Become Hi and Lois' Financial Advisor

[junkanoo]

Hi and Lois both turn 65 in 2026. She retired at 62 and he retired at 63. They made good use of their tax-deferred accounts through the years, but are now concerned that the only Roth assets they have come from a Roth conversion they did last year. They have $1 million in a taxable account, largely through an inheritance. They don’t expect any other inheritances to come their way. They have a combined $1,800,000 in T-IRA assets, having converted everything from their 403b/401k plans.

Lois took SS at 62, currently receives $20K ($17K taxable) and Hi is waiting until 70 to take his, thus maxing out survival benefits and allowing them the ability to do Roth conversions.
Lois has a $70,000 teacher pension that didn’t merit an increase this year (based on her state’s formula) and Hi has a $3,000 fixed pension from a prior job. They supplement that $93,000 of income with LTCG sales of 60K for a total of $150,000 of MAGI/AGI (the same in their situation). They live in a state without income tax and don’t see themselves ever leaving. They have four children who will equally inherit the remainder of their tax-deferred assets, and all their children make a modest income each year. They do not consider themselves charitably minded, believing that charity begins in the home.

Lois doesn’t have their old tax returns or pay stubs, but she guesses that their pre-2018 tax-deferred savings saved them either 25% or 28%, so she averaged the middle (26.5%). For the years 2018 through 2024 (when she retired) their savings were 23% (some years maybe 24% and some years 22%). So, her best guess is that their fully blended rate is 25%. Note: the tax savings each year were invested in stocks that didn’t pay dividends and earned the same as their tax-deferred accounts through the years. Lois paid their taxes last year from their taxable account and expects to do that for the foreseeable future.

Lois put a simple spreadsheet together to compare this year to last year, reasoning that the additional senior standard deduction and the Senior Deduction (since they are turning 65 this year) might make a difference in the analysis. She didn’t bother changing her SS income, as her payout is small and wouldn’t change the analysis.

Hi and Lois (both 64 in 2025) Roth Conversion - ACTUALS
AGI	Taxable Income	Roth Conversion	Federal Taxes 2025	Effective Tax Rate	Incremental Taxes over Base Case	Incremental Taxes/Roth Conversion
$ 150,000	$ 118,500	$ -	$ 9,813	8.28%​	None	N/A
$ 200,000	$ 168,500	$ 50,000	$ 22,698	13.47%​	$ 12,885	25.77%​
Hi and Lois (both 65 in 2026) Roth Conversion Evaluation
AGI	Taxable Income	Roth Conversion	Federal Taxes 2026	Effective Tax Rate	Incremental Taxes over Base Case	Incremental Taxes/Roth Conversion
$ 150,000	$ 102,500	$ -	$ 5,144	5.02%​	None	N/A
$ 200,000	$ 158,500	$ 50,000	$ 20,264	12.78%​	$ 15,120	30.24%​

Lois reasoned that doing a $50K Roth conversion last year, when that conversion cost 25.77%, might not be a clear win, but was worth doing as it serves as a hedge against possible future tax rate increases and/or one of them dying earlier than expected.

Noticing that doing another $50K Roth conversion this year would cost $15,120 (30.24%) or a full 5 percent more than her deferred savings of 25%, Lois wonders whether the better answer is not to do a Roth conversion and have that $15K continue to make money for them in their taxable account.

However, Lois keeps hearing about the value of Roth conversions and fears missing out. She decides to ask you - her trusted financial advisor - to help her decide. Please do so. What would you recommend and why?

 

[Koolau]

30% tax for a conversion seems too hight to possibly pay off down the road though who knows about future taxes?

 

[TheWizard]

I'd recommend a more detailed spreadsheet, one column per year, going out until they are both 75 or older.

The spreadsheet should total up their projected AGI from all sources. If there's a big jump in projected AGI when RMDs start, that means that Roth conversions in the years prior to RMDs are justified.

So then go back and add in Roth conversions each year at some moderate level and see what happens.

This will be an imperfect exercise since we cannot know what the annual returns on investments will be. So the spreadsheet and the determination of how much to Roth convert gets updated each year.

Note: definitely do NOT Roth convert so much in one year that your marginal tax rate gets higher than you expect at age 75 under current tax law...

