IRA to Roth conversion questions

[bizlady]

We are going to convert some traditional IRA to Roth this year for the first time and I have a couple questions.

1. To get to the top of a tax bracket, am I correct that this is calculated on taxable income and not AGI?

2. DH will get SS this year for the first time. Does any of the nontaxable portion have to be added back to income when calculating to get to the top of the ta bracket?

3. How are LT capital gains anticipated for 2018, currently taxed at 0% treated in conversion assuming we still stay in the 12% bracket? In other words, do I have to make any special calculation for those.

We will want to maximize conversion to the top of the 12% bracket. Income for 2018 is SS, taxable pension, interest income, small business income for which we will get 20% exclusion on the net, and trad IRA withdrawal.

Bigger question-- anyone considering going to the top of the 22% bracket if you know you will be in higher brackets come RMD time since the current tax brackets expire in 7 years?

 

[SecondCor521]

We are going to convert some traditional IRA to Roth this year for the first time and I have a couple questions.

1. To get to the top of a tax bracket, am I correct that this is calculated on taxable income and not AGI?

2. DH will get SS this year for the first time. Does any of the nontaxable portion have to be added back to income when calculating to get to the top of the ta bracket?

3. How are LT capital gains anticipated for 2018, currently taxed at 0% treated in conversion assuming we still stay in the 12% bracket? In other words, do I have to make any special calculation for those.

We will want to maximize conversion to the top of the 12% bracket. Income for 2018 is SS, taxable pension, interest income, small business income for which we will get 20% exclusion on the net, and trad IRA withdrawal.

Bigger question-- anyone considering going to the top of the 22% bracket if you know you will be in higher brackets come RMD time since the current tax brackets expire in 7 years?

1. Yes, you are correct.

2. No, it doesn't. But remember that some of his SS may be taxable based on how high your other income is. You could have up to 85% of his SS benefits be treated as taxable income. See instructions for line 20b of Form 1040.

3. Basically you stack your income: regular income at the bottom, which would include your regular W-2 income if any, taxable SS, and Roth conversions. Then on top of the regular income is where your LTCG is stacked. Then you subtract your deduction (either standard or itemized) from the bottom of that stack. Then you compare how high that stack of income is to $77,200 (assuming MFJ). Any LTCG that is below that point is taxed at 0%, and any amount above that is taxed at 15%.

(With the new tax law there is a small discrepancy between the 0%/15% LTCG tax dividing line and the top of the 12% bracket, which is $77,400. This discrepancy exists in 2018; I do not know if it extends to 2019 or beyond.)

Personally I haven't completely figured out what I am going to do for the RMD tax torpedo issue. Currently I plan to keep my income low for FAFSA purposes for the next four years. After that it looks like I can avoid the 24% bracket with modest conversions. But I have about a 20 year window to do conversions so at this point I have lots of flexibility.

I will add that in my opinion the rates in seven years are unlikely to revert to the pre-2017 rates. I think they will take the 2018-and-following rates and use them as a baseline if they decide to change them again. I do agree that they are likely to change again, but I have no idea how, so I assume 2018-and-following tax structure for my planning until I see otherwise.

 

[kaneohe]

1) yes, brackets based on taxable income. Remember std deductions change this yr and no exemptions.
2)taxable SS is a function of your other income. There is a SS wksht for calculating this. You could use 85% of SS as a maximum number but you might be giving away too much.
3) conversion adds other income "under" LTCG . If you add too much your LTCG may start getting taxed at 15% (the portion that exceeds the limit)

You might want to use tax software or a tax calculator like HR Block or Taxcaster to double check.

 

[Animorph]

Make sure you don't hit the AMT or healthcare tax if you are aiming at the top of the 22% bracket. I haven't looked at them for 2018, but they have been a problem previously. Some years have been stopped at AMT kick-in, some at 250k AGI, without hitting the top of the old 25% bracket.

