Roth Conversion thoughts - feedback?

[WestwardBound]

Hi all. I’m interested in feedback, thoughts, resource recommendations or advice on how to think about planning for roth conversions in my situation. I apologize upfront for the length of this post but I have a bit of a different cash flow situation than normal so added some explanation.

The bulk of my retirement savings are in tax-deferred 401k (43%) and a non-qualified thrift plan (32%). No current Roth money. Also have a taxable brokerage account (20%) and cash (5%).
My wife and I are both 58 in 2021
Annual cash need puts us in 24% tax bracket

• 2021 tax bracket is 12% (living off income and cash account)
• 2022-2024 (Age 59-61) no income but I can access 401k penalty-free
• 2025-2030 (Age 62-67) I will receive 6 yearly taxable payments from the non-qualified thrift plan that should cover most of annual cash need
• 2031 (Age 68) pension that should cover bulk of annual need

While no one knows the future of taxes, I would put a very low probability of lower rates in the future than the current 22%-24% brackets available where my income needs reside.

• My plan for 2022-2024 is to withdraw enough for annual cash need from the 401K which will put us in the low end of 24%. After that, I plan on converting up to the top of 24% bracket.
• For 2025-2030 I will convert any extra 401k to roth IRA beyond what I receive from the thrift plan (Dependent on where 2025 rates/brackets are)

Am I missing any fundamental issues around roth conversions given current tax law?
Am I correct in thinking there isn't much difference between topping out to 22% bracket or 24% bracket other than the 2%. I live in a state with 5% income tax in addition to federal.
Only for 2021, I can do a conversion for about 75k to the top of 22%. Thoughts on doing more to top of 24% bracket?

From what I've read, conversions generally make sense only if you can pay the taxes out of a cash account, not if you can sell investments. Is that correct?

I’m generally reserved about putting more financial detail than necessary on the internet but if any more specifics would help, let me know.

Thank you.

 

[RetireBy90]

Things to consider prior to SS if you will receive it include any additional cliffs for healthcare costs. Once you get on Medicare there is IRMAA which is additional cost depending on your MAGI.

I would second your plan to convert to the top of 24%. Our budget puts us in the 22% bracket for taxes but I'm converting well into the 24% as the extra 2% is worth it to give me a peace of mind that the tax hit is taken care of and I can withdraw from the Roth as I want not according to IRS schedule.

 

[RunningBum]

You don't tell us what your expected tax rate will be once you have to start RMDs, so it's impossible to say whether this is the right thing to do or not.

Assuming it will be 24% or more, converting up to the top of 24% probably makes sense. I agree that the extra 2% of the 24% bracket isn't a big hurdle.

Any ACA subsidy concerns?

From what I've read, conversions generally make sense only if you can pay the taxes out of a cash account, not if you can sell investments. Is that correct?

No, not correct. This just gets you the most favorable results. Roth conversions make the most sense if the taxes you pay now are at a lower rate than you expect to pay in the future, no matter how you pay the taxes. If it looks like you'd be paying the same tax rate in retirement, then it only benefits you if you pay taxes out of taxable.

If you can pay taxes out of cash from your taxable account, that is best. You get to convert the full amount, and you don't incur cap gains. If you have to sell funds in taxable, you will incur some cap gains but only on the gains, not the entire proceeds. If you have to pay out of the conversion, that reduces how much you can get into your Roth, since you had to use some of your 401k/tIRA money to pay taxes. Roth accounts have the most favored status because they grow tax free, so the more you can get in the Roth, the better.

I think a little too much is made of having to sell investment in taxable to pay conversion taxes. Pick the shares with the highest basis. Run all of your numbers including the effect of the cap gains to see what works best for you.

 

[SevenUp]

See Roth IRA conversion - Bogleheads for general discussion and some spreadsheet tools that might help you answer questions posed by other posters.

See also the section ~row 150 in the 'Misc. calcs' tab of the case study spreadsheet to quantify the "effect of the cap gains" RunningBum mentioned.

