ROTH IRA Conversion Advice

[ProGolferWannabe]

In 2020, I can convert $16,500 from a traditional IRA to a Roth IRA and stay in the same tax bracket (22%). I have very little in the way of Roth assets---virtually all my retirement funds outside my pension are in traditional IRAs and 401K's. Figured this was a no brainer....just have to pay $3700 in additional federal taxes.

I noticed that my next tax bracket is 24% (not much higher) and would permit me to convert about $156,000 of traditional IRA assets to Roth---tax bite would be about $37,000. I have assets outside of the IRA to pay this amount. I was thinking that given (a) I have very little tax diversification in my retirement funds, (b) tax rates are pretty low right now, and (c) 24% is pretty close to 22%, that it might be sensible to do this larger conversion.

My reluctance is that I really am not anxious to part with that $37,000 now, and I think that I can avoid any distributions until they are required in my early 70's--about 14 years from now.

Any thoughts on helping me make an informed decision?

 

[gerntz]

My thought is convert as tax rates are likely to never be lower. Gains on the $156K will likely surpass the $37K taxes in 14 years.

 

[bada bing]

On thing that might influence your calculations is the possibility the RMD age gets pushed back to 75. It is under consideration as part of Securing a Strong Retirement Act of 2020, which has bipartisan support. Potentially more years to convert is less incentive to push the limits.

 

[2017ish]

First three years of retirement, we had choice of zero taxes, but chose to convert to full extent of 24% bracket. We will continue to do so to the extent possible now that we've exhausted taxable accounts. (We retired at 56 and 57)

Factors considered: 1. Almost all of fairly substantial assets were in deferred accounts; 2. spouses are unlikely to die in the same tax year, and DW is statistically likely to have quite a few single taxpayer years with high RMDs; 3. Our heirs are all part of highly compensated couples; and 4. Seeing parents in their 90s, we want to simplify financial matters as much as reasonably possible for our future selves.

 

[Animorph]

Roth conversions are more valuable, given a constant tax rate, the earlier you can do them. The reason is that the $37k you spend on taxes is $37k that moves from your taxable account into your Roth. $156k removed from tIRA, -$37k for taxes = $119k, then you add $37k from taxable to make up the difference = $156k into the Roth. Don't use those mechanics, but that shows the concept. So even if you get no benefit from changing tax rates, you will probably save on taxes that would have been incurred on the $37k in your taxable account for a period of at least 14 years. The longer you avoid Roth withdrawals, the longer this benefit accrues. In my case it was slightly beneficial to Roth convert into the higher tax brackets early on. I have about 10 years before Roth withdrawals now and 0% capital gains and that time limitation have me filling only the 10% tax bracket next year. Unless this year's tIRA gains have been excessive.

Don't worry too much about "pay now" versus "pay later". This is a different problem than paying capital gains taxes. If tax rates remain constant, you pay the Roth conversion taxes from the tIRA withdrawal, and only put the $119k net into the Roth it is mathematically equivalent to just leaving the money in the tIRA. The IRS owns 22% of your tIRA, or whatever that constant tax rate is. The other 78% is yours, as if it was in a Roth already. It doesn't matter if you pay 22% of the whole thing now or piecemeal over a number of years. That 78% and all of the growth is always yours. So don't let a simple "pay later" mindset sway your decision.

If tax rates change, via the tax laws or because of your income (including SS, pensions, RMD's and joint/single status changes) then it weights the Roth conversion benefits one way or the other. Commonly, the extra income when RMD's hit can bump up your tax bracket, or you my have no taxes due early in retirement. That makes Roth conversions useful to smooth out your income throughout retirement and avoid income peaks that increase your tax bracket. Who knows what tax laws will do?

My whole retirement spending optimization starts with how much to withdraw from our tIRA each year in the future. Everything else is pretty much determined by that one number. If I need the cash, the withdrawal can be spent. If I don't need the cash, the withdrawal is a Roth conversion. The goal is mostly just to be tax efficient.

So, look at your tax rate in 14 years (I assume). If your tIRA RMD/withdrawal will still be in the 22% tax bracket (and think tax rates will remain as they are now) then crossing into the 24% bracket is not as appealing. It's probably still worth it for the savings on your taxable dollars, but maybe not worth the trouble for you. If you see RMD's withdrawn at 32%, get moving with your Roth conversions.

 

[RunningBum]

My reluctance is that I really am not anxious to part with that $37,000 now,

Just like your paycheck wasn't yours to spend until they took taxes out, your tax deferred savings isn't yours to spend until you pay taxes on the conversion or withdrawal. Pay the tax now, or pay more tax later as it grows, or let your heirs pay taxes on it. Eventually you'll pay taxes, unless you give it away.

I really think people need to get over that mental block.

