Wisdom of doing roth conversions !

[frayne]

Don’t know if I can word this correctly but would like to ask if doing T-IRA to Roth conversions make any sense except for legacy reasons at least in this case. Example: 70 year old MFJ couple with a million dollar T-IRA, 12% tax bracket (effective tax rate much lower), living comfortably off SS and IRA distributions at 3% take, in addition $300k+ in after tax accounts, no debt, own home, vehicles and RMDs at 72 will not effect current tax rate for the foreseeable future.
Investments in both pre/after tax accounts roughly 60/40 split.

I fully understand the advantages of a Roth along with the various conversion caveats, 5 year rule, IRMAA considerations, initial tax bite, etc. And I also understand the other side of the coin considerations; increased taxation of SS with larger RMDs and the uncertainty of dynamic market and changing tax environments. Also worth mentioning, besides spouse only have one heir who is doing just fine along with a couple of grandkids in their teens, smart and hopefully college bound.

I have also taken into consideration how the death of a spouse would change the entire picture.

Just curious what some of the sage members might add to my thought process/considerations and what I might be missing, concerning converting part of my T-IRA to a Roth IRA.

Thanks in advance for any and all comments.

 

[SecondCor521]

Based on your description, it's quite possible that the sole heir will have to empty the traditional IRA(s) that they inherit from this couple within 10 or 11 tax years. Because of the way generations work, those distributions may be taxed at a high rate.

Personally I try to incorporate at least a rough guess on the ultimate taxation of those traditional IRA dollars. If this couple you describe can pull traditional IRA dollars and pay 12% tax instead of leaving it to a sole heir to pull and pay 24% tax, then the family is $12 better off for every $100 converted to Roth (ceteris paribus).

Apart from Roth conversions, if the couple is doing fine and would do fine after the death of the first spouse, then it can make sense to change the beneficiaries to either the kid or the grandkids.

 

[RunningBum]

I'd probably convert to the top of the 12% bracket since tax rates may go back up in 2026, and death of you or your spouse may put the other at a higher tax rate. But if your SS isn't being fully taxed, it may be better to avoid that SS tax torpedo while you can before RMDs make it unavoidable.

It's probably not going to have a very big impact. The bigger gains usually come before you start taking SS.

 

[pb4uski]

... Personally I try to incorporate at least a rough guess on the ultimate taxation of those traditional IRA dollars. If this couple you describe can pull traditional IRA dollars and pay 12% tax instead of leaving it to a sole heir to pull and pay 24% tax, then the family is $12 better off for every $100 converted to Roth (ceteris paribus)....

Also, if the retiree lives in a no income tax state and the heir lives in a state with an income tax on tIRA withdrawals then there are additional advantages that could add a few more $$$ per hundred.

 

[thefist]

If you already do charitable giving, start doing them by QCD, assuming you are now 70.5. Spend or convert to top of 12%, then QCD on top. Each donation, assuming you would make it anyhow, will reduce RMD going forward.

 

[Perryinva]

Seems like its all covered, but I wanted to ask about the 5 year rule mentioned. I thought the 5 year rule was not part of the equation once past 59.5?

 

[chassis]

I don’t see wisdom in Roth conversions. Read McQuarrie and use the RPM spreadsheet. These two resources should convince you there is no advantage, or a very small one, to use Roth conversions.

 

[Midpack]

I don’t see wisdom in Roth conversions. Read McQuarrie and use the RPM spreadsheet. These two resources should convince you there is no advantage, or a very small one, to use Roth conversions.

Odds are Roth conversions will clearly pay for us**, but I’ve always said each of us needs to run our own numbers and plug in our own assumptions - that remains the case IMO. The McQuarrie docs I find show when it pays and when it doesn’t, he certainly doesn’t say it’s not wise for all.

** If there are tax rate hikes eventually as I choose to assume, we’ll save even more than TCJA and scheduled expiration.

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3860359

https://www.bogleheads.org/forum/viewtopic.php?t=351540

Much has changed since penalty-free Roth conversions were inaugurated in 2010. Tax rates have gone up and down. The re-characterization provision went away. Heirs can no longer stretch out inherited Roth accounts over a lifetime. Medicare surcharges were expanded and began to adjust for inflation. The age to begin Required Minimum Distributions was pushed out to age 72 and the IRS changed the RMD divisor tables to further slow the pace of distribution. Given these developments it seemed worthwhile to re-examine the rationale for Roth conversions. That effort exposed multiple flaws in conventional wisdom:
• Future tax rates need not be higher for a conversion to pay off;
• Nor is it all that helpful to pay the tax on conversion from outside funds;
• Nor are Roth conversions especially beneficial for top bracket taxpayers as compared to middle class taxpayers;
• Rather, the greatest benefit accrues to taxpayers who can make the conversion partly in the zero percent tax bracket, i.e., during a year with no other taxable income.

While the benefits from a Roth conversion are often small and slow to arrive, a Roth conversion will almost always pay off if given enough time, i.e., for life spans that extend past 90 and so long as annual distributions from converted amounts are not taken. Roth conversions work because of compounding, which requires the conversion to be left undisturbed for a long time. The paper elucidates the role played by the mathematics of compounding in underwriting the success of Roth conversions.

