PSA - Roth conversion plan miscalculation

[pb4uski]

Hey all,

I figured that I would share a recent discovery that I made regarding my Roth conversion planning. At the end of the day I don't think it will have much of an impact it is in the "nice problem to have" category, but nonetheless an unwelcome surprise.

I have a very detailed plan/projection of future RMDs and taxes from now to age 98 that I used to decide to do Roth conversions to the top of the 12% tax bracket.

What I overlooked was a substantial inheritance and the investment income that the inheritance would add to our taxable income. I guess my mind was in the old not counting chickens (inheritances) until they are hatched... which makes sense for overall retirement planning but as I've found out, doesn't make sense when planning Roth conversions.

If I had factored it in I'm not sure if we would have done anythnig differently since the 22% tax bracket is so wide, but nonetheless, something to consider.

 

[MarieIG]

Thanks for the info @pb4uski . Are you modifying your plan in any manner going forward?

 

[pb4uski]

Not sure at this time.

 

[Koolau]

I'm impressed that you've been able to hold your taxable to 12% up until this "good news - bad news" event (aka inheritance)!

Keep us posted on how it turns out.

 

[sengsational]

So what if your tax efficiency suffered slightly, the question is, with the inheritance and the associated increase in available spending, have you found a way to BTD?

 

[pb4uski]

^^^ Not even close. While we've opened the spigots some, we couldn't find a way to spend what we could prudently spend even before the inheritance. It is hard to change spending habits after 43 years of frugal living... and I will say harder for DW who grew up less affluent than I did... but even for me to some extent.

A great example is that we have a 2001 20' Bennington pontoon boat that we use regularly for cocktail cruises on the lake... sometimes just the two of us or sometimes with friends. We keep it up and it is in very good condition for 24 years old and runs well. I've priced out a new one and just a 2025 model year replacement of the same length, similiar layout and powerplant would be about $40,000 less whatever I got from trading or selling this one. We can easily afford it, but if what we have now runs well and meets our needs... then why? Only because we can doesn't seem good enough.

 

[Dtail]

So on a different matter but staying in the Roth decision making realm.
How would you feel if your RMD's without Roth conversions was in the 12% tax bracket, but with Roth conversions to the top of the 12% tax bracket still kept one in the 12% RMD tax bracket.
In this example, is it really worth converting except for the thought of future higher tax rates, filing as a single down the road, convert just through the 10% bracket?

 

[engineernerd]

So on a different matter but staying in the Roth decision making realm.
How would you feel if your RMD's without Roth conversions was in the 12% tax bracket, but with Roth conversions to the top of the 12% tax bracket still kept one in the 12% RMD tax bracket.
In this example, is it really worth converting except for the thought of future higher tax rates, filing as a single down the road, convert just through the 10% bracket?

Heck yeah. IMHO. 12% is hardly more than 10%, and almost all the uncertainties run in favor of higher taxes later. With the uncertainties that DON'T run in favor being ones where what you do now will make no difference.

 

[engineernerd]

^^^ Not even close. While we've opened the spigots some, we couldn't find a way to spend what we could prudently spend even before the inheritance. It is hard to change spending habits after 43 years of frugal living... and I will say harder for DW who grew up less affluent than I did... but even for me to some extent.

Agree there's no point in spending money just because you have it. In fact, buying a new boat or car or whatever is WORK, compared to just enjoying the well-oiled familiar machine you have!

Only if you are finding yourself bored with your life does it make sense to think about new things to do or try, some of which might cost money.

 

[Jerry1]

With SS and Pension, I can no longer convert any at the 12% level. If I could, I’d take every dollar I could and convert it. Not so much in consideration of what I will be paying in the future but as a “grab the win” approach - knowing that I paid at a much higher rate when I put it in my 401K.

 

[pb4uski]

So on a different matter but staying in the Roth decision making realm.
How would you feel if your RMD's without Roth conversions was in the 12% tax bracket, but with Roth conversions to the top of the 12% tax bracket still kept one in the 12% RMD tax bracket.
In this example, is it really worth converting except for the thought of future higher tax rates, filing as a single down the road, convert just through the 10% bracket?

In that case it probably doesn't matter what you do since 10% or 12% now vs 12% later isn't a big deal. But in that situation what you may want to consider is the impact on those who might inherit the traditional IRA. Probablyeither or anything in between is good.

