Strategic Capital Gains vs. Roth Conversions

[DawgMan]

I don't know the answer to this, but it's something I continue to wrestle with as i get ready to start taking withdrawals. There always seems to be allot of Roth conversion discussion here to help minimize lifetime taxes, especially when the consensus is we are most likely in the lowest tax climate we will be in... at least for some time. But can't the same be said for capital gains taxes?

In my case, 50%+ of my holdings are in after tax accounts. I am projecting a WR of 1.5% - 3%, depending upon which accounts I withdrawal from. As an example, I could withdrawal only from my after tax accounts initially and minimize my taxes (combination of return of capital, fund produced capital gains/dividends, plus any strategic capital gains sales) and be at the low WR range or draw 100% from tax deferred accounts + Roth conversions and be at the upper end. I have run the numbers and at 56, DW and I can fund our spend until RMDs hit with after tax accounts only, which paints a very desirable minimal tax picture. Of course, RMDs then hit me in the a$$!

So here's the big BUT... but, if I (we) believe capital gains taxes will rise in tow with income taxes, should we be considering cherry picking our lots of highest unrealized gains in our after tax accounts and selling (and say replacing) them to pay the lower capital gains tax now (using similar argument to a Roth conversion)? Basically, trying to reset our basis in our after tax accounts to minimize future tax hits?

Last time I ran i-orp (basic level inputs), it had me taking after tax until 591/2 and then a combo of after tax and tax deferred until RMDs, at which point, I still get slammed with taxes.

Based on the current tax code, if I take my desired spend from tax deferred accounts (which I can technically do before 59 1/2), I will be in the 24% tax bracket. How would you be tax smart with your withdrawals if you were in my situation?

 

[RunningBum]

This nags at me a bit too. My thought has been that I might not need much of my taxable, so I should leave it along and let my heirs get stepped up basis. But I'm not so sure that benefit will be there when I go. I haven't cranked the numbers to see if I should be taking 0% LTCGs instead.

One remark while I mull this over. I wouldn't pick the highest gainers. I'd be leaving them perhaps to donate to charity (before or after death) and leaving them in case step up inheritance is still around.

 

[pb4uski]

Same here. My first year retired I did capital gains trading... paid no tax and increased my basis. Then 7 years of Roth conversions.

For a while I was intentionally leaving taxable equities alone because eventually they would get a stepped up basis so it seemed a waste to voluntarily pay tax AND gains in sales for living expenses were reducing my headroom for Roth conversions.

Then this spring when I went into capital preservation mode I sold my taxable equities and filled up my 0% LTCG bracket for this year... so no Roth conversions this year but will resume them in 2021.

I guess my view is that it is more likely that ordinary rates will rise since they are scheduled to if Congress does nothing and they are expert at that so I would favor Roth conversions at this point in time to take advantage of those lower tax rates.

 

[audreyh1]

With our taxable accounts I have focused on reducing cap gains distributions by taking the opportunities to exchange to more tax efficient mutual funds as market conditions permit - tax loss harvesting due to a market drop and/or unrealized gains in a fund getting low enough to cause little tax hit.

I’m not concerned about unrealized gains in the more tax efficient funds. Since I rebalance annually in general, there are usually more recent shares with higher cost basis that can be used when a position needs to be trimmed.

 

[DawgMan]

This nags at me a bit too. My thought has been that I might not need much of my taxable, so I should leave it along and let my heirs get stepped up basis. But I'm not so sure that benefit will be there when I go. I haven't cranked the numbers to see if I should be taking 0% LTCGs instead.

One remark while I mull this over. I wouldn't pick the highest gainers. I'd be leaving them perhaps to donate to charity (before or after death) and leaving them in case step up inheritance is still around.

Good point regarding stepped up basis. Perhaps I’m a little different when in comes to legacy goals, and for that matter, concerns about surviving spouses tax burdens. If all the calculators say all our needs are met as a couple/single, with or without Roth conversions, and despite higher taxes with RMDs, how much effort should be put into over analyzing life time tax efficiency? I expect my gets will get a nice bucket of dough 1 day and if it is all inherited ira $$ they have to pay taxes on.... well, I hope they look at it as found $$!

All this said, within reason, I do want to be prudent and a good steward with what I have been fortunate to accumulate over the years and expect some significant gifting (kids/charities) while on this side of the dirt.

Oh what to do, what to do...,?

 

[DawgMan]

Agreed. The problem is this market has created nothing but gains! Hard to find losers to offset with!

