Roth Conversion From Taxable Account

[RetiredAt49]

Background
I am retired and 50 years old. I have approximately $1.5 million in a taxable brokerage account (100% equities). I currently need to withdraw about $50k/year from this stash.

Questions

1) Should I do taxable -> Roth at all?
2) How much can I transfer a year from this taxable account -> Roth?
3) When should I start doing Roth conversions?

 

[RunningBum]

1) This sounds like a Roth contribution. You can only make one with earned income.
2) You can't "transfer", you contribute. Again, you can only do with with earned income. I don't know offhand what the max contribution is but this is easily googled.
3) Not nearly enough info to know. Basically it's tax rate arbitrage. Convert as much as you can at a lower rate now than what you expect to be at when you start RMDs at 72. Include as best you can factors like ACA subsidy, IRMAA, SS taxation, 0% LTCG rate, and probably a couple others I've missed. If it looks worthwhile to do, might as well start this in.

 

[steelyman]

I think the current contribution limit (2022, age 50+) is $7000.

Makes the $10K I bond limit seem generous!

 

[RetiredAt49]

I think the current contribution limit (2022, age 50+) is $7000.

Makes the $10K I bond limit seem generous!

Wow so I can only contribute $7,000 a year to a Roth IRA? That’s only a fraction of 1% of my taxable brokerage account so I guess I’m missing the benefit (other than Roth gross tax free) but it’s such a small amount that I’m not sure it’s worth the hassle - unless I’m missing something.

I also have traditional IRA’s (about $300,000 worth) so perhaps it would make sense to convert those to Roth?

 

[Exchme]

RunningBum has it right, if you are working and have earned income, folks under 50 can contribute $6,000 to a Roth and 50+ can do another $1,000. No contributions are allowed if the MAGI exceeds $125,000 for singles and $198,000 for MFJ.

You do Roth conversions only from tax deferred accounts like a 401k, 403b or traditional IRA. When money is withdrawn from tax deferred accounts for Roth conversions or just to spend, it is taxed as regular income. You may pay the taxes on the conversion with your taxable $ and so effectively get a few taxable $ into Roth vs. paying taxes by making a bigger withdrawal from the tax deferred account.

The advantage of the Roth is that future growth will not be taxed and folks with large tax deferred accounts can level out their tax burden, avoiding high future tax brackets, by doing some conversions when their income is otherwise low. But for a retiree with no tax deferred account, it is too late to start a Roth.

 

[pb4uski]

.... I also have traditional IRA’s (about $300,000 worth) so perhaps it would make sense to convert those to Roth?

Yes, depending on your marital status, current and future tax brackets that is the play.

 

[Animorph]

With a large taxable account and a smaller tIRA account I'm pretty sure Roth conversions would be worthwhile if your tax rates are currently low enough.

$300k withdrawn from a traditional IRA at a 12% tax rate is $36k in taxes. Pay those taxes from the taxable account and it's like a $36k Roth contribution. Aside from normal Roth conversion tax rate considerations, the $36k is now in a Roth IRA instead of the taxable account. Any future gains will be tax free. That also means you want to do this earlier rather than later to allow those gains to compound.

Of course you probably don't want to do that conversion all at once. You'll want to stay within whatever lower tax bracket is available to you over time.

Two other considerations would be 0% capital gains (which might be handy for raising that $36k) and leaving enough taxable income to fill the bottom tax brackets (if that might be a problem at all). If you are currently able to use the 0% LTCG bracket then maybe the taxes from your taxable account aren't very much, minimizing some of the Roth conversion benefit. If someone living only off their portfolio ended up converting their entire portfolio to a Roth account they could be leaving some 0% income tax rates on the table in the future.

And last, if you knew all of your tIRA would be withdrawn at a 12% tax rate then 12% of your tIRA belongs to the IRS now and forever. You're just investing it for them and giving them a portion of it each time you withdraw. The timing of those withdrawals makes no difference in terms of taxes, unlike with taxable accounts where you benefit from derferring taxes as long as possible. At a simple 12% tax rate, a $300k tIRA has the same value to you as a $264k Roth IRA. So there is no reason to delay Roth conversions other than to make sure you are getting the lowest tax rates you will ever see throughout retirement. Needless to say, a Roth with $300k in it (taxes paid from a taxable account) is worth more than a tIRA with $300k in it, so take advantage of that ability to put an extra $36k into your retirement account!

 

[SecondCor521]

With a large taxable account and a smaller tIRA account I'm pretty sure Roth conversions would be worthwhile if your tax rates are currently low enough.

$300k withdrawn from a traditional IRA at a 12% tax rate is $36k in taxes. Pay those taxes from the taxable account and it's like a $36k Roth contribution. Aside from normal Roth conversion tax rate considerations, the $36k is now in a Roth IRA instead of the taxable account. Any future gains will be tax free. That also means you want to do this earlier rather than later to allow those gains to compound.

Of course you probably don't want to do that conversion all at once. You'll want to stay within whatever lower tax bracket is available to you over time.

