Roth Conversion Guide

[Time2]

What I would do, is using either the TurboTax What-If Worksheet or the dinkytown tax calculator is to sketch out 2020 tax assuming $0 Roth conversions. Then add Roth conversions to the top of the 12% bracket and compare the increase in tax to the amount of the conversion to get the effective rate on the conversion.

As noted, the harder part is to get an idea of your future tax rate before and after RMDs, but since SS and tax brackets grow with inflation and RMDs grow at at least the rate of inflation due to investment growth, I think you could get a rough approximation by using today's SS at the age you plan to take it (excluding COLA growth) and RMDs assuming you were now 72 (or maybe a little more).

Yes, I am using Dinkytown to calculate my maximun Roth Conversion in the 12% bracket. It is a little convoluted for me because, I get next years expenses this year, I also have to generate a December $30k tuition payment. Add to those any taxes due and money for an HSA. Then add in the Roth Conversions which generate taxable income, so I have rerun the taxes due and generate more income to pay those extra taxes which also means more income and more taxes. But I have it pretty well figured out, although my first asset sale generated a several hundred dollars more LTCG than I calculated.

I think I'll sneak up on the proper amount
with a bigger asset sale, redo the calculations to see how close I am and then one or two smaller asset sales to get it close.

 

[pb4uski]

x/(1-t) can be quite useful... where x is the desired net proceeds and t is the tax rate.

So if I want to net $10,000 and the marginal tax rate is 12%, an $11,364 withdrawal will result in $1,374 in tax and net proceeds of $10,000.

 

[Rocket Man]

Thanks! Great piece of information!

 

[Brat]

I wish I had converted more of DH's tIRA during the years before required minimum distributions. That would have been before the ACA so didn't need to factor that in.

 

[braumeister]

One of the best things I ever did was to take advantage of a special deal offered in 2010. I converted my entire traditional IRA to Roth at a stroke. Of course that led to an enormous tax liability, but for that one year only you could pay the tax over two years, half with the 2011 taxes and half with 2012. I bit the bullet and did it, and it feels so good to have that behind me!

Considering the state of things today, I wouldn't be at all surprised if they offered the same deal again next year.

 

[RunningBum]

One of the best things I ever did was to take advantage of a special deal offered in 2010. I converted my entire traditional IRA to Roth at a stroke. Of course that led to an enormous tax liability, but for that one year only you could pay the tax over two years, half with the 2011 taxes and half with 2012. I bit the bullet and did it, and it feels so good to have that behind me!

Considering the state of things today, I wouldn't be at all surprised if they offered the same deal again next year.

That was a great deal and I regret not taking advantage of it. It turned out to be a big winner because the gains in the next couple of years following made up for the tax liability, or at least would have in my case. It would've been good even for normal years. I didn't really do the math on it.

 

[Out-to-Lunch]

I did that, too, but since I was w*rking, I only had ~$20k in a rollover IRA from a previous employer. Too bad.

 

[FREE866]

Such an interesting topic. And thank you to all , esp PB4uski for helping me though this earlier in year.


I started doing Roth conversions this year and my effective tax rate is 7.38%. I am assuming when SS and RMDs start hitting ( 16-18 years from now) my effective tax rate will be much higher.

 

[Bigdawg]

x/(1-t) can be quite useful... where x is the desired net proceeds and t is the tax rate.

So if I want to net $10,000 and the marginal tax rate is 12%, an $11,364 withdrawal will result in $1,374 in tax and net proceeds of $10,000.

11364
-1374
=9900

Or did I miss something?

 

[pb4uski]

11364
-1374
=9900

Or did I miss something?

We both did. I typed $1,374 and it should have been $1,364... the 6 and the 7 are adjacent on the keyboard so obviously it's a typo.

But... $11,364 - $1,374 = $9,990... Not $9,900. Miscalculation or typo? I don't know, but in any event we're even.

 

[Out-to-Lunch]

EDIT: Dang, I gotta start hitting refresh before I submit these! Another crossing in the ether.

11364
-1374
=9900

Or did I miss something?

Well, Pb4 meant to say that the tax was $1364.

And your subtraction was off by $90

11364
-1374
=9990

 

[SevenUp]

Yes, to figure that tax drag you'd have to model it out.

See Break-even withdrawal rate for said model.

 

[sengsational]

See Break-even withdrawal rate for said model.

This is a bogleheads thread.

 

[Time2]

x/(1-t) can be quite useful... where x is the desired net proceeds and t is the tax rate.

So if I want to net $10,000 and the marginal tax rate is 12%, an $11,364 withdrawal will result in $1,374 in tax and net proceeds of $10,000.

I'm having a tough time extending this x/(1-t).
My 1 is made of LTCGs, only 56% are taxable.

My long way into this is Percentage taxable = Gross - (Gross- LTCG percentage) OR 1-(1-.56) =1-(.44) = .56
t = .56 * tax rate, then t = .56 * .12, so, t=0.0672 now if I plug t into x/(1-t)
x/(1-0.0672) = x/.9328. So if I want $40,000, I divide by .9328 and get $42,881.
Can anyone simplify that?

 

[Brat]

Everyone is pushing the numbers based on the current tax code and I will admit that the impact of ACA substudies is significant. That said, if ACA substudies are not a factor, consider that the tax rate for high-income taxpayers is likely to increase significantly in the near future. If your tIRA is expected to grow significantly your RMDs will flow directly to taxable income.

 

[FlaGator]

I'm in the conversion calculation dilemma, I just retired in June at 58, DW will follow in a year or so. We will have a lot of time to do conversions with little income. I've started on spreadsheet but just keeps getting more and more complex.



