Roth Conversions make sense?

[downrod]

I am currently less than 4 yrs from retirement. I am doing a lot of reading about withdrawal strategies and it sounds like Roth conversions are a big part of the picture for many people.

I brought this up with my current Vanguard advisor, and he said that it is very rarely advantageous to do so, and he seemed completely uninterested in doing any conversion with my accounts. Am I missing something here?

The Roth portion of my portfolio is very small ( less than 4%)

Total portfolio 1.25M

Tax Deferred 71.27%
Roth 3.69%
Taxable Account 5.94%
Cash-Savings 19.10%

Assuming that ACA is the rule of the land at that time, I will be on it for 6 months before Medicare kicks in, and my wife will be on it for 7 additional years before she is eligible for medicare

Looking at my situation, does a Roth conversion make sense? If so, when and how would you go about that? Should I ignore my advisor's advice?

I dont understand what the factors are that make a Roth conversion make sense and when it doesn't. I would appreciate any help. Thanks!

 

[RunningBum]

Defer when your taxes are higher than they will be later.

Take income, and convert, when your taxes are lower than they will be later.

Slight advantage to converting if the tax rate will probably be the same.

Most people don't convert while they are working because they fall into the first category. However, it's possible you don't, so run your own numbers because of how much you have in tax deferred. Of course you have to make some assumptions about tax rates. Will they stay the same? Will they revert to 15/25/... when the current tax plan expires? Will they go higher? Will they drop further? Your call.

Many people find that an ideal time to convert is between retirement and when they start SS. This is when your tax rate is likely to be lowest. It's also one factor in favor of deferring SS until 70.

 

[IrishMoss]

I retired at age 57 so I guess that's still considered "early." I am doing Roth Conversions from my IRA but actually smaller amounts because I am choosing to keep my taxable income lower (to qualify for ACA subsidies). Every little bit converted to roth helps, just makes sense to do it when you won't get a big tax ding for doing so.

 

[Animorph]

I see Roth conversions as a way to get some of your taxable account money into a tax-free Roth account. You convert $100, you pay, say, 12% to the IRS. So you get your $88 out of the tIRA and put it in the Roth. At that point it's a wash for you, $100 in tIRA = $88 in Roth at 12% tax rate. Mathematically no difference, if the tax rate stays constant. The advantage is that you are allowed to pay the tax with your taxable account money, placing $100 into the Roth account instead of just $88. It's like moving $12 from your taxable account to the Roth, where it is now tax free. So until you withdraw that $12 from the Roth you are saving any taxes you would have paid (for dividends or capital gains) had it stayed in the taxable account.

So for your case, do you have enough taxable savings or other income to pay Roth conversion taxes and support your living expenses? If you will be withdrawing significantly from tIRA funds for living expenses, then Roth conversion is only applicable to an additional withdrawal, which may make less tax sense.

And how much does moving some of your taxable money into a Roth save you? If you are easily within the 0% capital gains bracket you may not be paying any taxes on your "taxable" money already. In that case a Roth conversion might not have much benefit for you.

However, if the "constant tax rate" assumption does not hold it may still be beneficial to Roth convert. Will RMD's trigger a higher tax rate than you would pay any time before RMD's start? Roth conversion will reduce the tIRA balance, reducing RMD's, and no RMD's are required from Roth accounts.

You're trying to move money out of your tIRA at the lowest total tax rate. You can withdraw an amount that makes tax sense. If that's more than you need for expenses, the excess goes into the Roth.

All of this is driven by your specific tax situations throughout retirement, which Vanguard won't know. So definitely look into it for yourself.

 

[pb4uski]

.... Looking at my situation, does a Roth conversion make sense? If so, when and how would you go about that? Should I ignore my advisor's advice?

I dont understand what the factors are that make a Roth conversion make sense and when it doesn't. I would appreciate any help. Thanks!

You're not missing something... your Vanguard advisor is.

Two-part answer. Yes, assuming that once you retire you are in a lower tax bracket than you will be later once SS and any pensions start, you would be better off to do as much low-tax-cost Roth conversions as possible.

It makes sense to do Roth conversions where your marginal tax rate before conversions today is less than your marginal tax rate once SS and pensions kick in. Using us as an example... our marginal tax rate before conversions is 0% as our income absent conversions is less than the standard deduction... but once SS starts we expect to be in the 12% tax bracket and once RMDs start in the 22% tax bracket. So we have been doing Roth conversions to the top of the 12% tax bracket and paying about 7% of the amounts converted in tax... saving 15% comapred to the 22% we would pay later.

