Taxes from Roth conversion proceeds

[trapperjohn]

In principle, I understand that you should use other funds to pay taxes from a tIRA conversion to a Roth so that it maximizes the amount in the Roth. But if you have no other funds, and will face very large RMDs in the future, doesn't it make sense to pay the tax out of the conversion proceeds so that you can still move as much as possible into your Roth ASAP?

Possibly helpful background info:

I have about $950K in pretax tIRA, and about $100K in Roth I've had > 5 years. No other savings.

I'm 61, retired, with non-cola'd pension that already puts me in 25% bracket. I'm currently converting to top of the 25% bracket.

Not currently taking SS. When I *do* start SS, it will be approx $24k/yr.

Currently taking an additional $16K/yr out of tIRA for living expenses.

Paying taxes from tIRA withdrawals out of proceeds from those tIRA withdrawals.

Healthcare and LTC expenses are already accounted for in yearly expenses.

[JG in Hangzhou]

Posting to Follow. Need to learn more about this ROTH Ladder.

[pb4uski]

Sounds like you will pay 25% (or 28%) either way and that your SS will be 85% taxable either way so I'm not sure if it makes much of a difference.

One possible difference might be if you are in a state with state income tax now but plan to be in a state with no state income tax later then you may want to defer... or vice versa.

[Whisper66]

For many of us, the big issue with paying taxes from tIRA funds being withdrawen is penalties. But once you pass 59-1/2, you aren't be hit with the 10% penalty for the distribution of tIRA funds to pay taxes. So I think what you are doing is correct for your situation.

[Sunset]

It looks like your first RMD + SS will be approximately $57,000, which is $41,000 more than you are currently taking out of the IRA.

If adding $41,000 to your current income (Pension + $16,000 + any interest/investment) puts you into the 28% bracket (or close to it). Then yes take out extra now by converting it to a roth.

In general if you are close to the border of going into a higher tax bracket, over time you could easily slip into the higher bracket.

However, the actual amount involved could be low, and even if you were on the border right now, the extra amount would be $1,238 per year.

As for the paying taxes from the withdrawal part, that will occur whether you do withdrawal or conversion, so it does not make a difference.

[Fedup]

You will be in a higher bracket than you are now if you don't convert.

[Alan]

Quote:

Originally Posted by Whisper66 For many of us, the big issue with paying taxes from tIRA funds being withdrawen is penalties. But once you pass 59-1/2, you aren't be hit with the 10% penalty for the distribution of tIRA funds to pay taxes. So I think what you are doing is correct for your situation.

Good point, I hadn't even realized that. (I'd always been able to pay the taxes out of after-tax funds before age 59.5)

[trapperjohn]

Thanks for your replies. You've confirmed my thinking ... that I'll pay taxes either way, and if I don't do conversions now, I'll be in a higher bracket later when RMDs kick in, and I'll pay higher taxes then.

Thanks for the confirmation.

[Koolau]

I'm a big fan of Roths. Even though I'm now into RMDs, I will consider more conversions - paying taxes from proceeds. Mentioned in another thread, RMDs can eventually trigger such things as increased Medicare cost. The effect kicks in with one extra dollar at the inflection point. For that reason, I'm working toward controlling future RMDs. I'll be in the 25% bracket no matter what I do, so that's pretty much a wash. Reducing my 401(k) balance (without triggering Medicare or other bad things) continues to be my goal, though I don't have my strategy completely lined out yet. I don't do my own taxes and can't get my tax "guy" to participate in the discussion - maybe I need a new tax guy.

In theory, tax wise, it wouldn't matter whether I just take extra 401(k) payments (beyond my current RMD) and put the money in a taxable account OR convert some 401(k) money to Roths. (Yeah, I know, I think you still have to convert to a tIRA first.)

So to OPs question, if all else is equal, I see no problem with paying the taxes out of proceeds. YMMV

[evilanne]

Quote:

Originally Posted by trapperjohn I'm 61, retired, with non-cola'd pension that already puts me in 25% bracket. I'm currently converting to top of the 25% bracket. Not currently taking SS. When I *do* start SS, it will be approx $24k/yr. Currently taking an additional $16K/yr out of tIRA for living expenses. Paying taxes from tIRA withdrawals out of proceeds from those tIRA withdrawals. Healthcare and LTC expenses are already accounted for in yearly expenses.

You may want to be careful from age 63-64 on your withdrawals/conversions if you plan to sign up for Medicare at 65, since Part B is based on prior year income--not sure if it is 1 or 2 years, may depend on when your Birthday is, in relation to when taxes are filed.

For a single tax payer in 25% tax bracket, how effective is trying to stay within this tax bracket over the long run? For Single Taxpayers, the range of the bracket is about is about $54K, so if you are at the midpoint and can convert $27K per year, over 10 years that is $270K ($950-$270=$680K, ignoring any earnings) At a 4% RoR, you would still have RMDs of $24-$36K annually; at 6% RoR RMDs could increase up to $66K/year. Would it make sense to convert some into the next 28% tax bracket? You pay 3% more in taxes but all earnings in Roth would be tax free. Trying to wrap my head around this for myself, but I have a more time than OP and we don't know if they will ever reform the tax code.

