Why ROTH conversion is a bad idea for me.

[jeroly]

Leaving inheritances and surviving spouse issues aside, I think the biggest value in Roth conversions is for early retirees looking for a penalty-free withdrawal mechanism... if you convert $X in 2021 (paying income tax on the conversion amount) you can withdraw $X from the Roth in 2026 without penalty, and you can create a 'conversion ladder' to bridge the time until you can make penalty-free withdrawals.

[Winemaker]

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Originally Posted by pb4uski Not sure how you end up paying more in taxes by not converting now if you're currently in the 22% and will be higher once SS kicks in. The other thing to consider is that if you or your DW die earlier then the surviving spouse's RMDs will be in a much higher tax bracket where 22% might look like a screaming deal.

Anyway we look or plan for the future there is an unknown. Dying early, raising tax rates, falling markets, paying taxes too early, to name a few of the negatives. The preferred method of conversion is to have a taxable account to pay the conversion tax bite, we don't have any taxable account. To create that, we would be still using previously withdrawn funds to do that. Commutative, associate and distributive math principles still apply. Right now, we're going to spend half over the next 10 years before RMDs kick in. The amount we are taking out now is more than projected RMDs by $20,000/year.

[chassis]

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Originally Posted by RetireBy90 I don't want to jump on ya or just repeat what smarter folks than I have already said. I didn't do simulations or complex computations, just took my steady income today and added in my expected SS and then looked at the tax brackets and RMD if I was 70 today (did this couple years ago). The RMD would be taxed at 24% for the rest of our lives. I'm doing conversions into the 24% bracket a bit through 2025 and then will re-assess at that point. I'm able to convert about $80-$90K in 22% bracket and pay the taxes from after tax funds. It will allow me to contribute any remaining RMD via QCD and have about 2/3 of funds in the Roth where I can take out any time or pass to kids tax free. I recommend you run a excel spreadsheet to compute your total taxable income at age 72. You will be required to take RMD of about 4% first year and pay taxes. What bracket does that RMD in using today's dollars and brackets. If it is higher than your bracket today it will cost more in taxes to wait. I understand that some will do this and conclude it isn't worth it to me. I would suggest that couple others here enjoy playing with this just as I do, so a couple hours here or there is fun. Others just don't want to think about it any more than necessary. Good to both of them. Me ? I'm doing the calculations couple times a year and enjoying saving a few thousand in taxes. I have a tax liability of about $200K (taxes due if I do nothing) that I hope to get down to about $150-175K, to say nothing of the taxes I'd owe on the gains over next 7 years.

Thanks for the comment. I do have an Excel spreadsheet with RMDs per the government rubric and they are taxed. However I need to check the tax rate because I think it is static, and not dependent on the total income. That will make the RMDs more painful from a tax point of view.

On the other hand, I tinkered with i-orp changing nothing except the Roth conversion tax brackets, and there was no change in the predicted disposable income. At this point I remain of the belief that Roth conversions are not advantageous for me. I abhor both paying taxes before they are mandated and having handcuffs on my money.

Question that has not yet been answered: Do Roth conversion benefits accrue equally to large estates as they do to small estates? Use your own definition of small or large.

[SecondCor521]

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Originally Posted by chassis Question that has not yet been answered: Do Roth conversion benefits accrue equally to large estates as they do to small estates? Use your own definition of small or large.

Generally, I think large estates receive a greater benefit, where large is defined as traditional IRA value divided by number of heirs is large. The reason is that with the SECURE Act, traditional IRAs need to be drained in 10 years in most typical cases.

If you take a typical 80- or 90-year-old widow or widower with a $3M traditional IRA and a couple of 55-ish year old kids in the 24% bracket, then that $3M divided by two kids divided by 10 years still might push those kids into the 32% bracket.

If the same widow/widower has a $1M traditional IRA and wants to split it among their five kids, then that $200K each over 10 years is only $20K and not likely to do as much damage to their tax bills.

I think it does depend as well on the IRA owner's tax rates and the average expected tax rates of the heirs. No sense in grandma doing Roth conversions in the 32% bracket if the heirs will end up doing the withdrawals in the 24% bracket.

[RetireBy90]

So just one more benefit for me that I haven't brought up yet. I have couple friends and some family members that as they age they have less ability to manage a portfolio and taxes. For me, if I pay the taxes today at a rate that is affordable then when I age and loose a step in the cognitive area the taxes and any steps needed to minimize them will be done. You only loose against getting older one time.

