Save taxes doing Roth Conversion

[Sunset]

It really bugs me how roth conversion bumps tax free dividends/LTCG into the 15% tax bracket if you have a lot of either one.

Thinking of optimizing Roth Conversions by alternating years where conversion done.
Based on my calculations a person will save money doing this.
I welcome folks to point out where I messed up the numbers

To simplify I'm using very contrived numbers.
This is only of value to folks with large IRA's or short time to convert prior to SS & RMD's
I figured it out for Married couple filing joint.


Pretend person has $24,000 interest or regular income.
has capital gains and dividends of $77,400.

This person will pay almost zero tax.
If they do any IRA to Roth Conversions (or IRA withdrawals). They pay 27% tax (as the conversion money replaces the capital gain/dividend money spot) so the conversion money is taxed at 12% and the capital gain/dividend is taxed at 15%.

I am using this 2018 tax calculator as it handles dividends/Capital Gains.
https://www.olt.com/main/home/taxestimator.asp

This only concerns Federal taxes.

Here is the plan:

1st year:
$24,000 interest or regular income
$77,400 capital gains and dividends

Taxable income $77,400.00
Federal Taxes $225.00

Second year:
$24,000 interest or regular income
$77,400 capital gains and dividends
$200,000 Roth Conversion

Taxable income $277,400.00
Federal Taxes $48,189.00
Alternative Minimum Tax $ 0.00
Total Tax $48,189.00

Compared to yearly Roth Conversions of $100K the tax savings for 200K over 2 year conversions is $2,789
Taxable income $177400.00
Federal Taxes $25489.00
Alternative Minimum Tax $ 0.00
Total Tax $25489.00

For those interested, the break even point.
Yearly Roth Conversion $93,660 is the break even tax cost over the 2 years
Taxable income $171,060.00
Federal Taxes $24,094.00
Alternative Minimum Tax $ 0.00
Total Tax $24,094.00

Note:
I tried the dinkytown.net calculator as well https://www.dinkytown.net/java/Tax1040.html#

It also came up with a savings, but the tax paid was different
DinkyTown.net calculator says tax is $30 first year, and $50,142 when doing the 200K roth conversion
For comparison DinkyTown.net calculator says tax is $25,489 per yr if do 100K roth conversion
So the savings is only $806 over the 2 years, according to DinkyTown.

 

[audreyh1]

It really bugs me how roth conversion bumps tax free dividends/LTCG into the 15% tax bracket if you have a lot of either one.

Thinking of optimizing Roth Conversions by alternating years where conversion done.
Based on my calculations a person will save money doing this.
I welcome folks to point out where I messed up the numbers

To simplify I'm using very contrived numbers.
This is only of value to folks with large IRA's or short time to convert prior to SS & RMD's
I figured it out for Married couple filing joint.


Pretend person has $24,000 interest or regular income.
has capital gains and dividends of $77,400.

This person will pay almost zero tax.
If they do any IRA to Roth Conversions (or IRA withdrawals). They pay 27% tax (as the conversion money replaces the capital gain/dividend money spot) so the conversion money is taxed at 12% and the capital gain/dividend is taxed at 15%.

I am using this 2018 tax calculator as it handles dividends/Capital Gains.
https://www.olt.com/main/home/taxestimator.asp

This only concerns Federal taxes.

Here is the plan:

1st year:
$24,000 interest or regular income
$77,400 capital gains and dividends

Taxable income $77,400.00
Federal Taxes $225.00

Second year:
$24,000 interest or regular income
$77,400 capital gains and dividends
$200,000 Roth Conversion

Taxable income $277,400.00
Federal Taxes $48,189.00
Alternative Minimum Tax $ 0.00
Total Tax $48,189.00

Compared to yearly Roth Conversions of $100K the tax savings for 200K over 2 year conversions is $2,789
Taxable income $177400.00
Federal Taxes $25489.00
Alternative Minimum Tax $ 0.00
Total Tax $25489.00

For those interested, the break even point.
Yearly Roth Conversion $93,660 is the break even tax cost over the 2 years
Taxable income $171,060.00
Federal Taxes $24,094.00
Alternative Minimum Tax $ 0.00
Total Tax $24,094.00

Note:
I tried the dinkytown.net calculator as well https://www.dinkytown.net/java/Tax1040.html#

It also came up with a savings, but the tax paid was different
DinkyTown.net calculator says tax is $30 first year, and $50,142 when doing the 200K roth conversion
For comparison DinkyTown.net calculator says tax is $25,489 per yr if do 100K roth conversion
So the savings is only $806 over the 2 years, according to DinkyTown.

Once upon a time there was no 0% cap gains bracket, well maybe except maybe for folks with super low incomes. It's been a nice perk since it was introduced in 2008.

