ROTH Conversion Modeling Question

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joesxm3

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Does this logic make sense to model a current ROTH conversion compared to leaving in IRA until RMD time?

Take a conversion amount, say $10,000 and put into the ROTH column.
Take the federal and state taxes on the conversion and save for later, assuming that came out of taxable account.
Assume an annual growth rate for the ROTH money, say 4%.
Compute the future value of the ROTH in 2028, age 72 for first RMD.

Does it make sense to get the value to compare to IRA I should subtract the initial tax paid amount from the 2028 value of the ROTH?


For the other side of the comparison.

Leave the conversion amount in the IRA and leave the tax paid amount in the taxable account and assume the same growth rate.

Compute the 2028 value of the IRA amount.
Compute the 2028 value of the taxable account amount.
Subtract taxes due on the entire IRA amount, but only subtract taxes due for the amount of increase in taxable account.

Since I will be getting Social Security in 2028, assume that (at least) 50% of my SS will be taxable. Subtract this amount of tax from the IRA amount.

Compare this IRA net amount to the ROTH net amount above.


The part that confuses me is whether for the IRA side of the comparison I should count both the IRA amount and the current value of the taxable account money not used to pay conversion taxes in 2023, or should I just add the amount that the taxable money increased?

I have some further questions based on the results of this model, but I figure best to make sure I am off on the right foot here.

Thanks.
 
I decided to throw this question into Chat GPT and this is what I got for an answer. Let's see if we agree :)

Yes, your logic makes sense as a way to compare the benefits of a Roth conversion versus leaving the money in a traditional IRA until the required minimum distribution (RMD) age. By comparing the after-tax future value of the Roth conversion to the after-tax future value of leaving the money in the traditional IRA and taxable account, you can evaluate which option will result in more retirement income.

To clarify your question about subtracting the initial tax paid amount from the future value of the Roth conversion, it would make sense to do so if you want to compare the net after-tax values of the Roth and traditional IRA options. By subtracting the initial tax amount from the future value of the Roth conversion, you are effectively accounting for the fact that you paid taxes upfront on the converted amount, whereas with the traditional IRA option, you will pay taxes on the entire distribution (including earnings) at your marginal tax rate at the time of distribution.

Similarly, subtracting taxes due on the entire IRA amount (assuming 50% of your Social Security benefits will be taxable) and the taxes due on the increase in the taxable account from the future value of the traditional IRA and taxable account options, respectively, will give you the net after-tax values to compare with the Roth conversion option.

Overall, your approach is a good way to compare the potential benefits of a Roth conversion versus leaving the money in a traditional IRA and taxable account. However, it's worth noting that there are many other factors to consider when deciding whether to do a Roth conversion, such as your current and expected future tax rates, your retirement income needs and goals, and your estate planning goals. Therefore, it's important to consult with a financial professional who can help you evaluate all the relevant factors and make an informed decision.
 
I didn't try to follow your details, but the way I think about it is this:

Today's tIRA contains two pots of money. Mine and Uncle's. My choice is to give Uncle his pot now or to let his pot grow alongside mine and to give it to him on some future date. If my net tax rate is the same now and then, then it is a push. Giving him his pot now or later doesn't matter. If my future net tax rate is lower, it makes sense to wait. If it is higher, then I pay him off now.

Note that the growth rate of the account doesn't matter. Either way, your pot will grow to the same $ amount and, if you elect to pay him later, Uncle's pot will grow at the same rate as your pot.

"Net tax rate" isn't just Fed and State income tax though. IRMAA, ACA, taxable SS amounts, etc costs, if any, are part of net tax rate.
 
OldShooter said:
I didn't try to follow your details, but the way I think about it is this:

Today's tIRA contains two pots of money. Mine and Uncle's. My choice is to give Uncle his pot now or to let his pot grow alongside mine and to give it to him on some future date. If my net tax rate is the same now and then, then it is a push. Giving him his pot now or later doesn't matter. If my future net tax rate is lower, it makes sense to wait. If it is higher, then I pay him off now.

Note that the growth rate of the account doesn't matter. Either way, your pot will grow to the same $ amount and, if you elect to pay him later, Uncle's pot will grow at the same rate as your pot.

"Net tax rate" isn't just Fed and State income tax though. IRMAA, ACA, taxable SS amounts, etc costs, if any, are part of net tax rate.
Click to expand...


This is the way to think about it. I think you get into the weeds unnecessarily if you try to create the model OP was describing.
 
Other things to consider:
1. If married, consider tax ramifications should one spouse pass early leaving the other spouse filing as an individual.
2. Heirs? Leaving tIRA to them in their peak earning years could be costly to them.
3. Will you be making charitable donations? Using a tIRA allows you to make Qualified Charitable Donations right from the IRA, avoiding tax.
4. Other income while receiving RMDs could push you into higher tax brackets, such as an inheritance.
 
