ACA/Roth conversion dance--pls advise

[tmitchell]

I'm 57 and looking to optimize Roth conversions and ACA subsidies, since without subsidies a Bronze HSA is $850/mo. Yikes. This is the first year I'm not earning a salary, and I'm looking for advice to see if I'm thinking about this correctly. No kids, so leaving money behind isn't a goal.

Current IRA assets: $480k
Current income: appx $42k/yr.

To stay in the 12% tax bracket I'd only be able to convert about $11k/yr to remain under $54k/yr subsidy cliff and would pay $550 for Bronze HSA instead. Federal tax would be under $1k if my calculations are correct.

I ran a future value calculator on Investor.gov with 5% +/- 1% interest taking out 11k/yr and I still end up with over $700k in future assets. This may be an overestimate since I hold bond index in the 401k, but it still seem like a lot for RMDs.

I don't quite understand if this strategy would change when I start Medicare so would appreciate advice on that as well.

 

[PaunchyPirate]

I am in a very similar category to you. Retired at 56 (now 61), single, no children. No income other than what my investments earn. I choose to maximize my ACA subsidy to keep my health insurance affordable so I am largely delaying Roth conversions until I reach 65 when I can switch from ACA to Medicare. Since I retired, I have converted only $7500 from my IRA to my Roth IRA. I hope to convert more from 65 onward and will delay social security as long as I can in order to give me more conversion space in the lower tax brackets. For now, though, I choose to focus on ACA subsidies over Roth Conversion.

 

[RetiredAndLovingIt]

I'm doing the same as Paunchy. I keep my taxable income extremely low in order to qualify for my Silver plan which has a very low copay and deductible and costs me under $150 a month. I live off my savings which does not impact my income and my max Roth Conversion is about 15K-20K a year. I go to Medicare next month so I will bump it up a little bit this year and will have to pay some subsidy back at tax time but that's okay. Starting next year I will convert to the top of the 12% bracket and delay social security for a few more years while I figure this all out.

 

[anethum]

There are a lot of moving parts in the calculation which you have to take into account, including when you intend to start Social Security. I FIRE'd when I was 57 and was initially on COBRA, then on the ACA as soon as it began. In the early years on the ACA, my premiums were reasonable and a tax subsidy wasn't a major concern. But after age 60, my premiums jumped substantially. IIRC, at age 64 the full price for my Bronze PPO was $1,385/month. By keeping my MAGI under the 400% of federal poverty level cliff, I got a premium tax subsidy of about 50%. That was a tax subsidy of more than $8,000/year so it was a no-brainer. When my ACA premiums had been much lower, I did a lot of capital gains harvesting at the 0% federal tax rate and smaller Roth conversions. No pension, and 100% of my income was/is from my investments. I won't start Social Security until next year when I turn 70.

Health insurance under Medicare is much cheaper for me than the ACA, and I don't have to worry about going over a tax subsidy cliff. I'm still doing Roth conversions.

 

[djsander]

We do some Roth conversions to stay above medicaid and get a good subsidy. Like previous posters said we have a fairly good cash account so we don’t have to pull from retirement accounts. I try to keep our taxable income around 45k and I get a completely subsidized gold plan with a $500 or $750 deductible depending on where I land on the income range. The wife is already on Medicare. I’ve got another 1-1/2 years. It’s one of those things on how much you want to optimize between the subsidies and paying taxes. Some people say if you use Turbotax use it and set up an additional return and work with the numbers to see the different taxes and such. I am shooting for a low or close to zero premium so I know about what income that will take. Our state exchange lets you “see” what you are eligible for without setting up an account or logging in. Makes it easy to input different incomes and then check the plans and costs.

 

[pb4uski]

....I ran a future value calculator on Investor.gov with 5% +/- 1% interest taking out 11k/yr and I still end up with over $700k in future assets. This may be an overestimate since I hold bond index in the 401k, but it still seem like a lot for RMDs.

I don't quite understand if this strategy would change when I start Medicare so would appreciate advice on that as well.

If you have $700k later, your RMDs would only be $28k in the first year (4% IIRC). What tax bracket do you expect to be in before RMDs?

 

[Exchme]

There is no "subsidy cliff" for the next couple of years. Once you reach 4 X FPL, your premium credit is reduced by 8.5% per dollar of MAGI. Below is the ramps used to reduced the premium credit through 2025:

Income up to 150% of poverty = 0% (ie, the subsidy is enough to make the benchmark plan premium-free)
150% to 200% of poverty = 0% to 2%
200% to 250% of poverty = 2% to 4%
250% to 300% of poverty = 4% to 6%
300% to 400% of poverty = 6% to 8.5%
400% of poverty or higher = 8.5%

Because of the ramps, doing any Roth Conversions will incur greater than a 12% marginal tax cost. The other tripwire to watch for is the point where Qualified Dividend/LTCG taxes are phased-in. For singles, that is an AGI of $58525. In the zone where LTCG taxes are phased-in, each $ of Roth would cost you the 12% ordinary income tax, 15% LTCG tax and the reduction in the premium credit.

