Roth Conversion Advice, Please?

[Mo Money]

I would appreciate the input of those far more adept at understanding Roth conversions than I will ever be...

I am 58, single, and have about $500K in my Roth IRA. I have about $1.3M in my TIRA. Both accounts were rolled over from my former empl*yer 401Ks about five years ago.

I am currently living off of dividends and withdrawals, which are both taken from my taxable portfolio. If I want, I can likely live off of my taxable portfolio for the rest of my life, assuming a 4% withdrawal rate. My plan, however, is to increase spending right about now, and eventually draw down on the IRAs. I have sufficient cash in taxable accounts to pay tax bills for conversions. If I should need more cash to pay taxes, I could sell securities from my taxable portfolio.

The most recent tax return I have (2018) has me making $5500 in interest and $45,000 in ordinary dividends, of which $25,000 are qualified dividends. (Using rounded numbers here.) Counting some income from Schedule 1, line 22, my Total Income is about $55,000. My AGI is $55,000. My Taxable Income is $38,000. I anticipate that these numbers will remain more or less the same for the foreseeable future.

Being single, I plan to leave my estate to charity, a family member or two, and a few good friends, if they survive me.

I suspect that with the recent stimulus packages, tax rates will only go up from their current levels.

I have made a good-faith effort to read (and re-read) many ER.org posts on Roth conversions. But I am (surprise!) uncertain about whether it's smart to convert.

With my taxable income at $38,000, I only have $2,125 to to hit the top of the 12% bracket for 2019 and 2020.

1. Should I do Roth conversions into the 22% bracket on an annual basis?

2. If I decide to convert to the top of the 12% bracket (a $2,125 conversion amount), and I end up miscalculating my taxable income, my only downside is that I have to pay 22% on the amount of taxable income that goes into the 22% bracket, correct?

3. My accounts are at Schwab. If I decide to convert, do I just call a Schwab rep, and is the rollover easy to do?

4. If i do the rollover, do I then just calculate my taxes on the capital gain amount of the rollover, and add that amount to my estimated taxes for the quarter in which the conversion occurred, paying those taxes with cash from my taxable portfolio?

5. Since I'm 58, I have at least 14 years to do conversions, correct? (I'm thinking of doing about $35,000 of conversions per year, roughly to the top of the 22% bracket -- a total conversion of about $500K.)

6. Am I missing anything?

Thanks in advance for your wisdom.

 

[Midpack]

There have been numerous threads on Roth conversions. Here’s one I was involved in https://www.early-retirement.org/fo...ax-planning-income-optimization-99854-20.html

 

[RunningBum]

A few things to consider. I started trying to answer them to your numbered questions but you didn't ask everything needed. How much to convert is not a simple question. Basically you try to level out taxes over your lifetime, so while you are at a lower income now and would be at higher income when SS starts and you have to take the minimum required IRA distribution, you try to convert to level that out. Of course it's not easy because as you take income now you are lessening it later, and you have to guess at account growth rates, and make assumptions about future tax rates.

- Conversions are regular income on the entire converted amount, not capital gains. Remember that you deferred that income when you put it in the tIRA, and with any distribution or conversion you recognize that as ordinary income. Even the gains you made after the contribution are taxed as ordinary income.

- Have an idea how much you want to leave from your estate to charity, and try to leave that much in the tIRA. Unlike your heirs, a charity getting funds from a deceased tIRA does not incur a taxable event.

- For a single person, in 2020, once you get above $40,000 (very slightly different than the top of 12%), QDivs/LTCGs starts being taxed at 15%. So there is a range at which you get taxed at 12% for the conversion income, + 15% for the same amount of QDivs you've pushed into being taxed, for an effective 27% rate. Once all QDivs are taxed, you drop back to the regular income rate of 22%. So yes, you do take a bit of a bigger hit by going slightly over 12%, but it's not a cliff. That's your question #2.