You don't give a full picture of what your taxes will look like when you have RMDs, but I'm guessing under the current tax structure it would be 22 or 24% if you don't do the extra conversion, and at least 25% if the lower tax rates expire. If it's only 25%, the 1% is not that big of a deal, but the math says conversion is in your favor to convert at a lower rate, and also to convert at the same rate if you pay the taxes out of your taxable account.

Forum member AtlasShrugged wrote an excellent paper on the conversions factors. You can find a link to it in post 2 of this FAQ: https://www.early-retirement.org/fo...ira-401-k-to-a-roth-updated-2020-a-30664.html

 

[davebarnes]

We (ages 72/63) are on track to convert $1.3M from tIRAs to Roths over the next 15 years.
Why?
Because we have a high-earning daughter, equivalent son-in-law, and 2 (currently low income—because their parents have not sent them to earn a decent wage at the face of a coal mine) grandsons.
We will pay the taxes so they don’t have to.

Economically smart or stupid? I have no clue.
But, one thing is for sure. Congress will mess with tax laws at least once a decade.

 

[pb4uski]

My thought is convert as tax rates are likely to never be lower. ...

+1.

If you convert, you'll pay $37,440 in tax at 24% and have $156,000 in the Roth, which at 7% would grow to $402,251 in 14 years at 7%.

If you don't convert, the $156,000 in the tIRA would grow to $402,251 and even at 22% you would owe $88,495 in tax. Meanwhile, the $37,440 will only grow to $78,807 because its 7% return is taxed at 22% each year. So if after 14 years you cash out and pay the tax you'll only have $392,563 to spend.

By converting now, you effectively avoid taxes on that taxable account money used to pay the tax.

 

[Midpack]

My thought is convert as tax rates are likely to never be lower. Gains on the $156K will likely surpass the $37K taxes in 14 years.

+2.

Lots of good threads already, e.g. https://www.early-retirement.org/forums/f28/retirement-tax-planning-income-optimization-99854.html

https://www.early-retirement.org/fo...income-optimization-99854-17.html#post2339855

https://www.early-retirement.org/fo...income-optimization-99854-13.html#post2327989

 

[38Chevy454]

X3, I concur that tax rates are not likely to stay at current levels and probably will increase. For sure they ain't going lower!


I also think it is wise to consider the larger Roth conversion as it will minimize potential RMDs; and it can be beneficial for surviving spouse since the personal deduction becomes half of what it was as joint.

 

[Happyras]

X3, I concur that tax rates are not likely to stay at current levels and probably will increase. For sure they ain't going lower!


I also think it is wise to consider the larger Roth conversion as it will minimize potential RMDs; and it can be beneficial for surviving spouse since the personal deduction becomes half of what it was as joint.

+1, but more so, the surviving spouse will have huge RMD's and be filing as a single tax payer with higher brackets!!!!!

 

[Montecfo]

+1, but more so, the surviving spouse will have huge RMD's and be filing as a single tax payer with higher brackets!!!!!

This in my view is the most powerful reason for opportunistic Roth conversions.

 

[AtlasShrugged]

Any thoughts on helping me make an informed decision?

I wrote a Roth Conversion Guide that I shared in the following post.
https://www.early-retirement.org/forums/f28/roth-conversion-guide-106285.html

You may find that helpful.

Rick

 

[gerntz]

+1, but more so, the surviving spouse will have huge RMD's and be filing as a single taxpayer with higher brackets!!!!!

Which is why we don't intend to leave close to all of our tIRA's to each other but instead to a number of likely lower tax rate individuals. I mean if the tax rate would be so high why would the spouse need it all?

 

[gauss]

In 2020, I can convert $16,500 from a traditional IRA to a Roth IRA and stay in the same tax bracket (22%). I have very little in the way of Roth assets---virtually all my retirement funds outside my pension are in traditional IRAs and 401K's. Figured this was a no brainer....just have to pay $3700 in additional federal taxes.

I noticed that my next tax bracket is 24% (not much higher) and would permit me to convert about $156,000 of traditional IRA assets to Roth---tax bite would be about $37,000. I have assets outside of the IRA to pay this amount. I was thinking that given (a) I have very little tax diversification in my retirement funds, (b) tax rates are pretty low right now, and (c) 24% is pretty close to 22%, that it might be sensible to do this larger conversion.

My reluctance is that I really am not anxious to part with that $37,000 now, and I think that I can avoid any distributions until they are required in my early 70's--about 14 years from now.

Any thoughts on helping me make an informed decision?

I like how you think! Just don't get caught up on the amount you need to pay in Federal taxes.

The way I avoid this is that I always calculate my net worth after all the IRA/401k taxes are paid. That way I don't lull myself into believing that the extra money is actually mine.

FWIW there is another thread I just saw about someone who is rapidly approaching age 70 and just realized that he has a problem due to the lack of conversions leading up to this point. You might want to follow that thread too.

-gauss