Given the moderate size of the t-IRA and the size of the available ACA premium credits, I doubt there is a benefit to doing Roth Conversions for now.

 

[SevenUp]

I'm 57 and looking to optimize Roth conversions and ACA subsidies....

Roth Conversion and Capital Gains On ACA Health Insurance discusses this.

I don't quite understand if this strategy would change when I start Medicare so would appreciate advice on that as well.

And Roth Conversion with Social Security and Medicare IRMAA discusses this.

 

[topnotcher]

There is no "subsidy cliff" for the next couple of years. Once you reach 4 X FPL, your premium credit is reduced by 8.5% per dollar of MAGI. Below is the ramps used to reduced the premium credit through 2025:

Income up to 150% of poverty = 0% (ie, the subsidy is enough to make the benchmark plan premium-free)
150% to 200% of poverty = 0% to 2%
200% to 250% of poverty = 2% to 4%
250% to 300% of poverty = 4% to 6%
300% to 400% of poverty = 6% to 8.5%
400% of poverty or higher = 8.5%

Because of the ramps, doing any Roth Conversions will incur greater than a 12% marginal tax cost. The other tripwire to watch for is the point where Qualified Dividend/LTCG taxes are phased-in. For singles, that is an AGI of $58525. In the zone where LTCG taxes are phased-in, each $ of Roth would cost you the 12% ordinary income tax, 15% LTCG tax and the reduction in the premium credit.

Given the moderate size of the t-IRA and the size of the available ACA premium credits, I doubt there is a benefit to doing Roth Conversions for now.

Thank you! Great information.

 

[tmitchell]

If you have $700k later, your RMDs would only be $28k in the first year (4% IIRC). What tax bracket do you expect to be in before RMDs?

With $28k plus dividends/interest with portfolio growth, I imagine I'd end up in (today's) 22%. That's assuming I never earn any more income, which I'm not planning to.

 

[tmitchell]

There is no "subsidy cliff" for the next couple of years. Once you reach 4 X FPL, your premium credit is reduced by 8.5% per dollar of MAGI. Below is the ramps used to reduced the premium credit through 2025:

Income up to 150% of poverty = 0% (ie, the subsidy is enough to make the benchmark plan premium-free)
150% to 200% of poverty = 0% to 2%
200% to 250% of poverty = 2% to 4%
250% to 300% of poverty = 4% to 6%
300% to 400% of poverty = 6% to 8.5%
400% of poverty or higher = 8.5%

Because of the ramps, doing any Roth Conversions will incur greater than a 12% marginal tax cost. The other tripwire to watch for is the point where Qualified Dividend/LTCG taxes are phased-in. For singles, that is an AGI of $58525. In the zone where LTCG taxes are phased-in, each $ of Roth would cost you the 12% ordinary income tax, 15% LTCG tax and the reduction in the premium credit.

Given the moderate size of the t-IRA and the size of the available ACA premium credits, I doubt there is a benefit to doing Roth Conversions for now.

This is great thank you.


@SevenUp I appreciate those links as well and will dig in.

 

[RunningBum]

Be sure to run your own numbers on the ACA credit impact. For my own situation, I found that each $1000 added between 300%-400% ranged from a 14% to 18% ACA subsidy loss.

Treat this like a tax, on top of the direct incremental income tax on each $1000 converted. Some of this is in the 0% tax bracket so I have a 14-18% incremental, then it is in my 10% bracket making a 24-28% bracket. Compare this to what RMDs would do later, which might include IRMAA and pushing more QDivs into being taxed in addition to the marginal regular income tax rate.

 

[pb4uski]

With $28k plus dividends/interest with portfolio growth, I imagine I'd end up in (today's) 22%. That's assuming I never earn any more income, which I'm not planning to.

So in that case I would just Roth convert to the top of the 12% bracket as long as possible. It probably does't make a lot of sense to pay 22% now to avoid paying 22% later.

While I'm sure that you are aware, some will contend that it is ok to pay 22% now because tax rates may increase, current lower 2017 tax act rates may sunset to higher rates, a spouse could die throwing the surviving spouse into a higher tax bracket, heirs may be at more than 22%, etc. and they are all reasonable arguments... just not compelling to me... I'm not sure what to do with them since they are all low probability events.

