Traditional 401K Roth Conversions - How to determine the Benefits?

[G-Man]

Doing a Roth conversion and paying the conversion tax from cash on hand could be favorable even if the conversion is done at a 24% marginal rate and later you would incur a 22% marginal rate (add whatever state tax to those numbers). See that link for more details.

Some competing "other considerations":
- tax rates scheduled to increase under current law; the survivor having to pay single tax rates instead of MFJ, vs.
- nobody predicted the 2018 tax cuts so maybe again...?; incurring large medical expenses in later life so itemized deductions are large enough that you drop to the 12%/15% rates.

I'm reading the link you provided. What is "phase-in of taxation of Social Security benefits"? How would I know if I fall into that situation?

 

[SecondCor521]

I'm reading the link you provided. What is "phase-in of taxation of Social Security benefits"? How would I know if I fall into that situation?

See the instructions for Line 6b in the instructions for Form 1040 at

https://www.irs.gov/pub/irs-pdf/i1040gi.pdf

and the worksheet on page 31 of that PDF.

Essentially, if half of your SS plus your other income is more than $32K ($25K if single), then some of your SS benefits will be taxable and show up on line 6b of your Form 1040.

Depending on the situation, somewhere between 50% and 85% of your SS can be included in your taxable income.

So to answer your question exactly, fill out the first six lines of your tax return as you expect the data to be when you're on SS, and then see if line 6b is non-zero.

 

[G-Man]

See the instructions for Line 6b in the instructions for Form 1040 at

https://www.irs.gov/pub/irs-pdf/i1040gi.pdf

and the worksheet on page 31 of that PDF.

Essentially, if half of your SS plus your other income is more than $32K ($25K if single), then some of your SS benefits will be taxable and show up on line 6b of your Form 1040.

Depending on the situation, somewhere between 50% and 85% of your SS can be included in your taxable income.

So to answer your question exactly, fill out the first six lines of your tax return as you expect the data to be when you're on SS, and then see if line 6b is non-zero.

Ok. I know my wife and I SS will be taxed at 85%.

 

[SevenUp]

I'm reading the link you provided. What is "phase-in of taxation of Social Security benefits"? How would I know if I fall into that situation?

Ah, great question! See Taxation of Social Security benefits. And yes, you may already be beyond the point at which 85% of the benefits become taxable, but for others' interest....

 

[TheWizard]

I never felt a need to do "large" Roth conversions, never converted more than $50k per year.
My goal was never to zero out my tax-deferred accumulation just to contain it and reduce it a bit.

My RMDs started this year and are around $3000 a month, which is fine, just fine...

 

[TheWizard]

It does simplify Roth conversion planning when your base AGI is high enough that 85% of SS is taxable and all qualified dividends are taxed at 15%.
Main things I focused on were:
1) stay in 24% marginal bracket with conversions included, don't get into 32% bracket.
2) convert enough to get up close to but not over the next higher IRMAA tier threshold.

Turned out that 2) was the controlling limitation and is a bit tricky since your AGI for 2022 (for instance) determines your IRMAA tier for 2024.
But the inflation adjusted IRMAA tiers for 2024 won't be announced until mid way through 2023.

Note that the OP won't have to factor IRMAA into his planning until the year that the first of them turns 63...

 

[G-Man]

It does simplify Roth conversion planning when your base AGI is high enough that 85% of SS is taxable and all qualified dividends are taxed at 15%.
Main things I focused on were:
1) stay in 24% marginal bracket with conversions included, don't get into 32% bracket.
2) convert enough to get up close to but not over the next higher IRMAA tier threshold.

Turned out that 2) was the controlling limitation and is a bit tricky since your AGI for 2022 (for instance) determines your IRMAA tier for 2024.
But the inflation adjusted IRMAA tiers for 2024 won't be announced until mid way through 2023.

Note that the OP won't have to factor IRMAA into his planning until the year that the first of them turns 63...

Is AGI and same as your "Taxable Income" if I was using the irscalculators.com online calculator?

 

[SecondCor521]

Is AGI and same as your "Taxable Income" if I was using the irscalculators.com online calculator?

I don't know that particular calculator, but probably not. In general:

Taxable Income = AGI - deductions

The most well known and enduring deduction is the standard deduction.

The standard deduction depends on filing status, age, and blindness. As mentioned previously, it is also adjusted with inflation.

...

With a hat tip to someone else on the forum - I forget who:

IRMAA and ACA are based (approximately) on AGI.

Tax brackets are based on TI.

