently, the next $13,440 has 1.85 times it's normal tax rate of 22%, so would be a 40.7% marginal rate - ouch! The only way I could see pushing through would be if later in life you will be in the 32% or higher bracket, say after one of you passes. But I don't think that's the case based on what I see.

Once RMDs start, you could consider doing as RunningBum suggested, converted to the top of whatever IRMAA tier/tax bracket you are in, sometimes that can keep you from tripping over an IRMAA tier in the future or help lower the taxes for the surviving spouse after one of you passes.

Note: I was a little surprised given OP's backstory that there are no LTCGs, dividends, interest?

 

[SevenUp]

I checked OP's SS taxation and he is correct, only 69% is taxed, he can stand another $13,440 before SS is taxed at 85%. Put differently, the next $13,440 has 1.85 times it's normal tax rate of 22%, so would be a 40.7% marginal rate - ouch!

The first $5K would be hit with "only" a 22.2% marginal rate. The case study spreadsheet is a useful tool to show marginal rates in chart form.

Note: I was a little surprised given OP's backstory that there are no LTCGs, dividends, interest?

Agreed. Those could make the marginal rates even more unusual. See chart below from the Bogleheads' SS taxation article (not OP's exact situation, just an example):