Your input on options for 2021 income

[Scuba]

Not sure yet. We’re still trying to figure out the best option. If we have to take the money out and pay taxes on it, I’m not sure why we wouldn’t just use it for living expenses. I think I’m missing the magic of the Roth conversions…

Yes, I understand your dilemma. In our case, we need to convert a meaningful amount or it won’t make any real difference down the road. But converting a sizable chunk requires paying lots of taxes now. The tax-free growth of the money over time will eventually make up for today’s tax bite, but in our case, the projection is that we don’t break even until we’re almost 80.

 

[tb001]

That’s a long time for a break even... Are you using a cfp to help model or diy?

My current plan has us drawing down our tIRAs for living expenses in large chunks up front, until a smaller drawdown rate outpaces growth. But I think we really need to have someone get our plan.

 

[Montecfo]

We are so heavily tax deferred (60 pct) that Roth conversions will make little difference in our lifetimes. We have still done some and will continue to but likely only in the low brackets.

 

[pb4uski]

Not sure yet. We’re still trying to figure out the best option. If we have to take the money out and pay taxes on it, I’m not sure why we wouldn’t just use it for living expenses. I think I’m missing the magic of the Roth conversions…

Part of the magic is that if you do a Roth conversion and pay for the taxes with taxable funds, you end up effectively being able to end up with the taxable account money in the Roth, where it is tax-free for life.

So for example, let's say I have $10k in a tIRA and $2k in taxable.... if I convert at the end of the day I end up with $10k in a Roth where it is tax-free for life... and $2k of that $10k in the Roth is money that would have otherwise been subject to tax.

For our situation, out tax is $0 with no Roth conversions, my pension, DW SS and taxable account income is about equal to the standard deduction. OTOH, once my SS starts and DWs SS is increased for spousal benefits we'll be deep into the 12% tax bracket.... add RMDs to that and we'll be in the 22% tax bracket. So for us, it is paying a combination of 10%/12% now (11.5% weighted average for 2021) vs paying 12%/22% in 6 years when I am 72.

I'm willing to take a risk on paying 11.5% now as I'm pretty sure that either me, DW or our kids will pay more than 11.5% later and the real benefit of Roth conversions is tax rate arbitrage.

 

[Montecfo]

Part of the magic is that if you do a Roth conversion and pay for the taxes with taxable funds, you end up effectively being able to end up with the taxable account money in the Roth, where it is tax-free for life.

So for example, let's say I have $10k in a tIRA and $2k in taxable.... if I convert at the end of the day I end up with $10k in a Roth where it is tax-free for life... and $2k of that $10k in the Roth is money that would have otherwise been subject to tax.

For our situation, out tax is $0 with no Roth conversions, my pension, DW SS and taxable account income is about equal to the standard deduction. OTOH, once my SS starts and DWs SS is increased for spousal benefits we'll be deep into the 12% tax bracket.... add RMDs to that and we'll be in the 22% tax bracket. So for us, it is paying a combination of 10%/12% now (11.5% weighted average for 2021) vs paying 12%/22% in 6 years when I am 72.

I'm willing to take a risk on paying 11.5% now as I'm pretty sure that either me, DW or our kids will pay more than 11.5% later and the real benefit of Roth conversions is tax rate arbitrage.

But of course it is unlikely to make much difference in your lifetimes.

Paying tax on 100 percent of the Roth conversion now versus tax on 3-4 percent of that same number when you are 72...

Not saying it doesn't make sense. Just that you won't see a cash flow benefit for a very long time.

 

[RunningBum]

Not saying it doesn't make sense. Just that you won't see a cash flow benefit for a very long time.

But you can spend more now, knowing that you'd have that benefit now.

And really, your current cash flow is greatly improved doing a Roth conversion. You've moved money from an account you can't spend from to an account you can. Maybe that's a reach, but so is the implication that you can't benefit from a conversion until your 90s, or whenever this so-called break even is.

 

[pb4uski]

But of course it is unlikely to make much difference in your lifetimes.

Paying tax on 100 percent of the Roth conversion now versus tax on 3-4 percent of that same number when you are 72...

Not saying it doesn't make sense. Just that you won't see a cash flow benefit for a very long time.

