Roth Conversions make sense?

[RunningBum]

Just curious how others think about sequence of returns risk during their first years of FIRE before RMDs start? I’m open to Roth conversions but there also seems comfort in keeping as much money invested as possible in those first 10 years of FIRE vs. paying it out in taxes. I know everyone’s financial situation and risk tolerance and ACA management is different.

I'm probably not a good one to respond because I never altered any strategy due to SORR, but even if I did, I don't think I would've done anything different for Roth conversions. As pb4 says, the tax advantage for many of us, myself included, makes up for most possible losses. And while it'd be nice to do a conversion at lower prices if a downturn happens, the more likely prospect is that the market will generally go higher, which means I'm going to be paying more taxes later on the gains.

 

[downrod]

^^^ You got it. I'm just curious... were you talking with your Vanguard advisor about doing Roth conversions now while you are still working or once you retire?

I brought it up as a general question. I really didnt specify. He doesn't think it is a good idea for most people

 

[pb4uski]

I brought it up as a general question. I really didnt specify. He doesn't think it is a good idea for most people

Send him a link to this thread.

 

[mountainsoft]

I am currently less than 4 yrs from retirement. I am doing a lot of reading about withdrawal strategies and it sounds like Roth conversions are a big part of the picture for many people.

I don't understand what the factors are that make a Roth conversion make sense and when it doesn't. I would appreciate any help. Thanks!

Roth conversions make the most sense if you expect to be in a higher tax bracket after retirement. Pay the taxes now at a lower rate, so you won't have to pay them later when you're at a higher rate.

In my case, I'm just over four years from retiring and am doing annual Roth conversions now while we're still working and have extra money to pay the taxes. We're in the 12% bracket now and expect to be in the same 12% bracket in retirement. So there's no advantage to converting from that point of view. However, tax rates are low today and will most likely increase in the future. I would rather pay today's tax rate instead of tomorrow's tax rate.

Roth's don't require RMD's, and also don't count as income for calculation of SS taxes or for Medicare. The money can sit in your Roth account the rest of your life if you wish.

I contribute to my Roth now and only have about $70K left in my traditional IRA. I'm converting about $15-20K per year over the next few years, to stay within our current 12% tax bracket. Then we may have a year or two left on the traditional IRA once we retire.

 

[FIREchief]

I brought it up as a general question. I really didnt specify. He doesn't think it is a good idea for most people

Any advisor who is paid based upon AUM has a financial incentive to discourage Roth conversions. If I prepay my 22% taxes now, my $78 in the Roth is worth the same to me as that original $100 in my tIRA. However, my AUM-paid advisor just took a 22% pay cut. I've seen many reports of AUM based advisors discouraging Roth conversions for everybody. I believe that this is the primary reason.

 

[copyright1997reloaded]

There is another possible issue with Roth conversions when you have other income sources (e.g. ordinary and capital gains/qualified dividends)...the issue with "bumps" where additional ordinary income (such as comes from a Roth conversion) impacting capital gains/qualified dividend rates:

https://www.kitces.com/blog/long-term-capital-gains-bump-zone-higher-marginal-tax-rate-phase-in-0-rate/

And there are huge potential issues when one is also drawing social security:
[QUOTEChandler and Monica are retired, and thanks to the fact that both had successful careers, are each eligible for nearly $2,400/month in Social Security benefits. And because Chandler is 4 years older, his Social Security benefits have been further increased to $3,168/month with delayed retirement credits.

In addition to their combined $5,568/month ($66,816/year) in Social Security benefits, the couple is also drawing $28,000/year from Chandler’s IRA (due to required minimum distributions), and liquidated another $32,000 in long-term capital gains this year.

...
Accordingly, if the couple were to withdraw another $10,000 from their IRA while they are current in both the Social Security phase-in zone and the capital gains bump zone, not only would their ordinary income increase by $10,000, but the taxable portion of their Social Security would also increase by $8,500, and $10,000 of their long-term capital gains would be pushed up into the 15% zone.
...
Which means their $10,000 of additional income generated $11,526 – $6,531 = $4,995 of additional taxes… or a whopping 49.95% marginal tax rate, due to the combination of Social Security benefits phase-in, plus the capital gains bump zone (and the interaction effect between the two!).
[/QUOTE]

 

[Paulz]

One thing I haven't seen anyone mention is the effect of the Trump tax bracket changes. Converting now verses in 2026 would result in a roughly 4% reduction in tax rates. Just doing the conversion now, even if working and everything staying the same, should result in lower taxes.

 

[RockLife]

Exactly This

I retired at age 57 so I guess that's still considered "early." I am doing Roth Conversions from my IRA but actually smaller amounts because I am choosing to keep my taxable income lower (to qualify for ACA subsidies). Every little bit converted to roth helps, just makes sense to do it when you won't get a big tax ding for doing so.