Dang 1st world problems!

 

[VanWinkle]

Same here. My first year retired I did capital gains trading... paid no tax and increased my basis. Then 7 years of Roth conversions.

For a while I was intentionally leaving taxable equities alone because eventually they would get a stepped up basis so it seemed a waste to voluntarily pay tax AND gains in sales for living expenses were reducing my headroom for Roth conversions.

Then this spring when I went into capital preservation mode I sold my taxable equities and filled up my 0% LTCG bracket for this year... so no Roth conversions this year but will resume them in 2021.

I guess my view is that it is more likely that ordinary rates will rise since they are scheduled to if Congress does nothing and they are expert at that so I would favor Roth conversions at this point in time to take advantage of those lower tax rates.

This makes perfect sense to me, and I agree the likely hood of ordinary rates increasing is the highest percentage of chance. LTCG rates increasing will hurt the power brokers of each party and I doubt they allow that to happen.

 

[audreyh1]

Agreed. The problem is this market has created nothing but gains! Hard to find losers to offset with!

Dang 1st world problems!

Yes - that has been our challenge since 2013. Up until 2013 our investment income from our taxable accounts hadn't been so high, and I felt secure about staying below certain thresholds. But then a strong bull market grew our portfolio so much and the taxable investment income grew very quickly. I've been firefighting the last few years. I managed to jettison several tax inefficient mutual funds, but there are still some doozies and they are paying out big this year.

 

[Midpack]

Yes I think about it, and it’s a good question - another like many with no universal right answer. I’m doing large Roth conversions for the next 4-7 years so I’m not taking any capital gains for now, though I can always alter that for a given year. And I agree cap gains rates will increase with income. However, Roth conversions reduce my (otherwise too large) RMD’s when they start - a tax hit I can’t change from age 72 to 90+. I can delay capital gains as much as I’d like, RMD and the added taxes are “for life.” Right or wrong.

 

[MichaelB]

The only sure thing is if we realize the gain and sell today, tax will be paid on the gain and the total value of the portfolio declines by that amount.

No one knows the future of tax rates, how they apply to income and capital, or how they will impact retirement savings. As long as one has unrealized capital gains, part of the investment risk is shared by the US Treasury, which loses future tax revenue if the asset value declines. For that reason, I think it makes sense to sell investments to rebalance or reduce risk, but not to speculate on future tax rates.

 

[Chuckanut]

I guess my view is that it is more likely that ordinary rates will rise since they are scheduled to if Congress does nothing and they are expert at that so I would favor Roth conversions at this point in time to take advantage of those lower tax rates.

+1

Since the RMD age was raised to 72, I have been thinking I can make a few more Roth conversions. The idea of 10-20 more years of tax-free growth is appealing on many levels such as; my personal life span, as an alternative to LTC insurance, and the general quality of life as I spend the money on me, mine and others who have less.

I have a feeling this Congress will simply allow the tax rates on individuals to go up by 'doing nothing'.

 

[Midpack]

Since the RMD age was raised to 72, I have been thinking I can make a few more Roth conversions.

I have a feeling this Congress will simply allow the tax rates on individuals to go up by 'doing nothing'.

I was thinking about stretching out Roth conversions a little due to the SECURE act RMD age increase. Is there a published term/expiration like some laws have (e.g. TCJA) or is SECURE ongoing until Congress decides to change again?

 

[audreyh1]

I’m pretty sure the 72 age is permanent until they change it again. There is a whisper of 75.

 

[Animorph]

I just ran my preliminary simulation run for my retirement planning for 2021 and after. We're currently retired with no taxable income other than than our taxable investments. We're living off our taxable accounts, trying to minimize taxes on the tIRA and taxable accounts by using Roth conversions, and delaying Roth withdrawals until the taxable accounts are empty.

I have been Roth converting up to $250k AGI, so avoiding the healthcare tax above that. That's been normal for several years now.

For 2021 my calculations have been saying to Roth convert up to the top of the 10% tax bracket (until my SS hits in four years) and take 0% capital gains and a little bit into the 15% LTCG tax range as well.

The taxable account lasts until about 2033. Roth withdrawals start in 2033. RMD's start in 2032. At this point the RMD's are withdrawn at a 22% tax rate, the same as Roth conversions would see now. Assuming no tax changes.

So I have about 12 years from now until our first Roth withdrawals. I'm pretty sure taking 0% capital gains instead of making large Roth conversions is being driven by my time until Roth withdrawals, in addition to assumed equal tax rates for conversions or RMD's. The benefit of stuffing some of the taxable investments into the Roth for 12 years or less at this point is not as high as taking 0% capital gains, at least for me and my assumptions.

