Early Retirement / Roth Conversion Ladder

ponyboy

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Im curious what the best course of action will be when the time comes, just trying to think ahead.

We want to retire in approx 10 years. We will both be 50 years old at that time. My wife will be eligible for health insurance through the feds when we are 57...so we will be paying for health insurance for 7 years.

Since neither of us would be working and our income will be low, would it be optimal to start converting our IRA's to a roth using a conversion ladder? We would like to stay in the 12% tax bracket to keep taxes low. (taxes are subject to change)

Here is our financial picture as of now.

TSP/IRA - $1,332,000
Roths - $480,000
Brokerage - $338,000
Cash - $400,000

My concern is taxes later in life, when RMD's kick in. Im thinking to move as much in our IRA's as possible and pay the taxes with cash. Im hoping in another 10 years our accounts will also have grown substantially. No guarantees though. Tax rates will probably be different too. Lot can happen in 10 years.

Would there be a better strategy to move money around at that point?
 
It can often make sense to Roth convert after early retiring, because you can pay the conversion taxes at a low rate.

Roth conversions at that point also have two other nice effects:

1. It helps lower the balances in traditional IRAs and thus reduces RMDs later and helps stay out of higher brackets later. Note that if the markets are kind to your traditional IRA, it may grow faster than you are able to convert it.

2. It provides "conversion basis" that is spendable five tax years later. The five year delay is something that you need to plan around if you plan to use a Roth conversion ladder for spending money in early retirement.

I've been doing Roth conversions up to the level that makes sense for me for the past nine years of FIRE. What makes sense for me depends, in turn, on my ACA picture now and my IRMAA picture later. If you are on the ACA, you may notice that the loss of subsidy combined with the ordinary income tax brackets can result in an effective tax rate that is much higher than one would think initially.

I don't need my Roth conversion ladder for spending (point 2), but I still do conversions for the tax arbitrage (point 1).
 
Thanks. Our overhead is fairly low and we're frugal, so I'm not sure if we will need the money from the conversions but it's a great problem to have if need be.

I'm guessing it would be more beneficial to convert to a Roth rather than cashing out our brokerage, at a lower or zero tax rate? I assume brokerage accounts do not require RMDs after a certain point.
 
Thanks. Our overhead is fairly low and we're frugal, so I'm not sure if we will need the money from the conversions but it's a great problem to have if need be.

I'm guessing it would be more beneficial to convert to a Roth rather than cashing out our brokerage, at a lower or zero tax rate? I assume brokerage accounts do not require RMDs after a certain point.

Brokerage accounts never require RMDs under current law.

You will need to figure out if Roth conversions or selling from taxable at preferential rates is better for you overall. I sell from taxable to live on (including paying taxes on my Roth conversions) and then fill up to my target AGI with Roth conversions. But which is better can depend on a lot of factors including your age, the relative amount of basis vs unrealized gain in taxable, your estate plans, and probably some other things.
 
You need to use a spreadsheet or a program (see discussions started by midpack on tools recently) to see what bracket you'll be in when Social Security & RMDs kick in. Also IRMAA.

Should you do roth conversions now? Not if you're going to be in the same or lower tax bracket when SS & RMDs kick in.

Asset Location is something you can work on now. All your fixed income holdings should be first placed in your IRA. Equities should be first place in the ROTH, then the taxable & then the IRA. This limits the growth of the IRA & doesn't cause cap gains to be taxed as income when you withdraw funds. Also equities will grow faster in the ROTH since all gains will be tax free. Google this. Imho, it is worth learning about if you don't already know it.

If you're at the same bracket now that you think you'll be when SS / RMD /IRMAA become an issue, you should fund a ROTH first & then an IRA. I'm not up on funding amounts/rules any more. Obviously, any 401k match should be leveraged fully.

If you can limit your income to qualify for ACA subsidies when you ER (like you said, a lot can happen in 10 years), it makes sense to take the subsidy. Today, by my calculations, each $ you add to your AGI (cap gains harvesting or ROTH conversions) has a marginal tax effect (loss of subsidy) of 8.5-11% until of course, you fall off the cliff. When the time comes, the best way to model this is to use a tax program and try out different strategies to see what the marginal tax rate will be.

Based on your question of RMDs from taxable accounts, I guess you're just starting on this learning journey. Take your time & learn the ins & outs of ROTH conversions before you take a leap.

Good luck.
 
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Today, by my calculations, each $ you add to your AGI (cap gains harvesting or ROTH conversions) has a marginal tax effect (loss of subsidy) of 8.5-11% until of course, you fall off the cliff.

It's frequently worse than that, see the following articles to understand why:


Between 250% and 400% of FPL, it's frequently 15% or more. See the second graph at the second link.
 
OP - I feel tax brackets will go up with inflation and will closely enough match the savings growth, that using todays values is close enough. I recognize generally investment will grow a bit faster buy ignore it for now.

Using today's dollars means no guessing at inflation, bracket level, investment growth.

I can compare what is my income now vs my taxable income + SS (which is also in todays dollars) + my RMD.

Then it's easy to see if the marginal tax rate now is greater or less than the tax rate with SS + RMD.
That will largely point to whether Conversions now are a good idea.
 
ACA subsidy is one important reason which keep me from doing large scale Roth conversions right now. It is likely to be a consideration for you too at least between 50 and 57, unless ACA will be gone all together by the time of your retirement. In your situation, I'd rather retire at 57.
 
It's frequently worse than that, see the following articles to understand why:


Between 250% and 400% of FPL, it's frequently 15% or more. See the second graph at the second link.
Been lurking here forever but had to throw this homegrown chart as an update to SecondCor521 post.
ACA Subsidy Curves 2021-2025.JPG
 
First congratulations on your success, savings are substantial and you’ve already established a nice sized Roth. If you have the cash to pay the taxes on Roth conversions it certainly would be a great next step. I wouldn’t convert if you have to use IRA funds to pay the tax, just impacts the savings growth too much, better to let it continue to grow deferred.
 
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