I guess it depends on how you look at it. The below assumes that you start with $10,000 in an IRA and $1,200 in a taxable account... your tax rate until RMDs is 12% and after RMDs is 22% and a 7% rate of return.

If you look at the after-tax values then assuming that your tax rate today is lower than your tax rate once RMDs begin then the Roth conversion is beneficial from day 1... the benefits are initially modest (basically avoiding taxes on taxable account earnings).

If you look at nominal values, then with the Roth conversion you are out for the $1,200 taxes paid and then start benefitting once RMDs begin and you avoid paying 22% taxes on RMDs and taxable account earnings.

Since our heirs are currently and will likely be at 12% or higher it is an easy decision for us.

	After-tax values				Nominal values
	No conv after-tax value	Roth conv value	Roth advantage		No conv	Roth conv value	Roth advantage
64	10,000	10,000	0		11,200	10,000	-1,200
65	10,690	10,700	10		11,974	10,700	-1,274
66	11,428	11,449	21		12,801	11,449	-1,352
67	12,216	12,250	34		13,686	12,250	-1,436
68	13,059	13,108	49		14,632	13,108	-1,524
69	13,960	14,026	65		15,644	14,026	-1,618
70	14,924	15,007	83		16,725	15,007	-1,718
71	15,954	16,058	103		17,881	16,058	-1,824
72	15,325	17,182	1,857		18,967	17,182	-1,785
73	16,361	18,385	2,024		20,110	18,385	-1,725
74	17,459	19,672	2,213		21,313	19,672	-1,641
75	18,622	21,049	2,426		22,578	21,049	-1,530
76	19,855	22,522	2,667		23,908	22,522	-1,386
77	21,160	24,098	2,938		25,306	24,098	-1,207
78	22,542	25,785	3,243		26,774	25,785	-988
79	24,004	27,590	3,586		28,315	27,590	-724
80	25,550	29,522	3,972		29,932	29,522	-410
81	27,184	31,588	4,404		31,628	31,588	-40
82	28,911	33,799	4,888		33,406	33,799	393
83	30,735	36,165	5,430		35,269	36,165	896
84	32,661	38,697	6,036		37,220	38,697	1,477
85	34,693	41,406	6,713		39,263	41,406	2,143
86	36,837	44,304	7,467		41,402	44,304	2,902
87	39,097	47,405	8,308		43,642	47,405	3,763
88	41,480	50,724	9,244		45,985	50,724	4,739
89	43,991	54,274	10,283		48,436	54,274	5,839
90	46,635	58,074	11,438		51,001	58,074	7,072
91	49,420	62,139	12,719		53,688	62,139	8,451
92	52,351	66,488	14,137		56,499	66,488	9,989
93	55,436	71,143	15,706		59,442	71,143	11,700
94	58,682	76,123	17,441		62,528	76,123	13,594
95	62,096	81,451	19,355		65,764	81,451	15,687
96	65,687	87,153	21,466		69,159	87,153	17,994
97	69,463	93,253	23,791		72,721	93,253	20,532
98	73,433	99,781	26,348		76,461	99,781	23,320
99	77,608	106,766	29,158		80,396	106,766	26,370
100	81,998	114,239	32,242		84,538	114,239	29,702
101	86,613	122,236	35,623		88,901	122,236	33,335
102	91,467	130,793	39,325		93,499	130,793	37,294
103	96,572	139,948	43,376		98,356	139,948	41,593
104	101,943	149,745	47,802		103,487	149,745	46,258
105	107,593	160,227	52,634		107,701	160,227	52,526

 

[Montecfo]

I guess it depends on how you look at it. The below assumes that you start with $10,000 in an IRA and $1,200 in a taxable account... your tax rate until RMDs is 12% and after RMDs is 22% and a 7% rate of return.

If you look at the after-tax values then assuming that your tax rate today is lower than your tax rate once RMDs begin then the Roth conversion is beneficial from day 1... the benefits are initially modest (basically avoiding taxes on taxable account earnings).

If you look at nominal values, then with the Roth conversion you are out for the $1,200 taxes paid and then start benefitting once RMDs begin and you avoid paying 22% taxes on RMDs and taxable account earnings.