I have run scenarios of one of us dying early (and paying taxes at the single rate) and with an inherited IRA and the results have been the same, large Roth conversion last year and and now 0% capital gains. So it seems like a pretty robust plan.

I'm pretty sure if I assumed tax rates increased significantly in the future that might push me into an additional year of large Roth conversions. Certainly plenty to think about, but everyone's tax situation is different. In general I think Roth conversions should likely be preferred 10-12 years before Roth withdrawals (given RMD's will be withdrawn at an equal tax rate) and 0% LTCG's if possible after that.

 

[RunningBum]

I took a look at my situation. In the 3 years where I've taken an ACA subsidy, my tax has been $0 twice and $34 once, with room for only small Roth conversions. $10K was the highest, and last year I was so close to the cliff I did none. I have a lot of qualified dividends and those have all been at the 0% rate like LTCGs would be.

So with the room left under the subsidy limit, I'm better off taking regular income rather than LTCGs if both are taxed at $0. The one year I was a little bit into the 10% bracket.

In years where I went over the subsidy limit, I've opted to go way over so I wasn't getting 0% LTCGs anyway. I took a lot of cap gains to better position my holdings to get a subsidy in other years, and also did a large conversion, up to the healthcare tax at $200K (single).

Perhaps the OP has more room for 0% LTCGs than I have. But remember that you get 0% regular income on your standard or itemized deduction + HSA contribution + up to $3000 capital loss if you have one. For me that's a little over $20K. I think you are better served by using any room still there after other regular income such as pension, interest income and NQ dividend for Roth conversions before taking LTCGs.

 

[DawgMan]

I just ran my preliminary simulation run for my retirement planning for 2021 and after. We're currently retired with no taxable income other than than our taxable investments. We're living off our taxable accounts, trying to minimize taxes on the tIRA and taxable accounts by using Roth conversions, and delaying Roth withdrawals until the taxable accounts are empty.

I have been Roth converting up to $250k AGI, so avoiding the healthcare tax above that. That's been normal for several years now.

For 2021 my calculations have been saying to Roth convert up to the top of the 10% tax bracket (until my SS hits in four years) and take 0% capital gains and a little bit into the 15% LTCG tax range as well.

The taxable account lasts until about 2033. Roth withdrawals start in 2033. RMD's start in 2032. At this point the RMD's are withdrawn at a 22% tax rate, the same as Roth conversions would see now. Assuming no tax changes.

So I have about 12 years from now until our first Roth withdrawals. I'm pretty sure taking 0% capital gains instead of making large Roth conversions is being driven by my time until Roth withdrawals, in addition to assumed equal tax rates for conversions or RMD's. The benefit of stuffing some of the taxable investments into the Roth for 12 years or less at this point is not as high as taking 0% capital gains, at least for me and my assumptions.

I have run scenarios of one of us dying early (and paying taxes at the single rate) and with an inherited IRA and the results have been the same, large Roth conversion last year and and now 0% capital gains. So it seems like a pretty robust plan.

I'm pretty sure if I assumed tax rates increased significantly in the future that might push me into an additional year of large Roth conversions. Certainly plenty to think about, but everyone's tax situation is different. In general I think Roth conversions should likely be preferred 10-12 years before Roth withdrawals (given RMD's will be withdrawn at an equal tax rate) and 0% LTCG's if possible after that.

What are you using to do your "preliminary simulation run"?

 

[Animorph]

What are you using to do your "preliminary simulation run"?

Software I wrote myself. Not really applicable to anyone else. Detailed tax calculations and it optimizes tIRA withdrawals to maximize yearly spending.

 

[Dash man]

We’re doing both capital gains and Roth conversions this year. We will have significant RMDs in 8 years if we don’t do anything. We also believe there is a risk of changing the capital gains rates in some way, so we took some at the 15% rate. We have to pay the additional healthcare tax, but the Roth conversions will prevent the AMT, so it’s a wash. We’re well into the 32% bracket this year and we’ll owe a big tax bill. We’ll be using our most highly appreciated stocks for our donor advised fund in the years to come. Next year we’ll do Roth conversions, but capital gains we’re unsure of.

 

[ncbill]

I don't know the answer to this, but it's something I continue to wrestle with as i get ready to start taking withdrawals. There always seems to be allot of Roth conversion discussion here to help minimize lifetime taxes, especially when the consensus is we are most likely in the lowest tax climate we will be in... at least for some time. But can't the same be said for capital gains taxes?