 

[TheWizard]

Note: error in OP. Column 3 labeled Roth Contribution, should be Roth Conversion...

 

[old medic]

Seems similar to our situation, but no taxable account. We have room for $48.5K conversions each year at the cost of $6K extra tax (12%) a year. We are paying that out of withholding from pension, so the full conversion goes in. This now creates a tax-free bucket for our enjoyment now or a tax-free fund for our kids grand kids and hopefully be around for Great grandkids.
Also consider that as time goes by, the tax deferred may grow and now have to pay tax on more moneys than you started with.

 

[planuntilthefisthits]

"Hi and Lois both turn 65 in 2016." Your first sentence.

"Hi and Lois (both 64 in 2025)" Your first table entry.

Sorry, but that is the limit of my financial advice.

 

[TheWizard]

30% tax for a conversion seems too hight to possibly pay off down the road though who knows about future taxes?

I think that high marginal rate is due to the phase-out or phase-down of two things:
1) the 0% LTCG rate going to 15%
2) the $6000 senior deduction going to a lower value

So yes, it's possible to contrive a situation where your actual marginal rate is higher than your top tax bracket.

But in my case, for example, I'm fully phased out of both of those tax breaks, filing single with AGI around $190k with no Roth conversion. Adding a Roth conversion of $15k gets taxed at a true 24% marginal rate and avoids the next higher IRMAA tier...

 

[SevenUp]

A few things to get started:

1. They should ignore whatever marginal tax rate they saved in the past. That doesn't matter. What does matter is the marginal rate they would incur this year compared with what they expect that rate will be in future years.
2. What is their taxable basis? In other words, how much more than the $60K in LTCG did they sell for living expenses?
3. What is their expected annual living expense going forward?

 

[Al18]

I plugged your income into the 1040 tax calculator, and all your numbers are correct, except for the effective tax rate for 2026. which is 10.13%

You are loosing some of the 6K per person over 65 tax break, because your taxable income is $158,500 or $8,500 over the limit. If you reduced your LTCG from $60K to $50K (by carefully choosing those taxable stocks/funds to sell that did not appreciate as much), then your AGI would be $190K, taxable $147.3K your total Federal tax would be $18,443 which is an effective tax rate of 9.71%.

I would do the Roth IRA conversion, because it will likely reduce your taxes over your lifetime. I would use a tax calculator that project your taxes until age 90 or higher. You'll see the tax savings really kick in when your are required to do RMD at age 75.

 

[TheWizard]

A few things to get started:

1. They should ignore whatever marginal tax rate they saved in the past. That doesn't matter. What does matter is the marginal rate they would incur this year compared with what they expect that rate will be in future years.
2. What is their taxable basis? In other words, how much more than the $60K in LTCG did they sell for living expenses?
3. What is their expected annual living expense going forward?

I particularly agree with #1.
But #3 doesn't matter to everyone; my income (including RMD) generally exceeds my expenses by a fair amount.

What matter more to some of us is: are you living with a modest tax rate in early retirement only to see it increase significantly in later years when all retirement income streams are active...

 

[SevenUp]

They have $1 million in a taxable account

How much separate amounts of interest, non-qualified dividends, and qualified dividends does that generate?

 

[SevenUp]

3. What is their expected annual living expense going forward?

But #3 doesn't matter to everyone....

Yes. As their financial advisor, however, I'm checking on the realism of their aspirations.

 

[pb4uski]

To assess the wisdom of future Roth conversions, Hi and Lois are looking at the wrong thing when they compare the current tax cost of Roth conversions with ~25% that they saved in taxes when they deferred that income. The 25% is relevant to the decisito defer income but isn't relevant to the decision to do Roth conversions.

What Hi and Lois need to do is to compare the ~30% incremental tax rate of Roth conversions with the incremental tax rate of RMDs when they turn 73. Let's say that they don't do Roth conversions and the tIRAs grow at 7% a year for 8 years (73-65). The $1.8m in tIRAs today would be $3,093k and the RMD would be $117k ($3,093k/26.5 RMD factor for age 73). That RMD, once added to Lois' pension, Hi's pension and 85% of their combined SS, will likely put them in a much higher tax bracket... such that the incremental tax rate on the RMD will be much more than the ~30% that the Roth conversion would cost.

