Considering Roth Conversion

[mountainsoft]

I am considering converting a portion of my traditional IRA to a Roth IRA, but I'm curious if there are any negatives to doing so. We're planning to retire in 5 years.

To stay within my current 12% tax bracket, I could only convert about 15K per year. If I convert 15K for the next four or five years, I should be able to avoid RMD's by the time I'm 70 (spending down the remainder of my traditional IRA first). I would pay the conversion taxes from my regular savings account.

Is there a best time of year to make the conversion? I was thinking of finishing out this year with my traditional IRA so we could deduct the contributions on our next tax return. Then at the start of next year convert the first 15K, pay my estimated tax, and switch our contributions to the new Roth IRA. Does that sound reasonable?

Honestly, at our income level (55K now, 40K retired), I didn't see a huge incentive to convert to a Roth. We should stay well within the 12% tax bracket through retirement. However, if one of us dies the survivor could end up in the next tax bracket as an individual. So the Roth would help avoid that.

The Roth would also be easier for my daughter to inherit, though I'm not too worried about that. We're hoping to spend it before we die, and she can't complain if she inherits free money.

Since taxes are likely to increase over time, a Roth would help with that too.

I was going to wait until we retired to convert, but thought it might cause issues qualifying for healthcare subsidies. Better to do it now while we still have medical coverage and income to pay the taxes.

I assume I can have both a traditional and Roth IRA at Vanguard and invest in the same funds, as long as my total contributions are under the $6500 limit (for 50+ folks)? Specifically with Vanguard, is it difficult to work with the two different IRA types on their web site?

Anyway, I would love to hear from folks who have made Roth conversions to know what issues you encountered. Do you feel it was worth the trouble?

 

[Huston55]

OP-

Roth conversions while you’re still working make sense to me. However, I think you should do some analysis of your situation for the Post-FIRE to Pre-RMD years. As you’ll see from this thread, capturing LTCGs during those years might be more beneficial for you.

http://www.early-retirement.org/for...-instead-of-doing-roth-conversions-90648.html

 

[FI_RElater]

as Huston mentioned, with such a small conversion and at that low of an income (both now and in (potential) retirement), taking advantage of favorable long term capital gains at 0% should be examined

We did “capital gains harvesting” in the first years of retirement and will now do some Roth conversions but I’ve got a much larger 401k (not yet moved to IRA so as to simplify conversions with both deductible and non-deductible IRA) so will be in higher tax bracket in most of retirement post SS ( we already have pension income plus a large taxable account).

The 8606 is easy to follow... just need to keep up with the values in the various accounts.

 

[pb4uski]

Also consider state income taxes.... if you are subject to state income taxes now but will not in retirement then it may be better to wait. Otherwise you seem to have a good handle on the issues.

 

[mountainsoft]

if you are subject to state income taxes now but will not in retirement then it may be better to wait.

No state income tax here (Washington State) so that's not a concern.

 

[Dtail]

Do you need to manage income for ACA purposes before Medicare at 65?

 

[mountainsoft]

capturing LTCGs during those years might be more beneficial for you.

Never heard of that, but from the little research I did it sounds too complicated. I like to keep things simple, both for me, and for my wife. I also know that our mental capacity will probably decrease as I age, so the simpler the better (thus, avoiding RMD's would help keep things simple).

I only have one fund, VBIAX, in my IRA. I don't pay any attention to the gains and losses, and don't care to. I'm more the set it and forget it type.

In the short term a Roth conversion doesn't seem to offer much advantage for us, but in the long term it could really pay off. It's the transition between IRA types that I'm not sure of.

 

[mountainsoft]

Do you need to manage income for ACA purposes before Medicare at 65?

Yeah, we'll need to keep our income low enough to qualify for subsidies. I've estimated our spending at 40K per year, but I think I read somewhere that Roth conversions count as income which could bump us over the income limit (around 60K I think?).

I've been looking at so much stuff today I can't remember the details now, but it sounded like it would be smarter to make the conversion before we retired if it makes sense to convert.

 

[Dtail]

Yeah, we'll need to keep our income low enough to qualify for subsidies. I've estimated our spending at 40K per year, but I think I read somewhere that Roth conversions count as income which could bump us over the income limit (around 60K I think?).

I've been looking at so much stuff today I can't remember the details now, but it sounded like it would be smarter to make the conversion before we retired if it makes sense to convert.

That is correct. A Roth conversion DOES count for MAGI purposes in calculating subsidies.

Edit - I think the limit for a couple is around 64k.

 

[Huston55]

Never heard of that, but from the little research I did it sounds too complicated. I like to keep things simple, both for me, and for my wife. I also know that our mental capacity will probably decrease as I age, so the simpler the better (thus, avoiding RMD's would help keep things simple).

