VHCAX distribution - invest or use for tIRA2Roth?

[OfficeSpace]

DW and I opened VHCAX in our taxable account 20 years ago (before recognizing the ramifications). An involuntary distribution of nearly $40k ($4k DIV + $36k LTCG) appeared in our settlement fund this morning, bringing our taxable gross income to nearly $260k. We have ample cash reserves to cover our expenses next year. Would it be better to invest the distribution (we also hold VTSAX, VFIAX, VFIJX, VGSLX) or initiate Roth conversions and use it to pay the tax?

I resigned 12 months ago and DW is retiring three months from now (thread). With over $2M in our TSP accounts (combined), we are concerned about RMDs and inheritance. The more I read about Roth conversions here on ER and over on BH the more I realize how little we know! i-ORP recommends aggressive conversion before spending down Roth before traditional, which seems counterintuitive...

Perhaps it's too ambitious to transfer TSP to VG tIRA and then convert VG tIRA to VG rIRA before the end of this year when we don't really know what we're doing.

Insight and suggestions would be most appreciated!

 

[OldShooter]

...
Perhaps it's too ambitious to transfer TSP to VG tIRA and then convert VG tIRA to VG rIRA before the end of this year when we don't really know what we're doing. ...

Without commenting on the details, it looks to me like you've answered your own question. IMO uncertainty is a slam-dunk reason to resist haste.

 

[OfficeSpace]

Regardless of whether and when, it's worth thinking through the mechanics.

To remain in the 24% bracket, would we convert $106,001 ($340,101 + $25,900 - $260,000) with tax $25,440 ($106,001 * .24)?

If distributions made at the end of the month are higher than anticipated, then only the overage is taxed at 32%?

What are we missing? Thanks!

Numbers are actual AGI/MAGI (i.e. - before standard or itemized deductions) unless indicated as Taxable Income by an asterisk * which means you can add $25,900 MFJ...

Income level/effect (as of 1/1/2022) This for Married Filing Jointly...
$340,101* - 32% tax bracket

 

[audreyh1]

Yes, only the amount above the 24% bracket top is taxed at 32% so it’s no big deal if it’s a small excess.

What’s the rush? Your taxable income will be lower next year after both retired, right?

Sounds like you need time to evaluate your situation more carefully.

Personally I wouldn’t concern myself about heirs inheriting IRAs. Look to yourself first. Focus on what your tax brackets might look like when you start RMDs. Look at the future RMD amounts, taking into account other income,and subsequent taxes.

I would absolutely not follow the aggressive conversions recommended by i-ORP without really understanding how to use the tool.

 

[OfficeSpace]

Thanks!

Well, the sooner we start, the longer we will have to convert at lower brackets before 2030 when DW turns 64 and our income factors into the IRMAA surcharge computation (ACA is irrelevant as we have FEHB).

Yes, our earned income will be much lower next year, which would enable us to convert much more within the 24% tax bracket. We may wait until then and consider this year a dry run.

That's precisely our concern; with no conversions, i-ORP reports significant RMDs and associated taxes (ages are DW; DH is -5):

Federal Tax Bracket Report   - Amount of Taxable Income in Each Tax Bracket

 Age        NoTax     10%      12%      15%      25%      28%      33%     Total    Taxes   Penalty Capgains 
056            24       20       16        0        0        0        0       60        6        0        5
057            25       20       34        0        0        0        0       79        9        0        5
058            25       21       31        0        0        0        0       77        9        0        6
059            26       21       64        0        0        0        0      111       15        0        5
060            23       21        0       63        0        0        0      107       16        0        7
061            24       21        0       64        0        0        0      109       17        0        8
062            24       21        0       66        7        0        0      119       20        0        8
063            24       22        0       67        3        0        0      116       19        0        9
064            25       22        0       68        0        0        0      116       18        0       11
065            27       23        0       70        0        0        0      119       19        0       12
066            27       23        0       71        0        0        0      122       19        0       13
067            28       24        0       73        0        0        0      124       20        0       14
068            29       24        0       74      100        0        0      227       50        0        9
069            29       25        0       75      102        0        0      231       51        0       10
070            31       25        0       77      104        0        0      237       53        0       10
071            32       26        0       79      106        0        0      242       54        0       11
072            33       26        0       80      108        0        0      247       55        0       12
073            33       27        0       82      110       51        0      303       73        0       10
074            34       27        0       83      112      117        0      374       96        0        7
075            35       28        0       85      115      119        0      381       98        0        7
076            35       28        0       87      117      122        0      389      100        0        8
077            36       29        0       88      119      124        0      397      102        0        9
078            37       29        0       90      122      126        0      405      104        0       10
079            37       30        0       92      124      129        0      413      107        0       11
080            38       31        0       94      127      132        0      421      109        0       12
081            39       31        0       96      129      134       27      456      121        0       12
082            40       32        0       98      132      137       30      468      125        0       13
083            40       33        0      100      134      140       35      481      129        0       15
084            41       33        0      102      137      142       38      494      133        0       16
085            42       34        0      104      140      145       41      506      136        0       18
086            43       35        0      106      143      148       44      518      140        0       19
087            44       35        0      108      145      151       49      533      144        0        9
088            45       36        0      110      148      154      263      756      228        0        0
089            46       37        0      112      151      157      359      862      267        0        0
090            46       37        0      114      154      160      367      880      273        0        0
091            47       38        0      117      157      164      374      897      278        0        0
092            48       39        0      119      161      167      381      915      284        0        0
093            49       40        0      121      164      170      389      933      290        0        0
094            50       40        0      124      167      174      397      952      296        0        0
LastYear       51       41        0      126      170      177      405      971      301        0        0

