Roth Conversions, the basics?

[SunnyOne]

Can someone please recommend a source for me to start learning the basics of Roth conversions? when, how, how much, thanks

 

[skyking1]

Search 'roth conversion' in the search window here, there have been some fine discussions and recent ones on strategy.

 

[SnowballCamper]

Searching this site will get you a lot of information, mixed with opinions, but primarily based on individual situations. In many cases, some relevant details are left out about why someone chooses to do Roth conversions, and how much. In my searching I found the following article to be particularly informative about how different situations affect the benefits of Roth conversions.

https://www.i-orp.com/modeldescription/Vol15Issue1.pdf#page=49

The author runs this website https://www.i-orp.com for when you're ready to do a deep dive and run some calculations for your situation. FYI there is a bit of a learning curve for this calculator. It does answer your questions of when and how much, with projections for the remainder of your user specified lifespan. It does have some limitations (such as NIIT income) but for free, I don't think there is much better out there (now of course someone will tell me I'm wrong about that, and then you'll have another option ;-)

 

[RunningBum]

It's primary tax arbitrage. Many ER people are in a high tax bracket while working, low tax bracket when ER'd, and back in a higher bracket when SS, pensions, and RMDs start. That low tax window is when it's usually beneficial to convert. Once RMDs start there is usually little or no benefit. Usually the best course is to try to balance income fairly evenly over your remaining years, taking into consideration ACA subsidies, IRMAA, QCDs, capital gains taxes, and other individual factors. The math is not straightforward, but you may see an obvious level to convert to that has a larger gain, and the not-so-obvious conversion level probably has small enough benefit not to worry about getting exactly right.

Directly answering your questions:
When? Usually after you retire, before you start SS and take RMDs
How? Varies by where you have your accounts, but Vanguard has a "Convert to Roth"option in my tIRA account.
How Much? You gotta do your own math. Spreadsheets and estimated future tax runs.

 

[skyking1]

For us we are playing the 12% to 22% game.
For others, who are at the 22% to 24% game, the return is small. Having that much income is a good problem though

The big deal is the survivor tax torpedo that comes with dropping to the single brackets. Any money we can get taxed now will help the survivor greatly.

 

[aaronc879]

It's not a 'one size fits all'. People have different goals and strategies that involve Roth conversions. This blog was a help for me but you should check out other sources as well until you find what works for you.
https://rootofgood.com/roth-ira-conversion-ladder-early-retirement/

 

[kgtest]

It's primary tax arbitrage. Many ER people are in a high tax bracket while working, low tax bracket when ER'd, and back in a higher bracket when SS, pensions, and RMDs start. That low tax window is when it's usually beneficial to convert. Once RMDs start there is usually little or no benefit. Usually the best course is to try to balance income fairly evenly over your remaining years, taking into consideration ACA subsidies, IRMAA, QCDs, capital gains taxes, and other individual factors. The math is not straightforward, but you may see an obvious level to convert to that has a larger gain, and the not-so-obvious conversion level probably has small enough benefit not to worry about getting exactly right.

Directly answering your questions:
When? Usually after you retire, before you start SS and take RMDs
How? Varies by where you have your accounts, but Vanguard has a "Convert to Roth"option in my tIRA account.
How Much? You gotta do your own math. Spreadsheets and estimated future tax runs.

I would like to add to the When... in any lower than expected income earning year. For instance if you were off of work a lot one year in your working years and know your taxable income is low that year... do that Roth conversion up to the top of the 12% / bottom of the 22% tax bracket.

A quick back of the envelope example:

You were unemployed for most of the year in 2021, only earning a taxable income of $40k and recognize this is an opportunity to "convert".
The top of the 12% MFJ (not sure if you are married) bracket is

81,050.

You could convert no more then $41,050 in that 12% bracket...pay the $4926 in extra taxes, and then have that $$$ growing tax free from there on forward.

Its probably a bit more complex then that but getting a tax program like TurboTax and knowing exactly what your taxable income will be before the conversion is key!

 

[Midpack]

It's primary tax arbitrage. Many ER people are in a high tax bracket while working, low tax bracket when ER'd, and back in a higher bracket when SS, pensions, and RMDs start. That low tax window is when it's usually beneficial to convert. Once RMDs start there is usually little or no benefit. Usually the best course is to try to balance income fairly evenly over your remaining years, taking into consideration ACA subsidies, IRMAA, QCDs, capital gains taxes, and other individual factors. The math is not straightforward, but you may see an obvious level to convert to that has a larger gain, and the not-so-obvious conversion level probably has small enough benefit not to worry about getting exactly right.

