Roth conversion and tax bracket

[fh2000]

I and DW have been converting in the 24% band for the last few years. This is because we will move up a band from 20% to 40% in the UK with RMDs. Fortunately the tax treaty allows Roth conversions to be taxed only in the USA whereas IRA distributions are taxed in the UK. I am now 100% Roth and DW has about 3 years of conversions ahead of her.

I know this is a very personal decision. I am also a dual citizen but my home country does not tax me anything.

We have SS and RMD as income and not much else, so the slope of change for tax is gradual, after we start both. The wild card is the return on investment.

If we leave too much in, they could grow to larger amount. So we pay more tax by then, do we really lose out?

If I do a good chunk of Roth conversion paying taxes and losing ACA subsidy, we will lose the opportunity for larger gain, do we really gain much in the end?

My head hurts.

 

[googily]

Exactly. I gave up trying to move things around; especially now after the SECURE provisions are now in place. We're gonna pay 22% now, and/or 24% after one of us croaks. I am grateful to have the problem, but feel helpless that I can't engineer myself out of the situation.

Ditto. And that there's no clear answer! Drives me nuts.

 

[Alan]

I know this is a very personal decision. I am also a dual citizen but my home country does not tax me anything.

We have SS and RMD as income and not much else, so the slope of change for tax is gradual, after we start both. The wild card is the return on investment.

If we leave too much in, they could grow to larger amount. So we pay more tax by then, do we really lose out?

If I do a good chunk of Roth conversion paying taxes and losing ACA subsidy, we will lose the opportunity for larger gain, do we really gain much in the end?

My head hurts.

Where do you live? Sounds like you live in the USA if you are buying HI with ACA subsidies.

When I lived in the USA the UK did not tax me anything, even on my UK pensions, but the USA did. Now that I live in the UK the USA still taxes me on everything including my UK pensions, it is almost the only country in the world that taxes its citizens no matter where they actually live or where their income comes from, even if they were born outside the USA and have never lived there.

 

[rrs26ja]

So if you are taking $120,000 out of your 401k and have no other income such as dividends or social security.



Your federal tax rate would as follows:


Income = $120,000
Standard Deduction for married filing jointly = $-24,500


Taxable Income = $95,500
2019 Fed Tax = $15,055


Net Income = $80,445


Tax Rate = 15.76%


If you have excel I can send you a spreadsheet that calculates this.


Ron

 

[Jerry1]

And nobody has to go on record to "vote for a tax increase." They can just let the tax cuts expire without action, right?

That’s why I’m converting and why I think the rates will go back to their previous levels. If congress needed to go on record with a vote, it may make me feel different. But if all they have to do is let it expire, I think there’s a good chance that will happen.

 

[whatnot]

That’s why I’m converting and why I think the rates will go back to their previous levels. If congress needed to go on record with a vote, it may make me feel different. But if all they have to do is let it expire, I think there’s a good chance that will happen.

Can you provide a link to what the tax rates and brackets were at the previous levels? I’m not sure where to access this information. Thank you.

 

[pb4uski]

Can you provide a link to what the tax rates and brackets were at the previous levels? I’m not sure where to access this information. Thank you.

https://www.kdpllp.com/2017-vs-2018-federal-income-tax-brackets/

2018 column are current.... 2017 were former. Tax rates will revert to 2017 percentages in 2026 if Congress doesn't act to make the low rates permanent.

 

[whatnot]

https://www.kdpllp.com/2017-vs-2018-federal-income-tax-brackets/

2018 column are current.... 2017 were former. Tax rates will revert to 2017 percentages in 2026 if Congress doesn't act to make the low rates permanent.

Thank you.

 

[imnontrad]

Look not only your tax bracket but also how it will affect Medicare premiums. If you are single, anything over 87K modified AGI will cause an increase and anything over 109K will cause even more - and that is an increase for both B and D!
The Modified AGI amounts are double for married couples but I think couples should plan their Modified AGI for the time that one of them dies. The last thing someone would want to leave their spouse is higher expenses because of their decisions.