 

[G-Man]

I don't know that particular calculator, but probably not. In general:

Taxable Income = AGI - deductions

The most well known and enduring deduction is the standard deduction.

The standard deduction depends on filing status, age, and blindness. As mentioned previously, it is also adjusted with inflation.

...

With a hat tip to someone else on the forum - I forget who:

IRMAA and ACA are based (approximately) on AGI.

Tax brackets are based on TI.

Thanks for the clarification.

 

[Magus]

Really just depends on your marginal tax rate now vs the marginal tax rate in the future (including state taxes). If you are still working, generally better not to convert since an overwhelming majority of people have a higher marginal rate while working than they do in retirement. But like anything its complicated, including assuming both the Roth remains tax free and current marginal tax rates (adjusted for inflation) stay constant in the future. For myself right now its a no brainer to not convert - ~40% marginal tax rate today. vs probably blended 15% in the future a few years after I retire.

 

[G-Man]

Really just depends on your marginal tax rate now vs the marginal tax rate in the future (including state taxes). If you are still working, generally better not to convert since an overwhelming majority of people have a higher marginal rate while working than they do in retirement. But like anything its complicated, including assuming both the Roth remains tax free and current marginal tax rates (adjusted for inflation) stay constant in the future. For myself right now its a no brainer to not convert - ~40% marginal tax rate today. vs probably blended 15% in the future a few years after I retire.

My marginal tax rate now (22%) and projected in retirement (22%) will remain the same.

 

[Magus]

My marginal tax rate now (22%) and projected in retirement (22%) will remain the same.

I'd probably do it then, up to the amount you'd hit the next bracket assuming you have the cash to cover the taxes. Should really simplify your taxes in retirement and reduce risks with benefits, even if you aren't saving anything in the long run.

That said, a LOT of people over-estimate their taxes owed in retirement. A couple that's 55 today retiring at 65 would have to make roughly $150k/yr to have even a single dollar taxed at 22% federal (half that for single person). Not many retirees have that kind of income (especially folks in the 22% marginal bracket while working) so make sure you really run the math well.

 

[G-Man]

I'd probably do it then, up to the amount you'd hit the next bracket assuming you have the cash to cover the taxes. Should really simplify your taxes in retirement and reduce risks with benefits, even if you aren't saving anything in the long run.

That said, a LOT of people over-estimate their taxes owed in retirement. A couple that's 55 today retiring at 65 would have to make roughly $150k/yr to have even a single dollar taxed at 22% federal (half that for single person). Not many retirees have that kind of income (especially folks in the 22% marginal bracket while working) so make sure you really run the math well.

Is your assumption about the $150k income at 65 having a single dollar taxed at 22% federal based on the assumption that standard deduction and the 12/15% marginal tax bracket will increase 2 to 3% per year. So, the top of the 12/15% marginal tax bracket would be around $149K at age 65.

That is how I’m interpreting your post.

In a previous post, here was my projection of the standard deduction and top of the 12% marginal tax bracket at age 65.

Year 2032
Standard Deduction: $31,431

Top of 12% tax bracket: $101,847

 

[Magus]

I’m assuming this upcoming year at 7-8% (7% looks like the floor) and then 2-3% a year after that.

 

[G-Man]

I’m assuming this upcoming year at 7-8% (7% looks like the floor) and then 2-3% a year after that.

Let me model those increases in my calculation.

 

[G-Man]

You are right. If the standard deduction and marginal tax brackets increases as you predict, my marginal tax rate would be 12% at age 65/66. That may be a good time to start Roth conversions before I take SS at 70 and RMD starts at 72. That will give me good 5 years of Roth conversions.

I'm I thinking about this correctly?

P.S. In the NewRetirement software, in 2032 they predict that the top of the 12% marginal tax bracket would be $112,284 and the standard deduction would be $38,570.

In addition, I did not realize the special standard deduction for folks 65 and older.

If you are Married Filing Jointly and you OR your spouse is 65 or older, your standard deduction increases by $1,350. If BOTH you and your spouse are 65 or older, your standard deduction increases by $2,700

 

[Dash man]

The standard deduction reverts back to the pre-2017 method beginning in 2026 under current law.

https://www.fool.com/taxes/2017/12/03/surprise-these-5-gop-tax-breaks-will-end-by-2026.aspx


IRMAA uses Modified Adjusted Gross Income to determine your IRMAA brackets.

https://www.omnicalculator.com/finance/magi

 

[Magus]

Dashman - I’ll take the opposite of that bet 10:1 odds any amount you want up to $1k. We haven’t had a tax increase on bottom 90% in decades and neither party is likely to do it anytime soon. This is just part of the game to make the bills look cheaper than they really are or raise more revenue than they really will.