 

[bobandsherry]

So in that case I would just Roth convert to the top of the 12% bracket as long as possible. It probably does't make a lot of sense to pay 22% now to avoid paying 22% later.



While I'm sure that you are aware, some will contend that it is ok to pay 22% now because tax rates may increase, current lower 2017 tax act rates may sunset to higher rates, a spouse could die throwing the surviving spouse into a higher tax bracket, heirs may be at more than 22%, etc. and they are all reasonable arguments... just not compelling to me... I'm not sure what to do with them since they are all low probability events.

As Roth grows tax free isn't it perhaps better to pay 22% today? Let gains increase the total and then pay no tax on the withdrawal . Not sure where the sweet spot is for average returns.

As I understand it there is also a benefit that Roth is not subject to RMD. So it could be beneficial down the road as well.

 

[pb4uski]

As Roth grows tax free isn't it perhaps better to pay 22% today? Let gains increase the total and then pay no tax on the withdrawal...

No. If the tax rate doesn't change then there is no benefit to Roth conversions... it is totally a tax rate play.

From a different thread but on point:

Not true, but a popular misconception. Let's say that you have $9,500 of income and are in the 22% tax bracket. You can pay $2,090 of tax and put $7,410 in Roth. Let's assume that with investment returns that the Roth doubles in 10 years, then you have $14,820 to spend. Alternatively, you decide to invest the $9,500 in a tax-deferred account and it doubles to $19,000. Once you withdraw the $19,000 and pay 22% tax of $4,180 you have $14,820 to spend.

The tax free growth is only beneficial if the tax rate when withdrawn is higher than the tax rate with the income is deferred... the inverse of the tax benefit of tax deferred funds being where the tax rate when the income is deferred is higher than the tax rate when withdrawn.

With either tax-deferred or tax-free there is only a benefit or detriment if the tax rate changes between contribution and withdrawal.

 

[N02L84ER]

It could still be marginally better to convert even if the tax rates are the same. Taking the $9,500 income now might not throw you into a higher tax bracket or IRMAA level, but if the investment does a lot better than inflation (inflation usually doesn't double within 10 years), then the much larger $19,000 might throw you into a higher tax bracket or IRMAA level but not if you can pull it from the Roth IRA.

 

[pb4uski]

^^^^You are correct, there really is a slight benefit to converting even if tax rates are the same... it is a slight nuance that I omitted from the example to keep it simple, but I'll explain it now.

I'll change the example slighlty to be more realistic. Let's say that you have $10,000 in an IRA and $2,200 in taxable accounts, are in the 22% tax bracket and are considering doing a Roth conversion.

If you do the conversion, you end up with $10,000 in the Roth and $0 in taxable since the $2,200 has been used to pay the tax on the conversion. If the Roth then doubles over 10 years you have $20,000 to spend.

If you don't convert, over the 10 years the IRA doubles to $20,000, but the $2,200 in taxable doesn't because the income is taxed each year. The IRR for something to double over 10 years is 7.18%. However, if 22% of that income goes to pay income taxes, the after-tax growth is only 5.60% and after 10 years the $2,200 in taxable is $3,793 rather than $4,400. So at the end of 10 years when the IRA is withdrawn and the taxes are paid, the person is left with only $19,393 to spend ($20,000 IRA less $4,400 in taxes paid plus $3,793 in the taxable account).

The Roth conversion effectively shelters the taxable account money from future taxes since it ends up in the IRA.

If the tax rate is 12% at inception but 22% after 10 years because other income streams are online then the benefits are even better.

 

[tmitchell]

^^^^You are correct, there really is a slight benefit to converting even if tax rates are the same... it is a slight nuance that I omitted from the example to keep it simple, but I'll explain it now.

I'll change the example slighlty to be more realistic. Let's say that you have $10,000 in an IRA and $2,200 in taxable accounts, are in the 22% tax bracket and are considering doing a Roth conversion.

If you do the conversion, you end up with $10,000 in the Roth and $0 in taxable since the $2,200 has been used to pay the tax on the conversion. If the Roth then doubles over 10 years you have $20,000 to spend.

If you don't convert, over the 10 years the IRA doubles to $20,000, but the $2,200 in taxable doesn't because the income is taxed each year. The IRR for something to double over 10 years is 7.18%. However, if 22% of that income goes to pay income taxes, the after-tax growth is only 5.60% and after 10 years the $2,200 in taxable is $3,793 rather than $4,400. So at the end of 10 years when the IRA is withdrawn and the taxes are paid, the person is left with only $19,393 to spend ($20,000 IRA less $4,400 in taxes paid plus $3,793 in the taxable account).

The Roth conversion effectively shelters the taxable account money from future taxes since it ends up in the IRA.

If the tax rate is 12% at inception but 22% after 10 years because other income streams are online then the benefits are even better.