[RunningBum]

Another advantage for conversions in a large estate is the ~$11M estate tax exemption. The IRA tax liability is not considered when figuring the estate amount, so you'd be better to reduce your estate by the amount of the taxes due on a tIRA conversion than leaving it in an IRA. Just one factor to consider. And just because your estate is under the exemption amount doesn't make it a bad idea to convert, just that it's not a factor for you. Also, they could reduce the estate exemption again.

[Exchme]

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Originally Posted by DayDreaming I'm in a similar situation: single, no heirs, 60 yrs old, NJ resident. I'm on the fence about Roth conversions, but have been doing small ones for a few years (< $20k/year). IORP tells me that if I do massive conversions over the next 5 years, I'll have a few more thousand in disposable income each year, but even without that extra money, I still have more than I can spend each year. First World problem, I know. One thing I'm really looking at now is IRMAA. IORP tells me that if I do the big ROTH conversions it suggests, my Medicare costs will be somewhere around $2k/year, as opposed to $6k/year if I do no ROTH conversions. So even though I'm single with no heirs, I don't need additional income, I still don't see any harm in doing ROTH conversions. And I think I'd feel angry paying $6k Medicare costs knowing that I could have knocked that down to $2k. (I know that doesn't really make sense). So I might be doing some big ROTH conversions, just not as big as IORP suggests. I don't feel I need to totally empty out my tIRA, and I like the idea of having some tax diversity by moving more from tIRA to ROTH. FYI, in the year you turn 62, you might be able to exclude up to $75,000 income from your NJ state taxes: https://www.state.nj.us/treasury/taxation/njit7.shtml

Of course, the best thing you can do is hold all stock in your Roth, then fill taxable with stock and finally put any leftover stocks in the t-IRA. Be aware that i-orp (not a criticism of i-orp specifically, all the other tools do the same thing) have a built in limitation that they look at the allocation in each account, but not the global asset allocation. So if you tell it you want your Roth to be 100% stock (which is the right thing to do), computer programs will not understand that you intend to maintain your overall asset allocation by lowering the stock % in your t-IRA, it will just see that juicy 100% stock returns and will do crazy amounts of Roth conversions to go capture it. But it isn't real, you will actively balance out your stock percentage in your t-IRA.

The only way to get a non-crazy answer is to set the stock/bond allocation the same in all your accounts so the computer is strictly looking at tax brackets/IRMAA tiers, etc. and not just driving your asset allocation to more and more stocks. But it still may be overstating the need for conversions in that when your actual allocation is optimal with lots of bonds in your t-IRA, it grows more slowly than the computer assumes, so the computer sees more urgency in conversions than is really there.

So it's odd, but there really aren't any tools I can find that do a convincing job of calculating the optimum Roth conversion. Of course in the real world, bigger factors like market returns and life expectancy will swamp our feeble attempts to peer into the future, but I want to calculate something, darn it!

[chassis]

Thanks again for the comments.

@RunningBum @SecondCor521

I'm getting the idea that the principal motivation for Roth conversions is related to passing the estate to heirs. Do you agree?

In other words, following the logic in the comments above:
- Estate holder has heirs, therefore Roth conversions are attractive.
- Estate holder has no heirs, therefore Roth conversions are less or not attractive.

p.s. I have heirs (today), however I want to understand the hypothetical scenarios of with and without heirs.

[Out-to-Lunch]

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Originally Posted by chassis Thanks again for the comments. @RunningBum @SecondCor521 I'm getting the idea that the principal motivation for Roth conversions is related to passing the estate to heirs. Do you agree? In other words, following the logic in the comments above: - Estate holder has heirs, therefore Roth conversions are attractive. - Estate holder has no heirs, therefore Roth conversions are less or not attractive. p.s. I have heirs (today), however I want to understand the hypothetical scenarios of with and without heirs.

I do not agree that estate management is the principal motivation. Tax-rate arbitrage is the principal motivation.

[chassis]

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Originally Posted by Out-to-Lunch I do not agree that estate management is the principal motivation. Tax-rate arbitrage is the principal motivation.

@Out-to-Lunch thanks, I understand your comment. However at this point I don't see how this helps in my situation. I will continue to game and jigger i-orp and my own spreadsheets to see how this benefits me, or not.

