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Roth Conversion in Fat Fire - Does it make sense?
Old 05-29-2020, 05:45 PM   #1
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Roth Conversion in Fat Fire - Does it make sense?

So I realize I may not be the norm here, but I suspect some of you are in a similar situation. Yes, this is a first world problem, but if I/you are looking to maximize our potential after tax cash flow long term what is the right/best strategy?? Here's the pickle...

- I'm 56 with a DW, 4 grown/self sufficient kids (for the most part), 1 granddaughter, struggling with OMY syndrome, but thinking I may launch at the end or 2020 if someone just pushes me in the pool!
- Current income tax rates are arguably at their lowest level they will be at so odds are they will only be higher in the future.
- I am planning on a $300K + annual withdrawal (before you judge me, this is very discretionary spending as I have no debt) at a 3%-ish SWR, holding +/- 60/40 AA, maybe slide to 55/45.
- Half of my RE assets are in taxable accounts so the initial plan was to deplete those funds first and then deal with the tax devil when I have to, whatever the tax rates are.

So here is the pickle, do I enjoy the lower effective tax rate by depleting my taxable account first, which keeps my taxes much lower than drawing from my tax deferred accounts, or, do I do I do Roth conversions knowing I will probably be in 32% (maybe 24% if I'm lucky) tax bracket? My gut says roll the dice and DO NOT do Roth conversions? Any help?
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Old 05-29-2020, 06:29 PM   #2
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Due to the relatively high tax drag on your taxable holdings, it may be beneficial for you to start converting traditional to Roth - and pay the tax from your taxable funds - sooner rather than later.

You might also be stuck with the highest IRMAA tier whatever you do, but converting prior to the year(s) in which you and your spouse turn 63 might cost less than after that.

See the discussion about the breakeven tax rate for Very high earners and consider how that might apply to you.
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Old 05-29-2020, 06:38 PM   #3
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Originally Posted by DawgMan View Post
My gut says roll the dice and DO NOT do Roth conversions? Any help?
What is your gut expecting to happen in the future?

There are several rational reasons not to do Roth conversions:

1. You expect Congress to lower tax rates in the future. It sounds like you don't believe this.
2. You expect Congress to start taxing Roths somehow.
3. You expect to spend much less at some point before those 24%/32% taxes kick in (either by dying early or reducing spending).
4. You expect your stash to be reduced in size drastically.

In any of these cases, the dreaded tax torpedo won't happen to you.

However, if you don't believe in any of the above, delaying the start of Roth conversions (or other strategies in the same vein) could make the problem worse when you do face it.

Although I'm not taking as large of a withdrawal as you are mentioning, since I don't really think any of the above things are going to happen, I'm doing Roth conversions to the top of my particular limit (which in my case has to do with a FAFSA limit since I have three kids in college, but there are also ACA limits somewhat above that).

P.S. - No judgment here.
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Old 05-29-2020, 07:01 PM   #4
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An additional consideration - whomever survives between you or your spouse will have a much higher tax rate as a single person on 401K/tIRA withdrawals, so that may add to the case for doing some Roth conversions now.
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Old 05-29-2020, 07:19 PM   #5
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I suppose your income is already much higher while working than $300K and you are already paying the Net Investment Income Tax on some of your income.

In retirement, I would expect a big portion of your $300K to be return-of-capital which does not appear on your tax return. But it is hard for me to know on this side of the internet. If you want to do conversions, then why not?
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Old 05-29-2020, 07:21 PM   #6
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Just for ease of visualizing the situation, suppose that you are currently in the 24% bracket, $25k under the 32% bracket. Suppose that in 4 years, RMD's would force you to draw $100k from your IRAs. At that point, you'll pay 24% of the first $25k and 32% of the next $75k in taxes. Total = $30k in federal income tax. Alternatively, you could draw $25k each year between now and then and pay 24% tax each time. Total tax over 4 years = $24k in federal income tax. You have saved $6k in taxes by doing the Roth conversions.