- You have 12 years to convert before you have to take SS. That will bump your income up more, so you'll be able to convert less after that. RMDs will start at 72, and you'll have to take that first. I suspect it won't make much sense to convert beyond your RMD but I'm not sure. So, basically, 14 years to convert as you said.

- Speaking of SS, some try to convert everything before we start taking SS, to reduce the amount of SS that is taxed. That assumes SS taxation remains the same, which it may not. It may not work for your case of leaving some in the tIRA for charity anyway.

- If you're going to go to the top of 22%, and that won't take enough out of your tIRA, consider going to the top of 24%. It's just 2% higher, and if taxes return to the 15%/25%/etc levels after the current tax rates expire, you'll be converting at 1% lower.

- Have you looked at asset location for taxation purposes? If not read up at https://www.bogleheads.org/wiki/Tax-efficient_fund_placement .

- I can't speak for Schwab, but at Vanguard, I just do a transfer from my tIRA account to my Roth, and it informs me that this is a conversion and a taxable event. This ensures to me that it is doing exactly what I want. I'm sure you could call Schwab to confirm if it's not clear when you start the transfer.

 

[Dash man]

I would appreciate the input of those far more adept at understanding Roth conversions than I will ever be...

I am 58, single, and have about $500K in my Roth IRA. I have about $1.3M in my TIRA. Both accounts were rolled over from my former empl*yer 401Ks about five years ago.

I am currently living off of dividends and withdrawals, which are both taken from my taxable portfolio. If I want, I can likely live off of my taxable portfolio for the rest of my life, assuming a 4% withdrawal rate. My plan, however, is to increase spending right about now, and eventually draw down on the IRAs. I have sufficient cash in taxable accounts to pay tax bills for conversions. If I should need more cash to pay taxes, I could sell securities from my taxable portfolio.

The most recent tax return I have (2018) has me making $5500 in interest and $45,000 in ordinary dividends, of which $25,000 are qualified dividends. (Using rounded numbers here.) Counting some income from Schedule 1, line 22, my Total Income is about $55,000. My AGI is $55,000. My Taxable Income is $38,000. I anticipate that these numbers will remain more or less the same for the foreseeable future.

Being single, I plan to leave my estate to charity, a family member or two, and a few good friends, if they survive me.

I suspect that with the recent stimulus packages, tax rates will only go up from their current levels.

I have made a good-faith effort to read (and re-read) many ER.org posts on Roth conversions. But I am (surprise!) uncertain about whether it's smart to convert.

With my taxable income at $38,000, I only have $2,125 to to hit the top of the 12% bracket for 2019 and 2020.

1. Should I do Roth conversions into the 22% bracket on an annual basis?

2. If I decide to convert to the top of the 12% bracket (a $2,125 conversion amount), and I end up miscalculating my taxable income, my only downside is that I have to pay 22% on the amount of taxable income that goes into the 22% bracket, correct?

3. My accounts are at Schwab. If I decide to convert, do I just call a Schwab rep, and is the rollover easy to do?

4. If i do the rollover, do I then just calculate my taxes on the capital gain amount of the rollover, and add that amount to my estimated taxes for the quarter in which the conversion occurred, paying those taxes with cash from my taxable portfolio?

5. Since I'm 58, I have at least 14 years to do conversions, correct? (I'm thinking of doing about $35,000 of conversions per year, roughly to the top of the 22% bracket -- a total conversion of about $500K.)

6. Am I missing anything?

Thanks in advance for your wisdom.

I’m not far off from you in numbers except I file jointly. I’ve decided to bite the bullet and convert to the top of the 24% bracket. It will require me to pay taxes on capital gains and dividends that I might otherwise avoid if I stayed below the top of the 12% bracket. The actual income cap for avoiding dividend/CG taxes is slightly below the 12% bracket, so you’ll need to look it up. Only you can decide if it’s right for you. I believe tax rates will only go higher with the next change of administrations, so I’ve decided to move the money now.
Yes, a simple call to Schwab is all you need to do. No need to sell any equities, since they can just move them.
You will need to pay higher quarterly taxes, but you can spread them out within the same tax year.