Directly answering your questions:
When? Usually after you retire, before you start SS and take RMDs
How? Varies by where you have your accounts, but Vanguard has a "Convert to Roth"option in my tIRA account.
How Much? You gotta do your own math. Spreadsheets and estimated future tax runs.

Having started a very long thread on the subject after my exploration into Roth conversions in 2019, this above is a great concise summary. A successful Roth plan will yield the same tax bracket throughout retirement, to avoid being trapped in a higher tax bracket due to RMDs and passive income from age 70/72 until the end…

But you have to do the math yourself. I used http://incomestrategy.com/ and it only cost me a $20 subscription for one month, but there are several ways to approach it.

 

[skyking1]

That does not address the survivor benefit, which is significant. For example, if we have ~80K in income set up for the future in the form of pensions and SS, the survivor will go from the 12% bracket as a couple to the 22%, and then when the RMD's start the portion above the 12% break is even greater. Just another angle to look at.

 

[SevenUp]

Roth IRA conversion - Bogleheads may be helpful.

 

[pb4uski]

For us we are playing the 12% to 22% game.
For others, who are at the 22% to 24% game, the return is small. Having that much income is a good problem though

The big deal is the survivor tax torpedo that comes with dropping to the single brackets. Any money we can get taxed now will help the survivor greatly.

+1

 

[SunnyOne]

Thank you all. Retired a few months ago, moved to an income tax free state (for other reasons, lol) and not planning to start SS for awhile, so now looking at developing an optimal withdrawal strategy as well as staring at my big 401K balance and the tax implications of that.

I am single (divorced), so I assume there are no survivor implications.

 

[kgtest]

Thank you all. Retired a few months ago, moved to an income tax free state (for other reasons, lol) and not planning to start SS for awhile, so now looking at developing an optimal withdrawal strategy as well as staring at my big 401K balance and the tax implications of that.

I am single (divorced), so I assume there are no survivor implications.

Probably makes it (conversion) less appealing in that situation as your room to convert is a lot smaller window in terms of the tax brackets for Single taxpayers. I have only run numbers from a MFJ standpoint.

Do you anticipate a large inheritence at any point that might lend to Inherited RMDs?? If so, might make the conversion more beneficial in that situation.

For instance I will likely inherit 1 to 2MM of my folks IRAs that they do not withdraw from. They did aggressive roth conversions to try to lessen the 2 remaining children's future tax burdens as I will be in the 22-24% (current) tax bracket for likely much of my life. 50 to 65 might be the exception when I ER and do my own roth conversions. Right now they are in 12% bracket, and some years I am as well (But have been lucky with owning my own business pushing us down to 12% with all the expense write-offs).

When I inherit that money I believe it needs to be RMD scheduled at 1/10 the balance over a 10yr period. So I will take 100k to 200k RMD the first year. 90 to 180k the second, etc etc and no avoiding the tax torpedo in that scenario. I guess it could be worse and I could have an income problem instead of a tax problem.

 

[FI_RElater]

SunnyOne

as mentioned above, there's many threads over on the Bogleheads site...
on a few fairly long ones the discussion did focus that , yeah, it is more advantageous for couples due to the survivor aspect but is still advantageous for singles to convert to the top of the 12% , just below any cap gain limit (and any taxes for these conversions should be from taxable and NOT from the converted funds.) These converted funds can then be used in the years that funds are needed and one doesn't want to go over some limit (such as an IRMAA limit).

The threads there show that, while the overall effect isn't very large, it's the avoidance of those "tax torpedo"/IRMAA effects that it provides the best results. The threads also show that if you really never expect to ever enter the next bracket, even after RMD's start, that NOT doing any conversions may be just as acceptable since you still need to fill up the 0% bracket and if you stay at the 10/12% bracket the growth of the traditional IRA won't kick you into higher bracket with RMD over most timelines given non-aggressive allocations within it.

(Note that many there consider iorp to be too aggressive in Roth conversions in its recommendations; why pay tax early if not needed... it seems to presume a very aggressive allocation and hence higher growth (but doesn't seem to consider SOR risk) and thus the expectation that one would be in higher brackets in the future.)

 

[RunningBum]

Probably makes it (conversion) less appealing in that situation as your room to convert is a lot smaller window in terms of the tax brackets for Single taxpayers. I have only run numbers from a MFJ standpoint.

