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SEP or Roth Conversion
Old 11-29-2022, 12:31 PM   #1
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SEP or Roth Conversion

Hi. Situation: I started a new business this year and thus my income was drastically lower as I worked through launch. It has put myself and my husband into a much lower tax bracket than we are used to. I am leaning toward taking some of my cash flow and putting into a Roth conversion (to pay the taxes) instead of adding to my SEP IRA. I just wanted to check in with those of you on the forum to see if there is anything I may be missing in my thinking that it would be better to do the Roth in a lower income/tax year vs investing in tax deferred. Thank you.
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Old 11-29-2022, 02:50 PM   #2
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It seems to me adding to an SEP IRA would be ill-advised because, if I've got this right, would reduce this year's income value on which you must pay taxes. But you don't need to reduce this year's income.

The principle many people use is to fill-up the lower tax brackets in low income years under the presumption that after they retire, they'll have untaxed funds that will have to get pulled out (because of the required minimum distributions regulations).

I think what you want this year is to convert SEP money to Roth, and fill up those low brackets. You can buy tax software now, put in estimates for everything, then keep jacking up the conversion and stop when the marginal tax gets to where you want it.

And if you have money you want to save for retirement, put it directly into the Roth.
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Old 11-29-2022, 03:01 PM   #3
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If you are in an abnormally low tax bracket, then doing some Roth Conversions can be a good idea. Deferring income taxes with an SEP is not a good deal if those taxes would have been lower this year than they will be once SS and RMDs are going.

The optimum Roth plan depends on a lot of projections, many of which are highly uncertain. Some other things to factor in:
-Receiving ACA premium credits? - Roth Conversions may reduce those as well.
-Ages
-Tax deferred balance
-Projected SS benefits
-This year's taxable income and AGI
-Projected future earnings from your business
-Taxable balance
-Other cash flow in case business doesn't do as well as hoped
-Life Goals for tax deferred - QCDs, bequests to charity, reserve some for possible long term care, maximize value to heirs
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Old 11-29-2022, 03:01 PM   #4
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Roth conversion probably makes sense but there's not enough info here. Can you project what your info and tax rate looks like in retirement? Take into account RMDs, whether you'd hit IRMAA, and whether your SS might not be fully taxed to decide if Roth conversions look attractive now. This comparison is more important than your comparison to last year.
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Old 11-30-2022, 08:48 AM   #5
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Thank you for the insights. I have done some projecting, but not enough to be confident to make the comparison runningbum suggests. I will do a bit more work to better estimate the future. Im 55 now, married, with a IRA portfolio of 1.8 mil and brokerage of 250k, a townhome we use as a rental that will be paid off in 5 yrs. Dept free so taxes are an issue each year for us. Again, thank you for your comments and insights.
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Old 12-01-2022, 10:21 AM   #6
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I-orp takes a lot of effort to understand and get the inputs right, but can be a great data point.

But based on your last post, I would feel very confident that filling the 15% bracket would be a win.

One thing to keep in mind is that all of this doesn't make THAT much difference in the big picture, and taking some moderate action can get you most of the way there.
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