The situation is more complicated, of course. But that is the basic motivation for doing the Roth conversions.
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Old 05-30-2020, 04:07 AM   #7
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I would suggest looking at how much you can convert in your current tax bracket and convert what you can each year within that bracket. Then once you RE look at taking a mix of taxable and IRA to stay in target bracket.

For example, you say income of $300K. If you take all $300K from taxable, you will not have any taxes due except for earnings on the taxable account (cap gains and dividends). Then one day you will have to switch to IRA and have a tax due of $72K.
If you were to take say $150K from IRA and $150K from taxable, then your taxable income ($150K-$24K std deduction) of $126 would have tax due of $27,720.

If you were to do this for 30 years, total tax (assuming no changes in tax rates which will never happen) of $831K. First option of taxable first then IRA would cost total tax of $1,080. Savings of $250K or so.

Just one way to consider.
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Old 05-30-2020, 04:49 AM   #8
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Appreciate the feedback. I suppose I am accustomed to hearing how people do the Roth conversions typically up to the 12% bracket. I guess its all relative... 24% is better than 32%. As suggested, taking a combination of taxable and tax deferred withdrawals up to a certain tax rate may also do the trick provided I can forecast the potential impact of RMDs at some point. I had not thought of the effect of one spouse kicking the bucket early which is perhaps another argument for doing the conversions. Is iorp still the best tool for analyzing potential mix of withdrawal strategies or are there some other good tools out there?
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Old 05-30-2020, 04:57 AM   #9
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Appreciate the feedback. I suppose I am accustomed to hearing how people do the Roth conversions typically up to the 12% bracket. I guess its all relative... 24% is better than 32%. As suggested, taking a combination of taxable and tax deferred withdrawals up to a certain tax rate may also do the trick provided I can forecast the potential impact of RMDs at some point. I had not thought of the effect of one spouse kicking the bucket early which is perhaps another argument for doing the conversions. Is iorp still the best tool for analyzing potential mix of withdrawal strategies or are there some other good tools out there?
I found this thread to be very helpful.
https://www.early-retirement.org/for...ion-99854.html
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Old 05-30-2020, 05:05 AM   #10
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I suppose your income is already much higher while working than $300K and you are already paying the Net Investment Income Tax on some of your income.

In retirement, I would expect a big portion of your $300K to be return-of-capital which does not appear on your tax return. But it is hard for me to know on this side of the internet. If you want to do conversions, then why not?
Correct, my current working income is too high to make sense in doing conversions today. Any conversions would start when I stop my earned income (say 2021). My initial thought was to turn off the reinvesting of my dividends in my taxable account which would partially fill my cash bucket along with uncontrolled capital gains from funds/ETFs, then look at filling the rest with strategic sales (long term capital gains) and/or I suppose some withdrawal from tax deferred accounts, all with an eye on where my preferred top tax bracket might be (say 24%). I have the flexibility of the 55 rule for early 401K withdrawals if needed.