Smaller windows but you also get pushed into higher brackets much more quickly. I don't think it's any less appealing other than that a MFJ couple may be filing single some day. And it's possible the single person may get married and be MFJ.

 

[Yoheadden]

SunnyOne
The threads there show that, while the overall effect isn't very large, it's the avoidance of those "tax torpedo"/IRMAA effects that it provides the best results. The threads also show that if you really never expect to ever enter the next bracket, even after RMD's start, that NOT doing any conversions may be just as acceptable since you still need to fill up the 0% bracket and if you stay at the 10/12% bracket the growth of the traditional IRA won't kick you into higher bracket with RMD over most timelines given non-aggressive allocations within it.

(Note that many there consider iorp to be too aggressive in Roth conversions in its recommendations; why pay tax early if not needed... it seems to presume a very aggressive allocation and hence higher growth (but doesn't seem to consider SOR risk) and thus the expectation that one would be in higher brackets in the future.)

I think this is the issue a lot of us face that don’t Fat FIRE and are considering whether a Roth conversion would be beneficial or not. At current rates, I am in the 12% bracket and will be once I ER with my portfolio and SS to draw from.
The big unknown is if the rates will stay the same for the next 20,30, 40 years. Many think they will not and do Roth Conversions to protect against this.

 

[pb4uski]

Thank you all. Retired a few months ago, moved to an income tax free state (for other reasons, lol) and not planning to start SS for awhile, so now looking at developing an optimal withdrawal strategy as well as staring at my big 401K balance and the tax implications of that.

I am single (divorced), so I assume there are no survivor implications.

What I would do is to look at what your tax burden and tax rate on RMDs will be once you are collecting SS and having RMDs and compare it to what the tax burden would be on Roth conversions now.

I'd do a calculation of taxes with interest/dividends and SS, even if you are not yet collecting SS. Then add in ~4% of your tax-deferred account balance as an estimate of RMDs and note the increase in tax compared to the RMD.

Then look at the marginal tax cost of Roth conversions. I'd keep going until to the top of the current tax bracket or no more than where the tax cost today is equal to the tax cost later.

https://www.irscalculators.com/tax-calculator will be useful to you in looking at alternatives.

 

[SevenUp]

What I would do is to look at what your tax burden and tax rate on RMDs will be once you are collecting SS and having RMDs and compare it to what the tax burden would be on Roth conversions now.

I'd do a calculation of taxes with interest/dividends and SS, even if you are not yet collecting SS. Then add in ~4% of your tax-deferred account balance as an estimate of RMDs and note the increase in tax compared to the RMD.

Then look at the marginal tax cost of Roth conversions. I'd keep going until to the top of the current tax bracket or no more than where the tax cost today is equal to the tax cost later.

https://www.irscalculators.com/tax-calculator will be useful to you in looking at alternatives.

That calculator, or others on the web such as https://www.mortgagecalculator.org/calcs/1040-calculator.php can indeed be used iteratively along with hand calculations to get the marginal rates.

Or, if one can use Excel, using something like the case study spreadsheet (referred to as the personal finance toolbox in the Using a spreadsheet section of the Roth IRA conversion wiki) automates the process. That can be helpful in viewing "the forest" instead of going "tree by tree".

 

[googily]

Widow here, with the potential for rmds hitting six figures (assuming everything stays the same, which I'm sure it won't!). Like others, I've built a spreadsheet and spent many many hours gaming out pensions, SS (survivor and mine), rmds, spending, etc. I'm actually converting up to the top of the 24% bracket (while still working), for the privilege of being able to be in the 25% bracket once the tax laws revert (though I am one who think taxes will be going up). If I don't convert at 24%, I could have a few years at 15%, but also years hitting 28% or even 33%.

I'm pretty sure whatever I decide to either do or not do will turn out to be wrong. [emoji16]

 

[CardsFan]

I'm pretty sure whatever I decide to either do or not do will turn out to be wrong. [emoji16]

Unless you know your date of death, anything you do will be "wrong" (not optimized). But, prudent conversions now CAN reduce taxes later, or avoid IRMAA for a few years.

But, seriously, the benefits are nominal. That said, I will continue to convert (but stay below IRMAA) until RMD's kick in. The absolute worst case is no benefit. So, no down side.

Of course the WORST case really is if I convert and then the market tanks, and I paid taxes on more than needed to. But, I am not a market timer.