I only have one fund, VBIAX, in my IRA. I don't pay any attention to the gains and losses, and don't care to. I'm more the set it and forget it type.

In the short term a Roth conversion doesn't seem to offer much advantage for us, but in the long term it could really pay off. It's the transition between IRA types that I'm not sure of.

Understand the desire for simplicity. But, IMO, capturing LTCGs is less complicated than Roth conversions. But, it really only makes sense for you if you have substantial after-tax investments with significant CGs. Best of luck

 

[bingybear]

OP- harvesting capital gains is simple if your income is in the correct range. Note that harvesting capital gains adds to the MAGI for the ACA. If you have realized capital losses these can be good to cancel gains.

I have skipped the ACA subsidies thus far because I see (for me) that the roth conversion is more important in the long run. I am a bit set back that you are leaving assets sitting to pay for years of spending. (maybe this is not really all that odd), but you could keep it invested and sell as you need and still have little derived income.

Roth conversions are not all that bad if you can pay the tax from after tax funds. Last year we converted up to the top of the 15% bracket and paid about 3k in federal taxes. Capital gains were cancelled with carry over losses (+3k of other income), funded a family HSA with catch up, about 50k or so roth conversion(as I recall) and most other earnings were qualified dividends.

Look at your situation as the best choice is very situation dependent. Some focus on near term money and ignore longer term issues.

This is just a new game.

 

[mountainsoft]

I have skipped the ACA subsidies thus far because I see (for me) that the roth conversion is more important in the long run.

We will have healthcare through my wife's employer for the next five years. So it seems smarter to make the conversion now so we don't have to worry about it affecting our healthcare options.

I am a bit set back that you are leaving assets sitting to pay for years of spending. (maybe this is not really all that odd), but you could keep it invested and sell as you need and still have little derived income.

Huh? What "sitting" assets are you referring to? My IRA is invested in VBIAX mutual funds, 60/40 mix, planning to keep that even after retirement.

 

[bingybear]

Huh? What "sitting" assets are you referring to? My IRA is invested in VBIAX mutual funds, 60/40 mix, planning to keep that even after retirement.

I think I mixed part of another thread with this one. You and other posts brought up meeting ACA MAGI. Some other thread recently had a comment of meeting the ACA MAGI partially by using after tax cash to lower MAGI. Sorry for the confusion.

 

[mountainsoft]

OK, Never mind. I already talked myself out of the Roth conversion.

I had everything modeled nicely in Flexible Retirement Planner. First with the traditional IRA, then a second plan with the Roth conversion. The conversion looked so much better in the long term, it seemed like a no-brainer. But, as the computer phrase says "garbage in = garbage out".

The reason the Roth conversion looked so much better in the long term was because the money was staying in the IRA with higher returns (My typical 6% for estimations).

My traditional IRA model "reinvests" my RMD withdrawals to our regular savings account, which only earns 1.6% in my model.

So yeah, 6% earns more over time than 1.6%. So obvious it took me all day to see it. Analysis paralysis I guess. If I reinvest the RMD withdrawals at the same 6% rate, the traditional easily equals or outperforms the Roth conversion.

Long story short, KISS (keep it simple stupid). If it works, don't fix it. I'm staying with the traditional IRA.

 

[Perryinva]

Well, yes, if you just look at returns and current tax situation, then it is typically a wash. In a situation like yours, the advantages to the Roth are just as you listed originally, remaining half of a pair, future rate increases and inherited taxes. There is zero immediate or short term benefit. In fact, the only reason I am looking at it again is because if I convert before the tax rates change, there is an immediate 3% reduction in tax rate, 22% vs 25%, so while not a lot in the big plan, maybe $15k, it is still a net gain tor added future proofing. It is just painful to pay so much taxes for 4/5 years and have to wait until 70 to start seeing the payback of lower taxes pay off. ORP does a good job of illustrating the difference.

 

[mountainsoft]

Perry,

In our case, we're in the 12% tax bracket now and will still be in the 12% tax bracket after retirement. So the tax burden is basically the same whether we pay it now (Roth) or later (Traditional).

If my wife or I die, the survivor could possibly get bumped into the next tax bracket as an individual. I still think one of us would stay in the same tax bracket as expenses would go down once we're on our own, but even if we should get bumped up it wouldn't be the end of the world. Only a small portion of our income would be taxed at the higher rate anyway.

Taxes will probably increase over time, but so does everything else. As long as we plan accordingly, we should be fine.

My research into the Roth conversion was an interesting exercise. I wasted the better part of a day, but I learned a lot. In our case, the reward just doesn't justify the hassles of converting. We'll stay the course, stick to the plan, and enjoy the years we have left.