This is a really helpful example, thank you.

 

[Kings over Queens]

No comment to add, just saying something so I can search and find this thread later. Great info!

 

[tmitchell]

OP here with my decision after running a bunch of scenarios:

From now until Medicare, it seems to make the most sense to convert up to the 12% bracket in order to take advantage of ACA subsidy. I'll save over $400/mo on premiums (assuming no additional income) which basically covers the annual $4850 HSA contribution. If my health needs increase I can switch over to a silver plan which is also heavily subsidized.

From 65-73yrs I'll be able to increase my conversion amounts and get the RMDs down a bit more aggressively. If the taxes are too high from there I'll look at charitable contributions to bring the bill down.

I feel good about this plan since having more at my disposal now while I'm young aligns with my plan to front load spending for travel etc while I know I can enjoy it.

Thanks for all your input!

 

[BeachOrCity]

Just seeing this now.
I literally just did this math about same age in high tax state.
I am married with about 20k+ in unsubsidized price of aca

We get Medicaid up to 200% fpl here, and my income floor from divvies etc is probably over 40k anyway.

When I sampled aca subsidy and state tax from about 50k annual income at various levels all the way to 200k what I came up with was 20% in “taxes” with about 1/2 of that from lost subsidy and 1/2 from state taxes. Ymmv.

So NO WAY would I touch a Roth conversion in my situation. I would even venture that a Roth withdraw might be preferable to selling in taxable or withdraw from 401k as long as I am under 65 and in high tax state. These latter ones if I need cash that is not in cd bonds, unappreciated stock etc.

 

[SecondCor521]

There is no "subsidy cliff" for the next couple of years. Once you reach 4 X FPL, your premium credit is reduced by 8.5% per dollar of MAGI. Below is the ramps used to reduced the premium credit through 2025:

Income up to 150% of poverty = 0% (ie, the subsidy is enough to make the benchmark plan premium-free)
150% to 200% of poverty = 0% to 2%
200% to 250% of poverty = 2% to 4%
250% to 300% of poverty = 4% to 6%
300% to 400% of poverty = 6% to 8.5%
400% of poverty or higher = 8.5%

Because of the ramps, doing any Roth Conversions will incur greater than a 12% marginal tax cost. The other tripwire to watch for is the point where Qualified Dividend/LTCG taxes are phased-in. For singles, that is an AGI of $58525. In the zone where LTCG taxes are phased-in, each $ of Roth would cost you the 12% ordinary income tax, 15% LTCG tax and the reduction in the premium credit.

Given the moderate size of the t-IRA and the size of the available ACA premium credits, I doubt there is a benefit to doing Roth Conversions for now.

Note that the above mentioned "applicable percentages" understate the marginal rate effect. See this article to understand why:

https://seattlecyclone.com/marginal-tax-rates-under-the-aca/

and the updated 2021 version:

https://seattlecyclone.com/aca-premium-tax-credits-2021-edition/

You can work up a tax return in tax preparation software and adding $100 or $1000 of income to see the higher marginal rate effect. RunningBum's experience upthread is typical.

 

[Exchme]

Note that the above mentioned "applicable percentages" understate the marginal rate effect. See this article to understand why:

https://seattlecyclone.com/marginal-tax-rates-under-the-aca/

and the updated 2021 version:

https://seattlecyclone.com/aca-premium-tax-credits-2021-edition/

You can work up a tax return in tax preparation software and adding $100 or $1000 of income to see the higher marginal rate effect. RunningBum's experience upthread is typical.

Yes, the ramps make the marginal rate very high. I had worked it out at a few points, but hadn't seen these kinds of graphs - very cool, thanks for the links.
Since these are additive to the ordinary tax rate, the marginal conversion cost is near 30% for incomes between 250% of FPL and 400% of FPL.

 

[Surewhitey]

I am in a very similar category to you. Retired at 56 (now 61), single, no children. No income other than what my investments earn. I choose to maximize my ACA subsidy to keep my health insurance affordable so I am largely delaying Roth conversions until I reach 65 when I can switch from ACA to Medicare. Since I retired, I have converted only $7500 from my IRA to my Roth IRA. I hope to convert more from 65 onward and will delay social security as long as I can in order to give me more conversion space in the lower tax brackets. For now, though, I choose to focus on ACA subsidies over Roth Conversion.

This is my estimation as well.

Just talking to a slightly older friend thinking about starting SS early and I asked how that would affect his subsidy. He had never thought that far ahead & definitely made him think twice. They're currently paying $0 out of pocket for a $1500 deductible plan with BCBS of TX. They are very happy with it... Still trying to get DW on board and this is her main concern but doesn't believe it is that easy...