 

[kskmfire]

You can pre-plan your taxes using Intuit taxcaster or a planning xls like https://sites.google.com/site/excel1040/home/2018-tax-planner-new-tax-law.

There's a great explanation at Kitces.com https://www.kitces.com/blog/underst...st-capital-gains-for-a-free-step-up-in-basis/

If you can estimate your Wage income and capital gains, you can get really close. Do a comparison test of 2018 against 2017 filing. Don't let the lack of recharacterization scare you, just aim a little low. The worst that could happen is the 12%+15% double up if you extend above the 12% bracket.

 

[UpAnchor]

Bigger question-- anyone considering going to the top of the 22% bracket if you know you will be in higher brackets come RMD time since the current tax brackets expire in 7 years?

Yes, given that:

1. By far the largest part of our nest egg (~85%) is in Rollover IRAs, the remainder being in Roth IRAs (14%) and taxable (~1%). So a lot of forthcoming "ordinary income" to contend with from a tax standpoint.

2. RMDs and delayed SS both greet me in a little over 4 years so time is running out to aggressively Roth convert, although I have done to the top of the 15% bracket for the last 3 or 4.

3. We should be able to avoid any of the gotchas referred to by Animorph above.

So current thought is to convert to the top of the 22% bracket until the brackets revert back and then probably drop back to the 15%. Although portfolio value by that time will probably make that decision for me.

 

[pb4uski]

I guess that for me the 2% difference between 22% and 24% (or the 3% difference between 25% and 28% if rates revert) isn't compelling enough for me to convert into the 22% bracket....worst case is that in the long run on $1 million that one pays an additional $20k in taxes but a lot can happen that might change that.

 

[bingybear]

3. Basically you stack your income: regular income at the bottom, which would include your regular W-2 income if any, taxable SS, and Roth conversions. Then on top of the regular income is where your LTCG is stacked. Then you subtract your deduction (either standard or itemized) from the bottom of that stack. Then you compare how high that stack of income is to $77,200 (assuming MFJ). Any LTCG that is below that point is taxed at 0%, and any amount above that is taxed at 15%.

Add taxable interest, STCG and non-qualified dividends to regular income above.

In my case I expect I will exceed the 12% marginal bracket. Everyone needs to evaluate it for their situation.

 

[SevenUp]

Bigger question-- anyone considering going to the top of the 22% bracket if you know you will be in higher brackets come RMD time since the current tax brackets expire in 7 years?

Yes.

Even if you will be in the same bracket with RMDs, if you can pay the conversion tax from current cash then converting to Roth is favorable.

One caveat: if you convert so much now that your tax rate later becomes lower, then you overconverted.

 

[RunningBum]

And you can even be correct in your estimations and still be sub-optimal. People who converted at 15% in the past and are now at the age where they would be taking RMDs would probably be doing so at 12%. There's always an uncertainty. My guess is that these current rates are as low as they will get in my remaining years, but I could very well be wrong.

 

[bingybear]

One caveat: if you convert so much now that your tax rate later becomes lower, then you overconverted.

There are a lot of things that can happen. You inherit another IRA. One of you pass away and your filing status goes from MFJ to Single. Either one of things can throw your plans for a loop. Maybe you aren't inline for an inheritance, but change in filing status could jump your rates.

 

[Trooper]

You can pre-plan your taxes using Intuit taxcaster or a planning xls like https://sites.google.com/site/excel1040/home/2018-tax-planner-new-tax-law.

There's a great explanation at Kitces.com https://www.kitces.com/blog/underst...st-capital-gains-for-a-free-step-up-in-basis/

If you can estimate your Wage income and capital gains, you can get really close. Do a comparison test of 2018 against 2017 filing. Don't let the lack of recharacterization scare you, just aim a little low. The worst that could happen is the 12%+15% double up if you extend above the 12% bracket.

Great links, thanks.

 

[Brat]

The new tax law link, the downloaded form, is exacting. Thanks.