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Old 03-04-2021, 03:12 PM   #101
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It is a. But unless one has a crystal ball that is the best that you can do and I agree with many here that in the future it is more likely that tax rates will be higher than lower, so using todays 2017 Tax Act rates is conservative. And add to that that if DW or I die before RMDs kick in that the remaining spouse will be in a much higher single tax bracket unless we remarry (won't be me!).

The arbitrage is the marginal tax rate on a Roth conversion done today... increase in tax divided by the conversion amount. For us for 2021 that will be ~11.5%.

The comparison is to the projected marginal tax on an RMD... in our case in 2027... I'm estimating 15.3% (based on current tax rates, knowing that tax rates may well be higher).

While the difference in 2021 is a modest 3.8%, on $80k of conversion that is $3k.... well worth a couple of hours work... plus the benefit is likely understated since tax rates are scheduled to increase between now and 2027.
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Old 03-04-2021, 03:34 PM   #102
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As a first order answer, I do Roth conversions for tax arbitrage. But I do that arbitrage because I think it will result in more spending money for me during my lifetime. Generally speaking, I think it will also be beneficial to my heirs, but that depends on their tax rates in the future, which is hard to suss out.

As far as the question in post #100, one has to make assumptions about the future. I assume certain growth and inflation rates for investments and inflation-adjusted tax items. Generally speaking, I assume the status quo with regards to RMD ages and divisors, as well as tax brackets.

I then look at what I predict my age 72 marginal tax rate will be. I convert each year as long as I can remain below that tax rate. I'm agnostic as to the amount, but in general I'll likely end up converting modestly while my kids are in FAFSA universities (another two years or so), then up to the 400% FPL level until Medicare age (depending on what happens with the ACA cliff), then up to the top of a certain bracket after that. (I know what that certain bracket is now, but it'll likely change by the time I get there anyway for various reasons.)
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Old 03-04-2021, 03:48 PM   #103
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I consider it a win if I take money out of the tIRA/401k at a marginal tax rate less than when I put it in. There is no guess work about that. A great amount of it went in at 35% + and none of it went in at less than 24%. It is coming out at 22%.
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Old 03-04-2021, 03:50 PM   #104
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Letís just be clear, there may be several reasons to do Roth conversions depending on your situation. For me, they include, not in order of impact:

- IRMAA limits, if I donít convert today RMDs will increase my IRMAA.
- higher income with RMDs will disallow any loss on rental property
- of course, my expectation of higher tax rates after 2025 or even sooner
- The hit from single tax rates for the one to survive the longest
- I prefer to pass any remaining funds with taxes already paid
- with Roth I can take the money at any time without a tax impact, or impact of other income limits. If I. Want to buy a beach house, I can take purchase price in one year.
- it gets the tax bill done for me.

Iím sure others can add to this list. We had a thread where many advantages were discussed.
Again, if you donít want to do Roth conversions then that is fine with me. However, for the vast majority I think they are a great idea. Many can use them as a tool with some or all of benefits listed.
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Old 03-04-2021, 04:03 PM   #105
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I consider it a win if I take money out of the tIRA/401k at a marginal tax rate less than when I put it in.
^ This.
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Old 03-04-2021, 04:13 PM   #106
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Edit to add: Once again, I got caught out by the fact that I did not see the others had provided an answer (because your post was the last one on the previous page!).

It is ALL speculative. Your decision to put funds in a pre-tax account in the first place was speculation that you will, net net, be saving taxes versus when you spend the money.

The way I look at it, pre-tax contributions and Roth conversions allow you to smooth your taxable income over time to minimize taxes. If you are in a high tax bracket while working, (and you speculate that you will be in a lower one later), you can lower your taxable income by saving in a 401(k). If you are in a lower bracket now, you can do Roth conversions to realize more income now to spare it from higher taxation later.

But, yes, speculation is required.
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Old 03-04-2021, 05:17 PM   #107
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I consider it a win if I take money out of the tIRA/401k at a marginal tax rate less than when I put it in. There is no guess work about that. A great amount of it went in at 35% + and none of it went in at less than 24%. It is coming out at 22%.
Yup.
If monies go in at 35% and are taken out at 22%, but not doing max conversions to bring the 22% lower, not the end of the world.
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Old 03-04-2021, 05:54 PM   #108
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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.
Mostly (b) for me.

