Planning for this year's Roth conversion, hit a wall, stumped!

[Skitso999]

Am I crazy for wanting to avoid all this complication and spreadsheets and just plan to convert ~50K per year until 65 (i.e. for 10 years) and let the chips fall where they may? I didn't retire to pore over spreadsheets, and none of us really have any idea what brackets will be in 10 years anyway. My only guess is they'll be higher, which is why I'd do them at all.

I have this opinion as well! I'd much rather stick with the traditional IRAs and 401Ks rather than sweat the conversion difficulties. Especially if the taxes were to end up the same anyway. I'm thinking that the tax rates when taking the money out of my TIRA will be lower because of my lack of income elsewhere.

ALSO, just to make it more complicated, if you invest in TIRAs all your life (ex. $100), then you'll have a lot more money in that IRA, when compared to investing money after taxes in a Roth (ex. $100 * 0.78 tax factor = $78). That money can be transferred to your heirs at their dollar value on the day that you died, if you were to set up a family trust. What would your heirs prefer, the $100 invested 30 years ago, or the $78 invested 30 years ago, considering they won't need to pay taxes on it, if they sell the investments the day after you die?

 

[misanman]

ALSO, just to make it more complicated, if you invest in TIRAs all your life (ex. $100), then you'll have a lot more money in that IRA, when compared to investing money after taxes in a Roth (ex. $100 * 0.78 tax factor = $78). That money can be transferred to your heirs at their dollar value on the day that you died, if you were to set up a family trust. What would your heirs prefer, the $100 invested 30 years ago, or the $78 invested 30 years ago, considering they won't need to pay taxes on it, if they sell the investments the day after you die?

I'm confused. Heirs have to pay taxes on inherited IRAs, right?

 

[pb4uski]

Sincerely curious question: why convert in January and lock in your tax situation that early in the year? I'm sure you have a good reason but I can't figure out what it is.

I could understand if you thought the market was going up more next year, but I thought you think the market is overvalued, so I would expect you to expect it to drop.

I could also understand if you were going to move to your zero income tax state, but you said in another post on this thread you've already done that.

(The first few years I waited until December to Roth convert. This year I did about half of my Roth conversion in mid-March to take advantage of the low stock market. That worked out well, but it also meant that at the end of the year I was prevented from executing a possible tax idea for 2020 because my AGI was already locked in and about $1800 too high for the idea.)

I have done it at the end of the year in the past. However, my tax situation is very predictable now that I have no equities in taxable accounts... it's only interest, my fixed pension, SS and tIRA withdrawals/Roth conversions and the standard deduction... I would just as soon get that money into tax free earlier rather than later (not that it really matters all that much).

It was a totally different story when I had significant dividends, possible capital gain distributions, possible LTCG, etc. but I still could have done some early in the year and then top it off later as the tax situation crystalized.

What the investments do isn't as relevant because the money is in the same investments whether it is in the tIRA or in the Roth.

Given how simple our tax situation is I just don't see much downside of doing it earlier rather than later... much different from when I had oodles of unrealized LTCG that I might want to harvest.

 

[pb4uski]

I'm confused. Heirs have to pay taxes on inherited IRAs, right?

+1 his post makes no sense.

 

[cathy63]

ALSO, just to make it more complicated, if you invest in TIRAs all your life (ex. $100), then you'll have a lot more money in that IRA, when compared to investing money after taxes in a Roth (ex. $100 * 0.78 tax factor = $78). That money can be transferred to your heirs at their dollar value on the day that you died, if you were to set up a family trust. What would your heirs prefer, the $100 invested 30 years ago, or the $78 invested 30 years ago, considering they won't need to pay taxes on it, if they sell the investments the day after you die?

When both accounts are inherited, the Roth IRA is not taxed and the tIRA is taxed at the heir's ordinary income tax rate. So in your example, if the tIRA money pushes your heir into a 22% or higher marginal rate, the Roth is a better inheritance.

 

[cathy63]

You are going deeper into this "rabbit hole" but did you think about moving to a state with no investment/dividend taxes?
Maybe it is close to where you currently live. Maybe it is not related to your questions but will still save you a lot of money when converting TIRA to Roth.
There is a pic of all states' investment taxes at URL: https://www.forbes.com/sites/baldwi...t-states-for-dividend-lovers/?sh=2c07e2b855ac

The problem with all those tax maps is they use the highest possible number and treat it as if it applied to everyone. E.g. that 13.3% they show for California is the marginal rate on income over $1M. My actual California tax rate last year was 1.18%. I think the highest it ever got while we were working and cashing out stock options was about 4%.