I'm playing this game as well. Retired at 56, doing Roth conversions now while my income is so low. We're basically living off savings and our taxable income is only what's coming out of our taxable accounts. So trying to improve this situation:

Currently at 34/48/18 Taxable/Tax-Deferred/Tax-Free.

The idea is to get that Tax-Deferred amount down while deferring taking SS, which will make the conversions, well, not make any sense. And then at 70.5 we won't have such a big tax burden - trying to keep it in the 12% bracket.

And as you mention, there's the ACA subsidy game, trying to keep that where we want it as well. It's kind of like walking a tightrope while herding cats down the rope, with a hyperactive pitbull joining the party. Fun!

 

[RockLife]

I brought it up as a general question. I really didnt specify. He doesn't think it is a good idea for most people

Tell him you don't care about most people. You care about you, and would like a reasoned plan that meets your needs. There are other advisors you know.

 

[ERD50]

I brought it up as a general question. I really didnt specify. He doesn't think it is a good idea for most people

Send him a link to this thread.

[edit - I see I cross posted with RockLife - great minds think alike and all! ]

And tell him you don't care if it is or isn't a good idea for most people. You want to know if it is a good idea for you.

It's an interesting way to phrase it. It probably is true, so maybe that helps him say it with a straight face. But it may not be relevant to your situation. The following may explain his hand-waving approach:

Any advisor who is paid based upon AUM has a financial incentive to discourage Roth conversions. If I prepay my 22% taxes now, my $78 in the Roth is worth the same to me as that original $100 in my tIRA. However, my AUM-paid advisor just took a 22% pay cut. I've seen many reports of AUM based advisors discouraging Roth conversions for everybody. I believe that this is the primary reason.

-ERD50

 

[BoodaGazelle]

Unless you have guaranteed health care from some source other than ACA, you will want to live off of your non-deferred savings until you get to Medicare, otherwise you could end up with very large HI payments. This causes a "no win" situation if you (like me and others) want to both 1) convert as much as possible to Roth and 2) keep your MAGA as low as possible for ACA subsidies.



As far as I have been able to determine, there is *no* way to square this circle. My ACA subsidies are so good that I have decided to hold off on Roth conversions and to try and wait until I reach 65 (currently 63).


The bottom line is, if you are going to FIRE, you almost certainly have enough money to where you will want to have as much as possible in Roths (assuming you live long enough past 71).

 

[SoReady]

My ACA subsidies are so good that I have decided to hold off on Roth conversions and to try and wait until I reach 65 (currently 63).

I'm at the same age and trying to do the same thing. But what I recently realized is that my wife being 2 years younger means I still need to play the ACA game until I'm 67 (ACA calculated on household income). This reduces the number of years I can do Roth conversions.

In reading some of the posts here I picked up on the idea of forgoing the subsidies for a year and going to the 22% or 24% (maybe higher) tax bracket to get as much Roth conversion done as possible. I'm still mulling over this idea and trying to figure how to determine the cost benefit based on numbers. As someone else here always says "numbers are hard"!

Bob D

 

[RetireBy90]

One other advantage to ROTH over traditional is that if you want to make a large or even medium purchase, and you take say $35k from TIRA, you may get jacked into higher marginal tax rate. With the ROTH you can take none or all any time (after 5 year rule) with no tax implications.

 

[Indiana Randy]

Good Old Advise

Lots of good replies here. Most all leaving out the Important factor when the OP or anyone else made the decision between Roth VS Traditional IRA

Those that chose the traditional IRA received Tax Benefits for doing so. Isn't that of some value? Of course it is.

Any Roth Conversion is Really agreeing to Pay My Taxes NOW, instead of Later.

Depending upon the age of the account holder, it's NOT always a good idea.

Be Cautious about jumping on the Convert To Roth Bandwagon


Let me say this another way- If you're OLD, don't worry about or consider converting to a Roth IRA.

 

[RunningBum]

Lots of good replies here. Most all leaving out the Important factor when the OP or anyone else made the decision between Roth VS Traditional IRA

Those that chose the traditional IRA received Tax Benefits for doing so. Isn't that of some value? Of course it is.

It's only a temporary tax benefit. Eventually you'll pay the taxes. The question is, at what rate? Compare to your current rate.

Any Roth Conversion is Really agreeing to Pay My Taxes NOW, instead of Later.

Depending upon the age of the account holder, it's NOT always a good idea.

Be Cautious about jumping on the Convert To Roth Bandwagon


Let me say this another way- If you're OLD, don't worry about or consider converting to a Roth IRA.

What does age have to do with it? Please explain. What age is considered OLD for this purpose?

Once you're taking SS and forced to take RMDs, the numbers for conversion probably no longer work, but that's a factor of the numbers, not age. The usual recommendation is to look at the years before then to convert anyway--if the numbers work.

Most of us make the conversion decision based on whether it's financially advantageous to do so, using our best estimates on what future income and taxes would be. It's not a bandwagon, it's sound financial decision making. If you think your "good old advise" is sound, please back it up with some proof and details. Because right now I'm not seeing any.