 

[CRLLS]

I will ask, Are trying to minimize or eliminate future RMD's and their taxes? If so, then if you are not annually converting more that the average market gains (9% or so?) you are just minimizing the growth of the situation.

Paying taxes from the taxable or nontaxable can be close to a wash when you are in the withdrawal period IMO. Others disagree. It really depends on your situation and plans. But any difference most likely comes down to a small amount comparatively.

 

[pb4uski]

...1. Should I do Roth conversions into the 22% bracket on an annual basis?

2. If I decide to convert to the top of the 12% bracket (a $2,125 conversion amount), and I end up miscalculating my taxable income, my only downside is that I have to pay 22% on the amount of taxable income that goes into the 22% bracket, correct?

3. My accounts are at Schwab. If I decide to convert, do I just call a Schwab rep, and is the rollover easy to do?

4. If i do the rollover, do I then just calculate my taxes on the capital gain amount of the rollover, and add that amount to my estimated taxes for the quarter in which the conversion occurred, paying those taxes with cash from my taxable portfolio?

5. Since I'm 58, I have at least 14 years to do conversions, correct? (I'm thinking of doing about $35,000 of conversions per year, roughly to the top of the 22% bracket -- a total conversion of about $500K.)

6. Am I missing anything?

Thanks in advance for your wisdom.

1. It is a tough call, but I would say only convert to the top of the 0% preferenced income tax bracket ($200 less than the top of the 12% tax bracket as I recall). On the one hand, once SS starts you will almost certainly be in the 22% tax bracket, and typically we suggest doing Roth conversions to the top of the tax bracket that you will be in later. However, the problem in your case is if you do any Roth conversions over the 0% qualified income tax bracket, some conversions will be subject to 27% tax (12% on the roth conversions plus 15% on preferenced income pushed from 0% to 15%). From what you wrote, that would be $25k of qualified dividends that would go from 0% to 27%... ouch!

2. No, 27%... see above.

3. Yes, in fact you can probably just do it online without talking to a rep (at least I can at Vanguard).

4. If you do $35k of conversions, it will be 12% on the first $2,125, 27% on the next $25,000 and 22% on the remaining $7,875... or a net cost of about 25%.

5. Yes, 14 years.... but your headroom will be lower once you start SS... so for a minimum of 2 years and perhaps more.

6. Looks like you have things throughly covered.

You mentioned that your legacy will be charity. Unless they change the rules, after you are 70 1/2 you can make charitable contributions from your tIRA without paying tax... up to $100k a year. It might be worthwhile to do some of that charitable giving while you are alive so you can enjoy it more.

Also, I agree with RB that you might look at the tax efficiency of your taxable accounts... if you can convert the $5,500 of interest and $25k of non-qualified dividends to tax-free (perhaps munis?) that would give you another $30,500 of headroom a year for Roth conversions at 12% tax.

 

[Gotadimple]

1. It is a tough call, but I would say only convert to the top of the 0% preferenced income tax bracket ($200 less than the top of the 12% tax bracket as I recall). On the one hand, once SS starts you will almost certainly be in the 22% tax bracket, and typically we suggest doing Roth conversions to the top of the tax bracket that you will be in later. However, the problem in your case is if you do any Roth conversions over the 0% qualified income tax bracket, some conversions will be subject to 27% tax (12% on the roth conversions plus 15% on preferenced income pushed from 0% to 15%). From what you wrote, that would be $25k of qualified dividends that would go from 0% to 27%... ouch!

2. No, 27%... see above.

3. Yes, in fact you can probably just do it online without talking to a rep (at least I can at Vanguard).

4. If you do $35k of conversions, it will be 12% on the first $2,125, 27% on the next $25,000 and 22% on the remaining $7,875... or a net cost of about 25%.