 

[gauss]

My concern would be what would happen if you can no longer, for whatever reason, file MFJ.

In the case of a death of spouse, those single tax rates and the associated RMDs will be much more painful, potentially.

-gauss

 

[Dash man]

My concern would be what would happen if you can no longer, for whatever reason, file MFJ.



In the case of a death of spouse, those single tax rates and the associated RMDs will be much more painful, potentially.



-gauss

^^^This! Plus if I convert, I will be paying more IRMAA for a few years, but by 2026 I may not have to pay it at all for the rest of our lives. I’ll also be below the NIIT threshold after that.

 

[RunningBum]

Here's how I see Roth conversions in general.

Mostly Roth conversions are a tax arbitrage play. If you can pay a lower rate to convert now than you would later when you hit RMDs, you will benefit.

If you can pay the conversion tax from your taxable account, you further add to the benefit because you have moved the full conversion amount to your Roth rather than have it reduced by the tax. Of course making money available in your taxable account to pay the conversion tax may result in taxes on that, but it will be relatively small depending on the basis of whatever you are selling to pay the tax.

When do you see the benefit? Right away. The way I view this is that I set up my portfolio worth to use "after tax" values. So if I have $100K in a tIRA and I expect to pay 12% upon conversion, I use $88K as the value of this account. My total portfolio worth is what I multiple my WR% by. This $100K tIRA account gives me $3520/yr to spend ($88K*.04).

If instead I were to not convert but rather withdraw at RMD time and projected to be in the 22% tax bracket then, I would have to value that account at $78K. $78K * 4% WR is $3120/yr to spend.

The net is that I immediately have $400 more per year to spend by converting that $100K at 12% rather than waiting to withdraw at 22%. Is that too little to bother with? Consider that most tIRAs are a lot larger. It would be $2K per year, every year, if you have a $500K tIRA. $4K on $1M. If you live 30 more years that would be a $120K benefit on converting a $1M Roth at a 10% better tax rate, if I've done this right.

There may be further advantages as previously mentioned by paying the conversion tax out of taxable, and if I would actually be paying more than 22% dues to the SS tax torpedo. And if you are married, when one goes the other will be taxed at the single rate. But my calc above give a rough ballpark estimate, almost certainly on the low end, and proof that you reap the benefit immediately. There is no breakeven point. Someone (you or your heirs) are going to have to pay the taxes before you can spend that money. If you are going to donate (via QCDs) some of the tIRA, you just hold that amount out of conversion, and your calculations.

Some say you are taking a chance by converting because you are projecting future unknown tax rates. It's actually the opposite. By converting now, you are taking the bird in hand by locking in on today's tax rates. If you choose not to convert, you are taking a chance on future tax rates by continuing to defer that taxable income until later, when rates are unknown. If you think tax rates will be lower in the future, go ahead and roll the dice and wait to take the income in later years. IMO that's a bad bet.

Anyone who makes a blanket statement that Roth conversions are not worthwhile without looking at the specifics of a situation, primarily tax rates, should be ignored. Likewise if they make a blanket statements that Roth conversions are worthwhile without looking at those details.

----

In the OP's case the benefit will be much smaller, if at all, because they are looking at a neutral tax rate situation. They can get a small benefit by paying taxes from their taxable account, and they will benefit a little more if tax rates go up, or one is left to file at single tax rates. And as I said in my earlier post here, it could even be bad if the actual conversion rate is higher due being in the SS tax torpedo window. The best way to tell is to enter the numbers in a tax estimator like https://www.irscalculators.com/tax-calculator and then add conversion income and see what the marginal rate is (increase in taxes / conversion).

 

[Time2]

As has been said, the future is hard to predict...
But, with $1.1M in tax deferred accounts, and ten years before we both have forced RMDs, plus two SS checks, dividends aid out on taxable accounts, and what I consider the very real possibility that tax rates will rise, I think they are a good choice for us, the big question is 12% or 22% bracket. So far, one year at 12% and 1 year at 22%.
Plus, I think one of us will die before the other, so no more MFJ.

 

[Exchme]

OP hit most of the issues, so the decision sounds pretty well informed. Like everything about Roth conversions, the answers are highly specific to the individual, the only way to gain insight is to reflect on a lot of factors, model the results and make a judgment call.

-If tax rates go up, conversions now will look good.
-If gifting to charity becomes a priority, conversions will not look so good.
-If the heirs tick you off to where you don't care to optimize what they get, conversions are less attractive.
-If funds are needed for Long Term Care sometime in the future, conversions now are less likely to look good as that would have been tax deductible anyway.
-If markets go to the moon, conversions now will look good in hindsight.
-If a spouse dies early, conversions now will look good to the survivor in hindsight.

Others have mentioned, but OP should consider using taxable instead of tax deferred to pay the taxes for the conversion.

Especially in this case where the time for Roth conversions is kind of in the past, modeling will mostly confirm your assumptions, but I would still do a year by year model so you can avoid big mistakes and see what matters and what doesn't. My personal choice for modeling software is Pralana Gold as it can handle so many different circumstances and its tax package is very complete. The Roth Conversion module is being greatly improved for 2022, so each year can be tested with a different strategy (IRMAA tier, tax bracket, FPL limit for those on ACA). The newsletter said mid January release.