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What is the math on Roth conversions of depressed assets
Old 03-21-2020, 06:56 AM   #1
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What is the math on Roth conversions of depressed assets

I have been reluctant to do Roth conversions because DW and I are at the top of the 22% bracket. Conversions would hit us at 30-32% state and Federal. I can't wrap my head around the math needed to evaluate how much advantage there would be in pulling depressed equities out of IRAs and converting them to rebound eventually in Roths. It seems like I could mentally half the hit if I pulled the equities when they were down 50% (from what it would have cost me to do it at a peak).

Is the math that direct and simple, or am I missing obvious factors?

Edit: This gets confusing since I would also have to pay for the taxes using depressed assets so I would have that much less to rebound.
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Old 03-21-2020, 07:24 AM   #2
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It's principally a tax rate play with a second order impact of avoiding taxes on the monay used to pay the taxes if you have taxable account funds so I'm not sure is it very beneficial for you.

A brief example: Don has $100k in a tIRA and $30k in taxable and is in the 30% tax bracket. Overn the next 10 years investments double (7.18% annualized rate).
  • Option 1: Don converts, pays the $30k in tax and ends up with $100k in a Roth, after 10 years has $200k that can be spent.
  • Option 2: Don doesn't convert. The $100k tIRA doubles to $200k. The $30k in taxable grows to $49k rather than $60k because of taxes paid on its earnings each year [$49k = $30k * (1+7.18%*(1-30%))^10]. At the end of 10 years Don withdraws the $200k tIRA, pays the $60k in tax and has $189k to spend.
The $11k advantage is because Don avoids taxes on the income $30k for 10 years.

Now.... if Don doesn't have taxable funds to pay the tax then it is a push:

Don has $100k in a tIRA.
  • Option 1: Don converts and does a $30k withdrawal to pay the taxes and and ends up with $70k in the Roth, which then doubles to $140k over 10 years.
  • Option 2: Don doesn't convert and the tIRA doubles to $200k. Don then withdraws, pays $60k in tax and has $140k to spend.
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Old 03-21-2020, 07:50 AM   #3
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Thanks pb4uski. I have taxable funds to pay the taxes but they are equities so I would be selling depressed equities to pay the tax and wouldn't have those equities to rebound. The same concept exposes the flaw in my strategy to "convert equity sales to bond sales" in a downturn. I have been selling taxable at low CG rates to fund travel beyond our guaranteed income. My plan has always been when I have to sell taxable equities in a downturn I could simultaneously convert TSP G fund (Treasuries) to equities making up for the depressed sale. But the rebound in the TSP will be taxed at higher levels so not such a bright strategy.

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Old 03-21-2020, 07:57 AM   #4
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Thanks pb4uski. I have taxable funds to pay the taxes but they are equities so I would be selling depressed equities to pay the tax and wouldn't have those equities to rebound. ....(
I'm not sure that is a good reason because you can always sell equities to oay the taxes and then buy equities in the Roth and capture the same rebound.... so let's say that in the first example that you had $100k in the tIRA in bonds and $30k in taxable in stocks... you convert, sell the $30k in taxable to pay the tax then sell $30k bonds in the Roth and buy $30k of stock in the Roth.... ending up with $100in the Roth.... $70k bonds and $30k stocks.
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Old 03-21-2020, 07:59 AM   #5
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Other items that will impact your decision, as discussed in various other threads on Roth conversions are IRMAA, ACA, and your view of future tax rates. I converted early on with some depressed securities to top of 22% and will likely do more into 24% but I have after tax cash to pay taxes. Of course, that after tax cash (mostly CDs) may be used if the current collapse continues for 2 or 3 more years. Also my cash isn't pulling any return in at 1% CD rates.

I think there are many items to consider and each situation is unique. For me, even if it was a push I would still lean to paying now so as to have a liability (future tax bill) covered today.
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Old 03-21-2020, 08:01 AM   #6
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ARGH. Too math challenged. Now I have to rethink my asset sales location in a massive downturn. Instead of selling depressed equities (with no tax or even a loss) is it better to simply take a discretionary withdrawal from the TSP G fund and incur the taxes early? If things get really depressed and I have to make some decisions, I will have to get out the calculator and think things through a lot more thoroughly.

