Roth Conversions to Next Highest Bracket?

[PatrickA5]

I've done conversions to the top of the 12% bracket already. Can you think of any reason to convert more into the 22% bracket?

Right now, we have 82% in Traditional IRAs and 18% in Roths. So, we're top heavy in deferred accounts.

At 70, we'll be solidly in the 22% bracket and 85% of SS will be taxed. I don't see that changing. Of course, a decent amount will be taxed at 10% and 12%, so I'm not sure it makes much sense to convert at 22% now and then have some of it taxed lower down the road.

We probably won't have much non retirement taxable savings - most of the withdrawals will be coming from SS and retirement accounts. So, according to my TurboTax calculations probably 50% of the lower bracket taxable amounts will be coming from retirement accounts and 50% from SS.

Any reason to consider doing additional conversions (above the 12% bracket)? Thanks.

 

[MBAustin]

If your projected RMDs are significantly higher than what you expect to need for expenses, you could consider converting now to move that money to Roths for your estate (or for emergency expenses if needed, which wouldn't then push your taxable income higher).

 

[pb4uski]

I can't think of a reason. Perhaps if now you are in a low or no tax state and expect to later be in a higher tax state.

A nuance of a reason would be that if you pay the tax with after-tax funds, you effectively transfer those funds from taxable to tax free so those funds that will be used to pay the taxes are no longer be subject to tax.

But other than that, 22% now vs 22% later.

 

[Sunset]

Reasons to do it:

1. Perhaps you were in the 25% tax bracket when you put it in, and so taking it out at 22% is still some savings.
2. Moving some now, to ROTH gives you more flexibility later, example CCRA's entry cost is approx .5 -> 1 MM , imagine the tax bracket if you needed to put an extra $300K out of IRA to meet that type of expense in 1 year, while undergoing RMD & SS.
3. You are going to pay the 22% solidly, so pay it now, so the growth is tax free for ~20->30 more years.
4. Right now the rate is at 22%, but the gov't debt is going up, so someday the rate will rise from 22% maybe back to 25% or higher, remember back around 1917, the highest rate was ~77% So there is a LOT of headroom for the govt to raise rates.

I would not convert so much that you do it paying 22% , and your income falls to the 15% bracket with RMD's. Certainly do NOT convert it all.

 

[SecondCor521]

Some people think that the marginal tax rates will go up again in a few years when the TCJA tax rate reductions expire (I think in 2025 or 2026 IIRC), or earlier than that through a law change, or later than that through an effort to raise governmental income due to debt/deficit concerns.

If you agreed with any of those thoughts, you might view it as a good bet to convert now at 22% in order to avoid those higher rates later.

Have you accounted for the fact that your investments will grow at a certain rate, hopefully higher than the rate of inflation by which the tax brackets get adjusted?

 

[bingybear]

Look at how much do you typically have in qualified dividends and LTCG? (maybe not much since you noted little after tax $. But these can make some local marginal rates higher.

If you pulling $ for taxes out of the TIRA too, it may not be worth it.

One other thing to consider... when one of you passes and you end up filing as single. DMIL was widowed about a decade ago and she is in a high bracket.

Something to think about.

 

[gauss]

You mention 'we' so I assume you are currently married filing jointly.

If anything were to happen to either of you and the bulk of the funds needed to be converted later as a Single filer, you will be kicking yourself for not converting more now, filing jointly, when the tax brackets and standard deductions are twice as wide as those who file single.

This year, and likely next year too, we Roth converted throughout the 24% bracket.

This isn't mentioned often but a huge driver in our case.

-gauss

 

[pb4uski]

Look at how much do you typically have in qualified dividends and LTCG? (maybe not much since you noted little after tax $. But these can make some local marginal rates higher.

If you pulling $ for taxes out of the TIRA too, it may not be worth it.

One other thing to consider... when one of you passes and you end up filing as single. DMIL was widowed about a decade ago and she is in a high bracket.

Something to think about.