 

[pb4uski]

Look not only your tax bracket but also how it will affect Medicare premiums. If you are single, anything over 87K modified AGI will cause an increase and anything over 109K will cause even more - and that is an increase for both B and D!
The Modified AGI amounts are double for married couples but I think couples should plan their Modified AGI for the time that one of them dies. The last thing someone would want to leave their spouse is higher expenses because of their decisions.

But IRMAA isn't all that bad, at least in the first tier... $57.80/month in 2020... so $1,387.20 for a married couple... often a proverbial nit with respect to the tax savings for early retirees.

 

[Midpack]

https://www.kdpllp.com/2017-vs-2018-federal-income-tax-brackets/

2018 column are current.... 2017 were former. Tax rates will revert to 2017 percentages in 2026 if Congress doesn't act to make the low rates permanent.

I don’t see how “we” can keep this up indefinitely, but I’ve been wrong many times before...

 

[Theo]

Simple. Taxes don't fund spending. Congretional appropriations do.

 

[thatguy]

Are we typically paying the tax on these roth conversions from outside money or are we withholding from the conversion? I didn't start conversions till my first RMD. I withheld enough from the RMD to cover the tax on the conversion. Theoretically I could have started conversions sooner but there was not extra cash on hand to pay the tax.

 

[pb4uski]

While it is slightly preferable to use taxable funds to pay the tax if you have it, since Roth conversions are really a tax arbitrage play, it is benefal en if the taxes are paid from the tIRA (assumes you are over 59 1/2).

 

[RunningBum]

Are we typically paying the tax on these roth conversions from outside money or are we withholding from the conversion? I didn't start conversions till my first RMD. I withheld enough from the RMD to cover the tax on the conversion. Theoretically I could have started conversions sooner but there was not extra cash on hand to pay the tax.

Better to use outside money if you can because you are moving the full amount to the tax free Roth.

Are conversions really advantageous at RMD age? You know you can't convert the RMD portion, only anything over that, right? You can pay taxes from the RMD part though, just do it as a separate step. It seems to me your tax rate is probably as high now as it will be in the future, though it's not unreasonable to believe taxes might increase in the future.

 

[pb4uski]

^^^^ Could still be advantageous for a couple where if one passes the survivor will be in a higher tax bracket.

 

[thatguy]

Better to use outside money if you can because you are moving the full amount to the tax free Roth.

Are conversions really advantageous at RMD age? You know you can't convert the RMD portion, only anything over that, right? You can pay taxes from the RMD part though, just do it as a separate step. It seems to me your tax rate is probably as high now as it will be in the future, though it's not unreasonable to believe taxes might increase in the future.

After the RMD comes out, I can still convert some at 12%. I usually do enough withholding from the RMD to cover the conversion.

I do it all at in December. IRS expects estimated tax payments to be made in each quarter. Withholding works better for me.

Other income, not yet coming in from younger DWs SS & RMD, will cause higher tax rate later.

 

[SevenUp]

I’d like to offer a different perspective on Roth conversion costs and rates, particularly for people with multiple forms of taxable income and more complex returns.

Roth conversions have wide ranging effects on tax returns and Medicare premiums, including:

1) Ordinary income taxes – Conversion income increases ordinary income which bumps your total ordinary income into higher tax brackets and may cause itemized deductions to be phased-out (e.g., medical expenses).

2) Qualified dividends and LT capital gains taxes – The preferential tax rate on qualified dividends and capital gains is based on total taxable income. Conversion income may push the preferential rate from 0% to 15% or from 15% to 20%, which could cause qualified dividend and capital gains income to be taxed at higher rates.

3) 3.8% Net Investment Income Tax (NIIT) – Conversion income may push AGI over the $250,000 NIIT threshold which could cause additional taxes on investment income.

