Seeking Optimal Roth Conversion/RMD Strategy

[lawman3966]

A thread about the terrors of RMDs on another forum prompted me to ask the board for proposed Roth conversion strategies in view of my age and distribution of assets among taxable, tax-deferred, and tax-free (Roth) investments.

My data:

Age 55 (possibly retiring at age 56 about six months from now).
Taxable: $730K (551K equities; 185 non-equity - mostly cash, some bonds).
Tax-def: $360K
Tax-free: $115K
SS: $30K at age 70.

Assuming that I retire at 56, my income in the following year would be about $10K a year from dividends and cap gains. I also expect to wait until age 70 to draw SS.

Q: Based on the above, how much would you recommend converting from Tax deferred to Roth each year between age 56 and 70?

Additional Info:
Single; no dependents;
No pension.
Will want to qualify for ACA subsidies (expect to live in WA state).
Expenses running at $30K a year.
Income: Expect to draw from the $185K in non-equity investments in Taxable. May do some part time work (Uber or Lyft). Not counting on it, but I might make $10K or so a year.

 

[grasshopper]

Are living expenses coming out of Tax-def?, and how much are your expenses every year?

https://personal.vanguard.com/us/insights/retirement/living/estimate-your-rmd-tool

 

[RunningBum]

Single or married? Pension? Does that 10K include cap gains from investments you may have to sell to fund your years between 56-70? Are you going to try to qualify for an ACA subsidy?


Generally the idea is take the top of the 15% bracket, and add tax deductions and exemptions. Subtract from that your dividends, capital gains, and any pension. The remaining value is what you can convert under the 15% cap. Try not to go over, because for every dollar you go over, you're taxed 15% on that dollar you've converted, plus another 15% on a dollar of cap gains you've pushed into taxable. This means you might convert a conservative amount early in the year, and then wait until late December after mutual fund distributions are done to top it off.


If you're going for an ACA subsidy you may have to convert less.

 

[bingybear]

lawman, grasshopper is right about the need for more information. Also, are you single or what is the number of dependents (2 for you and spouse). Your tax deferred is not really all that large from an RMD standpoint. Your first RMD is likely to be just below 4% of the existing value... about $14k based on current amounts. This will likely grow if you invest it well. You need to estimate your overall tax condition for the years ahead and see what your tax rates would be if you convert early or not (taxes both before RMD and after).

Without the additional information....doing Roth conversions while in the 0% bracket is a no brainer (up to your standard deduction+personal exemptions). Note LTCG and QD would not be taxable until you exceed the 15% bracket.

What you can do will really depend on how you generate income.

 

[lawman3966]

Bump. Updated to answer various poster questions.

 

[Free To Canoe]

For next year I recommend optimizing your ACA first and convert some roth to get income for this optimization. In your situation I would only convert if it was a tax free event. A little bit of earned income will give you many options at tax time.

 

[Options]

Single or married? Pension? Does that 10K include cap gains from investments you may have to sell to fund your years between 56-70? Are you going to try to qualify for an ACA subsidy?


Generally the idea is take the top of the 15% bracket, and add tax deductions and exemptions. Subtract from that your dividends, capital gains, and any pension. The remaining value is what you can convert under the 15% cap. Try not to go over, because for every dollar you go over, you're taxed 15% on that dollar you've converted, plus another 15% on a dollar of cap gains you've pushed into taxable. This means you might convert a conservative amount early in the year, and then wait until late December after mutual fund distributions are done to top it off.


If you're going for an ACA subsidy you may have to convert less.

+1
Probably the best, most concise, and informative answer I've seen on this subject.

 

[bingybear]

+1
Probably the best, most concise, and informative answer I've seen on this subject.

While I agree with you that the quoted explanation is good as to why to stay in or below the 15% bracket, I'm not sure he will be above the 15% bracket at RMD time. He will have used up some of his taxable account between now and RMD which will likely reduce the investment income from that account. If we use the numbers he provided to day (effectively assuming his account grows with inflation as does SS and assume the tax rate is the same), his first year in RMD he would have (todays dollars) 30k SS + 14k RMD minus about 10k std deduction and exemption, so 34k which is in the 15% bracket. One thing missing here is if this income would create some taxability on SS.
Its easy to say convert while it is free. Since this hand wave indicated 15% bracket at RMD, convert in the 10% bracket. But converting up to the top of the 15% could cost him more in the long run assuming the above.

