What tax bracket should I stop doing Roth Conversions

[pb4uski]

...@pb4uski do you ascribe to the approach in i-orp?

... Separately, it has been agreed in another thread that the morning after you wake up from doing a Roth conversion, having paid Uncle Sam his due, you are poorer than the day before the Roth conversion. ...

I haven't used i-orp enough to have a view, but I will say that i-orp tends to recommend much higher Roth conversions that I've been comfortable with.

On the last part, please provide a thread link, because I don't believe anybody has agreed with that one is poor the day after a Roth conversion, in fact I think many people have disagreed with you on that... it's just that you don't get it so you're making stuff up that supports your position.

 

[RunningBum]

On the last part, please provide a thread link, because I don't believe anybody has agreed with that one is poor the day after a Roth conversion, in fact I think many people have disagreed with you on that... it's just that you don't get it so you're making stuff up that supports your position.

I only see what others are quoting, but this seems very troll-like.

 

[pb4uski]

+1 I assume that you only see what others are quoting because you have chassis on ignore? In almost 11 years on this forum I haven't put anyone on ignore yet, but chassis is climbing up the list of candidates.

 

[RunningBum]

Yep. I'm not here to be annoyed by someone who seems to deliberately misrepresent what others are saying, and I'm not seeing anything I can learn from them.

 

[OldShooter]

... @OldShooter you didn’t answer the question - do you ascribe to or support the approach in i-orp? ...

I have no idea. Google confirms to me that it is yet another retirement planner. That's the extent of what I know. I consider those planners to be more amusements than tools. See sig line.

... i-orp’s results are strongly influenced by assumed market (portfolio) performance. It says that investment returns matter. ...

Well as applied to Roth conversions, it's wrong. Not that I need a reason to ignore it, but that is one.

... Separately, it has been agreed in another thread that the morning after you wake up from doing a Roth conversion, having paid Uncle Sam his due, you are poorer than the day before the Roth conversion. ...

I'm sure I can find a thread where it has been agreed that the earth is flat and another where it has been agreed that the moon landing was faked. Would you take those as gospel too?

... Why would I make myself poorer? If over the planning horizon I found myself richer, having made myself poorer through Roth conversions, I would see the benefit.

However, I don’t see the benefit. Allowing once again for a tolerance of error on the analysis, any benefit to me over the planning horizon is nearly nil. It’s de minimis.

My guess is that your stubborn determination to ignore mathematical facts is probably making you poorer every day simply due to bad decisions.

 

[RetireBy90]

Separately, it has been agreed in another thread that the morning after you wake up from doing a Roth conversion, having paid Uncle Sam his due, you are poorer than the day before the Roth conversion.

Not sure who agreed to this, but this would only be true if you count your TIRA as all your asset. In my accounting I record the after tax value of my TIRA. Of the assets in that account only about 70% is mine, the other 30% belongs to IRS and state tax man. If I did a conversion today, without going into a higher marginal tax situation my after tax value would be the same, just some moved from the TIRA to the Roth.

 

[thefist]

An observation…. This topic is largely about math, yet in all the debate, chassis provides none, while disagreeing with those that have.

One thing is certain, the authors of these savings programs understood the math quite well. There is advantage to be had, but it’s not as simple as it appears.

 

[TheWizard]

I do modest Roth conversions in the 24% marginal federal tax bracket, plus 5% state tax.
Since I pay the tax with other money, I'm effectively putting more money into my Roth IRA which I can't normally do since I have no earned income anymore.

As an example, if I take $1000 out of my tax-deferred 403(b) to spend, or as part of my RMD in 2023 and beyond, then I pay $290 tax and have $710 left for me.

But if I take $1000 out of my Roth IRA, I have the entire amount to play with.

This logic is NOT true if when doing a Roth conversion where 29% of the amount withdrawn goes to taxes and only 71% remaining goes into the Roth IRA...