Good point... If you are at the top of the 12% bracket and have qualified dividends and LTCG... Additional Roth conversions would be taxed at 15%, 25%, or 27% depending upon how much you already have an ordinary income until all preference income is over the $77,200 0% LTCG tax bracket.

 

[camfused]

Maybe my situation is unique, but I have tried *many* (that's an understatement) iterations on my spreadsheet and for the ones where we end best long-term, we end up being in the 24% bracket when doing conversions.

This results in me getting everything out of our 401Ks before we reach 70, resulting in no RMDs.

My theory for why this is working like this is because my Roth will be my Bucket 3 (long-term), and I will have it in 100% stocks, so the sooner I get stuff into it, the better (long-term). Our 401Ks, are currently in very conservative funds, so that is probably also a factor: getting the money out of them.

I have our 401Ks like this because I retire next month, and it allows me to sleep at night. Given the ride of the markets the last several weeks, I am starting to look like a genius that I got out of the market in late summer! Shear-semi-educated-dumb-luck

 

[PatrickA5]

You mention 'we' so I assume you are currently married filing jointly.

If anything were to happen to either of you and the bulk of the funds needed to be converted later as a Single filer, you will be kicking yourself for not converting more now, filing jointly, when the tax brackets and standard deductions are twice as wide as those who file single.

This year, and likely next year too, we Roth converted throughout the 24% bracket.

This isn't mentioned often but a huge driver in our case.

-gauss

Yes, that's part of my thought process. Once one of us is gone, the SS + RMDs for the remaining single person will be at a higher rate, with the vast majority being taxed at 22% (or whatever that rate will be). It's quite possible that some of the income might even be taxed at the next bracket (currently 24%).

 

[PatrickA5]

Some people think that the marginal tax rates will go up again in a few years when the TCJA tax rate reductions expire (I think in 2025 or 2026 IIRC), or earlier than that through a law change, or later than that through an effort to raise governmental income due to debt/deficit concerns.

If you agreed with any of those thoughts, you might view it as a good bet to convert now at 22% in order to avoid those higher rates later.

Have you accounted for the fact that your investments will grow at a certain rate, hopefully higher than the rate of inflation by which the tax brackets get adjusted?

My projections have a 5% growth rate. I'm assuming me taking SS at 62 and DW at 70, but might delay my SS while doing conversions. We're both 60 now, so have a few years before worrying about the effect on Medicare premiums.

My guess is that the 22% bracket will probably be higher in 10 years when we start RMDs, but who knows. I can't see them being any lower.

 

[PatrickA5]

Reasons to do it:

1. Perhaps you were in the 25% tax bracket when you put it in, and so taking it out at 22% is still some savings.
2. Moving some now, to ROTH gives you more flexibility later, example CCRA's entry cost is approx .5 -> 1 MM , imagine the tax bracket if you needed to put an extra $300K out of IRA to meet that type of expense in 1 year, while undergoing RMD & SS.
3. You are going to pay the 22% solidly, so pay it now, so the growth is tax free for ~20->30 more years.
4. Right now the rate is at 22%, but the gov't debt is going up, so someday the rate will rise from 22% maybe back to 25% or higher, remember back around 1917, the highest rate was ~77% So there is a LOT of headroom for the govt to raise rates.
   

I would not convert so much that you do it paying 22% , and your income falls to the 15% bracket with RMD's. Certainly do NOT convert it all.

1. We were in the 28% (or higher) bracket during the majority of the contributions. Only the last couple of years have we been down in the lower brackets.

2. Good point. I hadn't thought about the fact that we could possibly need to do a large lump sum withdrawal for some reason. Another reason to beef up the tax free Roth some.

 

[PatrickA5]

I can't think of a reason. Perhaps if now you are in a low or no tax state and expect to later be in a higher tax state.

A nuance of a reason would be that if you pay the tax with after-tax funds, you effectively transfer those funds from taxable to tax free so those funds that will be used to pay the taxes are no longer be subject to tax.

But other than that, 22% now vs 22% later.

Our state doesn't tax $10K (each) of either IRA withdrawals (or conversions). So, we can convert $20K per year state tax free (state rate 5%). So, doing a minimum $20K conversion is a no brainer.

