Not much point in Roth conversions?

[ERhoosier]

The backdoor Roth process is a little different from a Roth conversion.

Of course. Clumsy verbiage. See IRS pubs 590 A & B.

 

[pb4uski]

Umm, there's more to Roth conversions than simply tax arbitrage...

Like what? It's mostly just tax arbitrage.

 

[RunningBum]

Like what? It's mostly just tax arbitrage.

Having money available for a large unexpected expense without having your income spike if you took it out of a tIRA.

Estate value reduction in case you die.

For couples, taking the income while filing joint vs taking RMDs as a single when one dies.

 

[Dtail]

Having money available for a large unexpected expense without having your income spike if you took it out of a tIRA.

Estate value reduction in case you die.

For couples, taking the income while filing joint vs taking RMDs as a single when one dies.

Agree in general, but isn't the 3rd example just a different type of tax arbitrage in the end?

 

[Montecfo]

Well, either you, or your beneficiary(ies) will eventually have to take it and pay the taxes.

True. But this is where it gets complicated. We have done Roth conversions when the rate difference is high, say 10-12%. But it is fairly clear in my case that I am simply prepaying taxes I would not otherwise have to pay in my lifetime.

So then it gets down to heirs and their future tax rates, future tax laws etc. and also investment returns hopefully far down the road. Lots of assumptions and time involved.

I think the most compelling reason to do Roth conversions if married is to hedge the much higher single tax rates one of us will likely be paying at some point in the future but this is also for an unknown period of time.

 

[Montecfo]

Having money available for a large unexpected expense without having your income spike if you took it out of a tIRA.

Estate value reduction in case you die.

For couples, taking the income while filing joint vs taking RMDs as a single when one dies.

I hear you. But the only reason to care about the income spike, in my view, is if it causes you to pay more taxes than you otherwise could have.

I think perhaps you are describing a psychological benefit?

If so I agree with you that it can feel a bit like paying down your mortgage e.g., it may help you SWAN?

 

[teej1985]

Like what? It's mostly just tax arbitrage.

Manufacturing taxable income to avoid getting stuck on Medicaid in early retirement.

 

[Gumby]

Manufacturing taxable income to avoid getting stuck on Medicaid in early retirement.

A very good point.

 

[Dash man]

We've been doing Roth conversions aggressively for a few years. Next year will be our last, but we will still have about $1M in tIRAs. That money will be used for charitable giving via QCDs. There's no need to go to zero in an IRA if charitable giving is part of your plan.
Our combined Roth accounts are now 2-1 in size over our tIRAs because of the conversions. We also have a sizable chunk in taxable accounts the we use to pay the taxes. We don't know if we'll ever need to pull from an IRA for living expenses. We do expect tax rates to increase over time as the national debt grows. But who knows?

 

[NanoSour]

I've been converting up to the top of the 24% bracket for the past two years and will convert the last 100K at the beginning of next year. One of the main benefits is how it simplifies withdrawal strategies for DW should something happen to me. Many of us are concerned about our spouses taking over the finances in our absence. Having everything in a Roth makes spending and tax decisions simple on a relative basis. If everything wasn't in a Roth, she may hire a Financial Planner and who knows what that would cost.

 

[Retire2023]

We've been doing Roth conversions aggressively for a few years. Next year will be our last, but we will still have about $1M in tIRAs. That money will be used for charitable giving via QCDs. There's no need to go to zero in an IRA if charitable giving is part of your plan.
Our combined Roth accounts are now 2-1 in size over our tIRAs because of the conversions. We also have a sizable chunk in taxable accounts the we use to pay the taxes. We don't know if we'll ever need to pull from an IRA for living expenses. We do expect tax rates to increase over time as the national debt grows. But who knows?

Along the same line as leaving funds for QCD's, we also think about leaving funds in tax deferred status to handle long term care/EOL needs which would be largely tax deductible. The problem is not knowing how much to leave and having to take RMD's on that larger balance until the "end is near" when the deductibility kicks in.

 

[Sunset]

I've been converting up to the top of the 24% bracket for the past two years and will convert the last 100K at the beginning of next year. One of the main benefits is how it simplifies withdrawal strategies for DW should something happen to me. Many of us are concerned about our spouses taking over the finances in our absence. Having everything in a Roth makes spending and tax decisions simple on a relative basis. If everything wasn't in a Roth, she may hire a Financial Planner and who knows what that would cost.

An IRA with only $100K inside, generates a pretty small RMD. If you would not be in the 24% bracket without the conversion (less than approximately $191K taxable), it seems like it would be unnecessarily paying extra tax to finish off the last bit.
Also issue of hitting another IRMAA bracket plays in there at some point.

 

[RunningBum]

Agree in general, but isn't the 3rd example just a different type of tax arbitrage in the end?

It is, and I almost didn't include it but people often seem to forget that they or their spouse will likely be filing single at some point.

 

[RunningBum]

I hear you. But the only reason to care about the income spike, in my view, is if it causes you to pay more taxes than you otherwise could have.

I think perhaps you are describing a psychological benefit?

If so I agree with you that it can feel a bit like paying down your mortgage e.g., it may help you SWAN?