 

[RunningBum]

I did a final analysis of my conversion planning for this year, and projected tax rates in the future.

I had already converted enough to cover my std deduction, Roth conversion, and cap loss carryover. The tax on that conversion is 0, with a (rounded up ) 10% "tax", or reductions of ACA subsidy.

I converted a little more to have some income to take a FTC credit. Still 0% + 10% subsidy loss.

I planned to stop here because each additional $100 would be taxed at 10% + 10% subsidy loss, for a cost of 20%. My thought was that I'd probably be in the 12% bracket in retirement.

But then I projected that when I hit RMDs, I'd be a little short of getting through the SS tax hump, so I'd be paying a 49.9% rate. If my RMD pushed me through that, I'd still be paying the 12+15%=27% rate by pushing more QDivs into being taxable. If I got through that, I'd be in the 22% tax bracket. I don't see a way that I'd be in the 12% bracket with no tax on QDivs.

So, this morning I topped off my conversion to get a little closer to the subsidy cliff, with some safety cushion. 20% now is better than 49.9% or 27% or 22% later.

I hope that a conversion started today counts for this year, even if it's not completed until after Jan 1. If not, I got an early start on 2021. I think my last conversion got into the Roth the next day.

 

[SecondCor521]

^If the $$$ leaves your traditional IRA today or tomorrow it will count towards 2020. I'd be fairly confident that the big three (Vanguard, Fido, Schwab) would get it on the books today.

 

[Skitso999]

I'm confused. Heirs have to pay taxes on inherited IRAs, right?

Heirs do not need to pay taxes on trust held assets. They're transferred to the names of the persons within the trust with a valuation at the date of death of the trust creators (Mom & Dad). No need to pay the capital gains that have accrued from the time of purchase through the date of death.

This is the way I understand it.

I'm not entirely certain whether you must dissolve the IRA before the date of death to make this work as I've said. If so, you would need to pay the taxes. Perhaps an accountant reading this could verify.

An example of this is, if your parents bought a house in 1961, and held it within a trust that was set up in 2003, and they both passed away in 2011, then the appreciation from the date of death of the last parent in 2011 through the time of house sale in 2021 is all you would be taxed on. Not too sure that stock shares or mutual fund shares within a TIRA would be treated the same way, but if they were OUT of the TIRA I know they would be.



AND, after a tiny bit of research, I may be overstating the benefits of this strategy. Here's a website I found:
https://www.investopedia.com/ask/answers/081815/can-i-put-my-ira-trust.asp

Here's a quote from it:
Advantages of a Trust Beneficiary
Naming a trust as the beneficiary to an IRA can be advantageous because owners can dictate how beneficiaries use their savings. A trust instrument can be designed in such a way that special provisions for inheritance apply to specific beneficiaries—a helpful option if beneficiaries vary greatly in age, or if some of them have special needs to be addressed. Many people also believe the trust provides tax savings for beneficiaries, but that is rarely the case.

Important factors to consider are how beneficiaries take possession of the IRA assets and over what time period. Seek advice from a trust adviser well-versed in inherited IRAs. To gain the maximum stretch option for the distribution of the account, the trust must have specific terms such as "pass-through" and "designated beneficiary." If a trust does not contain provisions for inheriting an IRA, it should be rewritten, or individuals should be named as beneficiaries instead.

AND, now it's getting really complicated:
While trusts can streamline most estate-planning areas, they can create more paperwork and even additional tax burdens for beneficiaries of an inherited IRA. Work closely with an estate planner, attorney, and accountant, who are all knowledgeable about trusts and IRAs, to maximize a legacy.

 

[GalaxyBoy]

^If the $$$ leaves your traditional IRA today or tomorrow it will count towards 2020. I'd be fairly confident that the big three (Vanguard, Fido, Schwab) would get it on the books today.

I transferred shares from DW's Schwab tIRA to her Schwab Roth on Sunday and it showed up as completed when I checked it early Monday morning. There was a small cash dividend that hit today so I transferred that as well, and it showed up instantaneously.

BTW, with Schwab you can only transfer whole positions of shares online, otherwise you have to make a phone call. Since her whole position of the ETF brought us to within $500 of our Roth conversion target for the year, we left it at that. I could have sold some shares and transferred cash to avoid picking up the phone, but laziness took over.