 

[PatrickA5]

Good point... If you are at the top of the 12% bracket and have qualified dividends and LTCG... Additional Roth conversions would be taxed at 15%, 25%, or 27% depending upon how much you already have an ordinary income until all preference income is over the $77,200 0% LTCG tax bracket.

Right now, our outside taxable accounts are in VG Prime Money Market. I don't foresee having QD or LTCG to worry about in the near term. It's possible DW will get a significant inheritance before we begin RMDs, so it's possible we might have some significant LTCG and QD at some point in the future. Another scenario that would boost us further into the 22% (or higher) bracket.

 

[Sunset]

Maybe my situation is unique, but I have tried *many* (that's an understatement) iterations on my spreadsheet and for the ones where we end best long-term, we end up being in the 24% bracket when doing conversions.

This results in me getting everything out of our 401Ks before we reach 70, resulting in no RMDs.

My theory for why this is working like this is because my Roth will be my Bucket 3 (long-term), and I will have it in 100% stocks, so the sooner I get stuff into it, the better (long-term). Our 401Ks, are currently in very conservative funds, so that is probably also a factor: getting the money out of them.

I have our 401Ks like this because I retire next month, and it allows me to sleep at night. Given the ride of the markets the last several weeks, I am starting to look like a genius that I got out of the market in late summer! Shear-semi-educated-dumb-luck

You are comparing slow growth 401K to (hopefully) fast growth 100% stocks ROTH. So the Roth wins every time.

I do find it very difficult to believe you need to completely empty your 401K's, as the first year of RMD a $200,000 401K would result in about $7,000 income.

It suggests to me you would be paying at a higher tax bracket than needed, just to get the money out.

 

[Cobra9777]

I've been converting to the top of the 15% (now 12%) bracket for several years. The conversion amounts are limited by two small pension annuities and some rental income. At this rate, I've projected that we will only convert about 35-40% of tax-deferred balances by 70. We are currently 57 and 58. With SS and RMDs, we will most likely be solidly into the 22% bracket, possibly higher though unlikely. So I'd like to do more if it makes sense. With the next bracket down from 25% to 22%, I've been analyzing possible conversions beyond the top of the 12% bracket. But for now, I've concluded that any potential upside is extremely small and there are too many unknowns.

For example, it's well documented that there is a small upside to Roth conversions even when rates are the same (at conversion and RMD). This is related to using taxable funds to pay the conversion tax, which effectively "transfers" those funds to the Roth where they permanently avoid taxation. But in our case, the conversion rate is HIGHER than 22% due to the 27% incremental rate on QDs and LTCGs. This mostly eliminates that small upside.

Of course, it's possible that the 22% rate will revert to 25%, which is the current law of the land. I think the probability of that happening is very low. But even if it did revert, the upside remains very small at significantly less than 3 percentage points due to the 27% incremental rate on some of the conversions.

Then there's the risk that markets do poorly over the next decade and tax-deferred balances shrink to the point that less of the RMDs are taxed at 22%. Possibly none? Worst case scenario is paying 27%/22% now and then ultimately only owing 12%. It may be a small risk but it's one I don't need to take for such a small upside potential. If the opposite happens and markets perform well, then we'll have more money than we need, and I'll be happy to pay tax at 22% (maybe even 25%), knowing that I avoided 28%-33% when I deferred that income.

That's my current thinking on this topic. I'm set to do my 2018 conversion in a couple days. So I'd love to hear alternative viewpoints and rationale. The one reason I find somewhat compelling: without further conversions, when one of us dies, the survivor would take huge RMDs at single rates. Certainly worth pondering further.

 

[38Chevy454]

I've been converting to the top of the 15% (now 12%) bracket for several years. The conversion amounts are limited by two small pension annuities and some rental income. At this rate, I've projected that we will only convert about 35-40% of tax-deferred balances by 70. We are currently 57 and 58. With SS and RMDs, we will most likely be solidly into the 22% bracket, possibly higher though unlikely. So I'd like to do more if it makes sense. With the next bracket down from 25% to 22%, I've been analyzing possible conversions beyond the top of the 12% bracket. But for now, I've concluded that any potential upside is extremely small and there are too many unknowns.

