What tax bracket should I stop doing Roth Conversions

[Time2]

I'm 66 , she is 62.

Say we have $2M in the stock market, allocated as below.
$1.2M tIRA
$240k Roth
$600k Taxable
We are spending about $45k per year.

When I'm 70 we will get $45k of SS
My RMDs start at 72 on about $600k. (grown to about $1M in 6 years)

Hers start 4 years later on the other $600k. ($1M in 6 years)
The first year I Roth converted $75k and stayed in the 12% tax bracket.
But the tIRA fund grew faster than the conversion.
I'm questioning whether I should max out the 22% bracket.
I can see $88k of forced income when I get my first RMD.
Running $12k dividends, $45k SS, and $32,850 RMDs through Dinkytown tax calculator, https://www.dinkytown.net/java/1040-tax-calculator.html
It leaves me well within the 12% tax bracket, I could add another $35k before going into the 22% bracket. So, 4 years later adding my wife's RMDs, we will just hit the 22% tax bracket.


After doing the above Dinkytown calculations, I now think max to the top of the 12% bracket. (I didn't know I waffled so easily)

Anyone have feedback, other than "ya, but tax rates will go up". Then I have to wonder, will the income level rise with the tax bracket percentage increase. ie I doubt the 12% bracket will increase as high as 22% and the income level will probably be higher. Suggesting I should not go into the 22% bracket with Roth Conversions.

 

[finnski1]

Can't follow your numbers. Do you have 2 million or 4.2 million?

 

[cat4ever]

I'm 66 , she is 62.

Say we have $2M in the stock market, allocated as below.
$1.2M tIRA
$2.4M Roth

Just a quick ? here, 1.2 + 2.4 doesn't add to 2M.

 

[OldShooter]

Roth conversions are essentially tax rate arbitrage where you don't know the future tax rate. Stop when you get to the point where your tax rate equals your expected future tax rate. If you are right, you win. Conversely ...

This is absent other considerations like ACA and IRMAA which effectively raise your current tax rate and RMDs, which may raise your future tax rate. Having fun yet?

 

[38Chevy454]

As OldShooter said, it is a pay now vs pay later, where you try to pick the lower rate option. I don't think rates will be any lower than present, and may be higher in future. So given your situation, it certrainly makes sense to maximize up to 12%. Whether to do more conversion and pay higher tax rates may still be an option. Especially if you look at after one of you passes and the surviving spouse has only half the deductions. It may make sense to do more conversions now to help that case later.

 

[Sunset]

OP - Going to the top of the 12% bracket is obviously a good choice, while your IRA may grow faster, you can feel good about getting some of the money out at 12% rather than leaving it in to grow and be taxed at a higher rate.

Personally, we are comfortable going into the 22% bracket, although writing that tax check is painful ! We do intend to stay below IRMAA triggers as that makes the tax rate too high (a mental thing).

We are content to leave a large amount in an IRA, as medical costs may be high, and then it will be largely deductible withdrawals.

Our reasoning for going into the 22% bracket, is we just have to look at what happens when there is only 1 of us left. At around $40K being the start of 22% bracket, it's a low bar.

 

[Time2]

Can't follow your numbers. Do you have 2 million or 4.2 million?

$2M total. I corrected my error in the OP.
Thanks

 

[Time2]

As OldShooter said, it is a pay now vs pay later, where you try to pick the lower rate option. I don't think rates will be any lower than present, and may be higher in future. So given your situation, it certrainly makes sense to maximize up to 12%. Whether to do more conversion and pay higher tax rates may still be an option. Especially if you look at after one of you passes and the surviving spouse has only half the deductions. It may make sense to do more conversions now to help that case later.

I had not thought about the surviving spouse with regards RMDs. Good Point.
Edit to add; The SS check will drop $15k when one spouse leaves. Just one more complication.

 

[SevenUp]

Running $12k dividends, $45k SS, and $32,850 RMDs through Dinkytown tax calculator, https://www.dinkytown.net/java/1040-tax-calculator.html
It leaves me well within the 12% tax bracket....

That may put you in the "12% bracket" but your marginal tax rate at that point is 22.2%.

If you can use Excel, the case study spreadsheet will probably give you a more useful picture of your tax rate topography.

 

[Time2]

That may put you in the "12% bracket" but your marginal tax rate at that point is 22.2%.