 

[gauss]

If you have any "after tax" contributions in your traditional 401k or traditional IRA, then you need to think about converting them before the end of 2021 or forever be barred from doing this if the proposed bills in congress become law.


See this discussion here for further info.

-gauss

 

[Sunset]

There is also the danger of incurring the NITT tax (extra ~3.5%) , but not sure how it applies to roth conversions or even IRA/401K withdrawals.

 

[Exchme]

There is also the danger of incurring the NITT tax (extra ~3.5%) , but not sure how it applies to roth conversions or even IRA/401K withdrawals.

The extra Medicare taxes are 0.9% of the AGI above $250K. NIIT is 3.8% of LTCGs if AGI is above the $250K threshold (MFJ, $125K single). The threshold is not indexed for inflation so will become important for more folks over time.

To the rest of OP's question, there are few generalities for Roth conversions other than you want to level out your (and your heirs') marginal tax rate over time. Everyone's situation is different and there are so many nooks, crannies, lumps and bumps in the tax code that others' specific situations are not likely to apply.

You really have to make a lifetime model to get a feel for a reasonable plan and then realize that only the current year is actionable, you get lots of chances to re-tune as returns, life situations and taxes change.

Other threads have discussed modeling tools like I-orp, Boglehead's Retiree Portfolio Model, Pralana Gold and others.

 

[4legsgood]

... NIIT is 3.8% of LTCGs if AGI is above the $250K threshold (MFJ, $125K single). ...

From IRS web site, NIIT threshold is:

Married filing jointly $250,000

Married filing separately $125,000

Single $200,000

Head of household (with qualifying person) $200,000

Qualifying widow(er) with dependent child $250,000

https://www.irs.gov/newsroom/questions-and-answers-on-the-net-investment-income-tax

 

[pb4uski]

OP, it sounds like once you are collecting SS that you'll be solidly in the 24% tax bracket? Will RMDs just push you further into the 24% tax bracket or into the 32% tax bracket?

Either way, it sounds like it would be best to convert to the top of the 24% bracket for two reasons.... 1) the likelihood of taxes going up is higher than them staying the same or going down and 2) more importantly, if you or your DW die prematurely, the surviving spouse would be thrusted into an even higher tax bracket where 24% will look pretty good.

Finally, if RMDs will be hoisting you into the 32% tax bracket then 24% is better than 32%... but it doesn't make a lot of sense to me to pay 32% now to avoid 32% later.

 

[WestwardBound]

Thank you all. My expectation for future tax rate is that we will likely have annual income that would keep us in the income bracket that is currently 24%. What the actual tax rate for that income level will be is unknown but I believe the probability that it will be greater than 24% is pretty high.

I may have the opportunity to manage income for IRMAA when we hit medicare but I will likely be paying some additional premium. For NITT, I should be able to manage any asset sales to minimize LTGs.

I will look into some additional modeling but withdrawing from 401k for living expenses and doing conversions up to 24% for the next three years seems to make sense (even though paying taxes now versus later has been a mental hurdle to overcome).

 

[pb4uski]

.... From what I've read, conversions generally make sense only if you can pay the taxes out of a cash account, not if you can sell investments. Is that correct?...

...No, not correct. This just gets you the most favorable results. Roth conversions make the most sense if the taxes you pay now are at a lower rate than you expect to pay in the future, no matter how you pay the taxes. If it looks like you'd be paying the same tax rate in retirement, then it only benefits you if you pay taxes out of taxable. ..

+1 If you pay the taxes out of taxable, you effectively make that tax amount tax-free for life.

The benefits if the rate is the same are more intangible... like insulating from future higher tax rates, for a married couple insulating your finances from higher taxes if one of you dies prematurely, etc.

 

[Dash man]

Also, remember that under current tax law, in 2026 the tax brackets revert to the 2017 tax rates with the brackets adjusted for inflation.