For example, it's well documented that there is a small upside to Roth conversions even when rates are the same (at conversion and RMD). This is related to using taxable funds to pay the conversion tax, which effectively "transfers" those funds to the Roth where they permanently avoid taxation. But in our case, the conversion rate is HIGHER than 22% due to the 27% incremental rate on QDs and LTCGs. This mostly eliminates that small upside.

Of course, it's possible that the 22% rate will revert to 25%, which is the current law of the land. I think the probability of that happening is very low. But even if it did revert, the upside remains very small at significantly less than 3 percentage points due to the 27% incremental rate on some of the conversions.

Then there's the risk that markets do poorly over the next decade and tax-deferred balances shrink to the point that less of the RMDs are taxed at 22%. Possibly none? Worst case scenario is paying 27%/22% now and then ultimately only owing 12%. It may be a small risk but it's one I don't need to take for such a small upside potential. If the opposite happens and markets perform well, then we'll have more money than we need, and I'll be happy to pay tax at 22% (maybe even 25%), knowing that I avoided 28%-33% when I deferred that income.

That's my current thinking on this topic. I'm set to do my 2018 conversion in a couple days. So I'd love to hear alternative viewpoints and rationale. The one reason I find somewhat compelling: without further conversions, when one of us dies, the survivor would take huge RMDs at single rates. Certainly worth pondering further.

I agree there is some risk, but I am also in the thought that now is a good time to do the conversions when valuations are down some. Sure they could drop more, but assuming the Roth is longer term money, I have confidence the market will be the best returns. So convert now and then ride the recovery in tax-free gains status. I do not have much confidence in tax rates remaining at current levels, so take advantage of the small break we have now.



I am also doing Roth conversions even though I am in the 22% bracket for them. For many of the reasons previous and above replies discuss.

 

[Gumby]

Our plan (to begin implementation in 5 months) is to Roth convert to the top of the 22% bracket (currently $165k).

Our two pensions and one social security will bring in just about $100k per year. So, using the $24k standard deduction, that means we'll be able to Roth convert roughly $89k at a 22% tax rate every year. That is about 4% of the amount we have in tax deferred (which was mostly put in at marginal rates of 28-35%). Given a reasonable rate of return in our tax deferred account, we will never be able to empty it before RMDs kick in. After only a few years, they will ineluctably push us into a higher bracket.

As I understand the law, marginal tax brackets are due to return to pre-2018 levels in 2025. So we will be in at least the 25% bracket based on pension/SS alone, and RMDs will quickly drive us into the 28% bracket. Given current national finances, I can see those rates going even higher. In any event, I do not see us ever dropping below the 22% rate, so I figure we might as well remove money from tax deferred accounts now.

 

[Sunset]

I agree there is some risk, but I am also in the thought that now is a good time to do the conversions when valuations are down some. Sure they could drop more, but assuming the Roth is longer term money, I have confidence the market will be the best returns. So convert now and then ride the recovery in tax-free gains status. I do not have much confidence in tax rates remaining at current levels, so take advantage of the small break we have now.

I am also doing Roth conversions even though I am in the 22% bracket for them. For many of the reasons previous and above replies discuss.

While we normally wait until near the end of the year to do the conversions, so this market drop has worked nicely in transferring shares, next year could be totally different.
Should the market not bounce back up, maybe even continue down, it seems like a good time to covert, basing the time to convert on the market value, rather than my usual end of year

 

[Gumby]

To my mind, Roth converting based on market conditions only matters if you are not going to invest in exactly the same thing in your Roth. I may make minor adjustments when I covert, but I expect to have almost exactly the same investments - only now forever tax exempt

 

[El Magnifico Loco]

I agree that converting funds now before RMD's take effect is the smart move, particularly as the market comes down from its euphoric high. The earlier comment about RMD's being taxed at the higher Single vs Married Filed Jointly tax rate is huge. In our case, when one of us passes, the (projected) tax rate increases from 24% to 32%, everything else being equal.