In my case, 50%+ of my holdings are in after tax accounts. I am projecting a WR of 1.5% - 3%, depending upon which accounts I withdrawal from. As an example, I could withdrawal only from my after tax accounts initially and minimize my taxes (combination of return of capital, fund produced capital gains/dividends, plus any strategic capital gains sales) and be at the low WR range or draw 100% from tax deferred accounts + Roth conversions and be at the upper end. I have run the numbers and at 56, DW and I can fund our spend until RMDs hit with after tax accounts only, which paints a very desirable minimal tax picture. Of course, RMDs then hit me in the a$$!

So here's the big BUT... but, if I (we) believe capital gains taxes will rise in tow with income taxes, should we be considering cherry picking our lots of highest unrealized gains in our after tax accounts and selling (and say replacing) them to pay the lower capital gains tax now (using similar argument to a Roth conversion)? Basically, trying to reset our basis in our after tax accounts to minimize future tax hits?

Last time I ran i-orp (basic level inputs), it had me taking after tax until 591/2 and then a combo of after tax and tax deferred until RMDs, at which point, I still get slammed with taxes.

Based on the current tax code, if I take my desired spend from tax deferred accounts (which I can technically do before 59 1/2), I will be in the 24% tax bracket. How would you be tax smart with your withdrawals if you were in my situation?

Federal capital gains tax (long term) rates have varied between 15% and 25% since WWII...with the 3.8% add-on for high incomes we're currently towards the higher end historically...I doubt they'll go much higher.

 

[oldphd]

As others have said, no right answer, but it is a first world problem.

One question, do you have any reason to want to access the money tied up with the capital gains investment?

We did. So I sold off for a few years to fill the 0% bracket, then had cash to put towards a new house. Now concentrating on Roth conversions. Too much money to fill up 12% bracket from now to RMD, but not enough to warrant 22%.

Plan is to start SS at 70. When combined with pensions, 12% is full. So all RMDs will be taxed at 22%, based on today's rates anyway.

So I will go part way into the 22% for at least a few years, subject to evaluation each year. Avoid IRMAA for sure. This year I arbitrarily picked $150K to allow me to get any future stimulus payments based on the rules of the first payment.

In some ways, I find that the make up of our numbers makes it relatively easy to decide. Ideally, I'll get to where all stocks are in Roth, future taxable is all bonds, and the amount in future taxable is targeted to be empty by RMD time. Any money I want to spend will come out of Roth.

Good problem to have!

 

[SecondCor521]

I came across a Kitces article where he shares his thoughts.

https://www.kitces.com/blog/long-te...one-higher-marginal-tax-rate-phase-in-0-rate/

Search for "Coordinating Capital Gains Harvesting And (Partial) Roth Conversions"

 

[pb4uski]

Yes, we've covered what he calls the "bump zone" quite frequently on this forum.

I had never heard the term "bump zone" for this before, but I think it fits well. Let's hope that bobandsherry doesn't see that post cuz it'll give him another pony to ride.

 

[karen1972]

I ran the calculators like I-ORP to get to an expected tax projection. I then set myself a personal "effective" tax rate I'm comfortable paying. Then I adjust accordingly as a combo to get to that.

My goal is really to try to not let my IRA snowball get any bigger so I always try to trim off the profits first and do my IRA conversion. Then the rest gets filled up with more conversion or more cap gains usually depending on how my cash reserve is and if I expect a large expense such as replacing the car.

As for my crystal ball, who knows, there was talk at one point about inflation adjusting cap gains too in which having long term cap gains would be even a better deal.

Right now I'm favoring Roth conversions with my short term goal of just getting to less than 50% of it still to be taxed so the snowball will start working in my favor.

 

[rkser]

I am following this informative thread

 

[Exchme]

Because of the non-linear "progressive" tax code, you will get the lowest lifetime tax if you can make your marginal tax rates equal in all years. So if you will have to take large RMDs in the future, it makes sense to do some Roth conversions now. However, the effective tax rate on those can be high due to things like ACA subsidies or IRMAA and knowing your future tax situation would be akin to knowing the future market situation.

Also, as mentioned above, if the markets decline after you do Roth conversions, then you have paid actual taxes on phantom gains. Personally, I plan to do some Roth conversions, probably up through the 22% bracket, but I doubt the impacts above that would be worth taking the risk.