However, if you plan to be getting ACA subsidies and need to manage your income to 400% FPL to get subsidies, there may not be a lot of headroom for Roth conversions.

We had a somewhat unique situation where subsidies would not be very valuable to us and the tax cost savings are better for us that ACA subsidies so we decided to forgo ACA subsidiesn favor of Roth conversions and tIRA withdrawals at low tax rates.

 

[RunningBum]

The advantage is that you are allowed to pay the tax with your taxable account money, placing $100 into the Roth account instead of just $88. It's like moving $12 from your taxable account to the Roth, where it is now tax free.

Yes, if at all possible, use taxable money to pay taxes on the conversion.

And how much does moving some of your taxable money into a Roth save you? If you are easily within the 0% capital gains bracket you may not be paying any taxes on your "taxable" money already. In that case a Roth conversion might not have much benefit for you.

I don't follow this, at least not for the OP. The part of SS that is taxable (if any) is regular income, and so are RMDs. The OP clearly is not going to be in a 0% tax situation after 70 without doing conversions.

All of this is driven by your specific tax situations throughout retirement, which Vanguard won't know. So definitely look into it for yourself.

I agree with that, but I think the VG person should be encouraging the OP to look at their tax situation, not just outright discouraging it.

One more benefit to converting, with the proposed changes to the stretch IRA, is that an inherited tIRA is a tax time bomb for many heirs since they'll have to deplete it in 10 years, during which they may still be working. I know some people say that's their problem and they should be grateful for anything, but I don't see any reason to purposefully sabotage it for them. A tIRA is tax deferred, so there's a tax liability that someone is going to have to pay, I don't see why one wouldn't want to do this in the most efficient way. Letting them inherit a Roth just means that you took care of that tax liability, which makes a lot of sense if you could do it at a lower tax rate than they would. Simple estate planning, without the effort and cost of creating some kind of trust or some other scheme. You can leave them more, without having to spend any less of your money.

 

[TheRunningMan]

I have a projected conversion plan that commences when I FIRE in 2.5 years. I look to manage my taxable income via conversion to keep myself in the 12% bracket each year. It will take approximately 9 years to complete, but I feel I will be in a stronger position given my expectation of rising taxes rates.

Thanks for posting your question; I am enjoying reading the responses of others on this matter.

 

[RunningBum]

I'm 10 years into a 21 year plan to try to complete my conversion by age 70. Looks promising, but will be close.

 

[walkinwood]

Great advice to the OP as usual. There are a couple of things that were not stated in the original post
- Does your wife intend to continue working after you retire?
- When do you & your wife plan to start taking SS.
- Any pensions kicking in when you retire

The above will increase your income & will affect whether ROTH transfers make sense.
It also looks like you have the bulk of your retirement savings are in t-ira accounts, so you should try and predict (even if it will, most definitely be wrong) what your RMDs will be to determine what tax bracket you'll fall in at that time.

It is a complex situation and you'll probably need to fire up a spreadsheet and/or use a tax program & simulate taxes in each year.

 

[kgtest]

I have a 20 year conversion plan up to today's 12% bracket, starting the year I ER. Of course if I am laid off or underemployed during the next 13 years PRE-FIRE, I will take a look and likely convert if tax liabilities decrease.

Currently executing what will be a 6 year conversion plan for DF...although with the potential senate stretch-IRA provisions, it might not be as imperative.

I always like to add, for those with wife's who've been off of work due to birth of child is always a good year to convert if it works out.

 

[FIREchief]

You're not missing something... your Vanguard advisor is.

+1. Hopefully you're not paying for such broad stroke advice. The original question rarely has simple answers, and every situation is unique to some degree.

 

[N02L84ER]

Yes, Roth conversions can make a lot of sense when your income drops. It is specific to each individual's situation as indicated in the previous posts. Another factor to consider is the tax situation when one person of a married couple dies. The marginal tax rate usually skyrockets at that point, so having moved more money into Roths and having smaller RMDs from traditional IRA/401ks can make a lot of sense.
We have been doing Roth conversions at an average of $22K for the past 13 years (when DH retired and I went to part-time work) and the Roth percentage of our investments has gone from 2.3% to 38.5%. We have paid less than 1K per year in taxes on the conversions since our state does not tax conversions. In our case, we are now living solely on our investments since I retired 7 years ago: no pensions, no SS, no work income, etc.