The latest issue to add to the spreadsheet is to figuring out the road between shooting for low nearly tax free income and getting ACA subsidies versus trying to take advantage of the 24% bracket while we have it. I think we can get subsidies of around 8-10K.



Anyone have any tips in relation to considering ACA subsidies?

Just stepped through that scenario.

I used subsidy limits as the upper bound for income (ignoring tax rates). Then estimated ACA MAGI and deducted that from my chosen subsidy limit. The remainder is my conversion amount. Expect taxes on that to be minimal

 

[SevenUp]

This is a bogleheads thread.

Is that a bad thing?

 

[simple girl]

Just stepped through that scenario.

I used subsidy limits as the upper bound for income (ignoring tax rates). Then estimated ACA MAGI and deducted that from my chosen subsidy limit. The remainder is my conversion amount. Expect taxes on that to be minimal

That's exactly what I am doing, too.

 

[pb4uski]

I'm having a tough time extending this x/(1-t).
My 1 is made of LTCGs, only 56% are taxable.

My long way into this is Percentage taxable = Gross - (Gross- LTCG percentage) OR 1-(1-.56) =1-(.44) = .56
t = .56 * tax rate, then t = .56 * .12, so, t=0.0672 now if I plug t into x/(1-t)
x/(1-0.0672) = x/.9328. So if I want $40,000, I divide by .9328 and get $42,881.
Can anyone simplify that?

If 56% of your gains are taxable a LTCG at 15%, then isn't your effective tax rate on those sales 15%*56% or 8.4%?

So t would be 8.4% and the gross would be $43,668 and result in $24,454 of LTCG (56% of $43,668) and $3,668 of tax at 15%... for a net after-tax proceeds of $40,000.

 

[Time2]

If 56% of your gains are taxable a LTCG at 15%, then isn't your effective tax rate on those sales 15%*56% or 8.4%?

So t would be 8.4% and the gross would be $43,668 and result in $24,454 of LTCG (56% of $43,668) and $3,668 of tax at 15%... for a net after-tax proceeds of $40,000.

I think my LTCGs are Taxed at 0%.
I have 6 entries in Dinkytown.
MFJ
$9500 Div And Interest (I put $9500 in Both lines Ordinary and Qualified)
$42,265 LTCGs
$62,680 IRA Distribution
$8100 HSA Contribution
I checked the 'You are 65 box' (makes Standard Deduction $26,100)
Here's a picture of the report.

 

[pb4uski]

1/(1-t) only works well within a single tax bracket or for broad-based planning.

In your case, you actually have 3 tax brackets coming into play. Your ordinary income is $28,480 [$80,245 of taxable income less $51,765 of preferenced income (LTCG and dividends)]. The first $19,750 of ordinary income is in the 10% tax bracket and results in $1,975 in tax. The remaining $8,730 is in the 12% tax bracket and results in $1,048 in tax.... resulting in $3,023 in ordinary tax. Since your taxable income is over $80,000, the Roth conversion results in $245 of preferenced income being pushed into the 15% tax bracket and $37 of tax. So your total tax is $3,060.

So the first $62,435 of the Roth conversion results in $2,994 of tax (4.8%... a combination of $34,100 @ 0%, $19,750 @ 10% and $8,730 @ 12%) and the last $245 results in $66 of tax (27%).

If it were me, I would reduce the Roth conversion from $62,680 to $62,435 to avoid the 27% marginal tax rate on that last $245.

 

[Time2]

1/(1-t) only works well within a single tax bracket or for broad-based planning.

In your case, you actually have 3 tax brackets coming into play. Your ordinary income is $28,480 [$80,245 of taxable income less $51,765 of preferenced income (LTCG and dividends)]. The first $19,750 of ordinary income is in the 10% tax bracket and results in $1,975 in tax. The remaining $8,730 is in the 12% tax bracket and results in $1,048 in tax.... resulting in $3,023 in ordinary tax. Since your taxable income is over $80,000, the Roth conversion results in $245 of preferenced income being pushed into the 15% tax bracket and $37 of tax. So your total tax is $3,060.

So the first $62,435 of the Roth conversion results in $2,994 of tax (4.8%... a combination of $34,100 @ 0%, $19,750 @ 10% and $8,730 @ 12%) and the last $245 results in $66 of tax (27%).

If it were me, I would reduce the Roth conversion from $62,680 to $62,435 to avoid the 27% marginal tax rate on that last $245.

Thanks pb, I thought the program was watching the last dollar tax rate, I see it's not, (seems it should). Now, I'll check by adding or subtracting $100, and check how the tax owed changes.

 

[SevenUp]

Thanks pb, I thought the program was watching the last dollar tax rate, I see it's not, (seems it should). Now, I'll check by adding or subtracting $100, and check how the tax owed changes.

A tax rate on $1 isn't of much use, unless it's only $1 in question. Usually much better to use a larger denominator when determining marginal tax rate.

 

[Time2]

A tax rate on $1 isn't of much use, unless it's only $1 in question. Usually much better to use a larger denominator when determining marginal tax rate.

I used $100, but, I don't understand where the problem lies. If In add $100 to my income and the the tax increases $12,
I think I'm still in the 12% tax bracket. If I add $100 and The tax increases $22, then I'm in the 22% tax bracket. I do this to optimize the numbers, when I add that last $100 and I jump from 12% bracket to 22% bracket, I have $100 too much income.
Where am I wrong?

 

[pb4uski]

You aren't... that's a sensible approach... you just need to keep in mind that type of income that you are adding... if you add $100 of ordinary income vs adding $100 of preferenced income then you'll get different marginal tax rates because there are two separate tax schemes that then get combined.