4) Medicare Part B and D premiums – Medicare premiums are based on a recipient’s modified adjusted gross income (MAGI). Conversion income may push MAGI over various Medicare thresholds thereby triggering additional Medicare premiums. These premiums are known as Income Related Monthly Adjustment Amounts or “IRMAA.”

The best way to estimate the total tax cost of a Roth conversion is to calculate its marginal tax cost. This calculation requires making a “before” and “after” calculation as follows:

1) Calculate your income taxes and Medicare premiums before Roth conversion income.
2) Calculate your income taxes and Medicare premiums after Roth conversion income.
3) The difference is your total marginal tax cost of a Roth conversion.

To calculate your marginal tax rate on a conversion, divide the total tax cost from step 3 above by the Roth conversion amount. For example, if you do a $100,000 Roth conversion and your marginal tax cost is $25,000, then your marginal tax rate would be 25%.

Also, you should include state income taxes, if any, in the before and after calculation.

If one is interested in an automated way to do that, the Case Study Spreadsheet when downloaded into Excel will consider all eight items listed (the four here and Retireby90's additions) and provide a chart of marginal rates vs. traditional withdrawal amounts.

 

[thatguy]

^^^^ Could still be advantageous for a couple where if one passes the survivor will be in a higher tax bracket.

That too.

 

[vdesalvo]

This Thought

Everyone seem to be about taxes, but I see it different as I see it about time and tax free growth. Yes, Uncle Sam is here to stay and does take a big piece of the pie. The longer you drag this on so you save that 2% the less you will/may make in tax free growth and time it has to sit before you can withdraw without penalty. Take the hit, pay the taxes, move it over and the money grows tax free, counter is counting down for penalty free withdrawn. Lots of variables, but at some point you you are out of the red and in the black on coming out ahead if you take a bigger hit as long as you stay in the 24% tax bracket.

 

[pb4uski]

No, the tax-free growth is a second order effect.... with the benefit being avoiding taxes on future income from the taxable account money used to pay taxes.

Let's first take an example where the tax rate is the same to isolate this second order effect. Joe has $50k in a tIRA and $11k in a taxable account. His marginal tax rate is 22% and we'll use a time horizon of 10 years and a total return of 7%.

Option 1: Joe converts to a Roth and pays the $11k in tax, ending up with $50k in the Roth. In 10 years, the Roth is worth $98,358 ($50k*(1+7%)^10).

Option 2: Joe stands pat. The $50k grows to $98,358 and is the withdrawn, at which point $21,369 ($98,358*22%) of tax is due. The $11k taxable fund has grown to $18,718 ($11k*(1+(7%*(1-22%)))^10). After the withdrawal and paying of taxes, Joe has $95,707 to spend....$2,651 less than Option 1.

The $2,651 is the amount of taxes paid over the 10 years on the taxable account returns... and is the difference between the growth of $11k with no taxes to $21,369 ($11k*(1+7%)^10) and to $18,718 with taxes ($11k*(1+(7%*(1-22%)))^10).

So now, let's add a twist that the marginal tax rate is 22% but jumps to 24% at the end of 10 years because Joe starts SS.

Option 1: Joe converts to a Roth and pays the $11k in tax, ending up with $50k in the Roth. In 10 years, the Roth is worth $98,358 ($50k*(1+7%)^10).

Option 2:Joe stands pat. The $50k grows to $98,358 and is the withdrawn, at which point $23,606 ($98,358*24%) of tax is due. The $11k taxable fund has grown to $18,718 ($11k*(1+(7%*(1-22%)))^10). After the withdrawal and paying of taxes, Joe has $93,470 to spend....$4,888 less than option 1... $2,651 due to taxes on the taxable account and $2,237 due to the increase in the marginal tax rate from 22% to 24%.

However, if one is looking at a 10% difference in marginal tax rates like between 12% and 22%, then the benefit of the lower tax rate is huge and overwhelms the benefit of not paying taxes on income from money used to pay the taxes.