Roth Conversions... When to stop?

[Midpack]

There are dozens of posts per day discussing income tax brackets. But what if CG rates change? The current political climate seems to be targeting only high earners, say, 200K+ or even 400K+.
Changing the CG rates could upend my current strategy. Maybe I don't need to consider that for a while, if ever, but that might be my tax black swan.

A week or 2 ago I went to a tax presentation at a local AAII meeting. The CPA, age 50, was really hammering down on converting as much as possible. Personally, I think he said he was putting all his savings into Roth401K, while his wife was doing all 401k (or IRA). It's a hedge on what might happen to tax rates going forward.

You’re going to have to decide what you think is most likely. No one can tell you what will happen or when, and there’s no foolproof approach. My conversions are based on what we know for sure now and then what I expect to happen, and broadly when WRT, tax rates and LTCG.

 

[RunningBum]

There are dozens of posts per day discussing income tax brackets. But what if CG rates change? The current political climate seems to be targeting only high earners, say, 200K+ or even 400K+.
Changing the CG rates could upend my current strategy. Maybe I don't need to consider that for a while, if ever, but that might be my tax black swan.

What do you think would change, and how much do you think it would affect you? Would it really be a black swan event that totally upends your strategy?

I'm not worrying for now about anything that doesn't seem very likely to happen. A reduction in SS benefits seems fairly likely, so I factor that in, along with 100% taxing of SS benefits. I've already factored in a 15% tax on CGs even though some of them will likely avoid a tax. If they are all taxed as regular income, that will hurt, but not crush me. Maybe you are more reliant on 0% CGs?

 

[Time2]

I'm almost 65, my wife is a young 61. we expect to delay SS until 70, at least for me.

My thinking over the last couple of years has been to do Roth conversions up to the 12% bracket. My thinking could be skewed as I have always paid a low amount in taxes. Many years my total federal tax burden was 2, 3, or 4%. I never really new what bracket I was in, but I'm sure it was lower.
We have for easy number $1M in tax deferred accounts and $500k in taxable accounts.


I'm wondering if we should bite the bullet and do Roth conversions up to the 22% bracket?


I added some growth to the accounts for the numbers below. (6%)

I expect our SS will be about $35k and another $10k+ of VTSAX dividends,
before we start to add RMDs which could be $29k first first 3 or 4 years and then jump to $49k.
So for 4 years, income is about $75k and then jumps to $95k, if we do not do Roth conversions.
Do these numbers look like Roth conversions in the 22% bracket would be a wise move?

 

[Midpack]

I'm almost 65, my wife is a young 61. we expect to delay SS until 70, at least for me.

My thinking over the last couple of years has been to do Roth conversions up to the 12% bracket. My thinking could be skewed as I have always paid a low amount in taxes. Many years my total federal tax burden was 2, 3, or 4%. I never really new what bracket I was in, but I'm sure it was lower.
We have for easy number $1M in tax deferred accounts and $500k in taxable accounts.


I'm wondering if we should bite the bullet and do Roth conversions up to the 22% bracket?


I added some growth to the accounts for the numbers below. (6%)

I expect our SS will be about $35k and another $10k+ of VTSAX dividends,
before we start to add RMDs which could be $29k first first 3 or 4 years and then jump to $49k.
So for 4 years, income is about $75k and then jumps to $95k, if we do not do Roth conversions.
Do these numbers look like Roth conversions in the 22% bracket would be a wise move?

Based on the numbers you’re providing I doubt converting to 22% would be financially beneficial (there are other reasons once you pass away that you may/not care about). Cocktail napkins numbers you’ll be at about $70K taxable ($95K-$24.8 std deduction) and you don’t get into 22% rates until $80.25K in 2020.

Very broadly speaking you want to keep your lifetime tax rate level, taxes while converting and after RMD and SS start. But it’s worthwhile to examine your exact numbers and assumptions for most people versus a rule of thumb if for no other reason than knowing for sure. Once you are 72 and beyond, you can’t correct if you find yourself in a (much) higher bracket than before, especially if effective tax rates increase, could easily be 20+ years.

 

[RetireBy90]

I would consider some things that may change as your journey continues.
First is the rates when one of you is gone and the single tax rates kick in. This change will hit most at some point will cost more taxes. Just that simple.
Second consider where tax rates will be in near future. Current rates are scheduled to revert after 2025 and would then raise your tax bite. Lots of things could happen by then or after. What is your best guess. It may be considered a gamble by some but you are in that game and not considering your best guess of tax rates in 5, 10, or 20 years won’t keep changes from happening.
Personally I’m converting to 22% and may add another $35K in 24% bracket to lower my TIRA by 2028 when I turn 72 and RMDs kick in. At that point we are thinking of using QCDs for charitable contributions rather than our current self directed fund.
Each situation is unique with many factors to consider ( including ACA limits and Medicare IRMAA levels). Good hunting

 

[tenant13]

You’re going to have to decide what you think is most likely. No one can tell you what will happen or when, and there’s no foolproof approach. My conversions are based on what we know for sure now and then what I expect to happen, and broadly when WRT, tax rates and LTCG.