 

[Badger]

While working we put the maximum into our 403b accounts as well as Roth IRAs. Once we became aware of backdoor Roths we started moving funds that way as well. We were accumulating a large amount in the 403b accounts during this time without thinking about the effect it would have at RMD time but could not move as much as we wanted to the Roth accounts. Now as we take the RMDs we are in a higher tax bracket. It would have been nice to be able to invest more of that 403b money into Roth accounts but that was not part of the game rules.
Not complaining. I just didn't know of any other plan to use than what I described.


Cheers!

 

[pb4uski]

.... Any Roth Conversion is Really agreeing to Pay My Taxes NOW, instead of Later....

You're on the right track but you forgot to complete the sentence....

... Any Roth Conversion is Really agreeing to Pay My Taxes NOW when my marginal tax rate is lower, instead of Later when my marginal tax rate is higher...

.

 

[oldphd]

But what I recently realized is that my wife being 2 years younger means I still need to play the ACA game until I'm 67 (ACA calculated on household income). This reduces the number of years I can do Roth conversions.

Bob,

Look at the math for ACA once you are on Medicare and your wife isn't. You'll find that the amount you are expected to pay doesn't change, but it only counts toward your wife's insurance costs. None of your Medicare/supplemental costs. Effectively reduces the subsidy.

We are in the one on and one not yet on Medicare situation, and I find that the subsidy is so small, even with pulling every lever I can, that it's not worth it to me to give up the conversion.

Oldphd

 

[SoReady]

This is an excellent point. Is there somewhere/site that might help in estimating this?

 

[pb4uski]

This is an excellent point. Is there somewhere/site that might help in estimating this?

I've never tried it because neither of us are on Medicare yet, but the first one that es to mind is healthsherpa.com. Or you might ask your state exchange or a navigator.

 

[SoReady]

Thanks. The sherpa site was a great help in estimating her costs for the 2 years we are not on the same plans (her - ACA; me-Medicare). I can't believe how much more the premiums can be because just one of us on ACA while another on Medicare.

How about a site where I can get an estimate of my medicare costs. Do you know of any of those?

 

[H2ODude]

One of the things that strikes me is the fact that one of us will outlive the other, and that could happen in our seventies. When that happens, the income tax whammy we're trying to mitigate takes one large jump. Hence I've attached a (non-quantified) benefit to Roth conversions. Actuarially I'm not likely to care (we're the same age, I'm the guy) but she and or the kids will. Anyone else consider this?

 

[CardsFan]

One of the things that strikes me is the fact that one of us will outlive the other, and that could happen in our seventies. When that happens, the income tax whammy we're trying to mitigate takes one large jump. Hence I've attached a (non-quantified) benefit to Roth conversions. Actuarially I'm not likely to care (we're the same age, I'm the guy) but she and or the kids will. Anyone else consider this?

That is the one scenario that entices me to convert into the 22/24% bracket before RMD's, but I just can't seem to pull the trigger on that quite yet.

If the proposed changes to stretch tIRA happen, that might be the tipping point, as it could benefit both DW and DS, in the long run.

 

[Clone]

Anyone else consider this?

Until Dec 2025, the MFJ bracket for 24% goes up to $321451.

After Dec 2025, for a single filer, anything above 37950 gets taxed at 25%. Anything above $91900 gets taxed at 28%. If I croak (and if the tax rates revert), DW will be locked into paying an incremental rate of 28%.

Even if I hang in there, the MFJ rate is 28% for anything over 153100. If I do not aggressively do ROTH conversions, the RMDs will push us over that number. So it is predictable that our incremental tax rate is in that 28% range, and therefore we should aggressively convert now. Certainly to the top of 22% (and probably into the 24%).

The bracket numbers will index some, and it is possible that the tax rates will not revert. But it is probably smart money to aggressively convert now. All of my tax deferred money went in when our incremental rates were above 22%, so we are still coming out "in the tax game". If the markets continue to stay strong, we will still be paying a lot of taxes. I am OK with that.

 

[googily]

Until Dec 2025, the MFJ bracket for 24% goes up to $321451.

After Dec 2025, for a single filer, anything above 37950 gets taxed at 25%. Anything above $91900 gets taxed at 28%. If I croak (and if the tax rates revert), DW will be locked into paying an incremental rate of 28%.

This is why, as a widow at 52 who is still working, I am converting to the top of the 24% bracket. It's not just comparing the percentages, it's the crazy difference in income levels when the brackets revert. (Even if they change to something else, I doubt as a single filer I'll suddenly get any sort of break.)

If I convert a lot before survivor SS starts when I'm 60, I would probably be able to straddle the line near 25-28% until my mid 70s. I plan to use up my tax deferred monies during my 60s, so that my RMDs will be pretty small and the Roth hopefully won't be. [emoji16]