5. Yes, 14 years.... but your headroom will be lower once you start SS... so for a minimum of 2 years and perhaps more.

6. Looks like you have things throughly covered.

You mentioned that your legacy will be charity. Unless they change the rules, after you are 70 1/2 you can make charitable contributions from your tIRA without paying tax... up to $100k a year. It might be worthwhile to do some of that charitable giving while you are alive so you can enjoy it more.

Also, I agree with RB that you might look at the tax efficiency of your taxable accounts... if you can convert the $5,500 of interest and $25k of non-qualified dividends to tax-free (perhaps munis?) that would give you another $30,500 of headroom a year for Roth conversions at 12% tax.

One more thing. IRMAA (Income Related Monthly Adjusted Amount). This is an increase in the amount of Medicare Part B premiums you pay based on your Gross Income. For single filers, this year that amount is $87,000. And CMS looks back two years to determine if any IRMAA is due.

So, convert to Roth but be mindful at age 63 to keep your income (from all sources) below the IRMAA amount, or you will be paying about 40% more in Part B Premiums when you turn 65.

Rita

 

[pb4uski]

While I agree that IRMAA needs to be considered but when it is framed as 40% more it sounds like a lot.... but if you are in the first tier above the base tier, the cost for 2020 would only be $693.60 ($202.40/mo vs $144.60/mo) ... worth considering but in many cases not so significant compared to the potential tax savings at 10% or so of the amount converted. YMMV

 

[Gotadimple]

3. My accounts are at Schwab. If I decide to convert, do I just call a Schwab rep, and is the rollover easy to do?

You have a Roth and a Traditional IRA, and both are at Schwab. Yes it is very easy to do. Just some semantics to be aware of:

A rollover happens when you move investments from one type of vehicle to another. For example, putting a 401-K into a Traditional IRA. I don't believe you have this situation.

A conversion happens when you move money (or investments) from a Traditional IRA to Roth IRA. This is what you are planning to do.

Yes, it's super easy at Schwab, and you can call and move the amount of money you want to convert over to the Roth. If you have a particular stock or mutual fund you want to convert to the Roth, they can do that for you as well. Generally, it is so easy, that after the first one - if you are comfortable with their website, you can do the annual conversions online. It's what I do.

 

[Mo Money]

Thanks -- sincerely -- for all of the input. I know that you took a fair amount of time to think it over and respond. This site never ceases to amaze me with the generosity of its members.

I will try to wrap my head around qualified income tax brackets and see if there's some sort of way to make a rollover work. I am also giving Income Strategy a try, as has been discussed on other threads.

While I have not given up yet, it may be that Roth conversions just aren't worth doing in my circumstances. Whenever something like that happens, I just try to remember that I may be paying a lot in taxes, but that's because I'm blessed enough to have income to be taxed!

BTW, earlier this week I spoke with a financial adviser friend-of-a-friend about this. He kindly took the time to do a telephonic presentation (Covid precaution). He told me it was a no-brainer to put about 40K a year into Roth conversions, but he did not have a grasp on ANY of the stuff you folks have been spotting. I thanked him, and he followed up with a program link called Money Guide Pro. It was a useless piece of fluff financial software, as far as I could tell. I am a math idiot, but I was unimpressed. Free software like FireCalc told me more.

I will likely circle back with a few more questions as I explore this issue a bit further. Again, I really appreciate the help.

 

[Mo Money]

I have thought over your advice, and I will aim to convert my TIRA to a Roth to the top of the 12% bracket. That's a pretty modest amount (probably under $5K), but I don't see why I shouldn't be doing what I can to increase my Roth balance.

I intend to wait till this December and add up all earned interest and dividends, plus interest and dividends projected till year end. I will then convert up to to top of my (single) 12% bracket, namely $40,125. Assuming I miscalculate and go over a bit, I will have to pay an effective 27% rate only on that modest overage, correct? (12% tax rate plus 15% qualified dividends rate.) That is, if I accidentally convert to $41,000, I will have an effective 27% tax rate on $875, right?