 

[thefist]

When to Stop

@Time2, if you’re still hanging around on this one…

I’ve been investigating a stopping point to conversions as well. Using i-orp I did the following:

- ran a base case with current age and balances. Terminal age 92.
There were 3 scenarios: no conversion, convert to 22, convert to 24.
The numbers worked out to a 4K/yr spending advantage if I convert the entire IRA balance as quickly as possible, up to 24%.

Next…
- update all your balances with the year 2 numbers from the first case. Adjust AA if needed. Increment your age by 1, and rerun the 3 scenarios above.
In this case the spending advantage was lower, as it included the effects of the first conversion.

- repeat as above.

What I found is that 3 large conversions would accomplish the goal and conversions after that point were negligible. Naturally, this is all dependent upon my unique scenarios.

But a key point is that this is a renewable question every year. The stopping point is where your advantage disappears. Find a calculator or model where you can do something like I did above.

The thing with i-orp, it uses the tax law as written. In 2026 it will revert to pre-TCJA, and for planning horizons this is the majority of the time. So that’s a big unknown.

 

[figuy1]

For the spreadsheet junkies who want a tool to assist in figuring out the Roth conversion dilema, this blog post along with the accompanying spreadsheet does a good job in finding a solution given A LOT of customizable parameters. It lets you customize on a year-by-year basis of what your current tax rate as well as future expectations, along with future asset growth expectations.

https://earlyretirementnow.com/2021/04/28/a-retirement-tax-planning-case-study-swr-series-part-45/

The spreadsheet isn't the easiest to use and is more complicated than most are looking for. It also doesn't factor in some things like ACA subsidies, one would have to fudge their marginal tax rate to approximate it, but it does do a good job at showing the moving parts if you can follow everything going on.

 

[RunningBum]

Investment return rate actually does play a part, doesn't it? I ran a simple spreadsheet, converting $10,000 at 22%, tax paid out of the conversion, comparing it to a tIRA withdrawal of that $10K in 5 years at 25%. So that's $10,000 invested in a tIRA, and $7800 in a Roth, with a 25% tax on the tIRA at the end of 5 years.

With a 5% yearly return, the Roth advantage is $383 ($9955 vs $9572. With a 6% return, the Roth advantage is $401 ($10438 vs. $10037).

If the conversion tax rate is the same as the withdrawal tax rate, as expected there is no advantage, no matter what the investment return rate.

It doesn't change the decision whether or not to convert, but a higher investment return rate does increase the advantage of converting. Even a negative return rate favors conversion if the tax rate at conversion is better (lower).

 

[OldShooter]

... If the conversion tax rate is the same as the withdrawal tax rate, as expected there is no advantage, no matter what the investment return rate.

I think that's what we have been talking about. Certainly it's what I have been talking about.

But winning the arbitrage bet is extra sweet if the Roth account has increased in value. Makes sense I think.

... Even a negative return rate favors conversion if the tax rate at conversion is better (lower).

Interesting thought ... if one loses the arbitrage bet but the account value declines, the tIRA may still be the better option. Depends on the arbitrage difference and the shrinkage percentage of course, but still an interesting thought.

All we need is good crystal balls ...

 

[SevenUp]

Interesting thought ... if one loses the arbitrage bet but the account value declines, the tIRA may still be the better option.

How?

traditional = Pre-tax * Growth * (1 - future_tax)
Roth = Pre-tax * (1 - present_tax) * Growth

The ratio of traditional/Roth = (1 - future_tax)/(1 - present_tax).

In other words, it doesn't matter whether Growth > 1 or Growth < 1.

 

[OldShooter]

How?

traditional = Pre-tax * Growth * (1 - future_tax)
Roth = Pre-tax * (1 - present_tax) * Growth

The ratio of traditional/Roth = (1 - future_tax)/(1 - present_tax).

In other words, it doesn't matter whether Growth > 1 or Growth < 1.