All this said, I think I can see how once I fill my cash bucket up for the year, there still could be room for me to convert up the 24% marker... 24% feels better than 32%!
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Old 05-30-2020, 05:16 AM   #11
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I found this thread to be very helpful.
https://www.early-retirement.org/for...ion-99854.html
Thanks. I just glanced over at the thread and will dive into the 20 pages!
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Old 05-30-2020, 08:22 AM   #12
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Appreciate the feedback. I suppose I am accustomed to hearing how people do the Roth conversions typically up to the 12% bracket. I guess its all relative... 24% is better than 32%.
For what it is worth, I’m converting into 24% bracket for couple more years, as are others. Many have reported converting to top of 22% bracket and my thinking is 24% is just 2% more. If taxes go up that 2% won’t seem like anything. I can think of many reasons my tax bill will go up along with other less direct snatching of my $$, like Medicare IRMAA and others. With a Roth it shouldn’t impact these rates. My plan is to convert through 2025 and then any RMD mostly covered with Qualified Charity Distro so no additional tax hit from the RMD. At least that is the plan.
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Old 05-30-2020, 08:35 AM   #13
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We’re planning on a similar withdrawal for the first 15 yrs and then expect to see a decrease as kids are gone, mortgage is paid off, etc... FWIW, I found iorp significantly overestimated our tax burden, but the ‘single’ person tax effect was significant. I basically went through and estimated income, spend and taxes for multiple scenarios (death of either of us, etc)NFPs each year of retirement. It was very helpful for planning purposes.
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Old 05-30-2020, 09:00 AM   #14
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- I am planning on a $300K + annual withdrawal (before you judge me, this is very discretionary spending as I have no debt) at a 3%-ish SWR, holding +/- 60/40 AA, maybe slide to 55/45.
Not meaning to be rude. This is off the subject and your question...what can you possibly spend this amount of money on in this day and age and possibly pretty far into the future? Our total spending is cut in half.
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Old 05-30-2020, 09:57 AM   #15
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My plan on this subject is to plan on my spending being relatively constant throughout retirement. With this in mind try to structure our income so the taxable portion is also about the same each year. Whatever method is fine (like Roth conversions, using deferred, or taxable funds) as long as the end goal of stable taxable is met.
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Old 05-30-2020, 10:16 AM   #16
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Interesting situation and different from the norm. While I'm an advocate of Roth conversions in your case it requires additional thinking.

One could make the argument that it is better to leave your taxable equities alone for a potential step-up in basis later on and do tIRA withdrawals for living expenses and/or Roth conversions to the top of the 24% tax bracket and pay the taxes from taxable.

What is the marginal tax rate of your non-spousal heirs likely to be? If less than the 24% that you'll pay if you convert now then it might be better to wait and let them pay it.... but that means that you'll be paying taxes on taxable account realized gains that would never have to be paid otherwise.

Have you sought any advice from a CPA specializing in personal financial planning? (aka CPA with a PFS designation).

https://account.aicpa.org/eWeb/dynam...erralwebsearch
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Old 05-30-2020, 10:23 AM   #17
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Is iorp still the best tool for analyzing potential mix of withdrawal strategies or are there some other good tools out there?
Careful of I-ORP results with that income level. E.g., it ignores the NIIT.

If its tax calculation matches a more rigorous one, the answers are probably good. Because a linear program may make large changes for small effects, it may suggest inappropriate changes if it misunderstands some of the effects.
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Old 05-30-2020, 03:12 PM   #18
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Not meaning to be rude. This is off the subject and your question...what can you possibly spend this amount of money on in this day and age and possibly pretty far into the future? Our total spending is cut in half.
Have you met my wife??

As mentioned, there is significant discretionary in our budget which includes a fair amount of travel, entertaining, gifting, and some goodies we like to enjoy. Tell me, what should I spend??
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Old 05-30-2020, 03:26 PM   #19
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I say go for it DawgMan. I struggle with spending what we spent 40 years saving. We are drawing about 1.5% each year, and when I start SS will have no need to take from retirement accounts. I can get a new truck, but we spent a lifetime LBYM and I don’t really have much I would buy. Perhaps a condo on coast but that would add to the estate. We do travel just not right now. We will pass along a bunch when we leave, But not deprive any needs or many wants.
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Old 05-30-2020, 05:14 PM   #20
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Have you met my wife??

As mentioned, there is significant discretionary in our budget which includes a fair amount of travel, entertaining, gifting, and some goodies we like to enjoy. Tell me, what should I spend??
Not suggesting what you should spend, just that we’re not traveling or entertaining for quite sometime. I get gifts and goodies. If we bought a new car, remodeled our house again, re landscaped our property and ate take out every day, would not come close to your discretionary spending. Just saying.
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