I'm a total outlier as far as conversions go because I don't think about my tax burden and focus on my yearly budget. As long as my planning software tells me my expenses are covered I'm happy. We don't know what's going to happen to tax rates and how political climate will affect our financial situation. I also have no clue how long am I going to live. The only thing I do know is that my health will deteriorate and I'll have to stop being as active as I am now.

So while I'll do the no-brainer conversions or capital gain harvesting (0 or 12% tax) I decided to focus more on age related enjoyable spending and less on intelligent saving. It's the complete opposite of my pre-FIRE MO and goes a bit against my nature but that's what I'm doing. It just tells you that there's not one good answer to the OPs question.

 

[kaneohe]

..............................................................

I expect our SS will be about $35k and another $10k+ of VTSAX dividends,
before we start to add RMDs which could be $29k first first 3 or 4 years and then jump to $49k.
So for 4 years, income is about $75k and then jumps to $95k, if we do not do Roth conversions.
Do these numbers look like Roth conversions in the 22% bracket would be a wise move?

some confusion in my mind about your numbers..........you say income 75K for yrs........starting from now? and then jumps to 95K.......when you start SS/RMDs........but you said RMDs alone would start at 29K, not even considering SS.......so wouldn't jump be bigger?

95K is gross income? If so, taxable would be about 70K- which is still in 12% bracket..........so I don't see converting in 22% bracket to be compelling. Also consider, your marginal tax rate may be even higher if you are pushing QDIV/CGs into higher bracket ........w/ marginal rate of 27%, not 22%.

Complicated issue since you also want to consider that tax rates may go up in future (if old rates come back as scheduled); also single survivor tax rates will be higher.

 

[Time2]

some confusion in my mind about your numbers..........you say income 75K for yrs........starting from now?

Starting at 72yrs old (RMDs)

and then jumps to 95K.......when you start SS/RMDs

When my wife turns 72 yrs old. (RMDs)

........but you said RMDs alone would start at 29K, not even considering SS.......so wouldn't jump be bigger?

Here's what I said, "I expect our SS will be about $35k and another $10k+ of VTSAX dividends,
before we start to add RMDs which could be $29k first first 3 or 4 years and then jump to $49k."


Sooo... from when we start SS and VTSAX dividends, $35k + $10k= $45k.
Then when I hit 72yrs old, RMDs of $29k, so, $45k + $29k= $74k income, 4 years later when my wife hits 72yrs old, add another $20k of income to make it $94k.

($1k math correction.)


95K is gross income? If so, taxable would be about 70K- which is still in 12% bracket..........so I don't see converting in 22% bracket to be compelling. Also consider, your marginal tax rate may be even higher if you are pushing QDIV/CGs into higher bracket ........w/ marginal rate of 27%, not 22%.

Complicated issue since you also want to consider that tax rates may go up in future (if old rates come back as scheduled); also single survivor tax rates will be higher.[/QUOTE]


The single survivor can turn out to be the biggest reason to max Roth conversions, if you could know death dates.


I threw it out, you brought it back, It's really a guess, we don't know future tax rates, we don't know what the market will do, we don't now who will die when and we don't know future tax changes.
I think I'll do my best in the 12% bracket, if I go over a few bucks in the maximizing, no big problem.

 

[Cobra9777]

Our two pensions and SS will put us solidly into the 22%/25% bracket at 70. Without conversions above the 12%/15% bracket, RMDs would likely push us into the 24%/28% bracket. So we are converting to the top of the 22% bracket with 10-11 years to go.

Depending on growth rates, this will result in most (but probably not all) of our tax-deferred balances being converted to Roth. RMDs on the remainder should be small enough to keep everything well inside the 22%/25% bracket. So that's the baseline plan... we'll stop when I calculate that RMDs on the remaining tax-deferred balance, plus our other known income streams, will fall safely inside the 22%/25% bracket.

I'll let things continue to evolve as situations change. But my mindset on this has definitely changed over the years. I'm much more inclined to settle up with the IRS at current rates rather than leave it to a highly uncertain future.

 

[thefist]

What do you think would change, and how much do you think it would affect you? Would it really be a black swan event that totally upends your strategy?

I'm not worrying for now about anything that doesn't seem very likely to happen. A reduction in SS benefits seems fairly likely, so I factor that in, along with 100% taxing of SS benefits. I've already factored in a 15% tax on CGs even though some of them will likely avoid a tax. If they are all taxed as regular income, that will hurt, but not crush me. Maybe you are more reliant on 0% CGs?

Perhaps "black swan" was a bit dramatic. For the near-mid term, I'm nearly 100% reliant on qualified dividends and capital gains. Certainly a good place to be. Any change to put that rate into the 20's would hurt. But that won't happen overnight, if at all. Since FIRE occurred about 3yrs earlier than plan, some extra selling has been necessary to get that AA and location improved. I'm still wondering what a "normal" tax year will look like.

