Those Who don't/didn't do Roth Conversions

[LateToFIRE]

^^^

Ok, now I've started down a new rabbit hole. I modeled (in RPM) one of us "expiring" well before the full retirement period, and was quite shocked at the result. Ending balance on portfolio was considerably lower. Further, it showed that Roth conversions made the problem even worse (maybe the expected tax savings were offset by lower income).

One thing that jumped out was the need to make aggressive WD's from the tIRA (above and beyond RMD's) towards end of forecast because the Taxable account had been depleted owning to reduced SS/pension income and earlier Roth conversions. In reality that hole in the plan would probably be filled by sale of assets of a more tax-friendly variety.

I'm still analyzing, but thought I'd put this out there given surprise. I suspect that the results would vary across many different possible scenarios, so not expecting my result to apply to others.

[Update: I see model is not automatically pulling from Roth accounts, once I manually adjusted it showed Roth conversions being accretive not destructive. Sorry for the panic. Curious if anyone else has tried modeling a widow(er) scenario.]

 

[CardsFan]

Hard to know if conversions will be worth it (given so many potential variables). I go back to, if its not gonna be a big hassle, then I like hedging my bets a bit and expanding that pot of "tax-free" [i.e. tax prepaid] funds even if the final dollar benefit might be negligible.

As for the past decision to load up the 401k/tIRA's, that was a no-brainer - have been fortunate to reside in or near the top bracket for past 20 years, so already [likely] "won" the tax arbitrage game in that regard. This conversion stuff seems like it's all about collecting those last few bonus points.

^^THIS

I got roasted a little earlier for comparing my current effective rate on conversions to the deferred tax when contributing, and I agree that the deferred rate is a "sunk cost" and really not part of the consideration for future conversions/withdrawals.

However, since we will be solidly in the 22% bracket (or higher if rates go up) when RMD's kick in, nibbling around the edges for some bonus points isn't a bad idea and it might help delay IRMAA for a few years

It can't hurt, even if we both live a long time, and could help our DS and DDIL if we go early and they need to empty the tIRA in 10 years, during their high earning years.

But let's get real. Nothing most of us are doing, or not doing, is going to move the needle that much.

 

[RunningBum]

^^THIS

I got roasted a little earlier for comparing my current effective rate on conversions to the deferred tax when contributing, and I agree that the deferred rate is a "sunk cost" and really not part of the consideration for future conversions/withdrawals.

Sorry you think I roasted you. I explained a few posts later why I made the point I did.

I also agree that for many of us, conversions won't move the needle that much. But I'm reminded of a recent discussion I had with my son that $25K wasn't life changing money for me, and he pointed out that it was for him.

If you want an incentive for a tie breaker situation, consider this: Putting money in a Roth gives you access to tax free money later. A good scenario may be that you want to move, and you'd like to use the proceeds from your existing house to fund the new house, but trying to do so can be very stressful. It can also put you in a bad negotiating position, having to take a low offer for your house or having to pass on the house you want to move to because yours isn't sold yet. But with a good Roth balance, you can fund the new purchase the new house with those funds. If you are able to time the sale right, I think you can even put the money back into a Roth within 60 days. If not, at least the money is in taxable where you can take advantage of QDiv and LTCG rates, and stepped up basis for heirs.

The counter to this is that assisted/memory living expenses can be mostly deducted tIRA withdrawal income. For those of you with multi-million $ IRA accounts, you probably will still have plenty of money in those accounts after conversions to pay for LTC so you can still do healthy conversions. If you want to.

It's more than "bonus points". It's real money, and in some situations having it in a Roth gives you a lot more leverage.

 

[CardsFan]

Sorry you think I roasted you. I explained a few posts later why I made the point I did.

I also agree that for many of us, conversions won't move the needle that much. But I'm reminded of a recent discussion I had with my son that $25K wasn't life changing money for me, and he pointed out that it was for him.

If you want an incentive for a tie breaker situation, consider this: Putting money in a Roth gives you access to tax free money later. A good scenario may be that you want to move, and you'd like to use the proceeds from your existing house to fund the new house, but trying to do so can be very stressful. It can also put you in a bad negotiating position, having to take a low offer for your house or having to pass on the house you want to move to because yours isn't sold yet. But with a good Roth balance, you can fund the new purchase the new house with those funds. If you are able to time the sale right, I think you can even put the money back into a Roth within 60 days. If not, at least the money is in taxable where you can take advantage of QDiv and LTCG rates, and stepped up basis for heirs.