Right now my Roth conversions are costing 10% Fed Tax and almost 10% loss of subsidy, so about 20% total. The subsidy loss could drop to 8.5% in 2021, if the senate passes the bill that the house has already done. I have in the past paid as high at 25% on some conversions.

In my projections for the future, I would not quite be out of the SS tax hump so the RMD cost of the first $1-2K is 49.95%. After that, I'm still pushing QDivs into being taxed so it's 27%. If I'm being too conservative on my income and I am out of the SS tax hump, then it's 27% until all of my QDivs are taxed, and then it settles down to 22%.

Clearly, this favors conversion for my case. I wonder how many other people have really tried to figure out their true marginal tax rates when they'll have to take RMDs.

If I consider (a), future tax rates returning to previous levels, I'm at 55.5%, 30% and 25% for the income levels above.

You call (a) speculative, but it's what tax rates WILL BE in 2026 unless Congress takes action to extend the tax cuts. In my opinion, and it is just an opinion, it's more speculative to assume that congress will extend the tax cuts.

My marginal state tax rate has been 5.75% all the way so there's no tax arbitrage there.
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Old 03-04-2021, 06:00 PM   #109
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There is a further advantage to Roth conversions if you can pay the tax out of your taxable account rather than out of the conversions. Keep the amount of taxes you paid in the Roth by paying out of taxable allows that amount to grow tax free. Even if conversion tax rates = future RMD tax rates, the tax free growth on that portion puts you ahead.
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Old 03-04-2021, 06:19 PM   #110
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I'm mostly (b) also. We deferred this income at 28% to 33%. Without conversions, we'd pay mostly 25% at RMD time, possibly some at 28% depending on how the IRAs grow. So I'm near-giddy to settle-up today at a mix of 12% and 22%.

I do expect rates to increase in 2026, per current law. I agree that it seems more speculative to assume otherwise. Beyond that, I'd say it's more likely that rates go up than down. But that plays a very minor role in my thinking.

I do consider the surviving spouse at single rates. And the advantage of using taxable funds to pay the tax.

I am not motivated in the least by pre-paying inheritance tax for the kids. Though I concede that it might actually play out that way.
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Old 03-05-2021, 12:08 AM   #111
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There is a further advantage to Roth conversions if you can pay the tax out of your taxable account rather than out of the conversions. Keep the amount of taxes you paid in the Roth by paying out of taxable allows that amount to grow tax free. Even if conversion tax rates = future RMD tax rates, the tax free growth on that portion puts you ahead.
That's my dilemma, not enough in taxable account to cover conversion taxes through RMD age..
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Old 03-05-2021, 08:15 AM   #112
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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.
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Old 03-05-2021, 10:03 AM   #113
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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
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Old 03-05-2021, 11:05 AM   #114
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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
Thanks @Out-to-Lunch

Are you saying the Roth conversion strategy results in less tax dollars being paid, with the same spendable funds? $1560 in this example.

I try to analyze financial decisions as investments. Nearly all businesses have standard forms that calculate NPV and breakeven. In this case, the investment is in accelerated tax payments. I do not understand (yet), the quantified payback value in terms of dollars or time. Where's the beef? What's the rub? What's in it for me? Quantified in terms of dollars or time.

I understand the hypothetical scenario of higher future federal income tax rates. It has been agreed on this thread that an element of speculation exists on the topic of future rates.

I want to become a believer in the Roth strategy, but so far I'm not there. I haven't seen a quantified (dollars or time) benefit for this, and the rationale of tax arbitrage contains speculation that I may choose not to participate in.

In my view, driving to the grocery store contains an element of speculation - that you will arrive in the parking lot safely and that the store will have the products you wish to purchase. Most people will say that is a low and acceptable level of speculation. I invest in equities, so I participate in speculation in that example. I am not saying that a world exists with no speculation.

I'm not sure I'm on board with the speculation of higher future income tax rates, to the extent I would choose to accelerate payments to the government. I remain open to changing my view.
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Old 03-05-2021, 11:37 AM   #115
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...In this case, the investment is in accelerated tax payments. I do not understand (yet), the quantified payback value in terms of dollars or time...
There is no investment in accelerated tax payments. The "breakeven" concept does not apply here. Breakeven implies that you spent some money (temporarily worsening your financial position) with the expectation of recovering it (and much more) over some period of time. In the case of Roth conversions, you are no worse off after paying conversion tax than you were before.