I don't think that your numbers for 2026 are correct Go to IRS & State Tax Calculator | 2005 -- 2025. I input 2026, both over 65, $73,000 of wages (for the pensions. uncheck the SS and medicare tax boxes to the right) and $20,000 of SS and $57,000 of LTCG. I get $150,000 of total income and $99,600 of taxable income after the standard deduction for a 65 yo couple and the 65+ deduction and a tax of $4,721 (12% marginal bracket).

If I then add $50,000 of Roth conversions (in the unearned income input box) the resulting tax is $18,221. The $13,500 difference in tax divided by the $50,000 Roth conversion is an incremental tax on the Roth conversion of 27%.

However, if you were currently subject to RMDs then your $1,800k of tIRA would result in a $67,924 RMD. If you did a $67,924 Roth conversion this year the tax would be $22,289, the incremental tax would be 25.9%.

I think what is happen is that Roth conversions are pushing LTCG from 0% to 15% in addition to being taxed at 12% and that is the reason that the incremental tax is 27% (12% + 15%). The 25.9% rate is because once all LTCG have been pushed into 15%, and additional Roth conversons are at 22% and the 25.9% is a blend of 27% and 22%.

I have a feeling that if you do a projection of age 73 taxes on RMDs with and without Roth conversions that you will find it is somewhat beneficial as your income and tax rates will be higher at age 73 because of Hi's SS, Lois' spousal SS benefit if applicable and growth in the tIRA resulting in much higher RMDs. For example, if you did no Roth conversions and the $1,800k tIRA grew at 7% annually for 8 years (73-65) it would be $2,890k and the RMD would be $109k on top of all their other income.

ETA: I don't think that IRS & State Tax Calculator | 2005 -- 2025 properly phases out the 65+ deduction for higher oncomes so you may want to use TT's What-If worksheet or some other tax calculator. That will change the numbers but is unlikely to change the conclusion that Roth conversions are likely somewhat beneficial for Hi and Lois.

Best approach is to do a spreadsheet projection of income, deductions, RMDs, etc. Don't forget to adjust the standard deduction and tax brackets for inflation.

 

[junkanoo]

I plugged your income into the 1040 tax calculator, and all your numbers are correct, except for the effective tax rate for 2026. which is 10.13%

The number is correct, just different. I'm using Taxable Income and your calculator is using AGI. I agree with the Tax Institute on this ... usually best to evaluate your tax rate based on Taxable Income, not on including income that is not taxed.

 

[sakowitzm]

Hi and Lois seem like excellent candidates for Retiree Portfolio Model (https://www.bogleheads.org/wiki/Retiree_Portfolio_Model) where they or their advisor can plug and play all kinds of scenarios.

 

[Al18]

I used the Dinkytown 1040 Tax calculator and quoted the effective tax rate directly off their page.

 

[junkanoo]

A few things to get started:

1. They should ignore whatever marginal tax rate they saved in the past. That doesn't matter. What does matter is the marginal rate they would incur this year compared with what they expect that rate will be in future years.
2. What is their taxable basis? In other words, how much more than the $60K in LTCG did they sell for living expenses?
3. What is their expected annual living expense going forward?

1. Lois has zero interest in what she thinks her marginal tax rate will be in the future nor what the so-called experts think. You know, those experts that predicted that tax rates would only go up before the Tax Laws of 2017. Said another way, if she can pay taxes now that break close to even (or better) compared to the rate/savings when she deferred, she will do that, otherwise, she is closing her purse to paying additional taxes (on Roth Conversions) on some shaky forecast of the future.

2. Zero. They have no capital losses to offset and that 60K meets their spending needs.

3. Good question. With a paid off house (with a new roof), they expect that Hi's (estimated) 70K SS at age 70 will offset the need to pull anything from their taxable account beyond perhaps a couple K to pay increased taxes on that 85% on ordinary income (all else being the same). They do have some concerns about end-of-life medical expenses, but believe that (if needed) pulling those from their T-IRA account will be very tax-efficient. Even if they're wrong, they believe that living within their means and 20 years of growth on that $1M will offset additional contingencies.

 

[target2019]

Hi and/or Lois could plug numbers into popular calculators, and test their results with/without Roth conversion, over the desired time frame.

I use Flexible Retirement Planner as a gut check, and was just looking at the effect of Roth Conversion or not over 25 year period.