Since our heirs are currently and will likely be at 12% or higher it is an easy decision for us.

	After-tax values				Nominal values
	No conv after-tax value	Roth conv value	Roth advantage		No conv	Roth conv value	Roth advantage
64	10,000	10,000	0		11,200	10,000	-1,200
65	10,690	10,700	10		11,974	10,700	-1,274
66	11,428	11,449	21		12,801	11,449	-1,352
67	12,216	12,250	34		13,686	12,250	-1,436
68	13,059	13,108	49		14,632	13,108	-1,524
69	13,960	14,026	65		15,644	14,026	-1,618
70	14,924	15,007	83		16,725	15,007	-1,718
71	15,954	16,058	103		17,881	16,058	-1,824
72	15,325	17,182	1,857		18,967	17,182	-1,785
73	16,361	18,385	2,024		20,110	18,385	-1,725
74	17,459	19,672	2,213		21,313	19,672	-1,641
75	18,622	21,049	2,426		22,578	21,049	-1,530
76	19,855	22,522	2,667		23,908	22,522	-1,386
77	21,160	24,098	2,938		25,306	24,098	-1,207
78	22,542	25,785	3,243		26,774	25,785	-988
79	24,004	27,590	3,586		28,315	27,590	-724
80	25,550	29,522	3,972		29,932	29,522	-410
81	27,184	31,588	4,404		31,628	31,588	-40
82	28,911	33,799	4,888		33,406	33,799	393
83	30,735	36,165	5,430		35,269	36,165	896
84	32,661	38,697	6,036		37,220	38,697	1,477
85	34,693	41,406	6,713		39,263	41,406	2,143
86	36,837	44,304	7,467		41,402	44,304	2,902
87	39,097	47,405	8,308		43,642	47,405	3,763
88	41,480	50,724	9,244		45,985	50,724	4,739
89	43,991	54,274	10,283		48,436	54,274	5,839
90	46,635	58,074	11,438		51,001	58,074	7,072
91	49,420	62,139	12,719		53,688	62,139	8,451
92	52,351	66,488	14,137		56,499	66,488	9,989
93	55,436	71,143	15,706		59,442	71,143	11,700
94	58,682	76,123	17,441		62,528	76,123	13,594
95	62,096	81,451	19,355		65,764	81,451	15,687
96	65,687	87,153	21,466		69,159	87,153	17,994
97	69,463	93,253	23,791		72,721	93,253	20,532
98	73,433	99,781	26,348		76,461	99,781	23,320
99	77,608	106,766	29,158		80,396	106,766	26,370
100	81,998	114,239	32,242		84,538	114,239	29,702
101	86,613	122,236	35,623		88,901	122,236	33,335
102	91,467	130,793	39,325		93,499	130,793	37,294
103	96,572	139,948	43,376		98,356	139,948	41,593
104	101,943	149,745	47,802		103,487	149,745	46,258
105	107,593	160,227	52,634		107,701	160,227	52,526

You don't benefit from day 1 in a cash flow sense.

You are making a balance sheet case. My question regards the lifetime cash flow view.

And yes, it does depend how you look at it and especially on what assumptions you make.

 

[Out-to-Lunch]

Our IRAs are all currently in bonds and are about 15% of our assets.

Without knowing the details of your situtation, I would hazard a guess that Roth conversions won't make much difference for you one way or the other. If your RMDs from 15% of your portfolio are large enough to be significant, than you have serious first-world problems!

EDIT: I did not originally see the next page of posts, where you explicitly state "The RMDs are deadly by the time we get to our 70s" Well, if ~30% of 15% of your portfolio going to taxes is "deadly" to you, well, I take my hat off to you.

 

[pb4uski]

You don't benefit from day 1 in a cash flow sense.



You are making a balance sheet case. My question regards the lifetime cash flow view.



And yes, it does depend how you look at it and especially on what assumptions you make.

It sort of hard to benefit from day 1 if one is paying something now to avoid paying more later... the benefit can't happen until later by definition. Like buying something on sale or deferring SS.