The counter to this is that assisted/memory living expenses can be mostly deducted tIRA withdrawal income. For those of you with multi-million $ IRA accounts, you probably will still have plenty of money in those accounts after conversions to pay for LTC so you can still do healthy conversions. If you want to.

It's more than "bonus points". It's real money, and in some situations having it in a Roth gives you a lot more leverage.

No offense taken. Roasted may have been too strong a word.

All your other points above, and others, are why I chose to Roth convert now, below the first IRMAA bracket. And, fortunately, we also fall into the high tIRA category. The best I can hope for is to convert gains, and I have not even kept up with that.

No harm, no foul

 

[Sunset]

One possible answer to the Widow(er) issue of suddenly paying higher tax rates on the total IRA withdrawals for folks that have large IRA's that cannot be converted to less than $1M (example) is:

Will or TOD/POD some portion of the IRA account to young beneficiaries. In many cases they are part of a couple or could be in a few more years and will pay less tax than a 80 yr old Widow(er).

 

[LateToFIRE]

Sorry you think I roasted you. I explained a few posts later why I made the point I did.

I also agree that for many of us, conversions won't move the needle that much. But I'm reminded of a recent discussion I had with my son that $25K wasn't life changing money for me, and he pointed out that it was for him.

If you want an incentive for a tie breaker situation, consider this: Putting money in a Roth gives you access to tax free money later. A good scenario may be that you want to move, and you'd like to use the proceeds from your existing house to fund the new house, but trying to do so can be very stressful. It can also put you in a bad negotiating position, having to take a low offer for your house or having to pass on the house you want to move to because yours isn't sold yet. But with a good Roth balance, you can fund the new purchase the new house with those funds. If you are able to time the sale right, I think you can even put the money back into a Roth within 60 days. If not, at least the money is in taxable where you can take advantage of QDiv and LTCG rates, and stepped up basis for heirs.

The counter to this is that assisted/memory living expenses can be mostly deducted tIRA withdrawal income. For those of you with multi-million $ IRA accounts, you probably will still have plenty of money in those accounts after conversions to pay for LTC so you can still do healthy conversions. If you want to.

It's more than "bonus points". It's real money, and in some situations having it in a Roth gives you a lot more leverage.

"In some situations"... and this is why the debate rages on. Becoming clearer and clearer to me that:

(1) One size does not fit all - some may benefit much more than others

(2) The dollar amount of potential savings may not be significant to some vs others

(3) Whether or not there is a benefit is typically subject to many variables well beyond anyone's control (such as when you die, changes to tax policy, etc.). Of course there are those who can convert at zero tax rates - that's a no-brainer zero cost option. Many of us will never be able to do that - no complaints, first world problem to have.

(4) Roth funds are "tax prepaid" not entirely "tax free" - I think this nomenclature is more accurate (though recognize growth is actually tax-free).

(5) The whole question feels like it has a lot of corollaries to insurance coverage - you pay to hedge your bets. You may or may not come out ahead - but you have capped your risk which has value, just as any hedge has a cost, but also has value by eliminating a certain amount of uncertainty.

As usual, apologize if I've run in and out of rabbit holes in a quest for knowledge. Watching and participating in the discussion has helped immensely in advancing my understanding of the topic!

 

[Gumby]

That's a pretty fair summary of the issue, I would say.

 

[Winemaker]

My other leg of our strategy is convert all of DW's accounts first, while we take modest distributions to be able to BTD. Since we sold the rentals, we reduced the amount of possible investment income the rentals produced by $20k, giving us more headroom to convert.

 

[LateToFIRE]

One possible answer to the Widow(er) issue of suddenly paying higher tax rates on the total IRA withdrawals for folks that have large IRA's that cannot be converted to less than $1M (example) is:

Will or TOD/POD some portion of the IRA account to young beneficiaries. In many cases they are part of a couple or could be in a few more years and will pay less tax than a 80 yr old Widow(er).

Thanks for the idea, but I don't think it addresses the problem of the widow(er) forced to take RMD's while being pushed into a significantly higher tax bracket as a result of becoming a single-tax-filer. I'm still thinking thru the widow(er) scenario - have to admit had not given it much thought.