My Excel gives me the impression that, for me, converting in the 22% bracket with current state tax rate is not very appealing. I did not include IRMAA, so that might help the ROTH side of the comparison.

I bought a Tesla this year and have to use up the $7500 tax credit. I either have to ROTH convert or sell some Series I bonds (I currently have a capital loss carryover).

I already converted some $50,000, which probably maxes out the 12% bracket. My dilemma is whether to convert in the 22% with state tax or sell some I bonds. The worst I Bond I have has a 1.7% real rate and several years left on it.

I hate to lose out on the nice interest rate, so I probably will just convert some in the 22% bracket enough to use up the tax credit.

For the next three years I probably will only ROTH convert up to the 12% bracket, and after that I will be hit by the Social Security torpedo.
 
Dash man said:
...
2. Heirs? Leaving tIRA to them in their peak earning years could be costly to them.....
Click to expand...


I've seen this mentioned many times, so don't take it personally. It's just that your post is a convenient opportunity for me to say that I believe this is not true. It is not "costing" your heirs anything. It's just that their inheritance net of taxes might be smaller than otherwise. But who cares? Whatever they get is free money they didn't have to earn for themselves and didn't have at all until they received a bequest. And if they don't want to pay taxes, they don't have to take the money.
 
The bogleheads' Retiree Portfolio Model is a free spreadsheet available at the bogleheads.org wiki that already has the federal tax rates, RMD schedule, SS taxation, NIIT and IRMAA already in it. It is not locked if you want to personalize it.

Pralana Gold is a paid Excel spreadsheet that is more thorough and flexible and is much more automatic in helping you do things like make Roth Conversion plans.

I'n sure there are some on-line tools too.

Or you could spend a few hundred hours writing your own tool and never being certain that you've fully debugged it.
 
Gumby said:
I've seen this mentioned many times, so don't take it personally. It's just that your post is a convenient opportunity for me to say that I believe this is not true. It is not "costing" your heirs anything. It's just that their inheritance net of taxes might be smaller than otherwise. But who cares? Whatever they get is free money they didn't have to earn for themselves and didn't have at all until they received a bequest. And if they don't want to pay taxes, they don't have to take the money.
Click to expand...


It all depends on what you are trying to accomplish. Our goal is to set up a dividend stream of income for our boys to preserve capital and pass on to future generations. So we aggressively convert to a Roth and invest in tax free dividend growth stocks.
Obviously your goal is different.
 
Gumby said:
I've seen this mentioned many times, so don't take it personally. It's just that your post is a convenient opportunity for me to say that I believe this is not true. It is not "costing" your heirs anything. It's just that their inheritance net of taxes might be smaller than otherwise. But who cares? Whatever they get is free money they didn't have to earn for themselves and didn't have at all until they received a bequest. And if they don't want to pay taxes, they don't have to take the money.
Click to expand...

In my case, I care.

I get your point, but if I can pay at a 15% effective rate, and avoid DS paying at 22% or higher, then the "family" saves 7%, or more.

It is not the only reason we convert. Lowering RMD's is the main driver.
 
Your heirs can also transfer the money into thier own retirement account and take distributions over like 10 years. This will give them time to ajust. I am not positive on the 10 years, it has to do with the person that died and how old they were.
 
joesxm3 said:
Does this logic make sense to model a current ROTH conversion compared to leaving in IRA until RMD time?

Take a conversion amount, say $10,000 and put into the ROTH column.
Take the federal and state taxes on the conversion and save for later, assuming that came out of taxable account.
Assume an annual growth rate for the ROTH money, say 4%.
Compute the future value of the ROTH in 2028, age 72 for first RMD.

Does it make sense to get the value to compare to IRA I should subtract the initial tax paid amount from the 2028 value of the ROTH?


For the other side of the comparison.

Leave the conversion amount in the IRA and leave the tax paid amount in the taxable account and assume the same growth rate.

Compute the 2028 value of the IRA amount.
Compute the 2028 value of the taxable account amount.
Subtract taxes due on the entire IRA amount, but only subtract taxes due for the amount of increase in taxable account.

Since I will be getting Social Security in 2028, assume that (at least) 50% of my SS will be taxable. Subtract this amount of tax from the IRA amount.

Compare this IRA net amount to the ROTH net amount above.


The part that confuses me is whether for the IRA side of the comparison I should count both the IRA amount and the current value of the taxable account money not used to pay conversion taxes in 2023, or should I just add the amount that the taxable money increased?

I have some further questions based on the results of this model, but I figure best to make sure I am off on the right foot here.

Thanks.
Click to expand...

Actually the Roth conversion comes out slightly ahead. Let's say that today you have $10,000 in a tIRA and $2,000 in a taxable brokerage account and that you will pay 20% in taxes.

