ROTH Conversion second thoughts

[Happyras]

I know many may be considering Roth conversions as part of a tax strategy to address potential changes next year. I thought I would throw out a caveat due to tax law structures. I did a conversion in April, which I now may have to regret despite the dip in market value.

I re-estimated our 2020 Fed taxes and found an error in my thinking at the time. As a majority of our income is from LT Capital Gains (spread through 2024) I had created a plan (installment sale) to maintain these gains within the 15% bracket for the next 4 years. However, when I made the Roth conversion, it pushed our AGI up to where nearly all of the Roth conversion pushed an equivalent amount LTCG into the 20% rate ( all of the conversion amount was essentially taxed as ordinary income 24% AND 5% more effectively due to tax on capital gains shift). We are paying 29% where I thought it was 24% on the conversion marginal rate. This may still be OK for us with changes in tax rates pending the election.

I can't do much at this point, but there may be others with high Cap Gains income that might miss this impact when doing a conversion. Yes, I feel a little stupid, but lesson learned......

BTW, with TurboTax I should have seen this, but it does not make this obvious. I found this very simple calculator that makes it so clear. https://www.nerdwallet.com/article/taxes/capital-gains-tax-rates

 

[RunningBum]

I'd bet that recovery after you did the conversion makes up for it. There was about a 20-25% gain there (assuming you're in equities). Kept in a tIRA, you'd eventually pay ordinary income tax rate on the gain, when you withdraw or later convert. Since it's in a Roth, that gain is tax free. So maybe you didn't do it right, but I think you came out better.

In Turbo Tax, you need to look at the Qualified Dividend and Capital Gain Tax worksheet. Line 19 tells you how much LTCGs are being taxed at 15%, with the tax on line 20. Line 22 tells you how much of it is being taxed at 20%, and that tax is on 23.

 

[Happyras]

In Turbo Tax, you need to look at the Qualified Dividend and Capital Gain Tax worksheet. Line 19 tells you how much LTCGs are being taxed at 15%, with the tax on line 20. Line 22 tells you how much of it is being taxed at 20%, and that tax is on 23.

Yup, there it is obvious. You are correct, the gain this year has offset the tax!

 

[SecondCor521]

Measure four times, cut once.

I did about half of my likely Roth conversion this year on March 17th for the reasons that RunningBum alludes to. I thought the loss of tax planning flexibility was worth the probable tax free gain.

I think I played it correctly, but with three kids in college whose plans change every few months based on the virus and other things, the loss of planning flexibility does have the ability to be problematic.

 

[SevenUp]

BTW, with TurboTax I should have seen this, but it does not make this obvious. I found this very simple calculator that makes it so clear. https://www.nerdwallet.com/article/taxes/capital-gains-tax-rates

If you can use Excel, any changes in tax rates for a wide variety of reasons will appear in the case study spreadsheet.

E.g., see the chart in this post.