[edit to add] Schwab says there could be a long wait for a phone call, so I didn't want to mess with it.

 

[pb4uski]

Heirs do not need to pay taxes on trust held assets. They're transferred to the names of the persons within the trust with a valuation at the date of death of the trust creators (Mom & Dad). No need to pay the capital gains that have accrued from the time of purchase through the date of death.

This is the way I understand it. ....

The first part, along with post #56 is just plain wrong... there is no free lunch... someone, either the trust itself or the beneficiary will pay taxes.

My dad's trust passes income on trust assets thru to my mom. We file a tax return for the trust which ends up with no tax obligation and the trust issues a K-1 to mom and she claims the income on her tax return. There are other trusts where the trust pays tax... I'm not real familiar with them but trust tax rates are higher.

2020 Estate and Trust Income Tax Brackets

• $0 to $2,600 in income: 10% of taxable income.
• $2,601 to $9,450 in income: $260 plus 24% of the amount over $2,600.
• $9,450 to $12,950 in income: $1,904 plus 35% of the amount over $9,450.
• Over $12,950 in income: $3,129 plus 37% of the amount over $12,950



 

[cathy63]

Heirs do not need to pay taxes on trust held assets. They're transferred to the names of the persons within the trust with a valuation at the date of death of the trust creators (Mom & Dad). No need to pay the capital gains that have accrued from the time of purchase through the date of death.

This is the way I understand it.

I'm not entirely certain whether you must dissolve the IRA before the date of death to make this work as I've said. If so, you would need to pay the taxes. Perhaps an accountant reading this could verify.

An example of this is, if your parents bought a house in 1961, and held it within a trust that was set up in 2003, and they both passed away in 2011, then the appreciation from the date of death of the last parent in 2011 through the time of house sale in 2021 is all you would be taxed on. Not too sure that stock shares or mutual fund shares within a TIRA would be treated the same way, but if they were OUT of the TIRA I know they would be.



AND, after a tiny bit of research, I may be overstating the benefits of this strategy. Here's a website I found:
https://www.investopedia.com/ask/answers/081815/can-i-put-my-ira-trust.asp

Here's a quote from it:
Advantages of a Trust Beneficiary
Naming a trust as the beneficiary to an IRA can be advantageous because owners can dictate how beneficiaries use their savings. A trust instrument can be designed in such a way that special provisions for inheritance apply to specific beneficiaries—a helpful option if beneficiaries vary greatly in age, or if some of them have special needs to be addressed. Many people also believe the trust provides tax savings for beneficiaries, but that is rarely the case.

Important factors to consider are how beneficiaries take possession of the IRA assets and over what time period. Seek advice from a trust adviser well-versed in inherited IRAs. To gain the maximum stretch option for the distribution of the account, the trust must have specific terms such as "pass-through" and "designated beneficiary." If a trust does not contain provisions for inheriting an IRA, it should be rewritten, or individuals should be named as beneficiaries instead.

AND, now it's getting really complicated:
While trusts can streamline most estate-planning areas, they can create more paperwork and even additional tax burdens for beneficiaries of an inherited IRA. Work closely with an estate planner, attorney, and accountant, who are all knowledgeable about trusts and IRAs, to maximize a legacy.

If a trust is a beneficiary of a tIRA, then the trust must follow the IRA distribution rules in the tax code -and- the terms of the trust document. Depending on how the trust docs are written it could be that the IRA is split among the trust beneficiaries into inherited IRAs, just as if they were the directly named beneficiaries on the IRA itself (best case); or it could be that the trust keeps the inherited IRA and has to take the distributions as income itself. It may or may not be able to distribute all of its income to the trust beneficiaries and report it on a K-1. Worst possible case is that the trust takes the distributions as income, keeps it, and then has to pay income tax at the trust tax rates, which are higher than rates for individuals. This is why the advice you quoted above is to have experts help set this up. Doing it wrong will result in more tax rather than less.

It is true that if the IRA owner removes all funds before he dies and pays the appropriate tax, then his heirs will get a step-up in basis on whatever else he invests in. There's no step-up for funds that are held in an IRA at the time of death, whether they're inherited by a trust, a spouse, or someone else. If the IRA is emptied before death, it's the same as the house value example you gave. Your heirs get a step-up in basis regardless of whether the assets are in a revocable living trust or just in your own name.