Not sure I understand your equations, but I haven't spent much time thinking about scenarios where these accounts don't grow. I'll have to noodle on that.

 

[SevenUp]

Not sure I understand your equations, but I haven't spent much time thinking about scenarios where these accounts don't grow. I'll have to noodle on that.

It's the commutative property of multiplication as applied to traditional vs. Roth.

 

[chassis]

Our friends at Morgan Stanley to the rescue:

Snips from: https://advisor.morganstanley.com/t...tage-group/Roth_IRA_Conversion_Strategies.pdf

/SNIP 1
Example
Tom, who is a HNW investor in the 39.6% tax bracket,
converts $1 million to a Roth IRA in 2016. The income tax on
the conversion is $396,000 ($1 million x 0.396). The tax paid
reduces the investor’s estate by $396,000. If Tom is at the
40% estate tax bracket, there is a potential estate tax
savings of up to $158,400 ($396,000 x 0.40).
/END SNIP 1

I left the last sentence in for sake of completeness, but in my view it's not germane to the discussion. In M-S's example, Tom is poorer upon completion of a Roth conversion. His estate is reduced by $396,000. Does everyone agree that Tom is poorer as a direct consequence of his decision to convert $1m to Roth?

/SNIP 2
Generally, the shorter the timeframe the less appealing it is
to convert because the investor will have less time to make
up for what he or she paid in taxes on the conversion —
especially if he or she anticipates being in a lower tax bracket
in retirement than at the time of the conversion.
/END SNIP 2

M-S notes "timeframe" to "make up for". To me this is the concept of a payback period to address the fact that Tom has impoverished himself by inflicting a tax wound upon himself by virtue of a Roth conversion. Does everyone agree that income tax on Roth conversions need to be paid back, and therefore payback and breakeven analyses can be done on the Roth conversion decision?

 

[SevenUp]

Does everyone agree that Tom is poorer as a direct consequence of his decision to convert $1m to Roth?

If this is Tom's estate then Tom is dead and doesn't care.

/SNIP 2
Generally, the shorter the timeframe the less appealing it is
to convert because the investor will have less time to make
up for what he or she paid in taxes on the conversion —
especially if he or she anticipates being in a lower tax bracket
in retirement than at the time of the conversion.
/END SNIP 2

M-S notes "timeframe" to "make up for". To me this is the concept of a payback period to address the fact that Tom has impoverished himself by inflicting a tax wound upon himself by virtue of a Roth conversion. Does everyone agree that income tax on Roth conversions need to be paid back, and therefore payback and breakeven analyses can be done on the Roth conversion decision?

See https://personal.vanguard.com/pdf/ISGBETR.pdf for a "break even tax rate (BETR)" analysis. There are many assumptions that go into such analysis, and the validity of those assumptions may vary from person to person.

No, there is no "need to [pay] back" the taxes. It's like the old Fram oil filter commercial: the IRS says "pay us now, or pay us later."

 

[Out-to-Lunch]

M-S notes "timeframe" to "make up for". To me this is the concept of a payback period to address the fact that Tom has impoverished himself by inflicting a tax wound upon himself by virtue of a Roth conversion. Does everyone agree that income tax on Roth conversions need to be paid back, and therefore payback and breakeven analyses can be done on the Roth conversion decision?

Oh fer cryin' out loud! I decided that rather than answer this question de novo, I would find a previous time that I addressed this question. It turns out that it was in response to YOU:

Thanks for the comments, this has been a great thread.

What do posters on this thread think the total lifetime benefit is by doing Roth conversions? It's a question similar to deciding when to start receiving Social Security.

What is your calculated breakeven age for Roth vs no-Roth strategy?

What is your calculated dollar, or percent of net worth, benefit for the Roth vs no-Roth strategy? This can be a NPV in today's dollars, or a future projected net worth number at an age of your choosing.

I'm not asking people to share their personal details, but rather to quantify the magnitude of impact of a Roth vs. no-Roth decision. Thanks again.

