New tax law and ROTH

[free2020]

Thought it may be a good idea to re-start a thread on Roth in light of the tax reform. To get this started, the article https://www.madfientist.com/new-tax-law/ has a nice summary of what has / has not changed re: Roth.

Folk who are planning/doing Roth conversions have plenty of reasons to smile. For starters, the tax brackets getting bumped up is a great boon for conversions. Fidelity has a nice side-by-side picture of the tax brackets for 2017 versus 2018. https://www.fidelity.com/viewpoints/personal-finance/tax-proposal-details. It appears that families with income in the 24% tax bracket have the broadest opportunity for Roth conversions ($165000 to $315000).

Thoughts?

 

[gauss]

I have been using a "maximize my current bracket" strategy to smooth out my Roth conversions by doing it every year.

If I continued this, I will have converted everything by 2025 (when the new/current rates expire). I will be only ~ 60 years old at that time.

I have decided, instead, to scale back so that I still have tax diversity in my asset base. I suspect I will only convert 50% between now and 2025.

This is definitely an opportunity for those who want to convert everything, or close to it, under the lower, wider tax brackets in effect through 2025.

-gauss

 

[FIREmenow]

"The law does end the Roth IRA recharacterization option starting in 2018, but 2017 recharacterizations will be permitted. Recharacterization allowed taxpayers to undo a Roth IRA conversion for a limited time, and was often useful if the value of the converted investments fell."

 

[RunningBum]

I have been using a "maximize my current bracket" strategy to smooth out my Roth conversions by doing it every year.

If I continued this, I will have converted everything by 2025 (when the new/current rates expire). I will be only ~ 60 years old at that time.

I have decided, instead, to scale back so that I still have tax diversity in my asset base. I suspect I will only convert 50% between now and 2025.

This is definitely an opportunity for those who want to convert everything, or close to it, under the lower, wider tax brackets in effect through 2025.

-gauss

I'm curious why you'd cut back that much? I'd think the lower rates would encourage you continue your plan, not change it. Perhaps that wasn't the impetus?

Ideally I'd like to get all of my conversions done by 62, so that if the market tanks I could start taking SS then. I'm not too worried if I don't get it done until 70, which is when I'm more likely to start SS. I don't want SS added to RMDs or conversions to put me in a higher bracket. Are you planning to finish converting by 70?

I sure don't think about it as tax diversification. Diversification to me means a desired mix, like some stocks and some bonds. I'd love to have 100% in my Roth if possible, never to be taxed again, not even gains. That pre-tax money was a necessary evil to protect against higher tax rates when I was working, but now I'd love to get it all converted over. But I'm trying to smooth out my tax rate over the years, so I convert some each year, hopefully finishing in the 62-70 age time frame. Perhaps that's what you're calling diversification?

 

[RunningBum]

"The law does end the Roth IRA recharacterization option starting in 2018, but 2017 recharacterizations will be permitted. Recharacterization allowed taxpayers to undo a Roth IRA conversion for a limited time, and was often useful if the value of the converted investments fell."

That's the only mention of Roth in the article. Recharacterization was also useful to max out your conversion, since you could trim it back once you calculated your taxes if you did more than the optimal.

The lower tax rates are the only other thing I see, but the OP calls this "for starters". What else is there? I don't see the Roth focus on tax law changes that the OP implies.

 

[Gotadimple]

For those thinking about conversions up to age 70, be aware that you are eligible for Medicare at age 65, and you will pay a Medicare Part B premium 'penalty' called IRMAA (income related monthly adjustment) if your modified adjusted gross income exceeds certain dollar levels starting two years before age 65. So it's just not about the RMD tax torpedo, but the Part B premium torpedo.

So, Single Filers and Married Filing separately pay the regular rate up to $85,000, Married Filing Jointly pay the regular rate up to $170,000. Above those amounts up to $107,000 (single), $214,000 (MFJ), you incur a 40% IRMAA adjustment to the monthly premium. Married Filing separately pay a 219% IRMAA for any amount over $85,000. There are 5 tiers of IRMAA increases. Details are here:
https://www.medicare.gov/your-medicare-costs/part-b-costs/part-b-costs.html

 

[Alan]

It is certainly good news for my wife and I. With the new brackets I should have my IRA conversions completed in 2 years instead of 3 and my wife’s IRA converted within 2 years after that. That would leave us with no tax deferred investments by the time we are 66.