I think some more analysis to estimate real growth might help. The obvious wild card is the tax rates in the future.

For some people it is obvious... either convert up to the top of the 15% bracket.... or don't convert at all depending upon the financial situation.

 

[LOL!]

The optimal may change from year to year and is certainly a very personal thing.

I have started Roth conversions. I am doing it the following way:

1. Run the calculator at Optimal Retirement Planner - Parameter Form to get a ballpark figure.

2. Run TurboTax with a "what-if?" tax calculation based on my income.

3. Start two new Roth IRAs and convert money into them with the idea of recharacterization one back to a traditional IRA. That is a free re-do that the IRS gives you. The idea is to have 2 different investments in the Roth IRAs that are risky. I hope one will gain a lot of money and one will not gain a lot of money or even lose money.

4. At Thanksgiving, get the latest TurboTax and re-do all the calculations. See where I stand on staying in the 15% marginal income tax bracket, so that my realized long-term capital gains are tax-free.* Adjust conversion or recharacterization as needed to fine-tune the numbers.

5. Rinse and repeat each and every year for the next 15 or so years.

* A slight complication on th LTCG is that I have carryover losses that will take years to be used up, so any money withdrawn from my taxable accounts will not be taxed for many years to come. But it all needs to be included in TT. And numbers will depend on how much tax-loss harvesting I do during the year, too.

Also, I am not using a tax estimator. I do not believe that estimates are good enough for the optimal calculation. So I do not use TaxCaster or any guesses from friendly folks on the internet. I am using a real up-to-date version of TurboTax late in the year.

 

[Ed_The_Gypsy]

Just eye-balling it, consider:
1) as you are single, I see no point in deferring SS until 70. Why not 62?
2) convert as little per year to Roth as you need to stay inside the limits for ACA (until Medicare at 65) after you are no longer covered by employer's health care benefits.
You do not need to convert everything to avoid the Tax Torpedo. I can leave about 90k in the trad IRA, to be subject to MRD, and still pay no tax ever after.

Sent from my SM-G900V using Early Retirement Forum mobile app

 

[lawman3966]

Just eye-balling it, consider:
1) as you are single, I see no point in deferring SS until 70. Why not 62?
2) convert as little per year to Roth as you need to stay inside the limits for ACA (until Medicare at 65) after you are no longer covered by employer's health care benefits.
You do not need to convert everything to avoid the Tax Torpedo. I can leave about 90k in the trad IRA, to be subject to MRD, and still pay no tax ever after.

Thanks for your insights.
The plan to defer SS until age 70 arises from data indicating that the break-even age for SS benefit-starting ages is about 82. Beyond that age, the higher monthly SS income serves as a convenient income floor. Some people regard the delay in starting benefits as an indirect way of purchasing longevity insurance.

Regarding the ACA, my impression was that there was a sliding scale of subsidies as a function of income, not an all-or-nothing outcome. The subsidies seem to peak at an income of 13K and die out as income rises to 50K or so. Determining whether it would be better to convert a little more and receive a slightly smaller ACA subsidy seems like a project for an Excel spreadsheet, not something I'd try to do in my head.

Thanks again for your input.

 

[Texas Proud]

If you are looking to get ACA credits you better do a tax what if...

When I did mine I was surprised that I was being taxed at between 25% to 23% based on my additional income... IOW, your credits are going down as your tax is going up....

I really do not think there IS a 15% bracket anymore if you are dealing with the ACA credit... but I could be wrong... I have only looked at my situation...

 

[RunningBum]

ACA subsidy is a sliding scale but it does fall off a cliff rather than dwindling to 0.


Maybe converting to 10% is a better strategy in your situation, but if you can get most of your tax deferred converted to Roth, probably none of your social security will be taxable, which is a nice break. It probably won't hurt to leave about 10K to be distributed after 70 since exemptions and deductions will absorb that.


You probably need to run a spreadsheet or use a tax program to run your scenarios for now and in retirement. I agree there is no need to take 15% income now only to pay 0% later. 10% top tax rate throughout works out better, if you can do that.

 

[lawman3966]

ACA subsidy is a sliding scale but it does fall off a cliff rather than dwindling to 0.

How so? There are tables for various family situations at the site linked below, and it seems to indicate a sliding scale, though for single persons, the subsidies appear to reach 0 at an income of about $30K - which is lower than I thought. But, it's not a "cliff" as far as I can tell.