Drawing from IRAs is treated as ordinary income. It was not taxed when you put it in, so you owe tax when you draw it (unless you are old enough to do a Qualified Charitable Donation), regardless of whether you are converting to a Roth. Only after tax money can go in a Roth, so it seems unreasonable to expect tax-deferred funds to be treated differently just because you are doing a conversion.

Anyone is welcome to stagger their annual activity to minimize taxes. Alternating Schedule A deduction worked well for a long time.

 

[pb4uski]

1st year:
$24,000 interest or regular income
$77,400 capital gains and dividends

Taxable income $77,400.00
Federal Taxes $225.00 ....

I think the tax in this scenario will be $30, not $225.

Ordinary income is $0....$24k interest less $24k standard deduction
Preferenced income is $77,400.... $77,200 @ 0% and $200 @15% = $30

 

[Sunset]

I think the tax in this scenario will be $30, not $225.

Ordinary income is $0....$24k interest less $24k standard deduction
Preferenced income is $77,400.... $77,200 @ 0% and $200 @15% = $30

That is what I had expected as well, so it seems the dinkytown calculator is more accurate.
Meaning the savings are only eight hundred over 2 yrs of taxes.. .

 

[cathy63]

Pretend person has $24,000 interest or regular income.
has capital gains and dividends of $77,400.

This person will pay almost zero tax.
If they do any IRA to Roth Conversions (or IRA withdrawals). They pay 27% tax (as the conversion money replaces the capital gain/dividend money spot) so the conversion money is taxed at 12% and the capital gain/dividend is taxed at 15%.

There's also a 10% bracket in there for first the $19,050 after the standard or itemized deductions.

I am using this 2018 tax calculator as it handles dividends/Capital Gains.
https://www.olt.com/main/home/taxestimator.asp

This only concerns Federal taxes.

Here is the plan:

1st year:
$24,000 interest or regular income
$77,400 capital gains and dividends

Taxable income $77,400.00
Federal Taxes $225.00

I think something is wrong with the math in this scenario. The top of the 0% cap gains bracket is $77.2K, so this couple has $200 in cap gains, which should be taxed at 15%. By my reckoning, they should be paying $30, not $225.

Second year:
$24,000 interest or regular income
$77,400 capital gains and dividends
$200,000 Roth Conversion

Taxable income $277,400.00
Federal Taxes $48,189.00
Alternative Minimum Tax $ 0.00
Total Tax $48,189.00

Compared to yearly Roth Conversions of $100K the tax savings for 200K over 2 year conversions is $2,789
Taxable income $177400.00
Federal Taxes $25489.00
Alternative Minimum Tax $ 0.00
Total Tax $25489.00

For those interested, the break even point.
Yearly Roth Conversion $93,660 is the break even tax cost over the 2 years
Taxable income $171,060.00
Federal Taxes $24,094.00
Alternative Minimum Tax $ 0.00
Total Tax $24,094.00

Note:
I tried the dinkytown.net calculator as well https://www.dinkytown.net/java/Tax1040.html#

It also came up with a savings, but the tax paid was different
DinkyTown.net calculator says tax is $30 first year, and $50,142 when doing the 200K roth conversion
For comparison DinkyTown.net calculator says tax is $25,489 per yr if do 100K roth conversion
So the savings is only $806 over the 2 years, according to DinkyTown.

Ah, I see the second calculator has the same number I got for the first scenario. I think that one's doing a better job.

 

[RunningBum]

I think dinkytown is right on the $30 first year, but I got the same as the first one for the other years.

You get the first 19050 at 25%: 10%, plus the 15% for the CGs you push in. $4762 tax

The next 58,350 (or is it 58,150?) is taxed at 27% (12%+15%) $15,755

After that you get taxed at 22% for a good chunk (87,600 if my quick math is right), $19272 tax

and the last $35,000 at 24%, $8400. Total tax 48189 2nd year, $30 first year, 48219 total.

When splitting the $100K, you get the same 25% and 27% both years, 4762+15755
then 22,600 at 22%. $4972. 25489 each year, or 50,978.

$2759 difference.

Another thing to consider, when you start collecting SS, and perhaps a pension, you'll already be pushing some of those CGs+QDivs into being taxable. So the 25% and 27% windows are shorter. Maybe it makes sense to not convert now, or maybe just to 25%, and then convert later when you can do more of it at 22% and 24%. So the goal would be to convert as little as possible at 27%, and instead converting at 25, 22, and 24%.

 

[pb4uski]

That is what I had expected as well, so it seems the dinkytown calculator is more accurate.
Meaning the savings are only eight hundred over 2 yrs of taxes.. .

No.... dinkytown is wrong... TT What-If says $30 too.

 

[Sunset]

No.... dinkytown is wrong... TT What-If says $30 too.

Maybe my post was too long, but at the end I say how dinkytown for the first year said tax was $30.

So dinkytown is correct for the first year.
But maybe not correct for the second year, which means the savings doing a 2 year cycle is worth it for the numbers I used.