 

[omni550]

For those thinking about conversions up to age 70, be aware that you are eligible for Medicare at age 65, and you will pay a Medicare Part B premium 'penalty' called IRMAA (income related monthly adjustment) if your modified adjusted gross income exceeds certain dollar levels starting two years before age 65. So it's just not about the RMD tax torpedo, but the Part B premium torpedo.

So, Single Filers and Married Filing separately pay the regular rate up to $85,000, Married Filing Jointly pay the regular rate up to $170,000. Above those amounts up to $107,000 (single), $214,000 (MFJ), you incur a 40% IRMAA adjustment to the monthly premium. Married Filing separately pay a 219% IRMAA for any amount over $85,000. There are 5 tiers of IRMAA increases. Details are here:
https://www.medicare.gov/your-medicare-costs/part-b-costs/part-b-costs.html

There's also a similar (although smaller) Part D premium torpedo. Details here:

https://www.medicare.gov/part-d/costs/premiums/drug-plan-premiums.html

omni

 

[gauss]

I'm curious why you'd cut back that much? I'd think the lower rates would encourage you continue your plan, not change it. Perhaps that wasn't the impetus?

...

At first that seemed like the obvious strategy. It was actually the much WIDER tax brackets, not the rates, that would have me converting assets much sooner than expected. My original plan probably would have me converting close to 50% by 2025 so this is not that much of a change -- I am just no longer filling out the whole tax bracket and the larger tax bills that would ensue.

However, what if rates are further lowered in the future? Tax diversification. Ie. having the opportunity to take advantage of future opportunities.

Also, on a more personal note, when we pass away, the majority of our assets will be likely going to charity.

Would much rather donate pre-tax vs after-tax assets.

In the mean time, however, RMDs may force me to convert the balance sooner than I would like.

Lots of moving parts here.

-gauss

 

[gauss]

For those thinking about conversions up to age 70, be aware that you are eligible for Medicare at age 65, and you will pay a Medicare Part B premium 'penalty' called IRMAA (income related monthly adjustment) if your modified adjusted gross income exceeds certain dollar levels starting two years before age 65. So it's just not about the RMD tax torpedo, but the Part B premium torpedo.

So, Single Filers and Married Filing separately pay the regular rate up to $85,000, Married Filing Jointly pay the regular rate up to $170,000. Above those amounts up to $107,000 (single), $214,000 (MFJ), you incur a 40% IRMAA adjustment to the monthly premium. Married Filing separately pay a 219% IRMAA for any amount over $85,000. There are 5 tiers of IRMAA increases. Details are here:
https://www.medicare.gov/your-medicare-costs/part-b-costs/part-b-costs.html

+1 I was shocked when I saw a couple paying close to $10,000 /year in Medicare premiums between the two of them (Part B and Part D).

The shocker was, I don't even think they were in the highest IRMAA category. I recommended that they get the SSA office asap to have this reviewed.

SSA office had them fill out form SSA-44 to recalculate the premiums in that the husband had retired and was no longer receiving the fairly high income that caused this.

Felt like I did some good that day.

-gauss

 

[RunningBum]

At first that seemed like the obvious strategy. It was actually the much WIDER tax brackets, not the rates, that would have me converting assets much sooner than expected. My original plan probably would have me converting close to 50% by 2025 so this is not that much of a change -- I am just no longer filling out the whole tax bracket and the larger tax bills that would ensue.

However, what if rates are further lowered in the future? Tax diversification. Ie. having the opportunity to take advantage of future opportunities.

Also, on a more personal note, when we pass away, the majority of our assets will be likely going to charity.

Would much rather donate pre-tax vs after-tax assets.

In the mean time, however, RMDs may force me to convert the balance sooner than I would like.

Lots of moving parts here.

-gauss

OK, I see, hedging your bets on current vs. future tax rates.

And I somehow hadn't realized pre-tax bequests to charity aren't taxed. I kind of figure I'll have what I plan to leave in my DAF, so that nugget probably won't apply to me, but still, I learned something. Glad I asked, and thank you for answering.