Assuming you are/will be enrolled in Medicare within 2 years, one other thing to think about when doing a conversion is to watch what it does to your Modified Adj Gross Income (MAGI) amount. This is the amount that drives your Medicare Part B premiums (among other things). In our case, our Roth conversion moved us into a higher bracket, resulting in ~$1,000 in extra Part B premiums. Note that any conversion you do in 2018 will not impact your Medicare Part B costs until 2020, however.

 

[Sunset]

To my mind, Roth converting based on market conditions only matters if you are not going to invest in exactly the same thing in your Roth. I may make minor adjustments when I covert, but I expect to have almost exactly the same investments - only now forever tax exempt

I may not have been clear in what I'm thinking;

I do conversions all the time, lets say $50,000 worth, and keep the same investment.
Last year $50,000 conversion is 1,000 shares.
This year $50,000 conversion is 1,100 shares. I got more shares moved over.

So my thinking is, since I'm going to convert next year, I should watch the market and do it when the market is low, rather than always wait until December and do it.

I tend to have a (+) viewpoint of the market, that it will go up over time, so for example it's looking like January the market will still be down.
So maybe my plan will be for next year:

1. Convert $25,000 which will be 550 shares in January.
2. Then later on, convert the other $25,000 worth.

Step 1. is hedging my conversion, if market goes higher over the year at least I got some in "cheap", if it goes lower I can get more in "cheaper".

 

[Gumby]

I may not have been clear in what I'm thinking;

I do conversions all the time, lets say $50,000 worth, and keep the same investment.
Last year $50,000 conversion is 1,000 shares.
This year $50,000 conversion is 1,100 shares. I got more shares moved over.

So my thinking is, since I'm going to convert next year, I should watch the market and do it when the market is low, rather than always wait until December and do it.

I tend to have a (+) viewpoint of the market, that it will go up over time, so for example it's looking like January the market will still be down.
So maybe my plan will be for next year:

1. Convert $25,000 which will be 550 shares in January.
2. Then later on, convert the other $25,000 worth.

Step 1. is hedging my conversion, if market goes higher over the year at least I got some in "cheap", if it goes lower I can get more in "cheaper".

I see your point now, and it does make sense.

 

[camfused]

You are comparing slow growth 401K to (hopefully) fast growth 100% stocks ROTH. So the Roth wins every time.

I do find it very difficult to believe you need to completely empty your 401K's, as the first year of RMD a $200,000 401K would result in about $7,000 income.

It suggests to me you would be paying at a higher tax bracket than needed, just to get the money out.

Yeah, believe me I have tried many different variations and emptying it out always wins.

 

[Cobra9777]

I agree there is some risk, but I am also in the thought that now is a good time to do the conversions when valuations are down some. Sure they could drop more, but assuming the Roth is longer term money, I have confidence the market will be the best returns. So convert now and then ride the recovery in tax-free gains status. I do not have much confidence in tax rates remaining at current levels, so take advantage of the small break we have now...

I certainly agree that converting more shares while prices are down is a good thing. And if you believe tax rates are going up, that's a good reason, although still just a "belief."

But whether I "ride the recovery" tax-free in a Roth or in tax-deferred is not a factor. This is due to growth in the funds that would have been used to pay conversion tax. Here's an example I posted in another recent Roth thread:

Example:
Assume: tIRA of $10K, taxable account of $1.2K, tax rate 12% now and 12% later, rate of return 7%, and 15-year timeframe.

If converted, obviously the tIRA and taxable go to zero, and the Roth of $10K grows to $27.6K at 7% over 15 years.

If not converted, the tIRA grows to $27.6K and the taxable account grows to $3.3K, which is exactly how much is needed to pay tax on the $27.6K tIRA. Net after-tax proceeds are exactly the same as the convert scenario...

Ultimately, the convert decision boils down almost entirely to the tax rate differential at time of conversion vs RMD. As noted previously, there is a smaller secondary benefit associated with using taxable funds to pay the tax, which in effect "transfers" money tax-free from taxable into the Roth.