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Roth conversions with ACA
Old 11-11-2020, 09:00 AM   #1
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Roth conversions with ACA

I have been using ACA for 5 years with an AGI ~$24K. I have been reading the posts of others bumping up their AGI to just under the ACA cliff with Roth Conversions. If I follow that, my ACA annual premium increases $5K and my federal taxes increase $4.4K a year, making this a ~25% cost to do the Roth Conversion (~$40K), and I'd lose the compounding interest of this $9.5K every year. What am I missing? Why are others doing this?
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Old 11-11-2020, 09:12 AM   #2
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There's a complete description of the 'levers' in the paper referenced in this thread: https://www.early-retirement.org/for...de-106285.html


Generally, the idea is to keep your income tax "the same" over your lifetime. This only makes sense if you will be paying high tax rates in the future. For instance, when you are forced to remove tax advantaged funds in your 70's (commonly called the 'tax torpedo' of RMD's).
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Old 11-11-2020, 09:29 AM   #3
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It's a complicated issue for sure. You should definitely read the paper in the link above.

I'll assume your numbers are correct. You have to try to project what your income and taxes will look like later. If you don't convert, will RMDs push you into a higher tax bracket, make more qualified dividends taxable, and make more of your SS benefit taxable? You may find those things cause a greater than 25% marginal tax rate on the IRA distribution.

Regarding the loss of compounding growth. The direct tax on the conversion makes this a wash if you pay taxes from the conversion money, or slight benefit if you pay the conversion tax from taxable. This is because future growth within the Roth is not taxed, unlike the growth you left in your tIRA. You can verify this with a fairly simple spreadsheet.

Another factor is whether you can get your IRA fully or mostly converted between 65 and 70. At 65 you are on Medicare and not trying to limit income for your ACA subsidy. It helps a lot if you delay SS until 70.
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Old 11-11-2020, 10:02 AM   #4
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Quote:
Originally Posted by Wille View Post
I have been using ACA for 5 years with an AGI ~$24K. I have been reading the posts of others bumping up their AGI to just under the ACA cliff with Roth Conversions. If I follow that, my ACA annual premium increases $5K and my federal taxes increase $4.4K a year, making this a ~25% cost to do the Roth Conversion (~$40K), and I'd lose the compounding interest of this $9.5K every year. What am I missing? Why are others doing this?
At ~25% I probably would not do it unless you expect your tax bracket once you are on Medicare to be 25% or more... IOW, the added cost of lost subsidies probably does not make it worthwhile in your situation.

However, the loss of compounding interest each year is a fallacy. For and example, let's put ACA aside and say that you had $40k to convert and $4.4k to pay the federal taxes. Let's assume an earnings rate of 7% annually and a time horizon of 10 years and a 11% tax rate.

If you convert, you end up with $40k in the Roth and in 10 years it grows to $78,686 that you can spend.

If you don't convert, the $40k tIRA grows to $78,686 and the $4.4k grows to $8,052. If you then withdraw at the end of 10 years, you withdraw $78,686, owe $8,655 (11%) in taxes so you have $78,083 to spend.

So as a result of converting you are $603 better off because you didn't have to pay taxes on the growth of the $4.4k.
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Old 11-11-2020, 10:10 AM   #5
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Quote:
Originally Posted by Wille View Post
I have been using ACA for 5 years with an AGI ~$24K. I have been reading the posts of others bumping up their AGI to just under the ACA cliff with Roth Conversions. If I follow that, my ACA annual premium increases $5K and my federal taxes increase $4.4K a year, making this a ~25% cost to do the Roth Conversion (~$40K), and I'd lose the compounding interest of this $9.5K every year. What am I missing? Why are others doing this?
I do Roth conversion to push income above the level to start receiving subsidy, not much more. I am gaining the benefits of receiving almost full subsidy, around $17,000 this year, and about $5000 for 2021. I plan to do this low amount of Roth conversion for the next few more years until DW reaches 65.

I am not able to see the tax gain if I contribute up to right below ACA cliff since I do not have pension so my income level will gradually increase but not dramatically like some members here.

So, I believe not everyone's future tax situation is the same.
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Old 11-11-2020, 07:43 PM   #6
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I would not convert if I were you...


I am assuming you are in the best silver plan where you deductible and copays are very low... going up income ruins that... IOW, you not only pay more for your premiums but also more for healthcare...


I took a quick look at the paper and saw no info on ACA credits... but like you did a quick calc and determined that it would not be beneficial for me.
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Old 11-12-2020, 03:03 PM   #7
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Quote:
Originally Posted by Wille View Post
I have been using ACA for 5 years with an AGI ~$24K. I have been reading the posts of others bumping up their AGI to just under the ACA cliff with Roth Conversions. If I follow that, my ACA annual premium increases $5K and my federal taxes increase $4.4K a year, making this a ~25% cost to do the Roth Conversion (~$40K), and I'd lose the compounding interest of this $9.5K every year.
Not including state tax, if applicable.

I'm close to your AGI and never found that it's worth it to do conversions vs. keeping income low for ACA, so I don't. Especially when you factor in the CSR bennies for Silver plans (reduced OOP costs) if you use healthcare on a regular basis.

ACA plans for AGI under 250% FPL are a solid choice if you can live with that income.
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