Roth Conversions - Much Ado About Little?

[RetireBy90]

Quote:

Originally Posted by BBQ-Nut Money has to come from somewhere to pay the tax on the amount of the conversion. So, depleting after tax assets or other accounts may be at risk, if needed to cover expenses, more so during a bad sequence of returns that it may never recover from. I don't think there is any one 'right' answer.

While I agree tax bill has to be paid from somewhere and there isn't any one 'right' answer, no matter when you take the money from taxable IRA/401K you will have to pay the tax.

2 points on this, and it is entirely personal to me, not the right answer for others.
1) If I take distributions from tax deferred account say from 60 to 70 then I MAY be able to pay a lower effective rate overall considering I will be required to take RMD at age 70. I will have a rental paid off when I turn 70 so I'll be paying a higher effective tax rate, and won't need the RMD money.
2) As others have stated, diversify between tax deferred and ROTH and taxable gives you options.

[NoiseBoy]

Thanks for posting the link. I read the paper and the charts and graphs really helped me understand the dynamics of paying taxes up front in order to differ or even avoid taxes later. Some food for thought in the article for me, as well as a reminder to run I-Orp. One issue I have with the calculator is that I have 2 pensions, one that I plan to start at 55, and one that I can't start until 62. Any ideas on how to model a different pension start age in I-Orp?

[sengsational]

Quote:

Originally Posted by Independent Is it using some very simple tax rule?

Not real nuanced, as far as I can tell. There is a table in the output that shows how much was untaxed, how much in the 10% bracket, etc. You might be able to use that to see if it's working as expected. My one wish is that we could enter the PPACA PTC amount, which, for early retirees, makes a pretty big difference in "taxes" (they pay ME!)

Quote:

Originally Posted by RetireBy90 ... large benefit to a ROTH is the elimination of unknown future taxes.

Good point. The assumption of tax increases through time might be a nice addition to the model.

Quote:

Originally Posted by RetireBy90 Feds go to a VAT or national sales tax and drop the income tax. Time to pay again

I hope there's an exclusion if they go that route. I think there would be riots by the AARP crowd if there wasn't a rebate for taxes already paid.

Quote:

Originally Posted by BBQ-Nut I don't think there is any one 'right' answer.

That's basically what the paper says. But if you look across a lot of scenarios, and accept the model's assumptions (admittedly kind of a big "if" when it comes to taxes staying the same), many of them don't have much payback.

Quote:

Originally Posted by NoiseBoy Any ideas on how to model a different pension start age in I-Orp?

You could calculate a present value of both pensions, then calculate an annuity starting in the year of the later one....that should be the conservative way to get that into the model.

[hnzw_rui]

Quote:

Originally Posted by RetireBy90 I hope to have it 50/50 by 70, and to live off RMD plus pensions and SS, leaving Roth to the kids.

Sounds like a decent plan, then.

[samclem]

It seems to me that future investment performance is >the< biggest unknowable in this "how much should I convert?" situation. It impacts the size of any future RMDs and the taxes to be paid on them. But, I know a few things:
1) If my investments perform poorly compared to my present expectations, I'll need the dollars to meet spending requirements and my marginal tax rate will be the same as my present rate or lower. I will be sorry if I converted too much and gave the dollars to the IRS in my earlier years.
2) If my investments have higher-than-expected returns, then I'll pay extra taxes on funds I didn't convert earlier, but the high returns mean I'll still have more money to spend than I'd planned on, so paying the taxes at this later time is not very painful. And--the uncertainty about portfolio returns and required spending decreases each year (as we approach our appointment with the grim reaper. A 60 year old needs to worry about returns/expenses for long timeline, a 90 year old--less so).

So, given the relative marginal utility of the dollars in each scenario, I bias toward converting less rather than converting more. The expected after-tax values in each case are not of primary importance, it is the expected utility of the remaining funds and the different "pain" of the tax bite. In my case, I will probably convert to the top of the 15% bracket (our present bracket), but not beyond that.

[Independent]

Along the same lines, GrayHare pointed out in another thread that you may incur tax-deductible medical expenses late in life.