Subsidy Amounts By Income Limits For The Affordable Care Act (Obamacare) | Financial Samurai

Maybe converting to 10% is a better strategy in your situation, but if you can get most of your tax deferred converted to Roth, probably none of your social security will be taxable, which is a nice break. It probably won't hurt to leave about 10K to be distributed after 70 since exemptions and deductions will absorb that.


You probably need to run a spreadsheet or use a tax program to run your scenarios for now and in retirement. I agree there is no need to take 15% income now only to pay 0% later. 10% top tax rate throughout works out better, if you can do that.

The 10% bracket only goes up to about $9K for single filers. I think I may have very little space for conversion once all my dividends are counted if I stuck to a 10% rule as you suggest. However, I do agree that a spreadsheet and tax program are needed to iron out the details.

 

[Independent]

A thread about the terrors of RMDs
....
Taxable: $730K (551K equities; 185 non-equity - mostly cash, some bonds).
...

Assuming that I retire at 56, my income in the following year would be about $10K a year from dividends and cap gains.

Putting these numbers together, it looks like you are expecting your combined dividends and capital gains to equal less than 1.4% of your equities. And, you're earning no interest at all on your $185k of cash and bonds.

Those numbers seem unusually low.

 

[RunningBum]

How so? There are tables for various family situations at the site linked below, and it seems to indicate a sliding scale, though for single persons, the subsidies appear to reach 0 at an income of about $30K - which is lower than I thought. But, it's not a "cliff" as far as I can tell.

Subsidy Amounts By Income Limits For The Affordable Care Act (Obamacare) | Financial Samurai

I use Health Insurance Marketplace Calculator | The Henry J. Kaiser Family Foundation. In my case, when I go $1 over, I lose $83/month in subsidies--almost $1K. That's pretty significant, IMO. I can't think of another case where just $1 of income costs you nearly $1000 in taxes or loss of subsidy.

The 10% bracket only goes up to about $9K for single filers. I think I may have very little space for conversion once all my dividends are counted if I stuck to a 10% rule as you suggest. However, I do agree that a spreadsheet and tax program are needed to iron out the details.

Yeah, I can't tell if you'd be better off converting to just 10% or up to 15%. If you're only going to be in 10% in retirement, it doesn't make sense to convert to 15% now.

 

[jim584672]

Chart of the "cliffs":

 

[blackfish]

I would prioritize ACA subsidies over RMD taxes in your situation. You can go to your state's health exchange site and input your information to see the subsidies vs income. You may actually need to "generate" income to get above the medicaid level. (You do not want medicaid), and if that is the case, do Roth conversions to get to the income level you desire.

Do all your Roth conversions between age 65-70 while on Medicare. I fully agree with waiting till 70 for SS.

Your withdrawal is low, even without considering SS. Financially you are set...enjoy life.

 

[bingybear]

When I did mine I was surprised that I was being taxed at between 25% to 23% based on my additional income... IOW, your credits are going down as your tax is going up....

I have not been in the 15% bracket for a long time, so I'm not real familiar with that end of the tax code. I expect this year I will become more familiar. I assume you are referring to low/middle income tax credits like EITC (not that this is the only one). I guess one could look at this as lowering the tax rate within a range. But like exceeding the 15% bracket with LTCG and QDiv... locally it looks like 30% marginal (don't argue.. I know that it really is the marginal rate)

How so? There are tables for various family situations at the site linked below, and it seems to indicate a sliding scale, though for single persons, the subsidies appear to reach 0 at an income of about $30K - which is lower than I thought. But, it's not a "cliff" as far as I can tell.

try this calculator for subsidies. I looked at it briefly and for a family of 2 adults (my situation), there is a large cliff between 62k and 63k (there is an exact number where there is a big jump). However, when I looked at single adult, I did not see the large jump... but I did not look at it closely. I would have thought these would be similar, but that may not be the case.

The 10% bracket only goes up to about $9K for single filers. I think I may have very little space for conversion once all my dividends are counted if I stuck to a 10% rule as you suggest. However, I do agree that a spreadsheet and tax program are needed to iron out the details.

For taxable income calculation, you have to consider how taxes are calculated. If your investment income is LTCG and QDiv, these are not actually taxed until these with other income exceeds the 15% tax rate. In addition you get a standard deduction and personal exemption that totals about 10k. Considering all this, you have about 19k for income from other normally taxed sources such as NQDiv or Roth rollovers.