Related thought tangent:

In addition to the tax hit, the loss of income due to SS/pension hit could be quite significant. If we live into our 90's, there's about $3M of combined SS/pension benefits we'd receive. If I get hit by the proverbial bus in my "prime" FIRE years, that's about a $1.3M loss of benefits (even assuming DW's SS benefit is stepped up to mine).

This begs the question - Is there a place for life insurance in retirement? I was planning to cancel all of mine upon retirement, think DW would still be fine, but might rethink that. Could be worth a new thread.

 

[Gumby]

Thanks for the idea, but I don't think it addresses the problem of the widow(er) forced to take RMD's while being pushed into a significantly higher tax bracket as a result of becoming a single-tax-filer. I'm still thinking thru the widow(er) scenario - have to admit had not given it much thought.

Related thought tangent:

In addition to the tax hit, the loss of income due to SS/pension hit could be quite significant. If we live into our 90's, there's about $3M of combined SS/pension benefits we'd receive. If I get hit by the proverbial bus in my "prime" FIRE years, that's about a $1.3M loss of benefits (even assuming DW's SS benefit is stepped up to mine).

This begs the question - Is there a place for life insurance in retirement? I was planning to cancel all of mine upon retirement, think DW would still be fine, but might rethink that. Could be worth a new thread.

I think it would be a great thread of its own. If you start it, I'll respond. I gave a great amount of thought to this issue and how to deal with it before we retired.

 

[ncbill]

Roth conversions are ultimately hedges since we can't know precisely the future vis a vis tax rates or other factors.

 

[Koolau]

"In some situations"... and this is why the debate rages on. Becoming clearer and clearer to me that:

(1) One size does not fit all - some may benefit much more than others

(2) The dollar amount of potential savings may not be significant to some vs others

(3) Whether or not there is a benefit is typically subject to many variables well beyond anyone's control (such as when you die, changes to tax policy, etc.). Of course there are those who can convert at zero tax rates - that's a no-brainer zero cost option. Many of us will never be able to do that - no complaints, first world problem to have.

(4) Roth funds are "tax prepaid" not entirely "tax free" - I think this nomenclature is more accurate (though recognize growth is actually tax-free).

(5) The whole question feels like it has a lot of corollaries to insurance coverage - you pay to hedge your bets. You may or may not come out ahead - but you have capped your risk which has value, just as any hedge has a cost, but also has value by eliminating a certain amount of uncertainty.

As usual, apologize if I've run in and out of rabbit holes in a quest for knowledge. Watching and participating in the discussion has helped immensely in advancing my understanding of the topic!

I like your summary. It does help to clarify. Thanks.

 

[Koolau]

Thanks for the idea, but I don't think it addresses the problem of the widow(er) forced to take RMD's while being pushed into a significantly higher tax bracket as a result of becoming a single-tax-filer. I'm still thinking thru the widow(er) scenario - have to admit had not given it much thought.

Related thought tangent:

In addition to the tax hit, the loss of income due to SS/pension hit could be quite significant. If we live into our 90's, there's about $3M of combined SS/pension benefits we'd receive. If I get hit by the proverbial bus in my "prime" FIRE years, that's about a $1.3M loss of benefits (even assuming DW's SS benefit is stepped up to mine).

This begs the question - Is there a place for life insurance in retirement? I was planning to cancel all of mine upon retirement, think DW would still be fine, but might rethink that. Could be worth a new thread.

Yeah, I have been thinking a LOT about the widow(er) situation of late. Looking down the double barrel of 77 puts a new urgency on it for me. I'm w*rking on my "upon-my-death" book as well as trying to clean up my life insurance plans. I made some mistakes back in the day and hope I can rectify them before "the need arises" as the insurance companies would say.

 

[Koolau]

I think it would be a great thread of its own. If you start it, I'll respond. I gave a great amount of thought to this issue and how to deal with it before we retired.

Yeah, I'm in too. I have a couple of universal policies that are about to explode on me and I need to know how to proceed. My life (or it's end) is becoming a very good bet against the insurance companies. How to play that at the big "casino in the sky" is a major issue to me right now.