If you convert, the $2,000 brokerage account money is gone to pay the taxes, leaving $10,000 in the Roth. With 5 years of 4% growth, in 10 years the Roth is worth $12,167 [10000*(1+4%)^5]

If you don't convert, the $10,000 in the tIRA grows to be $12,167 in 5 years. Meanwhile, the $2,000 brokerage account money grows at 3.2% after taxes at 20% each year, so after 10 years it is $2,433 [2000*(1+(4%*(1-20%)))^5]. When you take the $12,167 RMD you will owe $2,433 in tax [20% of $12,167] so after paying the tax you will have $12,074 left to spend.

So the Roth conversion is ahead by $93, which is the tax savings on the taxable account money growth over the 5 years.

So if the tax rate on the withdrawal doesn't change then the benefit is avoiding taxes on the taxable account money.

However, more commonly the tax rate is different lower in ER before pensions and SS start. In our case, I can convert now in 2023 at ~11% (a mix of 10% and 12% marginal) and avoid paying 17% (a mix of 12% and 22% marginal) on future RMDs, effectively prepaying the RMD tax at a discount.
 
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Thanks.

So are you saying that for the conversion side I don't need to subtract the money that the $2000 would have earned had I not paid taxes with it?

Edit.

Or maybe even subtract the entire $2000 since it is tax paid on the Roth side of the comparison?
 
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No, you don't because that money is gone to pay the taxes so it will never earn any income.

The impact that you are referring to is built into the RMD calculation of the future value of the taxable account money.

The importatant point to take away is that the main benefit is due to differences in tax paid on the conversion vs estimated taxes paid on the RMD for differences in tax rates and that the impact of the taxes on taxable account money during the growth period is negligible.

So it you would pay 22% now or 22% later then the benefit of a Roth conversion is negligible, but if you would pay 12% now vs 22% later than the benefit is substantial.
 
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I guess the main point is that 12% is good but 22% is a wash.

At 12% I might be able to convert about 30% before I hit 70 and get SS.

I don't have a huge IRA, but I have about the same amount in high!y appreciated series I bonds that are going to make a spike into 24% bracket in 2030,31,32. I guess I will just bite the bullet. I considered cashing early but the real yield portion is over 3% on these. I did not crunch but missing that interest for 7 years seems worse than an extra 2% or 4% bracket.
 
pb4uski said:
... The importatant point to take away is that the main benefit is due to differences in tax paid on the conversion vs estimated taxes paid on the RMD for differences in tax rates and that the impact of the taxes on taxable account money during the growth period is negligible.

So it you would pay 22% now or 22% later then the benefit of a Roth conversion is negligible, but if you would pay 12% now vs 22% later than the benefit is substantial.
Click to expand...
This is completely correct, of course, but I think it is important to emphasize that the decision must be made based on net taxes involved with a conversion. People seem to focus on the Federal tax rate, but that is only part of the story. IRMAA, taxable SS, ACA, and state tax are also part of "net tax" as well as possibly other things like means-tested real estate tax credits for seniors
 
When my huge series I bond bubble hits in 2030, if it is large enough to cause the entire 85% of my SS to be taxed, would it make sense to cash in some from future years up to the next bracket if that might keep some of SS from being taxed in the next year or keep from hitting the next IRMAA bracket?
 
I find that almost always my conversion ceiling is the point at which qualified dividends would be taxed. This keeps me at 10 or 12% regular income rate + subsidy loss, which I think is 16.8% at the income level I'm looking at. I had been in the 10% bracket but the higher interest rates on fixed income investments may push me into 12%. I might try to stay at 10% until I'm out of the ACA in 4 years.
 
joesxm3 said:
When my huge series I bond bubble hits in 2030, if it is large enough to cause the entire 85% of my SS to be taxed, would it make sense to cash in some from future years up to the next bracket if that might keep some of SS from being taxed in the next year or keep from hitting the next IRMAA bracket?
Click to expand...

First, keep in mind that the income level for SS taxation at 85% is not inflation indexed, so you might be at 85% by then anyway.

Second, it might depend on how far from 85% SS taxation you are.

Say you'll have $50K extra income from cashing in your IBonds, and you are trying to decide whether to take the full $50K one year, or spread it out over 5 years.

And say that you are $10K short of hitting 85% SS taxation. This could make your marginal tax rate for the next $10K as high as 49.95%*, assuming QDivs/LTCGs are involved. Above that you are probably back down to 27% marginal rate.

If you spread out the I Bonds over 5 years, $10K each, you'd pay $4995 tax each year, netting only $5005, or $25,025 total.

If you instead took it all in one year, the first $10K is taxed at 49.95%, and the other $40K at 27%. You'd pay $4995+$10,800, or $15,795 tax on that $50K, netting $34,205.

That's the extreme case, but I think it's likely that blowing way past the 85% mark in one year is better than paying the SS tax torpedo rate each year.

* 49.95% is my SS tax torpedo rate. Yours might be a little lower, or a lot lower if your QDivs/LTCGs are already fully taxed. Make your best guess on your numbers and plug them into a tax calculator.
 
Thanks.

Had not considered qualified dividends. Guess I will need to learn about those.
 
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