However, be careful with the above as this does not address the subsidy. The standard deduction and personal exemption do not exist in the MAGI for ACA and LTCG and QDIV are counted directly. There are other thing that add in and many credits are included in tax later.
As many have suggested, you need to run whatif calculations to understand what your options are. I will be doing that this year for my individual case. There are rules of thumb.. like converting "up to the top of the 15% bracket". This is great if you expect to be in a higher bracket at RMD time.

good luck

 

[Texas Proud]

I have not been in the 15% bracket for a long time, so I'm not real familiar with that end of the tax code. I expect this year I will become more familiar. I assume you are referring to low/middle income tax credits like EITC (not that this is the only one). I guess one could look at this as lowering the tax rate within a range. But like exceeding the 15% bracket with LTCG and QDiv... locally it looks like 30% marginal (don't argue.. I know that it really is the marginal rate)

I have been at the top of the 15% bracket the last few years.... or just over, so the bottom is new to me...

The EITC needs less than $3,350 of investment income to qualify... I do not qualify...

The changes I see is mostly in the ACA subsidy.... I have to pay between 8% and 9% of MAGI, so if MAGI goes up my subsidy goes down... and if MAGI goes up, I am paying 15% more in taxes on that income...

So, 15% more in tax and 9% less subsidy credit is the hit that I am taking... so my true marginal tax rate is 23 to 25%.... (lose a few other small credits)....


I do not believe there is a 15% marginal change to final taxes anymore if you qualify for the ACA credit... but since I have not done all possibilities there is not way I can be sure...

 

[bingybear]

I have been at the top of the 15% bracket the last few years.... or just over, so the bottom is new to me...

The EITC needs less than $3,350 of investment income to qualify... I do not qualify...

The changes I see is mostly in the ACA subsidy.... I have to pay between 8% and 9% of MAGI, so if MAGI goes up my subsidy goes down... and if MAGI goes up, I am paying 15% more in taxes on that income...

So, 15% more in tax and 9% less subsidy credit is the hit that I am taking... so my true marginal tax rate is 23 to 25%.... (lose a few other small credits)....


I do not believe there is a 15% marginal change to final taxes anymore if you qualify for the ACA credit... but since I have not done all possibilities there is not way I can be sure...

I don't know why the that really skipped my mind. I don't yet see health insurance as a tax... not on the ACA yet, still on cobra. But I see what your are talking about. This will really be trade between roth conversions up to the top of the 15% bracket (no ACA sub with 2 adults), or limiting conversions (or eliminating them) to get an ACA sub. There still is a 15% bracket above the ACA sub for a family of 2 adults.

 

[pb4uski]

If I do no Roth conversions then my health insurance costs ~$200/month after a $485/month credit. However, I can qualify to buy a cat policy for ~$425/month so I'm only spending an additional $225/month ($2,700/year) by ignoring ACA credits and the constraints associated with them.

In my case, it makes sense to look not at the subsidy, but the savings between the subsidized cost of health insurance and the cost of a cat poilcy. In my state, a cat policy is substantially (35-40%) less than a bronze policy.

But... later in life I spend little time in the 25% tax bracket with Roth conversions but without Roth conversions I spend many years in the 25% tax bracket. That extra 10% tax in those later years far exceeds the $2,700/year ACA benefit so for me, so Roth conversions are the way to go.

According to my projections. my age 71 RMDs are 3.5 times what they would be without Roth conversions and the extra 10% tax on the RMDs far exceeds the $2,700 a year of ACA tax credit benefit.

As always, YMMV.

 

[RunningBum]

What is a cat policy? I google it and am only seeing references to pet insurance.

 

[Texas Proud]

What is a cat policy? I google it and am only seeing references to pet insurance.

I would think catastrophic...

 

[pb4uski]

Yes, catastrophic health insurance policy. It has a $6,600 per person deductible vs $5,000 for a bronze plan but the bronze plan out-of-pocket max is $6,250 vs $6,600 for the cat policy. Similar preventative care benefits and the same network.

Since we are in good health and spend much less than the deductible most years, the benefits are not very different from our perspective. Both policies give us access to negotiated rates and insurance from the extreme cost of a significant health event or accident, which is principally why we purchase health insurance.