 

[Sunset]

I'm almost 65, my wife is a young 61. we expect to delay SS until 70, at least for me.

My thinking over the last couple of years has been to do Roth conversions up to the 12% bracket. My thinking could be skewed as I have always paid a low amount in taxes. Many years my total federal tax burden was 2, 3, or 4%. I never really new what bracket I was in, but I'm sure it was lower.
We have for easy number $1M in tax deferred accounts and $500k in taxable accounts.


I'm wondering if we should bite the bullet and do Roth conversions up to the 22% bracket?


I added some growth to the accounts for the numbers below. (6%)

I expect our SS will be about $35k and another $10k+ of VTSAX dividends,
before we start to add RMDs which could be $29k first first 3 or 4 years and then jump to $49k.
So for 4 years, income is about $75k and then jumps to $95k, if we do not do Roth conversions.
Do these numbers look like Roth conversions in the 22% bracket would be a wise move?

At those rates, I'd stay in the 12%
I would also harvest some long term capital gains any year you can squeeze them in and pay 0% on them.

 

[thefist]

Over the weekend I did several more runs with i-ORP, being a bit more careful with the input numbers. With closer inspection, the Convert to 22 and Convert to 24 yielded almost identical result of annual spending for me.

in this case, you can be flexible and watchful for downturns.

Take for instance 2018. The December drop that year was a Roth Conversion gift if you were holding at 22%, but willing and able to increase your conversion into 24% opportunistically.

So call it Convert the Dip rather than Buy the dip.

I also tried a couple experiments of maxing out the 24% bracket for 2 or 3 years and stopping. This appeared to produce a meaningfully better result (higher yearly spending). It's worth a closer look for sure. And certainly helps with the fear of writing that big tax check.

 

[Time2]

At those rates, I'd stay in the 12%
I would also harvest some long term capital gains any year you can squeeze them in and pay 0% on them.

Ya, I messed up this year and didn't do any Roths. But did withdraw $126k from my taxable account, $78,800 of which were LTCGs. I had about $24K of other income, so, I hope to pay $0 or at least very little tax this year.
This is our first full year retired, so after tax time I'll have a better understanding of it all.

 

[Sunset]

Ya, I messed up this year and didn't do any Roths. But did withdraw $126k from my taxable account, $78,800 of which were LTCGs. I had about $24K of other income, so, I hope to pay $0 or at least very little tax this year.
This is our first full year retired, so after tax time I'll have a better understanding of it all.

I'm not sure that is messing up, as there is the possibility that 0% for LTCG will disappear after the election, in which case you are going to look pretty smart

 

[Deaton7500]

Other thoughts to consider in a Roth conversion

Purpose of Partial Roth Conversions - Moving IRA to Roth lowers your RMD
In addition to a lower cumulative tax rate during your retirement, lowering your RMDs may also:

1) decrease the amount of taxes you pay on your social security earnings;

2) decrease the risk of higher Medicare premiums;

3) decrease the risk you’ll get stuck paying IRMAA for Medicare part B and D;

4) decrease your capital gains rate; and

5) leave you less susceptible to the widow/widower tax penalty (lower tax brackets once your spouse dies). If you have enough income deferred, however, it is unlikely you will benefit from any but the last of these potential savings.

The main reason to do partial Roth conversions: you get to keep more of the money you made.

Perhaps equally as important is that you leave a tax-free legacy to your children. Instead of your kids having to take “income” from your tax-deferred accounts–likely at their peak earning years–give them tax-free Roth money to enjoy.

 

[Sunset]

Purpose of Partial Roth Conversions - Moving IRA to Roth lowers your RMD
In addition to a lower cumulative tax rate during your retirement, lowering your RMDs may also:

1) decrease the amount of taxes you pay on your social security earnings;

2) decrease the risk of higher Medicare premiums;

3) decrease the risk you’ll get stuck paying IRMAA for Medicare part B and D;

4) decrease your capital gains rate; and

5) leave you less susceptible to the widow/widower tax penalty (lower tax brackets once your spouse dies). If you have enough income deferred, however, it is unlikely you will benefit from any but the last of these potential savings.

The main reason to do partial Roth conversions: you get to keep more of the money you made.

Perhaps equally as important is that you leave a tax-free legacy to your children. Instead of your kids having to take “income” from your tax-deferred accounts–likely at their peak earning years–give them tax-free Roth money to enjoy.

Nice summary.
Mostly, it's of less value if the person has a small IRA/401K. Could even end up paying extra tax doing it, if not done wisely with a small IRA/401K.

 

[CRLLS]

Presume that a person could keep convert enough such that their "other annual incomes" stay below some state-set level. By that I mean all taxable income from sources outside of the Roth. In many states they may qualify to freeze their property tax assessments from any increase. This can mean a lot over 10 or more years, especially in a growing locale. Also, in some states, they can pay no property tax at all if their AGI is below some "poverty"level. The tax would be placed as a lien against their property and be due upon the sale, presumably upon the death of the owner. This is not necessarily a good thing if one has heirs.