Would the calculation would be AGI minus standard deduction = amount to convert from TIRA to Roth? (While my tax preparer will likely find deductions exceeding the $12,400 standard deduction, I want to be safe and use the standard deduction, because my tax preparer will not have the my actual deduction amount until early 2021.)

It's too late to do conversions for 2019, in that the July 15, 2020 extension only applies to IRA contributions, not conversions, correct?

pb4ski and RunningBum kindly pointed out the issue with the 27% effective tax rate (mentioned above). I have read some of the Bogleheads threads on portfolio tax efficiency, but I can't see an out. But just to be certain, I'm going to ask this question:

The bulk of my annual income is from dividends generated in my taxable portfolio from short-term bond ETFs. I use these dividends toward my annual living expenses. I turn 59.5 in less than a year. Would there be any advantage to selling the bond ETFs in my taxable portfolio, and buying identical positions in my TIRA? Those ETFs are the fixed income portion of my asset allocation, so they need to be somewhere in my portfolios.

At first I thought such a maneuver might somehow be advantageous, but I doubt it, since I'd need to withdraw the dividends from the TIRA to live on, and those would be taxed at ordinary income rates, correct?

Thanks for your continued help (and patience!)

 

[NgineER]

Your plan will depend on how much you want to leave family and friends vs. charities. Charities as mentioned above will not owe taxes on their portion of a tax deferred inheritance/donation. Your friends and family certainly will, and it could be that they would owe more taxes than you would in a conversion scenario, but hey, they would be getting something and would be thankful for any and all, regardless of taxes. I guess it depends on if you want to prevent the gubmnt from clawing back more or less taxes when you pass...

Since you don't have any direct heirs and plan on leaving your estate to charities and family/friends my opinion is the following:

Convert up to the top of the 12% tax bracket prior to 59.5. After that age, withdraw from your tIRA as needed to meet your spending needs/desires.

Consider taking RMDs as QCDs while you are still alive (72+) - hopefully seeing the donations coming to good use in your targeted charities. At the time of your passing will the remaining tIRA to charities.

On your passing - donate your taxable and Roth IRA for friends and family - no tax implications for them.

 

[RunningBum]

I intend to wait till this December and add up all earned interest and dividends, plus interest and dividends projected till year end. I will then convert up to to top of my (single) 12% bracket, namely $40,125. Assuming I miscalculate and go over a bit, I will have to pay an effective 27% rate only on that modest overage, correct? (12% tax rate plus 15% qualified dividends rate.) That is, if I accidentally convert to $41,000, I will have an effective 27% tax rate on $875, right?

Almost correct. At $40,000 combined, qualified dividends get taxed at 15%. So that's your target, and if you convert to $41,000 you'll pay $270 or 27% on that last $1000.

Would the calculation would be AGI minus standard deduction = amount to convert from TIRA to Roth?

Yes. I say that without checking the tax forms to make sure there's no exception.

It's too late to do conversions for 2019, in that the July 15, 2020 extension only applies to IRA contributions, not conversions, correct?

Correct, too late.

The bulk of my annual income is from dividends generated in my taxable portfolio from short-term bond ETFs. I use these dividends toward my annual living expenses. I turn 59.5 in less than a year. Would there be any advantage to selling the bond ETFs in my taxable portfolio, and buying identical positions in my TIRA? Those ETFs are the fixed income portion of my asset allocation, so they need to be somewhere in my portfolios.

At first I thought such a maneuver might somehow be advantageous, but I doubt it, since I'd need to withdraw the dividends from the TIRA to live on, and those would be taxed at ordinary income rates, correct?

The link to the Boglehead's tax efficient asset placement would have you putting that short term bond fund in your TIRA, especially if dividends are not qualified, which I think is probably true?

So let's say you have an equity fund in your TIRA. If you swap the two investments, the qualified dividends from that equity fund in your taxable account would have a 0% LTCG rate if you stay under $40K as discussed above. You could use those dividends for living expenses. If that falls short of what you have today, you could sell a small amount of an asset in your taxable account, or withdraw the amount needed from your TIRA. Does that make sense?