I was thinking of a large enough income spike that would put you in a higher tax bracket if you had to withdraw extra from your tIRA. Perhaps you have a year where you buy a new car, then find out you need a new roof, and maybe the furnace goes out, all in the same year. Or at a larger scale, maybe you want to buy a second home or a new home before selling the old. In all of these cases it would be best to have converted money to a Roth at a lower rate so you can tap it to pay for these expense than to have little or no Roth and have to make a very large withdrawal from your tIRA. This is a real money benefit, not just psychological.

I haven't yet touched my Roth for anything like this but it is comforting to have it there in case I do need it. Yes, it helps me sleep well at night, because I know that it could save me from a large tax event.

 

[Dtail]

We will try not to touch the Roth if possible, but good to have it if needed.

 

[Dtail]

Manufacturing taxable income to avoid getting stuck on Medicaid in early retirement.

Since withdrawing a piece of the TIRA was necessary in early retirement, I went this way for control of the MAGI ACA vs the Roth conversion.

 

[Exchme]

Having money available for a large unexpected expense without having your income spike if you took it out of a tIRA.

Estate value reduction in case you die.

For couples, taking the income while filing joint vs taking RMDs as a single when one dies.

State level estate taxes are annoying for those living in such places and some areas have quite low estate size thresholds, so your point about estate taxes is valid for many. If TCJA expires after 2025, there could be also quite a few folks concerned about federal estate taxes. However, at the federal level, if your estate paid estate taxes, and your heirs itemize, they will get a deduction on the taxes on the inherited IRA RMDs called Income in Respect of a Decedent (pub 559) that is designed to avoid the double taxation.

 

[teej1985]

Since withdrawing a piece of the TIRA was necessary in early retirement, I went this way for control of the MAGI ACA vs the Roth conversion.

Did you do a 72t, then?

 

[RunningBum]

State level estate taxes are annoying for those living in such places and some areas have quite low estate size thresholds, so your point about estate taxes is valid for many. If TCJA expires after 2025, there could be also quite a few folks concerned about federal estate taxes. However, at the federal level, if your estate paid estate taxes, and your heirs itemize, they will get a deduction on the taxes on the inherited IRA RMDs called Income in Respect of a Decedent (pub 559) that is designed to avoid the double taxation.

Thanks for that, and I agree. In fact that sounded so familiar I went and looked at the document I put together for my son in case of my death, and it says to take the IRD deduction if my estate is taxed and I still have a tIRA. I just forgot about it because I've seen others make the same argument as me. As you say, it may be a factor in state estate taxes, but not federal. I'll try to remember that!

 

[SecondCor521]

However, at the federal level, if your estate paid estate taxes, and your heirs itemize, they will get a deduction on the taxes on the inherited IRA RMDs called Income in Respect of a Decedent (pub 559) that is designed to avoid the double taxation.

My understanding is that it doesn't avoid double taxation but ensures that the taxation is never at a rate more than 100%. But IRD is confusing to my brain and I always need to go read the Kitces article from time to time to straighten it out.

 

[Exchme]

My understanding is that it doesn't avoid double taxation but ensures that the taxation is never at a rate more than 100%. But IRD is confusing to my brain and I always need to go read the Kitces article from time to time to straighten it out.

Here is a link to the article on Kitces' site:

Deathbed Roth Conversions And The IRD Deduction

How The IRC Section 691(c) deduction for Income in Respect of a Decedent reduces the value of doing a deathbed Roth conversion for IRA beneficiaries.

www.kitces.com

The pull quote is:
Notably, though, the IRD deduction also means that the earlier Roth conversion strategy is actually unnecessary. There’s no need to pay income taxes up front (with a Roth conversion) to avoid subsequent estate taxes, because the IRD deduction provides that where estate taxes are paid, the income tax liability will be reduced to equalize the scenarios.

 

[Dtail]

Did you do a 72t, then?

I early retired at 57, but there were other funds coming in until 59 by chance.
At 59.5, I started the TIRA withdrawals.

 

[pb4uski]

Having money available for a large unexpected expense without having your income spike if you took it out of a tIRA.

Estate value reduction in case you die.

For couples, taking the income while filing joint vs taking RMDs as a single when one dies.

First one is tax arbitrage... paying less tax at a lower tax rate with Roth conversions rather than more tax and a higher tax rate if you have a large unexpected expense.

Not sure of the estate value reduction benefit... most are nowhere near the fedral estate tax limit but it might be a benefit if subject to state estate taxes, but arguably another tax arbitrage benefit by lowering state estate taxes.

Third one is clearly tax arbitrage and a frequently mentioned benefit.

 

[Ian S]

It is, and I almost didn't include it but people often seem to forget that they or their spouse will likely be filing single at some point.

For us and our Roth conversion planning, that is a significant issue: I'm 16 years older than my husband so the odds are that he will have quite a few years of paying taxes at the single tax rates.

 

[foxfirev5]

The gradual elimination of Michigan's retirement income tax has already had an impact on my taxes. The 4.25% state tax was a consideration. Now with the possibility of the 12% Fed bracket going to 15%, the elimination of the state tax would encourage me to continue with conversions. However, who knows what is next.