For us, the "very bad" scenario is high nursing home expenses. But, under the right conditions, those nh expenses would be tax deductible. We could get IRA money without paying FIT. So:

1) In the good case, we have no nh expenses and the kids inherit money still in traditional IRAs.
2) In the bad case, we have significant nh expenses, but we at least don't have to pay taxes when we hit the IRA to cover them.

[harley]

I may being too simplistic, but since I was in the 25-28% tax bracket when I was putting the money into the 401(k) that later got rolled into a t-IRA, and I'm in the 15% bracket when I convert the money to a Roth, I don't see how I'm not saving money. Especially since I'm probably going to be back in the 25-28% bracket someday when SS and RMDs start.

I guess the way I look at it, if I put in $100K while in the 28% bracket I saved $28K in taxes. If it costs me $15K to convert it to a Roth (over a few years), I'm $13K ahead. And that's not counting the tax free money I'll make on it before I die or withdraw it. Am I wrong?

[sengsational]

Let's see... you didn't know for sure that you would be ahead or behind when you originally escaped paying 28% on it. You know you're ahead now if you take it out. You don't know you'll be as far ahead in the future. Sounds like a bird in the hand situation.

[pb4uski]

Quote:

Originally Posted by harley I may being too simplistic, but since I was in the 25-28% tax bracket when I was putting the money into the 401(k) that later got rolled into a t-IRA, and I'm in the 15% bracket when I convert the money to a Roth, I don't see how I'm not saving money. Especially since I'm probably going to be back in the 25-28% bracket someday when SS and RMDs start. I guess the way I look at it, if I put in $100K while in the 28% bracket I saved $28K in taxes. If it costs me $15K to convert it to a Roth (over a few years), I'm $13K ahead. And that's not counting the tax free money I'll make on it before I die or withdraw it. Am I wrong?

No, I agree with you. I have a fairly sophisticated projection of our retirement out to age 100 and while our NW with Roth conversions is not significantly different for 60-70, it takes off after then and is 50% higher with Roth conversions at age 100... I suspect the compounded impact of the lower taxes with Roth conversions vs without.

[sengsational]

High level of tax deductible medical costs, utility of the money if the market does one thing or the other...all things that I hadn't thought about that push away from an aggressive conversion strategy. That, coupled with the fact that i-orp tells me my situation is pretty close to a wash (presuming that big 'if' of tax rates staying the same), has me leaning towards a less aggressive conversion strategy.

[hnzw_rui]

Quote:

Originally Posted by pb4uski No, I agree with you. I have a fairly sophisticated projection of our retirement out to age 100 and while our NW with Roth conversions is not significantly different for 60-70, it takes off after then and is 50% higher with Roth conversions at age 100... I suspect the compounded impact of the lower taxes with Roth conversions vs without.

Curious, have you factored in results of reinvesting excess RMD in a taxable account in your NW projections? That's one thing I realized while doing my own projections. Just because you're required to take RMDs does not mean you have to spend all of it.

[grasshopper]

I have not seen this addressed before. Scenario you have started SS at 70, starting to take RMDs, you have 200K in LTCG, but you are already butting up against the tax bracket you converted Roths in. While you are more than likely to have boat loads of money with SS and RMDs, what to do about taking gains if you need to.

[hnzw_rui]

Quote:

Originally Posted by grasshopper I have not seen this addressed before. Scenario you have started SS at 70, starting to take RMDs, you have 200K in LTCG, but you are already butting up against the tax bracket you converted Roths in. While you are more than likely to have boat loads of money with SS and RMDs, what to do about taking gains if you need to.

Curious, why would you need to take gains? Given the step up in basis upon death, assuming SS and RMDs cover all your expenses, I'll just leave the taxable account as is.