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Old 03-21-2020, 08:04 AM   #7
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If the amount to pay the taxes come from the tIRA (or any tax-deferred account for that matter) then it is a push.
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Old 03-21-2020, 08:08 AM   #8
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Originally Posted by pb4uski View Post
I'm not sure that is a good reason because you can always sell equities to oay the taxes and then buy equities in the Roth and capture the same rebound.... so let's say that in the first example that you had $100k in the tIRA in bonds and $30k in taxable in stocks... you convert, sell the $30k in taxable to pay the tax then sell $30k bonds in the Roth and buy $30k of stock in the Roth.... ending up with $100in the Roth.... $70k bonds and $30k stocks.
I'm not sure I get this. Our small Roths are 100% equities right now so no offsetting conversions are possible. Our taxable brokerage is also 100% equities following the old adage to keep bonds in deferred and equities in taxable. If I convert tIRA equities to Roth equities I have to come up with the 30% tax hit. I can get it by selling depressed equities from taxable (or a Roth) or I could take a bond distribution from a tIRA and incur 30% on that withdrawal. No room to roam.
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Old 03-21-2020, 08:11 AM   #9
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Originally Posted by pb4uski View Post
If the amount to pay the taxes come from the tIRA (or any tax-deferred account for that matter) then it is a push.
What is a push?
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Old 03-21-2020, 08:13 AM   #10
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What is a push?
It doesn't matter one way or the other.... it is neutral.

See the second example in post#2 where taxes are paid from the tIRA.
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Old 03-21-2020, 08:20 AM   #11
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I'm not sure I get this. Our small Roths are 100% equities right now so no offsetting conversions are possible. Our taxable brokerage is also 100% equities following the old adage to keep bonds in deferred and equities in taxable. If I convert tIRA equities to Roth equities I have to come up with the 30% tax hit. I can get it by selling depressed equities from taxable (or a Roth) or I could take a bond distribution from a tIRA and incur 30% on that withdrawal. No room to roam.
ok... so let's extend the example where Don has $30k in taxable and $100k tIRA and he converts. For tax efficiency, his $30k in taxable is all stocks and the $100k in the tIRA is all fixed income and he likes his 23/77 AA.

He converts the tIRA to a Roth IRA and sells the $30k in stocks to pay the tax on the conversion. He has $100k in the Roth but it is all fixed income and he still wants a 23/77 AA... so in the Roth he sells $23k of fixed income and buys $23k of stocks... getting back to his desired 23/77 AA.
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Old 03-21-2020, 08:26 AM   #12
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I was thinking this would be a great time to do Roth conversions at a low, but when I looked to do it i realized that my tIRA is all bond funds, which have taken much less of a hit. I'll still convert some soon, but it's much less urgent of a play than those of you who have stocks in your tIRA.
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Old 03-21-2020, 09:14 AM   #13
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We have all of our fixed income in tax deferred but I wasn’t thinking of converting them. We also have a Lou if equities in tax deferred. The idea was to convert them to get them out out while depressed. The need to come up with an additional 30% to pay taxes (with no good sources) is what drops the utility.
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Old 03-21-2020, 09:16 AM   #14
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I was thinking this would be a great time to do Roth conversions at a low, but when I looked to do it i realized that my tIRA is all bond funds, which have taken much less of a hit. I'll still convert some soon, but it's much less urgent of a play than those of you who have stocks in your tIRA.
Yeah, I also had the realization recently that there are two sides to the coin of "keep your slowly appreciating investments in tIRA, and quickly appreciating funds in Roth."

Sometimes, like now, "slowly appreciating" really means "not quickly depreciating."
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Old 03-27-2020, 06:27 PM   #15
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I had given up on an ACA subsidy this year now that I sold a townhouse at a capital gain (not going to live there 2 years, not going to buy another rental), and I was just about to do a Roth conversion, but I held off until 2Q (this was before the estimated tax payment dates moved). Then I looked at my holdings and saw some big opportunities for tax loss harvesting, so I did that. Now I see that I had enough losses to cover the townhouse profit. I'm back on the ACA subsidy plan, which means no conversions until late December when I see if I have any room at all, or if I'm going over anyway and might as well convert some.

My math on the question of ACA subsidy vs. conversion is that last year I could've only converted $4000 at 0 or 10% before I started pushing LTCGs+QDivs into being taxed for an effective 25% or 27% marginal rate. That $4000 may be taxed at 22% later, so it'd cost me somewhere between $400-$800. The subsidy last year was worth $9000, this year is about $6000, so the subsidy is a much better play.
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Old 03-28-2020, 09:42 AM   #16
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We have all of our fixed income in tax deferred but I wasn’t thinking of converting them. We also have a Lou if equities in tax deferred. The idea was to convert them to get them out out while depressed. The need to come up with an additional 30% to pay taxes (with no good sources) is what drops the utility.