A taxpayer wouldn't be able to convert $300K all at once and stay entirely in the 12% bracket. Even for MFJ, the 12% bracket is only about $60K in size. The rest of the conversion would likely fall into the 22% and 24% brackets. Which may or may not make sense depending on the overall numbers (SS, pension, IRMAA, ACA, etc.).

 

[Helen]

Wow so I can only contribute $7,000 a year to a Roth IRA?

This is a big improvement. In the old days I think the limit was $2,000 for an IRA. 401ks were maxed out at 10% of your gross salary, not to exceed a certain maximum. When they established the 401k rules they didn't index for inflation.

Here is an interesting timeline of retirement plans:

https://www.ebri.org/docs/default-source/fast-facts/ff-318-k-40year-5nov18.pdf

 

[madatrub]

RunningBum has it right, if you are working and have earned income, folks under 50 can contribute $6,000 to a Roth and 50+ can do another $1,000. No contributions are allowed if the MAGI exceeds $125,000 for singles and $198,000 for MFJ.

You can still backdoor to roth, even above the income limits.

 

[TheWizard]

...That also means you want to do this earlier rather than later to allow those gains to compound....

No.
Assuming the same investments in the Roth IRA as in the tIRA and the same marginal tax rate now vs later years, the "compounding" is independent of when you do the Roth conversion.
This is a common Suze Orman mistake, ignoring the commutative property of multiplication.

But you pay less tax, in general, the earlier you Roth convert, so good for the OP to start now...

 

[RunningBum]

No.
Assuming the same investments in the Roth IRA as in the tIRA and the same marginal tax rate now vs later years, the "compounding" is independent of when you do the Roth conversion.
This is a common Suze Orman mistake, ignoring the commutative property of multiplication.

But you pay less tax, in general, the earlier you Roth convert, so good for the OP to start now...

True, but spreading it out over all the years is better than waiting (probably. With so little info from the OP it's impossible to give detailed advice). 20 years of converting $15K/yr is probably better than waiting 10 years and converting $30K/yr in those 10 years.

 

[Exchme]

OP said "I" rather than "we", so saying single tax brackets.
With $300K in IRAs and 50 years old, Roth conversions are probably a good idea as otherwise the IRA could grow pretty substantially before RMDs start.

If OP needs ACA insurance, then staying within 4 x Federal Poverty Level for the MAGI is essential to get a premium credit. That's $54,360 and includes everything from interest, dividends, Roth Conversions, odd jobs, short and long term capital gains, state tax refunds, and even things that are excluded from a regular AGI calculation are added in such as the non-taxable portion of SS benefits, tax exempt interest and excluded foreign income. For 2022, any ACA MAGI above causes an 8.5% premium credit reduction. Beyond this year, it is a cliff, go over $1 and you get no premium credit.

If no ACA is needed, the situation changes very slightly. The best target is probably an AGI below the top of the 0% LTCG bracket. That AGI target is the std deduction ($12,950) + $41,675 = $54,625. That AGI does not include non-taxable portion of SS benefits, tax exempt interest of excluded foreign income. If you do a few $ over this, the tax cost on the increment is steep, paying regular income tax of 12% on the extra $, plus pushing a $ of capital gains to be taxed at 15%, so 27% (until all the capital gains have been taxed)

Some folks leave a residual in their IRA as a reserve for long term care, as that would be mostly tax deductible. Some leave their IRA mostly alone to give it away as QCDs, starting at age 70.5.

In any plan, you have to consider all the factors, your SS benefit and claim age, any pension, expectations for tax law changes, state taxes, possible big expenses or life changes like moving, asset allocation and your expectation for market returns, the goal for your money (live comfortably, give to charity, give to heirs). So OP has some work to do.

 

[Animorph]

No.
Assuming the same investments in the Roth IRA as in the tIRA and the same marginal tax rate now vs later years, the "compounding" is independent of when you do the Roth conversion.
This is a common Suze Orman mistake, ignoring the commutative property of multiplication.

But you pay less tax, in general, the earlier you Roth convert, so good for the OP to start now...

Not anything to do, exactly, with compounding. It's the extra value of having $300k in the Roth instead of $300k in the tIRA. $36k of that Roth amount is what was added by using the taxable account to pay the conversion taxes. The longer that $36k is in the Roth account, the more taxes you save on capital gains and dividends. Over 10 years that may be a significant amount. Over one year, who cares. And income tax rates have very little to do with that $36k. Especially if you can generate a capital loss when raising the cash within the taxable account.

 

[TheWizard]

Not anything to do, exactly, with compounding. It's the extra value of having $300k in the Roth instead of $300k in the tIRA. $36k of that Roth amount is what was added by using the taxable account to pay the conversion taxes. The longer that $36k is in the Roth account, the more taxes you save on capital gains and dividends. Over 10 years that may be a significant amount. Over one year, who cares. And income tax rates have very little to do with that $36k. Especially if you can generate a capital loss when raising the cash within the taxable account.

I tend to agree with that. Roth conversions are a good way for folks with no earned income to effectively put more money into tax-free investments.
I did it paying 24% Federal tax, not 12%...