 

[Sunset]

Thanks for the idea, but I don't think it addresses the problem of the widow(er) forced to take RMD's while being pushed into a significantly higher tax bracket as a result of becoming a single-tax-filer. I'm still thinking thru the widow(er) scenario - have to admit had not given it much thought.

Related thought tangent:

In addition to the tax hit, the loss of income due to SS/pension hit could be quite significant. If we live into our 90's, there's about $3M of combined SS/pension benefits we'd receive. If I get hit by the proverbial bus in my "prime" FIRE years, that's about a $1.3M loss of benefits (even assuming DW's SS benefit is stepped up to mine).

....

By thinking of it as $1.3 million, it sounds like a problem to be solved.
I'm not sure of your numbers, but for discussion say the widow(er) has a family SS drop of $40K per year.

Probably in this case close to 20% of it is taxable (rough estimate), so the real purchasing drop is $32K.

There is some savings by being single vs couple in expenses, maybe 25% savings overall, so on 100K spending per year that would be $25K.

The total decrease would amount to $7K, which for many folks can be made up by simply spending extra savings over the next 20 years of lifespan remaining, (using est age at 80 when death occurs).

 

[audreyh1]

You can have other beneficiaries in addition to or besides the spouse on an IRA. It can be used to help manage the RMD issues after a spouse’s death. Just needs to be looked at as part of the big picture.

 

[carty1]

Roth or No Roth

"In some situations"... and this is why the debate rages on. Becoming clearer and clearer to me that:

(1) One size does not fit all - some may benefit much more than others

(2) The dollar amount of potential savings may not be significant to some vs others

(3) Whether or not there is a benefit is typically subject to many variables well beyond anyone's control (such as when you die, changes to tax policy, etc.). Of course there are those who can convert at zero tax rates - that's a no-brainer zero cost option. Many of us will never be able to do that - no complaints, first world problem to have.

(4) Roth funds are "tax prepaid" not entirely "tax free" - I think this nomenclature is more accurate (though recognize growth is actually tax-free).

(5) The whole question feels like it has a lot of corollaries to insurance coverage - you pay to hedge your bets. You may or may not come out ahead - but you have capped your risk which has value, just as any hedge has a cost, but also has value by eliminating a certain amount of uncertainty.

As usual, apologize if I've run in and out of rabbit holes in a quest for knowledge. Watching and participating in the discussion has helped immensely in advancing my understanding of the topic!

Absolutely correct!

 

[pb4uski]

...(4) Roth funds are "tax prepaid" not entirely "tax free" - I think this nomenclature is more accurate (though recognize growth is actually tax-free). ...

Please elaborate on how Roth funds are not tax free and provide an example of how Roth funds ever result in taxes. What you wrote doesn't make sense to me.

Unless perhaps you're saying that they are tax-prepaid because taxes were already paid on the income used to make those Roth contributions. But the same could be said for tax free municipal bonds bought from taxed income. Are you suggesting that we call them tax-prepaid instead of tax-free?

I think your tax-prepaid is an unhelpful mischaracterization. Taxable, tax-deferred and tax-free are all attributes applied prospectively.

 

[LateToFIRE]

Please elaborate on how Roth funds are not tax free and provide an example of how Roth funds ever result in taxes. What you wrote doesn't make sense to me.

Unless perhaps you're saying that they are tax-prepaid because taxes were already paid on the income used to make those Roth contributions. But the same could be said for tax free municipal bonds bought from taxed income. Are you suggesting that we call them tax-prepaid instead of tax-free?

I think your tax-prepaid is an unhelpful mischaracterization. Taxable, tax-deferred and tax-free are all attributes applied prospectively.

Yes, what I meant was that taxes have already been paid on the $$$ used to fund a Roth. Folks have been referring to Roth conversions has creating "tax-free" funds, and that seems misleading to me. The taxes have simply been pre-paid (granted in some cases funds may have been converted at zero-tax, in which case the funds are truly tax-free"). I recognize that the growth (gains, dividends) in the Roth account is actually tax-free.

So, really what most people will have in a Roth account is a blend of tax-prepaid and tax-free funds. Maybe a good nomenclature would be "tax-advantaged" [or "tax-hedged"]. But, you're more of an expert on this than I am, and I certainly do not want to cause confusion - just trying to make sense of it all and the "tax-free" descriptor was really throwing me off.