Is the 5 year rule in effect if a Roth conversion is initiated after age 59 1/2?

[NoiseBoy]

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Originally Posted by tenant13 My friends are my age, so are the members of my somewhat distant family that I know (I haven't met the next generation). I'm not a fan of charities - I feel like administrative costs of running these things are the main purpose of their existence. I know I really should do it - I had a heart attack in March - but without a clear idea of what to do it's really not easy.

I'm in a similar situation. My sister is 2 years older than me, and will inherit her husband's COLA'd pension plus his Soc Sec. They're not very thrifty, but she's nearly 20 years younger than her husband, so she's in pretty good financial shape. Her two daughters (both late 20's) are my only younger relatives. I know them both, but neither one has successfully "launched" yet, so I have no desire to hand them a significant portion of my estate and they are young enough to be responsible for their own financial futures.

I'm working with an attorney to draft my first will/trust right now. He informed me that any money I have in tax deferred accounts can be left to charity, tax free. Since I don't have a better plan at the moment for how to apportion my estate, I'm going to use that bit of info and leave everything I have that is tax deferred to charity. Since I don't have any specific ideas on what charities I want to support, I'm going to use the United Way for the largest chunk and specify my county. My alma-mater will get the next biggest piece and so on, with my family getting the rest.

The way I look at it, if I don't make any plans, then my sister, and eventually my nieces, are going to become millionaires with "my money" and who knows what they will do with it. Even if the United Way is only 75% efficient, I'd rather have them distribute that amount to charities in my county, than give it to my financially challenged family. Hopefully this first version of my estate plan will never see the light of day as I will live long enough to create a more thoughtful approach. I also believe that it's easier to tweak a plan, once you have something down on paper. Just thought I'd share my thinking in case these ideas might appeal to you a little.

[Out-to-Lunch]

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Originally Posted by chassis @Out-to-Lunch thanks, I understand your comment. However at this point I don't see how this helps in my situation. I will continue to game and jigger i-orp and my own spreadsheets to see how this benefits me, or not.

Fair enough. I am confused, however. You asked specifically about an estate-vs.-no-estate situation. So you could not have been speaking about your situation specifically, right? (I was speaking about the fact that, in general, the principal motivation is tax rates.)

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Is the 5 year rule in effect if a Roth conversion is initiated after age 59 1/2?

There are two different 5-year rules. One is still applicable after 59.5, and the other isn't.

In effect: the oldest Roth must be at least 5 tax years old (to get all the advantages).
Not in effect: The rule that a particular tranche of conversions must be five years old is not in effect.

[thefist]

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Originally Posted by Out-to-Lunch I do not agree that estate management is the principal motivation. Tax-rate arbitrage is the principal motivation.

+1

[thefist]

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Originally Posted by Exchme Be aware that i-orp (not a criticism of i-orp specifically, all the other tools do the same thing) have a built in limitation that they look at the allocation in each account, but not the global asset allocation. So if you tell it you want your Roth to be 100% stock (which is the right thing to do), computer programs will not understand that you intend to maintain your overall asset allocation by lowering the stock % in your t-IRA, it will just see that juicy 100% stock returns and will do crazy amounts of Roth conversions to go capture it. But it isn't real, you will actively balance out your stock percentage in your t-IRA.

This is a good point, but IORP does let you specify a glide path by setting a stock/bond percentage at end of plan. For a simple example, if you specify a 40yr planning period, and 100--->60 stock allocation, I'd assume it knocks off 1% a year. That's not necessarily realistic when conversions happen, as you might be moving 10-20% of an IRA over at a time in a big conversion.

You can also see huge differences based upon returns.
Start with 500k IRA, 400k stock/100k bond, with plan to convert 100k per year:
1) stocks go up 25% in a great year, new stock balance is 500K. Convert 100k stock, and you're back to 400k/100k
2) bad year, stocks decline 25%, new stock balance is 300k. Convert 100k stock and you're around 200k/100k. Huge difference from #1, but now your recovery takes place tax free.

For tools like IORP using CAGR, individual years like this aren't modeled well.
Running IORP annually with actual balances remedies this limitation.

In a scenario like #2, that one single conversion year might alter the overall plan significantly.