 

[pb4uski]

So is it fair to say that there is no real tax advantage of leaving a tIRA to a trust? There might be other advantages in terms of controlling distributions from the grave but no tax advantages, as if set up wrong possibly tax disadvantages?

 

[cathy63]

So is it fair to say that there is no real tax advantage of leaving a tIRA to a trust? There might be other advantages in terms of controlling distributions from the grave but no tax advantages, as if set up wrong possibly tax disadvantages?

I can't say there's never any tax advantage. There could be (probably are) some special circumstances where it makes sense. I just know that in our situation, which is a married couple with one adult child who is not our dependent, our estate attorney made a big point of telling us not to change the beneficiaries on our IRAs to our trust.

 

[SecondCor521]

I can't say there's never any tax advantage. There could be (probably are) some special circumstances where it makes sense. I just know that in our situation, which is a married couple with one adult child who is not our dependent, our estate attorney made a big point of telling us not to change the beneficiaries on our IRAs to our trust.

Although it is no longer as much of a benefit, it used to be standard advice to not leave IRAs to trusts because that generally eliminated the ability to do a stretch IRA. With the SECURE Act eliminating stretch IRAs, this is no longer applicable, but the tax issues alluded to probably make it still good advice.

Someone else on this board is leaving their IRA to a trust, and I asked why but didn't really grok the answer. It was complicated and seemed to perhaps involve the controlling beyond the grave aspect of things. A state estate tax was involved in the answer as well. I can dig that post up if anyone wants me to.

 

[devans0]

When I first started at E-R.org, my two fears were would I have enough, and how to minimize my taxes. I had/have enough.


I thought that the plan for taxes was good, to top out and max my tax bracket with conversions each year. FWIW, about $120K per year was the place we ended up. Optimal for us was calculated to be about $100K Roth conversion per year. It would have been better tax wise, but we needed to move more money over at a faster rate.

Now, we have two years left to convert the final amount and we will probably just pull the plug and convert the remainder in January. It will allow us to start drawing SS at 69 with the bulk of our money in Roth 401Ks'

The one thing that forced higher numbers is that we have done quite a bit better than expected in investing. RMD's are looming and I am looking forward to being done and in a low tax position with simpler finances.

I think that many of E-R types tend to caution and also tend to too conservative estimates of conversions early on. Maybe I am projecting myself and assuming too much. At any rate, watch for that going forward is my only advice.


Good luck with your decision

 

[MarieIG]

Telly, sorry to say this but I'm going to make you head hurt even more.

Another significant factor that you need to consider is your actual marginal rate for that Roth conversion into the 22% tax bracket if you have significant preferenced income (qualified dividends and LTCG). What happens is that once you start converting into the 22% tax bracket, if you have qualified income, your marginal tax rate is actually 27% rather than 22% for the amount of your preferenced income, and then drops down to 22% for the remainder.

For example, let's say that you have converted to the top of the 12% tax bracket but also have $50k of qualified income (and $55,050 of ordinary income) and you are considering additional Roth conversions into the 22% tax bracket and decide to conver another $50k.

Before that additional $50k your tax is $3,276. After the additional $50k of Roth conversion your tax is $16,741, and increase of $13,465 (26.9% of the $50,000)! What is happening is that each $1 of Roth converision above the 0% preferenced income tax bracket adds $1 of ordinary income that is taxed at 12% but also pushes $1 of preferenced income from the 0% bracket into the 15% bracket... with the combined effect of a 27% marginal tax rate until no preferenced income is taxed at 0%.

https://www.kitces.com/blog/long-te...one-higher-marginal-tax-rate-phase-in-0-rate/



You can play with https://www.dinkytown.net/java/1040-tax-calculator.html to see the impact. Open two windows and put MFJ and in one window input $55,050 of pension income and $50,000 of taxable IRA distributions and in the other window input $55,050 of pension income and $100,000 of taxable IRA distributions.

Wow, I just read through this thread again, and plugged our numbers into the 2020 calculator. Ouch! I believe that there will be an NIIT surcharge. Since IRMMA won't be a consideration until 2022, am thinking about raising the conversion for 2021 to 100k, paying the tax out of dividend income, and then dropping down to 50k conversions in 2021-2025 (keeping an eye on DH's IRA withdrawals). That should keep us from going up another IRMMA bracket in any event. Unless the market totally tanks (or new taxes make this completely impractible) this won't empty my IRA, but will transer about 250k into the Roth, which is better than no conversions.