If you can use Excel, the case study spreadsheet will probably give you a more useful picture of your tax rate topography.

You are right! But, if you drop $1000 income from Roth Conversion that puts you in the 12% bracket.

 

[RunningBum]

You may be in the 12% bracket, but your marginal rate isn't 12%.

I ran your numbers thru dinkytown, assuming all $12K of dividends are qualified. You came up with $3631 in taxes, right? Take a look at how much SS is taxed. $25,848, right?

Now, suppose you do more conversion such that you have $1000 less in RMDs ($31850). I show $3409 in taxes. That's $222 less on $1000 less income, so your marginal rate is 22.2%. How can that be when you are squarely in the 12% bracket? Only $24,998 of SS is taxed with the lower income. That $1000 difference in RMDs also caused an $850 difference in SS taxation.

Who knows, by then all SS may be taxed, which means your marginal rate goes back to 12%.

Are those dividends qualified? When you converted $75K, does that mean you kept those dividends from being taxed? When people talk about converting to the top of 12%, what they really mean if they have QDivs is convert to the top of the 0% tax rate on those dividends, which is $80,800 AGI.

In any case, if you converted to the top of the 22% bracket, you'd have a window of $12,000 where your regular income was taxed at 12% and divs at 15% for a marginal rate of 27%. After all divs are taxed, the marginal rate drops back to 12% for the next $250, then you go into the 22% bracket.

Looking to the future, with your projection of $32850 RMDs, your AGI is $70698, so the QDivs are not taxed. If they were taxed, this would push even more SS into being taxed, and I think you'd find your marginal rate to be 49.95%.

Given all that, I would continue converting to the point of having QDivs taxed ($80,800 limit) but I would repeat this exercise every year to make sure your RMDs won't push QDivs into being taxed, probably due to the tIRA continuing to grow with high returns. If that happens, convert more.

What investments do you have in your tIRA? I keep the bond portion of my AA in my tIRA, for a couple of reasons. Bond income is generally regular income, so it's better to not have it in taxable. And if I'm going to have bond or other non-equity holdings to reduce volatility even if it puts a drag on my earnings in good times, putting it in the tIRA slows the growth of that account.

 

[SevenUp]

You are right! But, if you drop $1000 income from Roth Conversion that puts you in the 12% bracket.

Regardless of the nominal bracket, it is your marginal tax rate that matters.

Do you foresee something significantly different from the rates below? These are based (unless I made a typo) on MFJ both over 65 with $12K qualified dividends and $45K Soc. Sec. benefits.

 

[RunningBum]

I agree with SevenUp, you have to pay attention to marginal tax rates, not just what tax bracket you are in.

 

[Time2]

You may be in the 12% bracket, but your marginal rate isn't 12%.

I ran your numbers thru dinkytown, assuming all $12K of dividends are qualified. You came up with $3631 in taxes, right? Take a look at how much SS is taxed. $25,848, right?

Ya, I found a $12k IRA deduction, that should not have been in there.
So, I find I can have about $55.6k of tIRA distribution and stay in the 12% bracket.
MFJ, $12k Dividends Qualified, $55.6k Taxable IRA distribution, $45k SS.
I get $7,843 of tax.
If I add $100 to the $55.6k it cost me $20 in tax.
If I subtract $100 from the $55.6k It lowers my tax $12.

 

[Time2]

Regardless of the nominal bracket, it is your marginal tax rate that matters.

Do you foresee something significantly different from the rates below? These are based (unless I made a typo) on MFJ both over 65 with $12K qualified dividends and $45K Soc. Sec. benefits.

I'm not understanding this. My method is to find where the last $100 of extra income costs me $12. But if I add another $100 it costs me $22.
Willing to listen if I'm wrong.
I do understand I have about $19,500 that is taxed at 10%, is this what I'm missing?

 

[RunningBum]

I'm not understanding this. My method is to find where the last $100 of extra income costs me $12. But if I add another $100 it costs me $22.

Your last $100 may cost you $12 in taxes, but that doesn't mean that every $100 before that cost you $12. There was a range where it cost you $22.20, because of how SS taxation works. Once you have all SS taxed, the marginal rate goes back down to $12.

That said, I wouldn't convert to 22% today just because you have some window where it'd later be taxed at 22.2% later.