With conversions limited to the 24% bracket, i-ORP recommends the following (we won't need anywhere near $175K in Disposable Income):

Nominal Withdrawal Report - Plan's Income and Spending in Inflated Dollars

Age         RMD    TaxDef  AfterTax  RothIRA IRA2Roth  GuarInc   Yield    Taxes     DI    
056             0      293      209        0      293        0       58       92      175
057             0      285      203        0      285       20       53       94      182
058             0      297      219        0      297       20       48       98      189
059             0      310      236        0      310       20       42      102      197
060             0      134      201        0      134       20       38       54      205
061             0      144      217        0      144       20       32       56      213
062             0       95      178        0       95       69       28       54      221
063             0       21      167        0       21       69       24       30      230
064             0       28      183        0       28       69       19       32      239
065             0       37      204        0       37       69       13       37      249
066             0       46      223        0       46       69        7       40      259
067             0       55      243        0       55       69        0       43      269
068             0       58        1      174        0       69        0       21      280
069             0       60        0      184        0       69        0       22      291
070             0       24        0      185        0      117        0       23      303
071             0       26        0      195        0      118        0       23      315
072             2       27        0      205        0      119        0       24      328
073             1       29        0      216        0      120        0       24      341
074             0       31        0      227        0      121        0       25      354
075             0        0        0      219        0      180        0       31      368
076             0        0        0      232        0      183        0       31      383
077            84       84        0      187        0      185        0       58      399
078            89       89        0      198        0      187        0       59      414
079            94       94        0      209        0      189        0       61      431
080            99       99        0      220        0      192        0       63      448
081           104      104      248        0        0      194       19      100      466
082           110      110      269        0        0      197       11      101      485
083           116      116      290        0        0      199        3      104      504
084           121      121       92      191        0      202        0       82      524
085           127      127        0      286        0      205        0       73      545
086           134      134        0      301        0      207        0       75      567
087           140      140        0      317        0      210        0       77      590
088           147      147        0      334        0      213        0       80      614
089           154      154        0      351        0      216        0       82      638
090           160      160        0      369        0      219        0       85      664
091           166      166        0      389        0      222        0       87      690
092           172      172        0      410        0      225        0       89      718
093           179      179        0      431        0      228        0       91      746
094           185      185        0      454        0      231        0       94      776
LastYear      190      190        0      479        0      234        0       96      807

I would prefer the Real Withdrawal Report - Plan's Income and Spending in Today's Dollars but specified inflation as 2% income and 4% spending so it looks wacky ("If, in your run parameters, your spending inflation percentage is not the same as your income inflation percentage then this report will not make much sense and doesn't mean much. This is because all of the columns except Spending are deflated with the income inflation percentage while Spending is deflated with the spending inflation percentage.")

 

[RunningBum]

I don't get what the VHCAX distribution has to do with a Roth conversion, other than to reduce how much to convert if you have a conversion plan. But it doesn't sound like you have a plan for this year.

I'm generally in favor of being aggressive with Roth conversions, but there's not nearly enough info to make any kind of recommendation. There are so many opposing factors in doing conversions, such as ACA subsidies, IRMAA, 0% LTCGs for example, that I don't like making suggestions, especially when it seems the person asking does not have a handle on these things.

One guideline I have is that when it's difficult to decide, there is probably less at stake with the decision. For myself, I find it an easy decision to convert up to one point, and clearly a bad decision to convert at another point. Between those two points, it probably matters very little to my overall situation to convert or not. Maybe that's where you are, but I can only guess, so I won't.

 

[audreyh1]

The IRMAA surcharge may be the lesser of evils compared against reduced years for RMD conversions. You don’t have to use that as a hard deadline.

 

[OfficeSpace]

I don't get what the VHCAX distribution has to do with a Roth conversion, other than to reduce how much to convert if you have a conversion plan. But it doesn't sound like you have a plan for this year.

Our plan for this year's involuntary distribution from that actively managed account in our taxable portfolio was to invest it as usual, but as we have headroom in the 24% bracket for the first time, it seems prudent to at least consider as an alternative using it to cover the taxes on an inaugural conversion.

We appreciate the input and sage advice!