 

[Winemaker]

As I mentioned in another thread, DW and I are doomed. With pensions, 401k, rental income, divvies and interest, we are already in the 22% bracket. If we convert $5,000, $50,000, or $100,000/year for the next 10 years, we are still in 22% bracket. If we have a $3 mil portfolio, RMD is $118,000, and we're still in the 22% bracket. We'll be borderline with SS, and if we still have the rentals, as all of my spreadsheets have shown.
If one of us croaks early, we'll be miserable anyway, well, at least I will be.

 

[omni550]

As I mentioned in another thread, DW and I are doomed. With pensions, 401k, rental income, divvies and interest, we are already in the 22% bracket. If we convert $5,000, $50,000, or $100,000/year for the next 10 years, we are still in 22% bracket. If we have a $3 mil portfolio, RMD is $118,000, and we're still in the 22% bracket. We'll be borderline with SS, and if we still have the rentals, as all of my spreadsheets have shown.
If one of us croaks early, we'll be miserable anyway, well, at least I will be.

Whichever one is is left, filing as a single, will likely be in an even higher tax bracket.....and miserable, too.

omni

 

[JoeWras]

I'm hoping there was some recent reply sarcasm? If one has so much income that they can't do lowest bracket conversions, that's a good problem to have. Just sayin'.

I'm planning on conversions next year and due to making bank returns closer to 2% (versus the previous <1%), I'll have more income and less room for conversions. Oh well.

 

[joeea]

However, what if rates are further lowered in the future? Tax diversification. Ie. having the opportunity to take advantage of future opportunities.

I agree with the part about diversification.

But I wouldn't be willing to bet on rates being lowered in the future. Nor would I be willing to bet on low inflation rates continuing.

Maybe that's just me.

 

[Winemaker]

I'm hoping there was some recent reply sarcasm? If one has so much income that they can't do lowest bracket conversions, that's a good problem to have. Just sayin'.

I'm planning on conversions next year and due to making bank returns closer to 2% (versus the previous <1%), I'll have more income and less room for conversions. Oh well.

Yes, sarcasm. We've been blessed although we planned well, that is, multiple income streams, we have always planned for a punch in the face. As mentioned on other previous threads, we have already had two, the twin loss of retiree health insurance just before retirement. A coal company pension? State teacher pension? Means tested SS? Reduced SS? Prolonged market collapse? Maybe more punches to follow?

Yes, doomed to pay taxes, more like destined, because of the planning. It's a great problem to have. I thought the OP was in a similar boat, so I was saying that everyone can't dodge Uncle Sam by converting to a Roth. Or by dying.

 

[free2020]

Yes, sarcasm. We've been blessed although we planned well, that is, multiple income streams, we have always planned for a punch in the face. As mentioned on other previous threads, we have already had two, the twin loss of retiree health insurance just before retirement. A coal company pension? State teacher pension? Means tested SS? Reduced SS? Prolonged market collapse? Maybe more punches to follow?

Yes, doomed to pay taxes, more like destined, because of the planning. It's a great problem to have. I thought the OP was in a similar boat, so I was saying that everyone can't dodge Uncle Sam by converting to a Roth. Or by dying.

Yes, indeed. Many here by taking early retirement have taken on the responsibility to plan for the long term. This group is thus above the crowd. For one, thinking about RMD at age 45, 50, 60 etc. is not what the crowd does. Ask around, I did. RMwhat? The broader brackets under the new tax regime is what my focus is on, as it appears to be with several others. It makes for a longer runway to execute the conversions if your plan is to do that. It probably makes sense to convert more at, say, 61 versus spreading it out over ages 61 to 65 if you are a compounder, no? Does compounding tax free for five years offset prepaying Uncle Sam?

 

[meierlde]

One other way to look at it is if you compare the old and new limits in the old 25 and 28% bracket, depending on how large RMDs will be in a few years, if over 60, is to instead of doing roth conversions, just withdraw the money and save a few percent on taxes. Note if you invest in dividend paying stocks with the withdrawn money you pay 15% (unless in the top bracket) instead of paying whatever rate your dividends inside the non roth 401k pay at based upon the tax bracket.