[Options]

Quote:

Originally Posted by samclem It seems to me that future investment performance is >the< biggest unknowable in this "how much should I convert?" situation. It impacts the size of any future RMDs and the taxes to be paid on them. But, I know a few things: 1) If my investments perform poorly compared to my present expectations, I'll need the dollars to meet spending requirements and my marginal tax rate will be the same as my present rate or lower. I will be sorry if I converted too much and gave the dollars to the IRS in my earlier years. 2) If my investments have higher-than-expected returns, then I'll pay extra taxes on funds I didn't convert earlier, but the high returns mean I'll still have more money to spend than I'd planned on, so paying the taxes at this later time is not very painful. And--the uncertainty about portfolio returns and required spending decreases each year (as we approach our appointment with the grim reaper. A 60 year old needs to worry about returns/expenses for long timeline, a 90 year old--less so). So, given the relative marginal utility of the dollars in each scenario, I bias toward converting less rather than converting more. The expected after-tax values in each case are not of primary importance, it is the expected utility of the remaining funds and the different "pain" of the tax bite. In my case, I will probably convert to the top of the 15% bracket (our present bracket), but not beyond that.

This. Emphasis added.

Same plan of action here to convert to the top of the 15% bracket and not beyond.

[RetireBy90]

So if I am psychic and read between the lines correctly, sounds to me like many who have commented on this thread have most of RE assets in IRA, 401K, or taxable account. I have most expenses covered by 2 pensions and SS at age 70. We have retirement savings also, but kinda gives a different start point, my retirement savings will be some for living expenses before 70, then self insured for unknown expenses like LTC, but mostly to pass along to kids. So if they are to pass along does that change your conclusion about to ROT or not?

[pb4uski]

Quote:

Originally Posted by hnzw_rui Curious, have you factored in results of reinvesting excess RMD in a taxable account in your NW projections? That's one thing I realized while doing my own projections. Just because you're required to take RMDs does not mean you have to spend all of it.

Yes, that is exactly what I do. Spending is based on living expenses, increased each year for inflation and any cash flow in excess of what is spent is invested.

[pb4uski]

Quote:

Originally Posted by RetireBy90 So if I am psychic and read between the lines correctly, sounds to me like many who have commented on this thread have most of RE assets in IRA, 401K, or taxable account. I have most expenses covered by 2 pensions and SS at age 70. We have retirement savings also, but kinda gives a different start point, my retirement savings will be some for living expenses before 70, then self insured for unknown expenses like LTC, but mostly to pass along to kids. So if they are to pass along does that change your conclusion about to ROT or not?

I think Roth conversions makes more sense in that case (which is similar to ours) in that I'm converting at 15% or less and if I didn't convert and left it to my kids in a tIRA then they woudl pay taxes on it at more than 15%.

[grasshopper]

Quote:

Originally Posted by hnzw_rui Curious, why would you need to take gains? Given the step up in basis upon death, assuming SS and RMDs cover all your expenses, I'll just leave the taxable account as is.

A round the world trip, I hope to die with $10 in my pocket.

Luxury round-the-world tours on private jets take off - NBC News

[Cobra9777]

Quote:

Originally Posted by pb4uski I have a fairly sophisticated projection of our retirement out to age 100 and while our NW with Roth conversions is not significantly different for 60-70, it takes off after then and is 50% higher with Roth conversions at age 100... I suspect the compounded impact of the lower taxes with Roth conversions vs without.

Just curious if your NW referenced above includes tax-deferred accounts measured net of tax, or pretax? Also, would you mind sharing at what age your NW with conversions exceeds your NW, with no conversions? I assume it takes several years after age 70 (when lower RMD tax kicks in) to recover the upfront tax paid on conversions as well as the foregone growth associated with the upfront tax.

[pb4uski]

Pre-tax. I'm 60 now.

NW no Roth conversions compared to NW with Roth conversions after 5, 10, 20, 30, and 40 years is 101%, 105%, 114%, 123%, 139% and 152%, respectively. Taxes on the conversion amounts are relatively modest.... 7% of the conversion amount most years (was 7% in 2014 too), creeping up to 14% at 69 and 70. The taxes saved from 71 to 74 are about equal to the taxes paid from 60 to 70 and there are substantial savings each year thereafter.

My projected tax deferred balances at age 70 are 30% of what they would be if I did no Roth conversions and my Roth balance is 4.5x higher.