 

[Mo Money]

Holy Moly, Running Bum! Let me cipher on that... (I'm taking a break from mowing my lawn and have to finish up, but I'll be back!) Holy moly!

 

[pb4uski]

....I will try to wrap my head around qualified income tax brackets ...

This may be helpful: https://www.kitces.com/blog/underst...st-capital-gains-for-a-free-step-up-in-basis/

 

[pb4uski]

.....The link to the Boglehead's tax efficient asset placement would have you putting that short term bond fund in your TIRA, especially if dividends are not qualified, which I think is probably true?

So let's say you have an equity fund in your TIRA. If you swap the two investments, the qualified dividends from that equity fund in your taxable account would have a 0% LTCG rate if you stay under $40K as discussed above. You could use those dividends for living expenses. If that falls short of what you have today, you could sell a small amount of an asset in your taxable account, or withdraw the amount needed from your TIRA. Does that make sense?

Since you are living off of taxable, I would consider swaping the short-term bond ETFs for a high-quality short term muni ETFs or just directly buying high-quality short-term munis. I suspect that you can generate the same or more income and get much more headroom for 12% Roth conversions ($50k?).

Then, once you are 59 1/2 you might do Roth conversions to the top of the 12% tax bracket, 80% or so early in the year, and then top it off at the end of the year as you wrap up you year-end tax planning and do Roth withdrawals during the year for spending. It is the same as doing tIRA withdrawals for living expenses and topping that off with Roth conversions to the top of the 12% bracket, but a tad more tax-efficient as earnings on the early Roth withdrawal are tax free.

 

[Brat]

To maximize the benefit of a TIRA TO ROTH conversion pay all the associated income taxes out of your current (already taxed) checking or savings account, IRS has a direct pay tool to do that.

 

[Animorph]

You'll be taking something like 4% of your tIRA for your first RMD at 72. With no growth in the next 14 years, that would be $52k, but probably way more (2x?), even against inflation adjusted tax brackets. What will your taxes look like then?

A Roth conversion is mathematically neutral to your net worth if you withdraw from the tIRA, pay taxes from that withdrawal, roll the remainder into a Roth, and your tax rate always stays the same.

One benefit of doing a Roth conversion is that you may be able to fill in one or more lower tax brackets while your income is low, before RMD's hit. You might get 88% (12% tax rate) of some of your tIRA money, instead of only 78% (22% tax rate). You probably want to do that, but should be careful of losing tax credits, subsidies, or 0% capital gains.

A second benefit of doing a Roth conversion is that you can pay the taxes from your taxable account instead of from the money withdrawn from your tIRA, allowing you to place the entire tIRA withdrawal into the Roth. The benefit of this is that you have essentially moved an amount equal to the tax payment from your taxable account to your Roth. No more taxes in the future on some of your previously taxable money! The value of this depends on what taxes you are saving now that this money is out of your taxable account. Maybe a little, maybe a lot. But, there may be tax credits, subsidies, or 0% capital gains rates that are lost by converting too much, so the overall benefit is highly dependent on your tax situation.

A third benefit is more intangible. You may benefit from a Roth conversion if tax rates increase. If you can pay 22% taxes now but they would be 28% later you would benefit by paying them now. This includes the case where a spouse dies and you suddenly find yourself using the single tax brackets, as well as income tax rate increases, or even super-successful investing in your tIRA when maybe you should have done that in your Roth. Of course tax rates may go down, or a VAT or wealth tax might blur the lines between a tIRA and a Roth. So this benefit is unknown until some point in the future.

You have a chance for the next 14 years to pull money out of the tIRA at less than that RMD tax rate, move a bunch of your taxable account into your Roth account, and avoid possibly rising future tax rates. But it may cost the loss of some tax credit, subsidy, or 0% capital gains. Lots of stuff to look at, which is why there is so much discussion and a lack of simple answers.