G-man - I believe that is correct.

 

[MichaelB]

This is just part of the game to make the bills look cheaper than they really are or raise more revenue than they really will.

The reason tax bills have 10 year sunset provisions is to comply with senate reconciliation process rules, which is how the legislation is passed.

One of the conditions for reconciliation is there can be no increase in the budget deficit after the 10th year.

 

[Dash man]

Dashman - I’ll take the opposite of that bet 10:1 odds any amount you want up to $1k. We haven’t had a tax increase on bottom 90% in decades and neither party is likely to do it anytime soon. This is just part of the game to make the bills look cheaper than they really are or raise more revenue than they really will.

G-man - I believe that is correct.

Sorry, I don’t gamble.
I do my projections using current law. If the TCJA gets reinstated, I’ll be celebrating. But I don’t plan on speculation of what our government may do.

 

[SevenUp]

If the standard deduction and marginal tax brackets increases as you predict, my marginal tax rate would be 12% at age 65/66. That may be a good time to start Roth conversions before I take SS at 70 and RMD starts at 72. That will give me good 5 years of Roth conversions.

I'm I thinking about this correctly?

For those who want to maintain the same standard of living, it's likely that income will also have had to increase and thus probably maintain the same bracket (unless the tax law itself changes, in whatever direction).

If the vast majority of income is fixed (e.g., non-COLAed pensions or other non-COLAed annuities) then the drop to a lower tax bracket can provide some relief from the ravages of inflation, but that would likely be small comfort.

Rather than forecast inflation, it's common to look at things in "today's dollars" (i.e., ignore inflation completely). That includes assuming no SS increases and using real instead of nominal rates of return assumptions for investments.

 

[Magus]

For those who want to maintain the same standard of living, it's likely that income will also have had to increase and thus probably maintain the same bracket (unless the tax law itself changes, in whatever direction).

If the vast majority of income is fixed (e.g., non-COLAed pensions or other non-COLAed annuities) then the drop to a lower tax bracket can provide some relief from the ravages of inflation, but that would likely be small comfort.

Rather than forecast inflation, it's common to look at things in "today's dollars" (i.e., ignore inflation completely). That includes assuming no SS increases and using real instead of nominal rates of return assumptions for investments.

While true, most of the real long term growth in the US have an implied assumption of low inflation in them since the US has had low inflation for more than 95% of our years in existence (basically late 70s, early 80s and the last twelve months as the only exception) for which those real return assumptions are modeled. Just make sure you do everything in real terms if you do that way or it’s really easy to get mixed up but that indeed should work well. Modeling 2-3% inflation as he is doing after this year should get you to the same answer however as you suggest

 

[pb4uski]

My marginal tax rate now (22%) and projected in retirement (22%) will remain the same.

If that is the case, and particularly if your tax rate in retirement before and after RMDs will be 22%, then Roth conversions will be of negligible benefit to you, but no harm either. There may still be reasons to do them even at 22%, albeit less compelling reasons. First, if one of you die early and the surviving spouse inherits the deceased spouse's IRA then quite the newly single surviving spouse ends up in an even higher tax bracket and therefor pays higher taxes on the RMD. Also, tax rates are likely to increase in 2026 from 22% to 25%.

 

[G-Man]

If that is the case, and particularly if your tax rate in retirement before and after RMDs will be 22%, then Roth conversions will be of negligible benefit to you, but no harm either. There may still be reasons to do them even at 22%, albeit less compelling reasons. First, if one of you die early and the surviving spouse inherits the deceased spouse's IRA then quite the newly single surviving spouse ends up in an even higher tax bracket and therefor pays higher taxes on the RMD. Also, tax rates are likely to increase in 2026 from 22% to 25%.

Actually I was wrong. If the standard deduction and marginal tax brackets increases as Mangus predicts, my marginal tax rate would be 12% at age 66, year 2032. That may be a good time to start Roth conversions before I take SS at 70 and RMD starts at 72. That will give me good 4 years of Roth conversions.

I will start modeling Roth conversions in the NewRetirement tool starting at age 66 and compare it to my baseline plan.

P.S. In the NewRetirement software, in 2032 they predict that the top of the 12% marginal tax bracket would be $112,284 and the standard deduction would be $38,570.

 

[TheWizard]

P.S. In the NewRetirement software, in 2032 they predict that the top of the 12% marginal tax bracket would be $112,284 and the standard deduction would be $38,570.

Do we know what they predicted for 2022 back in 2012?