 

[Dtail]

With SS and Pension, I can no longer convert any at the 12% level. If I could, I’d take every dollar I could and convert it. Not so much in consideration of what I will be paying in the future but as a “grab the win” approach - knowing that I paid at a much higher rate when I put it in my 401K.

Yes the original 401k deduction while working usually isn't mentioned much. Most folks just concentrate on the projected RMD tax bracket rate with or without conversion.
If one's working tax rate was in the 33% (back then) rate or higher, even RMD's in the 22% rate with NO Roth conversions is a win to some degree.

 

[Exchme]

What I overlooked was a substantial inheritance and the investment income that the inheritance would add to our taxable income.

Do you keep your bonds preferentially in your tax deferred? That would minimize any non-qualified dividends and so minimize the impact on your tax bracket as well as slow the growth of your tax deferred.

If your tax deferred is now overflowing with bonds, with the new unexpected money, you might re-evaluate your asset allocation and invest the inherited money more aggressively with the idea that it is for legacy, so has decades to grow. I find that as our savings grow, I have less interest in the short term safety of bonds and more interest in thinking long term. Even if markets are overvalued today, odds are good that stocks will outperform bonds over such a long period.

 

[MarieIG]

^^^ Not even close. While we've opened the spigots some, we couldn't find a way to spend what we could prudently spend even before the inheritance. It is hard to change spending habits after 43 years of frugal living... and I will say harder for DW who grew up less affluent than I did... but even for me to some extent.

A great example is that we have a 2001 20' Bennington pontoon boat that we use regularly for cocktail cruises on the lake... sometimes just the two of us or sometimes with friends. We keep it up and it is in very good condition for 24 years old and runs well. I've priced out a new one and just a 2025 model year replacement of the same length, similiar layout and powerplant would be about $40,000 less whatever I got from trading or selling this one. We can easily afford it, but if what we have now runs well and meets our needs... then why? Only because we can doesn't seem good enough.

Well, in that situation - if I were enjoying the pantoon I had, it would seem a total waste of money (to me) to go out and buy another one.

We're not going to discuss how someone, whom shall not be identified, had to think long and hard before agreeing to a certain DH buying a fancy new toaster oven when the fifteen-year-old one still heated toast.

 

[Mark1]

We can easily afford it, but if what we have now runs well and meets our needs... then why? Only because we can doesn't seem good enough.

Plus there are other downsides to a shiny new pontoon, such as, researching the new models, dealing with the salesperson, etc. With me it usually not about the money, but the additional hassle.

Some folks would say optimizing Roth conversions is a hassle, whereas, you might consider it a neat puzzle to work on. Everyone is different.

 

[pb4uski]

I'm much more flexible and willing to increase spending where the expenditure improves our quality of life or makes living more convenient.

A really tiny example is we now splurge on higher quality toilet paper!

 

[pb4uski]

Do you keep your bonds preferentially in your tax deferred? That would minimize any non-qualified dividends and so minimize the impact on your tax bracket as well as slow the growth of your tax deferred.

If your tax deferred is now overflowing with bonds, with the new unexpected money, you might re-evaluate your asset allocation and invest the inherited money more aggressively with the idea that it is for legacy, so has decades to grow. I find that as our savings grow, I have less interest in the short term safety of bonds and more interest in thinking long term. Even if markets are overvalued today, odds are good that stocks will outperform bonds over such a long period.

Our fixed income/bonds are mostly in traditional IRA, and some in Roth IRAs. Taxable is mostly equities, preferred stocks and baby bonds and a good portion of those are qualified dividends.

 

[G-Man]

With SS and Pension, I can no longer convert any at the 12% level. If I could, I’d take every dollar I could and convert it. Not so much in consideration of what I will be paying in the future but as a “grab the win” approach - knowing that I paid at a much higher rate when I put it in my 401K.

Same here. I wish I could be in the 12% marginal tax bracket. The younger me would have put more in Roth and a brokerage account as opposed to tax-deferred account. In addition, guaranteed income sources like pensions and SS benefit makes it hard to be in the 12% marginal tax bracket.

 

[Dtail]

I'm much more flexible and willing to increase spending where the expenditure improves our quality of life or makes living more convenient.

A really tiny example is we now splurge on higher quality toilet paper!