[H2ODude]

One thing I believe I saw mentioned on this board was the impact of filing status changing when one of the couple checks out. In our case it doesn't appear that we can advantage much by doing more than about $20k a year conversion out of my tIRA, currently about $1.4 mil. However, since no doubt ONE of us will check out first, that will make a pretty big change in the tax rate for all those minimum distributions since the survivor will be filing as single, not married. Well, unless she marries the pool boy. But isn't that a pretty significant incentive to Roth conversions when you're facing a big MRD stream? I just don't see a lot of talk about that. Longevity unknowns are big, but I'd guess the chance of one outliving the other by a wide margin are pretty steep.

[2017ish]

Quote:

Originally Posted by H2ODude One thing I believe I saw mentioned on this board was the impact of filing status changing when one of the couple checks out. ....

yeah, this is the deal clincher for us. If both of us are still alive and kicking at 90+, the numbers are close for converting aggressively. The odds that DW will be alone and paying single tax rates in her 90s (and, maybe even in her late 80s), will make aggressive conversions over multiple years an easy decision in our particular circumstances.

[2017ish]

Quote:

Originally Posted by evilanne You may want to be careful from age 63-64 on your withdrawals/conversions if you plan to sign up for Medicare at 65, since Part B is based on prior year income--not sure if it is 1 or 2 years, may depend on when your Birthday is, in relation to when taxes are filed. ...

Isn't the medicare surcharge assessed (or not) on a continuing look back basis? So if we don't convert from 63-64, causing high income beginning at age 70.5, wouldn't the Part B premiums go up at age 73 or thereabouts?? And, conversely, if you had high income at 63-64, then dropped the income at 65-66, wouldn't the "premium" go down?

(Still in our 50s, so haven't closely examined this aspect of things yet.)

[evilanne]

I don't know...thought it was just when you initially get it

https://www.medicare.gov/your-medica...t-b-costs.html

Based on current numbers it looks like anything under the top of the 25% tax bracket using standard deduction would qualify you for standard medicare rate . They base it on your modifed adjusted gross income (MAGI) = Your AGI + Tax Exempt Interest see https://www.ssa.gov/pubs/EN-05-10536.pdf

I don't see anything where they look at your tax return except initially or if beneficiary requests that it be lowered based on reduced income. Once you file for Medicare it appears to depend on whether or not the premiums are paid from your Social Security Check or not.

Quote:

The majority of Medicare beneficiaries have nothing to worry about. Most people who have their premiums deducted from their Social Security checks are protected by what’s called the "hold harmless" rule: Their Medicare charges can’t increase by any more than their Social Security income goes up.

Source: 2017 Medicare Premiums Could Jump 20% for Some People | Money

[2017ish]

Quote:

Originally Posted by evilanne I don't know...thought it was just when you initially get it https://www.medicare.gov/your-medica...t-b-costs.html ...

Ah, took me a little bit to find, but as suspected it is determined each year, not just at age 65; thus, if high income only at 63-64, you aren't doomed (nor can I successfully manipulate my way into never paying IRMAA ):

Quote:

Aside from the income bracket indicated above, policy holders who have Part D IRMAA will be notified by the Social Security Administration if they are part of this adjustment or not. This is determined every year in line with the Modified Adjusted Gross Income as indicated by your two-year income tax return report. Once the assessment is done, the SSA will notify you at the end of November. If you have just purchased Part D coverage, you will be notified as soon as your policy kicks in. For example, if you purchased Part D coverage after the assessment, you will be notified by the SSA on January 1, if you are included in the IRMAA.

https://www.medicare.gov/your-medica...t-b-costs.html

[sengsational]

Whenever the topic of RMD comes up and nobody mentions i-orp, I usually suggest running it. It takes some time to get all of the inputs tuned, but once you get that under your belt, you can do a few "what if" scenarios / sensitivity analysis.

i-orp has been criticized as being more aggressive on Roth conversions than many here are comfortable with. Since it's an optimization, it doesn't "know" it's doing a big Roth conversion now to only save a small amount. In other words, the optimization doesn't factor-in the "bird in the hand" in the near future with the more distant future that needs to be planned-for, but isn't as certain to be traversed (aka you might die before then, lol!).

But you can conduct sensitivity analysis by limiting conversions, taking SS at different ages, changing the plan duration for self and spouse, etc. In other words, you move some levers and see what happens. Gives you a feel for how much all of these options really mean to your spending in retirement.

[Sunset]

Quote:

Originally Posted by 2017ish Ah, took me a little bit to find, but as suspected it is determined each year, not just at age 65; thus, if high income only at 63-64, you aren't doomed (nor can I successfully manipulate my way into never paying IRMAA ): https://www.medicare.gov/your-medica...t-b-costs.html

Thanks..... I don't feel I have to worry since for a couple we can keep the AGI below $170,000 except for when I sell our rental house

But it won't be the end of the world if it goes back down the next year...