 

[pb4uski]

Yeah, I don't know of anyone other than you that refers to Roth as tax-prepaid or tax-advantaged, always just tax-free and I think that your characterizations are unhelpful, misleading and create unnecessary confusion for the uninitiated and I hope you just let it go

In all cases, taxable, tax-deferred and tax-free refer to the tax status of income in those accounts. To refer to income and growth from assets in a Roth as tax-free is also consistent with characterizing municipal bonds income as tax-free.

IOW, this stuff is complex enough as it is without people making things up. Sorry.

 

[LateToFIRE]

By thinking of it as $1.3 million, it sounds like a problem to be solved.
I'm not sure of your numbers, but for discussion say the widow(er) has a family SS drop of $40K per year.

Probably in this case close to 20% of it is taxable (rough estimate), so the real purchasing drop is $32K.

There is some savings by being single vs couple in expenses, maybe 25% savings overall, so on 100K spending per year that would be $25K.

The total decrease would amount to $7K, which for many folks can be made up by simply spending extra savings over the next 20 years of lifespan remaining, (using est age at 80 when death occurs).

A bit hard to follow your numbers (that's on me not you) but I think I got the gist of it. Basically, you're suggesting I think in terms of after-tax figures, and also account for the fact that expenses are likely to drop materially for a single vs couple.

 

[LateToFIRE]

Yeah, I don't know of anyone other than you that refers to Roth as tax-prepaid or tax-advantaged, always just tax-free and I think that your characterizations are unhelpful l, misleading and create unnecessary confusion for the uninitiated and hope you just let it go

In all cases, taxable, tax-deferred and tax-free refer to the tax status of income. To refer as income and growth from assets in a Roth as tax-free is also consistent with characterizing municipal bonds income as tax-free.

Hmmm, I see. I don't love the accounting convention, but recognize the need for consistency. At least I understand the definitions now. Thx

 

[RunningBum]

Yes, what I meant was that taxes have already been paid on the $$$ used to fund a Roth. Folks have been referring to Roth conversions has creating "tax-free" funds, and that seems misleading to me. The taxes have simply been pre-paid (granted in some cases funds may have been converted at zero-tax, in which case the funds are truly tax-free"). I recognize that the growth (gains, dividends) in the Roth account is actually tax-free.

So, really what most people will have in a Roth account is a blend of tax-prepaid and tax-free funds. Maybe a good nomenclature would be "tax-advantaged" [or "tax-hedged"]. But, you're more of an expert on this than I am, and I certainly do not want to cause confusion - just trying to make sense of it all and the "tax-free" descriptor was really throwing me off.

My point was that if it looks like you'll pay the same tax rate for a Roth conversion now vs. a tIRA withdrawal later, many people say it's not worth the bother. But if you do those conversions annually and build up a large Roth IRA balance, if you need a large sum at a later point, the Roth IRA withdrawal transaction is tax free. But if you have to take it out of your tIRA, that transaction is taxed and for a large amount the tax rate is likely to be much larger.

Everyone realizes that your Roth IRA is made up of contributions you made post-tax, or taxable conversions from a tIRA. I don't think we really need a caveat reminder that Roth withdrawals, while tax-free, are only so because the tax was previously paid. I can agree that a Roth IRA is a tax-advantaged accounts, but withdrawals from that account are tax-free.

 

[LateToFIRE]

My point was that if it looks like you'll pay the same tax rate for a Roth conversion now vs. a tIRA withdrawal later, many people say it's not worth the bother. But if you do those conversions annually and build up a large Roth IRA balance, if you need a large sum at a later point, the Roth IRA withdrawal transaction is tax free. But if you have to take it out of your tIRA, that transaction is taxed and for a large amount the tax rate is likely to be much larger.

Everyone realizes that your Roth IRA is made up of contributions you made post-tax, or taxable conversions from a tIRA. I don't think we really need a caveat reminder that Roth withdrawals, while tax-free, are only so because the tax was previously paid. I can agree that a Roth IRA is a tax-advantaged accounts, but withdrawals from that account are tax-free.

Ok, I get it. Thx

 

[JDARNELL]

My other leg of our strategy is convert all of DW's accounts first, while we take modest distributions to be able to BTD. Since we sold the rentals, we reduced the amount of possible investment income the rentals produced by $20k, giving us more headroom to convert.

What is the rational of converting DWs account first?