Haha. I only buy the high quality toilet paper and take it on vacation with me.

 

[Chuckanut]

Same here. I wish I could be in the 12% marginal tax bracket. The younger me would have put more in Roth and a brokerage account as opposed to tax-deferred account. In addition, guaranteed income sources like pensions and SS benefit makes it hard to be in the 12% marginal tax bracket.

+1

In my younger days, there were no Roth IRA's so I did what was the best at that time, ordinary taxable on withdrawal IRA's. Later in life I opened Roth accounts and started Roth conversions and did as well as I could while keeping to the lower tax brackets.

 

[Livefree]

So on a different matter but staying in the Roth decision making realm.
How would you feel if your RMD's without Roth conversions was in the 12% tax bracket, but with Roth conversions to the top of the 12% tax bracket still kept one in the 12% RMD tax bracket.
In this example, is it really worth converting except for the thought of future higher tax rates, filing as a single down the road, convert just through the 10% bracket?

Yes it's worth it to us. Our kids will inherit the bulk of ours, and will need to deplete within ten years, and because they have good paying jobs, they'll pay a ton in taxes.

 

[SecondCor521]

OP, it's not clear whether the inheritance has happened or not - it sounds like not yet. I also can't remember if you have kids or not.

I am in a similar situation where I have more money than I need or can spend and I am likely to inherit some money from my father at some point in the future.

One planning opportunity I am likely to do is to disclaim 3/4 of my portion of my future inherited traditional IRA. This will mean that my three kids and I will split my portion - 1/4 to each of us. This has several nice benefits:

1. It gets that 3/4 and it's future growth out of my estate, which helps me start to avoid a potential estate tax situation in my future.

2. It spreads the tax burden of the inherited traditional IRA withdrawals across four people across 10 years, rather than one person across 10 years. This is likely to result in lower marginal tax rates on those withdrawals.

3. It does a bit of the "Die With Zero" thing where my kids get some of their inheritance early. I can watch and either enjoy seeing them enjoy the money, and/or I can adjust my plans going forward if the money is not a blessing to them.

4. If done properly, I believe it sidesteps gift taxes.

In order for this to work, it is necessary to have the original owner of the traditional IRA list you as "pb4uski per stirpes" before they pass away - without the per stirpes then any disclaimed portion might go to, for example, your siblings. Per stirpes can often be what the original owner wants anyway.

Check with your attorney, there may be other issues.

 

[SecondCor521]

On the Roth conversion aspect, I don't rely on it but I do pencil in my projected inheritance in my planning spreadsheet. It's weird and emotional to do that, but I know my parents would want me to make reasonable plans based on reasonable assumptions.

In my case, I think it also doesn't make much of a planning difference. I try to predict my highest marginal tax rate before age 85, and usually there is some ACA breakpoint where I go from well below that marginal breakeven to well above. So it's pretty easy to find the target AGI currently.

There are some tax changes to ACA brewing for next year, but I'll deal with those then.

 

[N02L84ER]

OP, we were put in your situation 5 years ago when we were almost 60 y.o. We had been converting to remain in the 12% bracket since ER at age 52 and had not even considered that we might get an IRA inheritance before age 70. Then, the s-MIL died at age 75 right after the Secure Act made the change to 10 year depletion of IRAs. The RMDs have replaced the Roth conversions for that 10 year period, although we will be doing Roth conversions on top of the beneficiary IRA RMDs once we are both aged 65 and we will not worry about exceeding the top of the 12% bracket. If you are going to have financial "problems", at least this is a good problem to have.

 

[pb4uski]

OP, it's not clear whether the inheritance has happened or not - it sounds like not yet. I also can't remember if you have kids or not. ...

Yes, it has already happened. However, since I managed DM's finances I could have and should have anticipated that and built it into the plan. Since it was out of sight/out of mind I didn't really consider it. And yes, we have two kids.

I may try to get the kids more earlier rather than later so they can enjoy it and we can watch them enjoy it.

Our grands are 1 and 3 and I've always wanted to stay at the Grand Floridian at Disney World so I want to splurge on a family vacation to Disney World for us, our kids and spouses and the grandkids. I know it will be big $$$ but hopefully will be a vacation the grandkids will never forget. I'm just not sure what age for the youngest grandchild to plan on doing it while factoring in that we are now 70 and are not getting any younger.