 

[Cobra9777]

We're converting to the top of the 12% bracket. But we have two small pensions and some rental income, so the conversion amounts are relatively small. I started at 52, but there's no chance we can convert the entire tax-deferred balance by 70 (or 72 under the new proposal) unless we convert well into the 22% bracket. I'm not willing to do that since it's highly unlikely we would be above the 22% bracket after SS and RMDs start. If tax rates revert to 25%, then there is some small upside potential for converting at 22%, but that's a big "if" and I'm still unwilling at this point.

My goal is to hit 70 with a roughly equal mix of taxable, tax-deferred, and tax-free (Roth+HSA). This should enable quite a bit of spending flexibility without ever exceeding the 22% bracket. Most years when working, we were in the 28-33% brackets. We'll probably convert about half at 12% and pay 22% on most of the RMDs.

 

[CardsFan]

OP
Your FA may not be giving you bad advice, at this point in time. Since you are still working, I guess most of your conversions would be in the 22% bracket. I would focus on contributing to Roth accounts, as opposed to converting, but even then you may be contributing in the 22% bracket.

Once you are retired,with presumably a lower income, then conversions to the top of the 12% bracket are a no-brainer. Odds are you will never be below 12% again.

I use this calculator to estimate what RMD's may be at retirement: https://www.schwab.com/public/schwa...anning/understanding_iras/ira_calculators/rmd

 

[FIREchief]

OP
Since you are still working, I guess most of your conversions would be in the 22% bracket.

How did you conclude this from the original post? I didn't see any detail like this.

 

[CardsFan]

How did you conclude this from the original post? I didn't see any detail like this.

I did not CONCLUDE, as I said, I guessed. I could be wrong, in which case contributing to Roth accounts pre-retirement makes even more sense.

 

[MichaelB]

I understood the first line of the OP to mean still working

I am currently less than 4 yrs from retirement.

 

[pb4uski]

OK, now I'm confused.

If OP is talking about doing Roth conversions now while he is still working then I totally agree with his FA... not a good idea while still working.

Once the OP stops working then a totally different story. I thought the OP was talking about doing Roth conversions during the first few years after he retires.

 

[downrod]

Thank you all for the information. It sounds like the Roth conversions are something that I should do, once I retire and my tax rate is lower. I appreciate the help!

 

[pb4uski]

^^^ You got it. I'm just curious... were you talking with your Vanguard advisor about doing Roth conversions now while you are still working or once you retire?

 

[Ginny]

Thank you all for this discussion. It helped me decide to do a small roth conversion now that I am fully retired and before I start my RMDs, whenever that is, hopefully in 7 years and not in 5 years.

I am living the life due in part to this forum. Thanks oh wise ones!!

 

[Markola]

Just curious how others think about sequence of returns risk during their first years of FIRE before RMDs start? I’m open to Roth conversions but there also seems comfort in keeping as much money invested as possible in those first 10 years of FIRE vs. paying it out in taxes. I know everyone’s financial situation and risk tolerance and ACA management is different.

 

[JoeWras]

^^^ You got it. I'm just curious... were you talking with your Vanguard advisor about doing Roth conversions now while you are still working or once you retire?

I'm curious too. I don't have an ongoing Vanguard advisor, but I did take them up on their free "review with a pro" offer a few years ago.

He totally endorsed the Roth conversion idea during the gap between ER and taking SS.

 

[flintnational]

Markola, I may be missing something but I think it just comes down to taxes (unless ACA subsidies or other items are in play). If you can pay less now than in the future, conversions make sense. In fact, a major market downturn could help with taxes. Lower total taxes will be due on the conversion and when the market recovers, your remaining investments will be tax free and you will have paid taxes on the smaller conversion amount.

 

[pb4uski]

Just curious how others think about sequence of returns risk during their first years of FIRE before RMDs start? I’m open to Roth conversions but there also seems comfort in keeping as much money invested as possible in those first 10 years of FIRE vs. paying it out in taxes. I know everyone’s financial situation and risk tolerance and ACA management is different.

I guess I view Roth conversions and SOR as separate issues... SOR is less of an issue for my Roth conversions as when I do conversions I reinvest in the same ticker as I sold/exchanged in my tIRA.

I'm paying ~8% federal tax on my conversions vs 22% later so that 14% savings can cover a lot of SOR risk.

Finally, in our case Roth conversions are finetuning... a little more than 2% of the total portfolio each year.... federal taxes paid out on Roth conversion are ~0.16% each year.