I think this question is ill-posed.

Most of the time that I have seen the matter posed as a "break-even" decision, it is framed as "I need XX years of tax-free growth to make up for the taxes." But this is the wrong way to look at it. It really is about the tax rate when the money is withdrawn (either now, by conversion, or later, for spending).

To simplify, consider $1,000 in a tIRA. Further, let's assume that you will be in the same tax bracket (say, 22%) both now and later, and that you will pay for taxes out of the tIRA funds. (More on that last assumption later.)

In scenario A, you convert it now, and have $780 in your Roth. Let's say over the next 10 years, the money doubles, there are no further taxes, and you therefore have $1560 in spendable funds.

In scenario B, you wait 10 years, and your tIRA money doubles to $2,000. You then decide to spend that, and you take it out and pay your $440 in taxes, which leaves you with (drum roll...) $1560 to spend.

Mathemeticians call this "the commutative law of multiplication." There is no break-even time period.

Obviously, if the tax rate is higher later, you are better off if you convert now; and, contrariwise, if your tax rate is lower later, you would be better off waiting.

Things can get a little more complicated if you are paying for taxes from other funds, like a taxable account. This favors converting now, because you effectively move some of your money in a non-tax-preferred savings vehicle into a tax-preferred account. You can read more about that here: https://personal.vanguard.com/pdf/ISGBETR.pdf

I give up! ¯\_(ツ)_/¯

 

[pb4uski]

Troll.

 

[FlaGator]

Our friends at Morgan Stanley to the rescue:

Snips from: https://advisor.morganstanley.com/t...tage-group/Roth_IRA_Conversion_Strategies.pdf

/SNIP 1
Example
Tom, who is a HNW investor in the 39.6% tax bracket,
converts $1 million to a Roth IRA in 2016. The income tax on
the conversion is $396,000 ($1 million x 0.396). The tax paid
reduces the investor’s estate by $396,000. If Tom is at the
40% estate tax bracket, there is a potential estate tax
savings of up to $158,400 ($396,000 x 0.40).
/END SNIP 1

I left the last sentence in for sake of completeness, but in my view it's not germane to the discussion. In M-S's example, Tom is poorer upon completion of a Roth conversion. His estate is reduced by $396,000. Does everyone agree that Tom is poorer as a direct consequence of his decision to convert $1m to Roth?

/SNIP 2
Generally, the shorter the timeframe the less appealing it is
to convert because the investor will have less time to make
up for what he or she paid in taxes on the conversion —
especially if he or she anticipates being in a lower tax bracket
in retirement than at the time of the conversion.
/END SNIP 2

M-S notes "timeframe" to "make up for". To me this is the concept of a payback period to address the fact that Tom has impoverished himself by inflicting a tax wound upon himself by virtue of a Roth conversion. Does everyone agree that income tax on Roth conversions need to be paid back, and therefore payback and breakeven analyses can be done on the Roth conversion decision?

Troll.

Yep. Or someone who (remarkably?) knows his knowledge is far below the confidence in said knowledge.

Saw the same on the real estate "bubble" thread-supreme confidence in the belief while ignoring assessments who have been in the game for many decades.

So, Chassis, why the continued needling of those who have a different opinion, or who's analysis doesn't fit with yours?

 

[Time2]

@Time2, if you’re still hanging around on this one…

I’ve been investigating a stopping point to conversions as well. Using i-orp I did the following:

- ran a base case with current age and balances. Terminal age 92.
There were 3 scenarios: no conversion, convert to 22, convert to 24.
The numbers worked out to a 4K/yr spending advantage if I convert the entire IRA balance as quickly as possible, up to 24%.

Next…
- update all your balances with the year 2 numbers from the first case. Adjust AA if needed. Increment your age by 1, and rerun the 3 scenarios above.
In this case the spending advantage was lower, as it included the effects of the first conversion.