 

[Montecfo]

It sort of hard to benefit from day 1 if one is paying something now to avoid paying more later... the benefit can't happen until later by definition. Like buying something on sale or deferring SS.

Yes. And that is my point. It has a negative cash flow effect which will take time to overcome, decades in fact. It is like an investment.

 

[RunningBum]

Yes. And that is my point. It has a negative cash flow effect which will take time to overcome, decades in fact. It is like an investment.

Except you have zero cash flow on a tIRA until you pay the tax.

 

[Montecfo]

Except you have zero cash flow on a tIRA until you pay the tax.

This is true but it is not relevant to the point I was making.

But if it were relevant I would point out that zero cash flow bests negative cash flow, which is what you get when you prepay taxes by doing Roth conversions.

This does not mean Roth conversions are bad. It is just part of understanding their nature.

 

[RunningBum]

This is true but it is not relevant to the point I was making.

But if it were relevant I would point out that zero cash flow bests negative cash flow, which is what you get when you prepay taxes by doing Roth conversions.

No, you've taken money that couldn't be spent (in a tIRA) and moved it to a place where it could be spent (in a Roth, subject to age and 5-yr limitations). Seems like positive cash flow to me.

I don't see how anyone can think a Roth conversion has negative cash flow. No matter though. You view them as you see fit, I'll do the same.

 

[Montecfo]

No, you've taken money that couldn't be spent (in a tIRA) and moved it to a place where it could be spent (in a Roth, subject to age and 5-yr limitations). Seems like positive cash flow to me.

I don't see how anyone can think a Roth conversion has negative cash flow. No matter though. You view them as you see fit, I'll do the same.

Well, hmm, it is just a fact. You prepay taxes, it is negative cash flow. By definition.

Now it may be overcome over time. But it is what it is. And viewing it differently doesn't change that.

 

[Out-to-Lunch]

Well, hmm, it is just a fact. You prepay taxes, it is negative cash flow. By definition.

Now it may be overcome over time. But it is what it is. And viewing it differently doesn't change that.

Well, what if you spent the now-spendable Roth funds later that day. Would you view that as a negative cash flow for several hours, and zero cash flow after several hours?

 

[pb4uski]

Well, hmm, it is just a fact. You prepay taxes, it is negative cash flow. By definition.

Now it may be overcome over time. But it is what it is. And viewing it differently doesn't change that.

I concede that it is a negative cash flow. But... are you really prepaying taxes or simply paying off a liability in advance... like paying down your mortgage.

Both are negative cash flows... one reduces net worth and the other one doesn't ... in fact it might increase net worth if the liability is settled for less than book value (settled at 12% vs 22%).

 

[Montecfo]

I concede that it is a negative cash flow. But... are you really prepaying taxes or simply paying off a liability in advance... like paying down your mortgage.

Both are negative cash flows... one reduces net worth and the other one doesn't ... in fact it might increase net worth if the liability is settled for less than book value (settled at 12% vs 22%).

Thanks for that. If we can't simply acknowledge things that are factually true, it is hard for a discussion to go further.

Paying a bill before it is due is commonly called prepaying it. Paying off a liability in advance is also prepaying it. I do not see a difference there.

Paying a bill before it is due may have a future financial benefit, as you note, and as I have stated with Roth conversions.

I don't find it similar to prepaying a mortgage. If you want to know why, then send me a PM and I will respond. I appreciate the discussion but I think we get far afield from the OPs question.

Again, thanks.

 

[Scuba]

That’s a long time for a break even... Are you using a cfp to help model or diy?

My current plan has us drawing down our tIRAs for living expenses in large chunks up front, until a smaller drawdown rate outpaces growth. But I think we really need to have someone get our plan.

I had our CPA model it as well as Fidelity.

 

[Scuba]

No, you've taken money that couldn't be spent (in a tIRA) and moved it to a place where it could be spent (in a Roth, subject to age and 5-yr limitations). Seems like positive cash flow to me.

I don't see how anyone can think a Roth conversion has negative cash flow. No matter though. You view them as you see fit, I'll do the same.

Well, if you’re taking funds out of a taxable brokerage account to pay the tax on a Roth conversion, you’re definitely generating a negative cash flow vs just leaving the funds in a tIRA, allowing taxes to continue to be deferred, and allowing taxable brokerage funds to continue to grow. It’s hard for me to understand why you wouldn’t see this as a negative cash flow.