 

[Al18]

Does Hi or Lois have any taxable lots with less LTCG, as I mentioned above?

 

[pb4uski]

1. Lois has zero interest in what she thinks her marginal tax rate will be in the future ...

If that's the case then Lois is looking at the wrong things in deciding whether it is beneficial to do Roth conversions now or in the near future, so unfortunately, we can't be of any help to her.

The only reason to do Roth conversions now is if the tax cost now, measured by the incremental tax rate on conversions, is the same or less than either the expected incremental tax rate on future RMDs or the incremental tax rate on withdrawals by beneficiaries who inherit said tIRAs.

 

[junkanoo]

I don't think that your numbers for 2026 are correct Go to IRS & State Tax Calculator | 2005 -- 2025. I input 2026, both over 65, $73,000 of wages (for the pensions. uncheck the SS and medicare tax boxes to the right) and $20,000 of SS and $57,000 of LTCG. I get $150,000 of total income and $99,600 of taxable income after the standard deduction for a 65 yo couple and the 65+ deduction and a tax of $4,721 (12% marginal bracket).

If I then add $50,000 of Roth conversions (in the unearned income input box) the resulting tax is $18,221. The $13,500 difference in tax divided by the $50,000 Roth conversion is an incremental tax on the Roth conversion of 27%.

Running out of time for today, so can't address everything .... but @Al18 confirms that he got the same tax as I got. I'm using the Case Study Spreadsheet, he used Dinkytown.

LTCGs were 60K not 57K. 20K of SS does not apply to AGI, only 85% of SS (17K).

For a couple, both 65+, 150,000 AGI - 35,500 (standard 65+ deduction) - 12,000 (Senior Deduction) = $102,500 of Taxable Income in 2026 ... not 99,600.

 

[TheWizard]

1. Lois has zero interest in what she thinks her marginal tax rate will be in the future nor what the so-called experts think. You know, those experts that predicted that tax rates would only go up before the Tax Laws of 2017. Said another way, if she can pay taxes now that break close to even (or better) compared to the rate/savings when she deferred, she will do that, otherwise, she is closing her purse to paying additional taxes (on Roth Conversions) on some shaky forecast of the future...

Sounds like Lois is saying Don't let the tax tail wag the horse.

That's fine. Not everyone is concerned about making modest improvements to their tax situation in coming years. She won't be the first...

 

[SevenUp]

They have $1 million in a taxable account, largely through an inheritance.

1. Lois has zero interest in what she thinks her marginal tax rate will be in the future....

Then she might as well use coin-flipping and dart-throwing to judge whether, and if so, how much to Roth convert.

2. Zero [basis in the taxable account]. They have no capital losses to offset and that 60K meets their spending needs.

That's inconsistent with the basis step-up that comes with inheritance.

3. Good question. With a paid off house (with a new roof), they expect that Hi's (estimated) 70K SS at age 70 will offset the need to pull anything from their taxable account beyond perhaps a couple K to pay increased taxes on that 85% on ordinary income (all else being the same). They do have some concerns about end-of-life medical expenses, but believe that (if needed) pulling those from their T-IRA account will be very tax-efficient. Even if they're wrong, they believe that living within their means and 20 years of growth on that $1M will offset additional contingencies.

Without the large amount of LTCG that leads to a 27% marginal tax rate in some zone, and if they are past the $6K/person senior deduction phase-out, they may be subject only to ~24% tax rate after age 75.

If so, that reduces the impetus for Roth conversions now at higher marginal rates.

 

[pb4uski]

You'll need to model it out but if they don't do any Roth conversions now then I'm thinking that they're going to get hosed when RMDs start due to:

1. 7 years of growth of the tIRA that exceeds the increases in tax brackets and the standard deduction and
2. 85% of HI's SS pushing them into higher tax brackets.

 

[Al18]

I used $60K LTCG and a RMD of $117K in the dinkytown calculator. Assumed the $6K over 65 tax cut per person is still in effect and no more Roth IRA conversions are done in 2026 or later, as detailed in post #14. Dinkytown says your a AGI will be $267K, taxable income will be $231.5K and your federal tax will be $36,800 the first year you take RMD's and you’ll be in the 22% tax bracket. Your federal taxes will continue to increase every year afterwards.