Reason is: your tIRA is *NOT* all yours. From the moment you deferred the income, you created a liability which has grown alongside the part you *DO* own. It's just a question of when, and at what rate, you decide to finally settle that liability.

By converting, you simply retire the liability early, assuming that rates are lower now than if you had waited until the tax torpedo, when SS and RMDs start. I suppose you could say it's break-even from Day 1, but that's not entirely accurate either. In a sense, you are just locking in your gain vs the higher rate when you deferred the income.

Here's an old thread with lots more discussion on this specific point.
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Old 03-05-2021, 11:53 AM   #116
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There is no investment in accelerated tax payments. The "breakeven" concept does not apply here. Breakeven implies that you spent some money (temporarily worsening your financial position) with the expectation of recovering it (and much more) over some period of time. In the case of Roth conversions, you are no worse off after paying conversion tax than you were before.

Reason is: your tIRA is *NOT* all yours. From the moment you deferred the income, you created a liability which has grown alongside the part you *DO* own. It's just a question of when, and at what rate, you decide to finally settle that liability.

By converting, you simply retire the liability early, assuming that rates are lower now than if you had waited until the tax torpedo, when SS and RMDs start. I suppose you could say it's break-even from Day 1, but that's not entirely accurate either. In a sense, you are just locking in your gain vs the higher rate when you deferred the income.

Here's an old thread with lots more discussion on this specific point.
I like this explanation! Nicely said.
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Old 03-05-2021, 11:56 AM   #117
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Let me say just one more thing: When I say "future tax rate," there can be a lot hiding there. Things like MFJ vs. single, IRMAA tiers, NIIT, ACA subsidies, SS tax torpedo, etc. All of these could be (IMHO) lumped into "future tax rate," but obviously they all require a little more thought (and speculation!) than simply the federal and state marginal rates.
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Old 03-05-2021, 02:04 PM   #118
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....What do posters on this thread think the total lifetime benefit is by doing Roth conversions? ...
I'm not sure if this helps or not.

I have a projection model from now (age 65) to age 91. My current plan is to do Roth conversions in a way that levelizes my effective tax rate from age 65-71... I'm converting slightly into the 22% tax bracket over the next 6 years... then RMDs begin at age 72.

This plan compared to if I do not do any Roth conversions:

Taxes paid: 91% of the no Roth conversions
Age 91 invested assets: 107% of no Roth conversions
Age 91 invested assets net of deferred income taxes @ 22%: 109% of no Roth conversions

So I think that the benefit of Roth conversions are substantial enough to be worth the effort.... and these numbers presume that tax rates are the same as today and that both of us live until 91.

To me, the precision isn't all that important... it shows that it is beneficial to us with conservative assumptions so that alone makes it worthwhile... the fact that the actual results will likely be better is icing on the cake.
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Old 03-05-2021, 02:41 PM   #119
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I'm not sure if this helps or not.

I have a projection model from now (age 65) to age 91. My current plan is to do Roth conversions in a way that levelizes my effective tax rate from age 65-71... I'm converting slightly into the 22% tax bracket over the next 6 years... then RMDs begin at age 72.

This plan compared to if I do not do any Roth conversions:

Taxes paid: 91% of the no Roth conversions
Age 91 invested assets: 107% of no Roth conversions
Age 91 invested assets net of deferred income taxes @ 22%: 109% of no Roth conversions

So I think that the benefit of Roth conversions are substantial enough to be worth the effort.... and these numbers presume that tax rates are the same as today and that both of us live until 91.

To me, the precision isn't all that important... it shows that it is beneficial to us with conservative assumptions so that alone makes it worthwhile... the fact that the actual results will likely be better is icing on the cake.
Thanks @pb4uski. This is exactly what I am looking for. I'm working on tuning up my model to be able to project/forecast this.

Does your projection model tell you at what age the 107% or 109% are equal to 100%?
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Old 03-05-2021, 02:55 PM   #120
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I think it would only be 100% at time zero (age 65) and it would get progressively better if I extended the projection... sort of like compounding interest.
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