 

[RunningBum]

Maybe a good way to see this is with your dinkytown calculator. Start with $15,000 for your RMD and add $1000 at a time, charting your tax each time. Also note your AGI and how much SS is taxed at each $1000 RMD increment. You should see that it's not a smooth line, because of how SS is taxed.

 

[SevenUp]

Your last $100 may cost you $12 in taxes, but that doesn't mean that every $100 before that cost you $12. There was a range where it cost you $22.20, because of how SS taxation works. Once you have all SS taxed, the marginal rate goes back down to $12.

And a range where it cost $18.50, also due to Taxation of Social Security benefits.

In fact, in Time2's situation, there is no 12% rate at all (it jumps from 0% to 18.5%) until ~$47,440 of tIRA distributions have caused the SS benefits to be 85% taxable.

Time2, does the chart make any more sense now?

 

[Time2]

Regardless of the nominal bracket, it is your marginal tax rate that matters.

Do you foresee something significantly different from the rates below? These are based (unless I made a typo) on MFJ both over 65 with $12K qualified dividends and $45K Soc. Sec. benefits.

Is this chart for my specific case? (The numbers I posted)

 

[Time2]

And a range where it cost $18.50, also due to Taxation of Social Security benefits.

In fact, in Time2's situation, there is no 12% rate at all (it jumps from 0% to 18.5%) until ~$47,440 of tIRA distributions have caused the SS benefits to be 85% taxable.

Time2, does the chart make any more sense now?

Yes, but!
I can understand how SS being taxed differently depending on income will cause the chart you posted.
What I don't get (using Dinkytown) is the last $100. $100 more income costs more than $12, $100 less income only saves $12. Are there two points where it costs $12, but more in between those two points? IF yes, then what am I supposed to look at?

 

[SevenUp]

Is this chart for my specific case? (The numbers I posted)

That was my intent. Is it consistent with your findings?

 

[RunningBum]

Yes, but!
I can understand how SS being taxed differently depending on income will cause the chart you posted.
What I don't get (using Dinkytown) is the last $100. $100 more income costs more than $12, $100 less income only saves $12. Are there two points where it costs $12, but more in between those two points? IF yes, then what am I supposed to look at?

Yes, see my post #17
https://www.early-retirement.org/fo...oing-roth-conversions-109662.html#post2621102

 

[SevenUp]

Yes, but!
I can understand how SS being taxed differently depending on income will cause the chart you posted.
What I don't get (using Dinkytown) is the last $100. $100 more income costs more than $12, $100 less income only saves $12. Are there two points where it costs $12, but more in between those two points? IF yes, then what am I supposed to look at?

Don't know. I'm not a fan of any of the web-based estimation programs (Dinkytown, mortgagecalculator, TaxCaster, etc.), although some are better than others.

If you don't mind Excel, you might give the case study spreadsheet a try. Spreadsheets aren't for everyone but it does allow one to "see the forest" instead of going tree by tree.

ETA: To clarify, by "Don't know" I mean "Don't know why Dinkytown gets a 12% marginal rate for a $100 reduction at the income amount you have been discussing. It would happen at the end of the 12% "trough" shown in the chart, but there the increased income would cost 27%."

 

[Time2]

That was my intent. Is it consistent with your findings?

I don't know because, with my method I'd have to run many runs varying the income and graph it. What are you using to make this graph?

 

[Time2]

Don't know. I'm not a fan of any of the web-based estimation programs (Dinkytown, mortgagecalculator, TaxCaster, etc.), although some are better than others.

If you don't mind Excel, you might give the case study spreadsheet a try. Spreadsheets aren't for everyone but it does allow one to "see the forest" instead of going tree by tree.

ETA: To clarify, by "Don't know" I mean "Don't know why Dinkytown gets a 12% marginal rate for a $100 reduction at the income amount you have been discussing. It would happen at the end of the 12% "trough" shown in the chart, but there the increased income would cost 27%."

Dinkytown is close at $55,600 vs the $58,000 I glean from the graph, with the numbers I provided. I don't know what the discrepancy is. I found Dinkytown matched perfectly with Turbo Tax this year. Although I do not get SS, it's possible Dinkytown has a problem calculating with SS.
I have used the CSS, but found the learning curve long, so much detail I didn't feel I needed. Dinkytown worked for me.
I don't get why the graph rises to about 13% when part of the income is taxed at 10% and the rest at 12%, where does the 13% come from?