- repeat as above.

What I found is that 3 large conversions would accomplish the goal and conversions after that point were negligible. Naturally, this is all dependent upon my unique scenarios.

But a key point is that this is a renewable question every year. The stopping point is where your advantage disappears. Find a calculator or model where you can do something like I did above.

The thing with i-orp, it uses the tax law as written. In 2026 it will revert to pre-TCJA, and for planning horizons this is the majority of the time. So that’s a big unknown.

Yes, still keeping up with the thread.

I'm convinced converting in the 12% bracket is a good idea, for two reasons, I'm pretty sure SS and RMDs will push us to a higher bracket, and I think tax rates will increase.
The question I have now is,should we start my wife's SS now? The downside of this is it would reduce the amount I could Roth convert for the next 7 years. I'll take my SS at 70 to increase my wife's income after I die.
I have not used i-orp, it's probably time for me to try it.
Would it answer the question about whether my wife should take her SS now or later?

 

[RunningBum]

Yes, still keeping up with the thread.

I'm convinced converting in the 12% bracket is a good idea, for two reasons, I'm pretty sure SS and RMDs will push us to a higher bracket, and I think tax rates will increase.
The question I have now is,should we start my wife's SS now? The downside of this is it would reduce the amount I could Roth convert for the next 7 years. I'll take my SS at 70 to increase my wife's income after I die.
I have not used i-orp, it's probably time for me to try it.
Would it answer the question about whether my wife should take her SS now or later?

Are there any other reasons to take her SS early? Being single I don't know all of the spousal situations. What does opensocialsecurity.com say?

One of the reasons besides longevity insurance that I plan to defer SS until 70 is to have more years without SS to do Roth conversions, just as you are considering.

 

[thefist]

The question I have now is,should we start my wife's SS now? The downside of this is it would reduce the amount I could Roth convert for the next 7 years. I'll take my SS at 70 to increase my wife's income after I die.
I have not used i-orp, it's probably time for me to try it.
Would it answer the question about whether my wife should take her SS now or later?

You specify the age you want to take SS in each i-orp run. So do multiple runs and change the age to see the difference. You also need to specify your benefit. So get that from SSA.gov for more accurate results. I-orp also let’s you test with full benefits or the potential benefit cut coming in 2035-ish.
I-orp is a bit different. It calculates what your maximum spending COULD be, and assumes you will spend it down to ZERO in the time period. You can also specify an ending balance if you want to leave a certain legacy amount.

 

[Exchme]

Yes, still keeping up with the thread.

I'm convinced converting in the 12% bracket is a good idea, for two reasons, I'm pretty sure SS and RMDs will push us to a higher bracket, and I think tax rates will increase.
The question I have now is,should we start my wife's SS now? The downside of this is it would reduce the amount I could Roth convert for the next 7 years. I'll take my SS at 70 to increase my wife's income after I die.
I have not used i-orp, it's probably time for me to try it.
Would it answer the question about whether my wife should take her SS now or later?

I-orp is not a SS timing tool. You can use opensocialsecurity.com for a thorough look. I recommend looking at a range of discount rates, its default is to use current 20 year TIPS yields of -0.39%. While that is the close to a risk free rate, I struggle to think it's a reasonable choice and have seen discussions from folks way smarter than I that it should be more like your portfolio return. So I think the best answer is to look and see how sensitive the answer is to the discount rate in your particular case.

 

[Out-to-Lunch]

The question I have now is,should we start my wife's SS now? The downside of this is it would reduce the amount I could Roth convert for the next 7 years. I'll take my SS at 70 to increase my wife's income after I die.

In our case, the optimal solution according to opensocialsecurity is the one you are contemplating, viz., me at 70 and my wife at 62. However, the answer was VERY insensitive to her claiming age. Her claiming age was basically a wash as long as I claim at 70. So, it could be that it would benefit you to delay her claiming for, say, a few years to allow a few years of conversions.