I’m struggling with the same question. We’ve never had a Roth due to income limitations while working and reluctance to incur the tax hit in retirement. Conceptually, if we are ever going to do a conversion, now seems like a good time. However regardless of whether you pay the taxes with taxable funds or IRA funds, it still means future appreciation and tax savings have to be sufficient to offset the up front hit.

Fidelity has a simple model on their website that advises us not to do the conversion. However it doesn’t allow for different rates of return and also I don’t believe it considers IRMAA. Would love to find a good model that’s a bit more sophisticated. Intuitively I feel that converting assets while equity values as well as tax rates are at a low point makes sense.
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Old 03-28-2020, 06:37 PM   #17
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I had income and invested through previous dips. Now retired so this one is killing me trying to honor AA.

I got excited about possible conversion to Roth as a “move” to take advantage of situation, doesn’t make sense for me.
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Old 03-29-2020, 09:15 AM   #18
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I have been reluctant to do Roth conversions because DW and I are at the top of the 22% bracket. Conversions would hit us at 30-32% state and Federal.
...
I scanned this thread for "RMD" and didn't see it mentioned.

If you are taking RMD's then perhaps your tax bracket this year will be lower if you do not take them. As I understand it one can suspend RMD's this year only under the new tax act. This perhaps allows you to take make some Roth conversions at favorable rates.

I thought I was done with Roth conversions because we have SS now and I ran through the taxable money. But last year I inherited a house which I sold. Now this new present has appeared to allow Roth conversions since on RMD is required. Strange but true.
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Old 03-29-2020, 04:51 PM   #19
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Originally Posted by pb4uski View Post
It's principally a tax rate play with a second order impact of avoiding taxes on the monay used to pay the taxes if you have taxable account funds so I'm not sure is it very beneficial for you.

A brief example: Don has $100k in a tIRA and $30k in taxable and is in the 30% tax bracket. Overn the next 10 years investments double (7.18% annualized rate).
  • Option 1: Don converts, pays the $30k in tax and ends up with $100k in a Roth, after 10 years has $200k that can be spent.
  • Option 2: Don doesn't convert. The $100k tIRA doubles to $200k. The $30k in taxable grows to $49k rather than $60k because of taxes paid on its earnings each year [$49k = $30k * (1+7.18%*(1-30%))^10]. At the end of 10 years Don withdraws the $200k tIRA, pays the $60k in tax and has $189k to spend.
The $11k advantage is because Don avoids taxes on the income $30k for 10 years.

Now.... if Don doesn't have taxable funds to pay the tax then it is a push:

Don has $100k in a tIRA.
  • Option 1: Don converts and does a $30k withdrawal to pay the taxes and and ends up with $70k in the Roth, which then doubles to $140k over 10 years.
  • Option 2: Don doesn't convert and the tIRA doubles to $200k. Don then withdraws, pays $60k in tax and has $140k to spend.
It is also a growth play isn't it. If you take a 0% growth over 10 years, and if you pay taxes from your after tax account;
  • Option 1: Don converts, pays the $30k in tax and ends up with $100k in a Roth, after 10 years has $100k that can be spent.
  • Option 2: Don doesn't convert. The $100k tIRA remains $100k. The $30k in taxable remains $30k. At the end of 10 years Don withdraws the $100k tIRA, pays the $30k in tax and has $100k to spend.
So the benefit of this method (paying taxes from an after tax account) increases as your return increases. Of course, there is no guarantee on the rate of increase.


Am I missing something?
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Old 03-29-2020, 05:09 PM   #20
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It is also a growth play isn't it. If you take a 0% growth over 10 years, and if you pay taxes from your after tax account;
  • Option 1: Don converts, pays the $30k in tax and ends up with $100k in a Roth, after 10 years has $100k that can be spent.
  • Option 2: Don doesn't convert. The $100k tIRA remains $100k. The $30k in taxable remains $30k. At the end of 10 years Don withdraws the $100k tIRA, pays the $30k in tax and has $100k to spend.
So the benefit of this method (paying taxes from an after tax account) increases as your return increases. Of course, there is no guarantee on the rate of increase.


Am I missing something?
That makes sense. It's the tax free growth in the Roth that makes it favorable in this kind of situation. No growth means you've lost your advantage.

While you aren't guaranteed any return, we invest in the market because in the long term we do expect it to grow.
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