 

[WestwardBound]

+1 If you pay the taxes out of taxable, you effectively make that tax amount tax-free for life.

The benefits if the rate is the same are more intangible... like insulating from future higher tax rates, for a married couple insulating your finances from higher taxes if one of you dies prematurely, etc.

Thanks. Helpful thoughts.

Also, remember that under current tax law, in 2026 the tax brackets revert to the 2017 tax rates with the brackets adjusted for inflation.

Yes, part of my belief that future rates will be higher. It will be an "interesting" debate in congress over what to do...

 

[Koolau]

Thanks. Helpful thoughts.



Yes, part of my belief that future rates will be higher. It will be an "interesting" debate in congress over what to do...

If congress can just let taxes "rise" on their own, I'm guessing that's the way they will go. Actually voting to raise taxes is usually problematic and you can read my lips though YMMV.

 

[RetireBy90]

Just read the following that seems to say Congress is considering eliminating ALL after tax Roth conversions. I think this has been reported earlier in this thread but I wanted to ensure this was reported. I'm a bit fuzzy, but when you have a mix of before and after tax contributions to your IRA then any conversion or withdraw is taxed proportional to the taxable contribution percentage. That is if you contribute $5K one year after tax and then $5K pre-tax, then any conversion or withdraw would be 50% taxable. This could bite those not necessarily expecting to be hit. I'm not sure how they would implement it if your just not allowed to convert after tax contributions and you can't specify only pre-taxed funds.



https://www.marketwatch.com/story/c...retirement-tax-move-11632861718?siteid=yhoof2

The bill “prohibits all employee after-tax contributions in qualified plans and prohibits after-tax IRA contributions from being converted to Roth regardless of income level, effective for distributions, transfers, and contributions made after Dec. 31, 2021,” reports the House Ways & Means Committee.

 

[pb4uski]

.... It will be an "interesting" debate in congress over what to do...

I'd bet the house that they do nothing... whcih is what they are expert at... and as a result rates revert.

 

[WestwardBound]

I'd bet the house that they do nothing... whcih is what they are expert at... and as a result rates revert.

Not that anyone knows, but would that mean the brackets revert as well and the current 24% shrinks back to a smaller relative top end when it goes to 28%?

Although I assume the prior brackets would be adjusted for inflation from 2018 to 2025...

 

[SecondCor521]

Not that anyone knows, but would that mean the brackets revert as well and the current 24% shrinks back to a smaller relative top end when it goes to 28%?

Although I assume the prior brackets would be adjusted for inflation from 2018 to 2025...

My understanding is that the brackets and rates both revert to pre-TCJA and then are adjusted for inflation.

I think there is a decent chance that they will change things again, we won't revert, and the new thing will be the thing until they change it again. They seem to like fiddling with it more lately. But who knows.

 

[Koolau]

^^^ Another game of hot potato

 

[jayanu]

for YE tax planning from Ed Slott - read - file:///C:/Users/jayan_000/Downloads/2021_Yearend_Checklist.pdf

 

[RunningBum]

for YE tax planning from Ed Slott - read - file:///C:/Users/jayan_000/Downloads/2021_Yearend_Checklist.pdf

Is there a place on the net for that? We're not going to be getting something off your local C: drive!

 

[gauss]

I'd bet the house that they do nothing... which is what they are expert at... and as a result rates revert.

+1 Agreed.
Unless they can find somewhere else to "pay for" continuing the tax cut.
I think that was the problem with the original bill if memory serves.

-gauss

 

[pb4uski]

Yes, that rings a bell... they were forced to include rates reverting to get the 10-year budget impact under a certain threshold. Notable that they didn't have corporate tax rates revert like they did with individual tax rates. Swine!

 

[jayanu]

Is there a place on the net for that? We're not going to be getting something off your local C: drive!

Oops! Sorry.
Try
https://qe305.keap-link001.com/api/v1/click/6134870215884800/5031569129472000