 

[JoeWras]

Yes, indeed. Many here by taking early retirement have taken on the responsibility to plan for the long term. This group is thus above the crowd. For one, thinking about RMD at age 45, 50, 60 etc. is not what the crowd does. Ask around, I did. RMwhat? The broader brackets under the new tax regime is what my focus is on, as it appears to be with several others. It makes for a longer runway to execute the conversions if your plan is to do that. It probably makes sense to convert more at, say, 61 versus spreading it out over ages 61 to 65 if you are a compounder, no? Does compounding tax free for five years offset prepaying Uncle Sam?

Yep. RMDwhat? Many times it is Retirementwhat or Savingwhat or 401kwhat.

 

[RunningBum]

One other way to look at it is if you compare the old and new limits in the old 25 and 28% bracket, depending on how large RMDs will be in a few years, if over 60, is to instead of doing roth conversions, just withdraw the money and save a few percent on taxes. Note if you invest in dividend paying stocks with the withdrawn money you pay 15% (unless in the top bracket) instead of paying whatever rate your dividends inside the non roth 401k pay at based upon the tax bracket.

If you don't need the money for spending, I'd much rather have the money in the Roth. 0% on those dividends and growth instead of 15%.

 

[free2020]

If you don't need the money for spending, I'd much rather have the money in the Roth. 0% on those dividends and growth instead of 15%.

Me too. Only regret I have is not starting on Roth earlier in life. Albeit the 5 year rule, loading up on Roth before putting any money in after tax brokerage accounts would have been awesome. I didn’t do that. Oh well. Now I try to tell my 20 something’s in my circles to do this.

Compounding is a wonder by itself, tax free compounding is super wonderful

 

[audreyh1]

I'm hoping there was some recent reply sarcasm? If one has so much income that they can't do lowest bracket conversions, that's a good problem to have. Just sayin'.

Yeah - pretty much.

 

[meierlde]

If you don't need the money for spending, I'd much rather have the money in the Roth. 0% on those dividends and growth instead of 15%.

Of one of the differences is how close to 70.5 you are and do you have anyone to inherit the money? Being 68 this year, it just seems to me better to take it out and pay the 15% on the dividends. (note if you go with 500 or total stock market index funds the dividends paid are about 1.8 percent since they don't throw off a lot of dividends and very few cap gains. meaning the impact is fairly small on taxes, and the IRMMA impact is identical. (Since both show up on the AGI), And as I have but 3 years till rmds are due, it won't make a lot of difference. (If younger more years make a difference).

 

[RunningBum]

Of one of the differences is how close to 70.5 you are and do you have anyone to inherit the money? Being 68 this year, it just seems to me better to take it out and pay the 15% on the dividends. (note if you go with 500 or total stock market index funds the dividends paid are about 1.8 percent since they don't throw off a lot of dividends and very few cap gains. meaning the impact is fairly small on taxes, and the IRMMA impact is identical. (Since both show up on the AGI), And as I have but 3 years till rmds are due, it won't make a lot of difference. (If younger more years make a difference).

I just don't see any sense at all in paying 15% on the dividends when you could pay 0. I can't see any case for it.

Sure, it's small. If you take $20K, at 1.8% dividends, that's $360 in dividends, or $54 in taxes, but why pay $54 if you can pay 0? Not to mention that any capital gains would be taxed if you sell later.

Some will have a low tax rate and so divs and CGs would be 0%, so it'd be a wash, but I'd still put it in the Roth to make sure your other divs and CGs don't stray above that line to be taxed.

 

[Winemaker]

If you don't need the money for spending, I'd much rather have the money in the Roth. 0% on those dividends and growth instead of 15%.

You only have to pay taxes if you sell, if you invest for growth. Divvies are low. Like I said, I'm paying 22% for the next 10 years, qualified divvies 0-15%. Unspent money goes into growth funds, taxed only for capital gains, if I sell. Stepped up basis at death, 0% estate tax because less than $5 mil. 0% state tax to DW, 4.5% state tax upon death to my kids. At this point, I'm still in control.

Would I like the option of a Roth, hell yeah! But I gotta go with plan B because A doesn't show an advantage at this point.