The only way it becomes a positive is that over time, the tax-free growth of a Roth eventually makes up for the hit of paying taxes when the conversion is made. In our case, it’s projected to take 16 years. If we were 40 or 50, that would seem to be more palatable than when we’re in our 60’s. But YMMV.

 

[RunningBum]

Well, if you’re taking funds out of a taxable brokerage account to pay the tax on a Roth conversion, you’re definitely generating a negative cash flow vs just leaving the funds in a tIRA, allowing taxes to continue to be deferred, and allowing taxable brokerage funds to continue to grow. It’s hard for me to understand why you wouldn’t see this as a negative cash flow.

Because the taxes are a fraction of the cash you've made available for spending. I pay a little out of my taxable account to get a lot in my Roth. One of the benefits of doing Roth conversions is that you make that money available for spending. If I have a major expense, over $100K say, I can take money out of the Roth tax-free. If I take it out of the tIRA I take a major tax hit because I pushed my taxable income up a couple of brackets. So I have better cash flow after conversions.

So far nobody else sees it my way, so I won't prolong the discussion. Probably I'm bending the definition of cash flow too much.

At the very least this should be seen as a neutral transaction in my net worth. I'm removing a liability by the amount of asset I reduced by paying the taxes.

 

[NgineER]

I just want to add a consideration for the Roth conversions in that a surviving spouse will be in a much higher tax bracket.

 

[pb4uski]

Well, if you’re taking funds out of a taxable brokerage account to pay the tax on a Roth conversion, you’re definitely generating a negative cash flow vs just leaving the funds in a tIRA, allowing taxes to continue to be deferred, and allowing taxable brokerage funds to continue to grow. It’s hard for me to understand why you wouldn’t see this as a negative cash flow.

The only way it becomes a positive is that over time, the tax-free growth of a Roth eventually makes up for the hit of paying taxes when the conversion is made. In our case, it’s projected to take 16 years. If we were 40 or 50, that would seem to be more palatable than when we’re in our 60’s. But YMMV.

That 16 years is consistent with the right column of the analysis that I provided at post #32, which was 17 years... the negative cash flow of paying the tax is offset each year by avoiding tax on what was effectively transferred from the taxable account to the Roth. The disadvantage grow a little each year until RMDs begin at which point it is recovered over about 10 years.

 

[Time2]

Not sure yet. We’re still trying to figure out the best option. If we have to take the money out and pay taxes on it, I’m not sure why we wouldn’t just use it for living expenses. I think I’m missing the magic of the Roth conversions…

I'm sure there is disagreement, but say MFJ and you are now living on $70k, you have $1.5M in IRAs and you have 8 years until RMDs start. It is very conceivable that when you start RMDs your IRAs will have grown to $3M. In that 8 years you also started SS, Say, that's $45k for the couple. Your RMDs will be $110k, SS, $45K, you probably have some dividends from a taxable account $20k, $110+$45k+$20k =$175k, That puts you in the 22% bracket, another $16k and you are in the 24% bracket. If one spouse dies and you are filing as a qualified widow(er) then you are still in the 22% bracket. (it's not as bad as I expected) These numbers are at today's rates, which are expected to go up in 2025.

I can only see pay if you can convert in the 12% bracket, and that limits you to say $10k of dividends and $90k of IRA withdrawals allowing $30K to go into your Roth conversion. That $90k withdrawal most likely does not even match the growth of your IRA. Your IRA still just keeps getting bigger along with the RMDs when they come due.
Did I mention it is complicated? Making it difficult to know what the right thing to do is.

 

[Montecfo]

As I mentioned earlier, given the long runway to get a return on your investment in prepaid taxes, assumptions made over the planning horizon affect the results in powerful ways.

I have noticed that folks doing that math fairly consistently seem to assume large market returns between the conversions and RMD time. It is human nature: assume current conditions will continue.

However, many analysts are projecting lower than typical market returns from here, given our current rising rate environment and reversion to the mean.

That should be a consideration when evaluating the many moving parts, in my view.