[thefist]

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Originally Posted by Exchme The only way to get a non-crazy answer is to set the stock/bond allocation the same in all your accounts so the computer is strictly looking at tax brackets/IRMAA tiers, etc. and not just driving your asset allocation to more and more stocks. But it still may be overstating the need for conversions in that when your actual allocation is optimal with lots of bonds in your t-IRA, it grows more slowly than the computer assumes, so the computer sees more urgency in conversions than is really there.

I think there's one point you may have missed. IORP considers the known tax laws, and seems to REALLY like the low tax rates currently in effect through 2025. Perhaps IORP is right on that front. I think most people out here expect taxes to go up in the future. What we don't know is how low in the income brackets increases will happen.
I think the sunset of the 2017 tax law in 2026 is where IORP urgency comes from.

[pb4uski]

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Originally Posted by chassis Thanks again for the comments. @RunningBum @SecondCor521 I'm getting the idea that the principal motivation for Roth conversions is related to passing the estate to heirs. Do you agree? In other words, following the logic in the comments above: - Estate holder has heirs, therefore Roth conversions are attractive. - Estate holder has no heirs, therefore Roth conversions are less or not attractive. p.s. I have heirs (today), however I want to understand the hypothetical scenarios of with and without heirs.

Be careful... I'm not sure how an estate has "no heirs" or is "without heirs"... if you die intestate (without a will) then state law dictates who the decedent's heirs are... (generally follows bloodlines) so whether you have a will or not you have heirs... it is just a matter as to whether you define who they are or the state does.

If some of your heirs are individuals and some are charities, then it is better to leave the Roths to the individuals and the tIRAs to the charities.

https://www.nolo.com/legal-encyclope...argest%20share.

[RunningBum]

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Originally Posted by chassis Thanks again for the comments. @RunningBum @SecondCor521 I'm getting the idea that the principal motivation for Roth conversions is related to passing the estate to heirs. Do you agree? In other words, following the logic in the comments above: - Estate holder has heirs, therefore Roth conversions are attractive. - Estate holder has no heirs, therefore Roth conversions are less or not attractive. p.s. I have heirs (today), however I want to understand the hypothetical scenarios of with and without heirs.

No, I don't agree with that at all.

As out-to-lunch wrote, my main driver is the tax-rate arbitrage.

Estate factors can go either way. If I spread out my estate to have many heirs, and none of them are in a very high tax bracket, that may make conversions less attractive. Other situations can make it more attractive. So I don't see how you could say "I [don't] have heirs, therefore ...". It's not that simple.

In my own situation, I have an heir I care deeply about, but he's going to get plenty no matter what, so I'm going to optimize Roth conversions for the most benefit to me, which includes the possibility of spending it all down. I can't spend it unless I convert or withdraw it, so I look at whether it's better for me to convert now or withdraw later. As a tiebreaker I would look at what it does to his situation when he inherits.

[Gumby]

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Originally Posted by Out-to-Lunch I do not agree that estate management is the principal motivation. Tax-rate arbitrage is the principal motivation.

Tax rate arbitrage is my only motivation, since I don't have any heirs.

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Originally Posted by pb4uski Be careful... I'm not sure how an estate has "no heirs" or is "without heirs"... if you die intestate (without a will) then state law dictates who the decedent's heirs are... (generally follows bloodlines) so whether you have a will or not you have heirs... it is just a matter as to whether you define who they are or the state does...

True enough, but if I don't care enough to have chosen them as my heirs, I don't care about their tax situation.

[pb4uski]

^^^ My point was that from what chassis wrote he seemed to think that it was possible to die without heirs, but I don't think that is the case... either you name them if you have a will or state law names them if you don't have a will.

[chassis]

Thanks @pb4uski.

I'm trying to separate the variables. They seem to be: estate/heir related, and tax arbitrage related. Several posters have commented that tax arbitrage is the main driver for Roth conversion.

Regarding tax arbitrage:

a. is the arbitrage today's rates vs legislatively changed future rates after RMD age, or

b. is the arbitrage a non-RMD rate vs a (higher) RMD rate, regardless if or how tax rates change in the future?

If the choice is a., I see a speculative nature to the Roth conversion decision. The speculation is whether and how future income tax rates will change.

If the choice is b., this can be sleuthed out with a calculator. So far, i-orp and my own spreadsheet have not sleuthed the "Roth conversion is good" indicator for me.