Roth conversion vs subsidy vs RMD income levels

[bingybear]

I know at least parts of this has been discussed and the problem is likely very dependent one each person's situation. I recall many posts that tended to focus on local marginal rates often focused on ACA subsidies. I expect this problem to need global optimization.

What I'm trying to understand is what is the best choices going forward to optimize the overall system. But that I should really assume that I keep as many dollars legally in the end with a time adjusted value of the $.

In my case I have more $ in after tax accounts than tax deferred and lots more than tax exempt. I think its about 55/43/2 taxable/deferred/exempt. To throw another twist.. inherited (stretch) IRAs may be in our future.

Presently my taxable generates mostly dividends and some LTCG with a small amount of ordinary income. I presently fund HSA to the max for investing for later heath care and pay the medical bills out of pocket. My IRAs are primarily invested in fixed income portion of our allocation.

Last year I converted up to the top of the 15% bracket (on cobra so subsidy did not come into play).

I'm curious on what analysis has been done to determine the trade off of all these interacting parts or what your thought process on this is. I've seen some do conversions up to the 15% bracket, some into or up to the limit of the 25% bracket, and some just focused on the subsidy.

I'm well aware of the marginal rate issues with the PTC, for CG & QD when exceeding the 15% bracket.

Feel free to tell me my location of my allocation doesn't make sense, but suggest a replacement with reasons so I can understand why.

Any insights would be appreciated.

 

[RunningBum]

I get a headache every time I try to figure out the ACA subsidy vs Roth conversion. I have a lot in my taxable account and dividends and CG distributions alone put me over the subsidy limit, unless I do tax loss harvesting. At 54, the subsidy at 400% would be worth about $1000 to me, according to notes I took (did not recheck calcs today). It will be worth a lot more as I get older and insurance premiums rise. Remember that the subsidy is not really a discount on insurance, it sets the maximum you have to pay, so the savings is a lot more when your rates are higher.

My thought for me is to not try to manage my income to get below 400% of FPL until the subsidy is worth more. in the meantime I convert up to the 10% income bracket, because I'm also pushing more div/CGs into being taxable so it's really 25%. If the subsidy survives this election year I may start looking to take it in 2017.

It just seems really difficult for me to take a holistic approach since I have to weigh when to take the cap gains losses vs. the amount of the subsidy, with how long I can make those losses last, vs. how long there will be a subsidy. If it was just comparing the value of the subsidy with the value of converting to a Roth, it would be a bit easier, but there's still the question about how much converting to a Roth actually saves you in the long run because of doubt about future investment returns and future tax rates.

This is why I think it's really a personal decision based on your numbers and your prediction for the future. Best you can do is to identify all of the issues, and I'm not even sure I have done that myself.

 

[RunningBum]

btw, if I thought a financial advisor could really do this for me, I'd pay for one, but I have the feeling that they won't really consider all of the factors fully either. I wouldn't know if they are doing it right unless I analyzed it for myself and they showed all their work. Maybe I should try a fee based one once. Does anyone have any experience with an FA based on trying to answer the ACA subsidy vs. Roth question? I also have the feeling that even if I do it the wrong way the difference isn't going to be as much as the FA fee.

 

[ziggy29]

Just for completeness, on the other side of the ACA subsidy income scale, if you have so little income that you don't qualify for ACA subsidy, conversions can at least get you to the income level needed. That's especially important in states without expanded Medicaid.

 

[MBSC]

Here are a couple of articles on the subject. The charts help visualize the issues.

ACA Optimization in ER

ACA Optimization vs Tax Minimization

 

[pb4uski]

I gave up on trying to manage our income to gain subsidies. If we did no conversions our dividend and LTCG would put us out of Medicare but with full subsidies with a bronze plan... a savings of ~$800/month and $9,600/year.

But... because the lowest cost bronze level plan would cost more than 8% of our income even if I do conversions to the top of the 15% tax bracket we are eligible to buy catastrophic coverage even though we are over 30. The cat coverage costs us $460/month so not doing subsidies really costs us ~$5,500/year... not the $9,600/yr suggested by looking only at unsubsidized bronze plan premiums (the coverage of the cat and bronze plans are similar and the networks are identical).

With the cat insurance I am free to do Roth conversions up to the top of the 15% bracket... ~$74k conversion last year and the tax cost me $7k (a little less than 10%). Once my pension and RMDs start I would likely be in the 25% bracket for many years so I would pay tax of ~$18k on ~$74k of conversions if I do them later.

So alternative 1 would be get free HI now, pay $0 tax but pay $18.5k in tax later. Alternative 2 is pay $5.5k for cat insurance + $7k in taxes now but pay $0 in tax later. Guess which direction I chose?

Of course, YMMV. It works in our case because HI premiums are not age rated in our state and cat coverage is substantially lower than bronze which seems not to be the case in some other parts of the country. If cat coverage were not available to us or was closer in price to bronze coverage then it would be a closer call.

 

[Animorph]

It is highly dependent on your personal tax situation.

The most important thing to estimate is your marginal tax rate when RMD's hit.

If that RMD tax rate is one or more tax brackets higher than your current marginal tax rate then the Roth conversion is probably beneficial, barring ACA subsidies or other tax oddities. Convert up to the top of the tax bracket below the RMD tax rate. Continue until the RMD tax rate is equal to your current rate.

That's the easy part, and probably gets you 80% to 90% of the optimum Roth conversion benefit.

Beyond that you have to get fairly detailed in your calculations to justify more Roth conversion. I try to optimize yearly spending while limiting the maximum portfolio withdrawal percentage.

 

[bingybear]

my income from the taxable accounts puts me above the Medicade level, but below the cliff. So if I get an HDHP, I drop my income by contributing to the HSA.

pb4uski -- I had just assumed I could not get a cat plan. Do cat plans also have "agreed upon rates" with the providers? I will have to check this out. I will have to consider my one "existing condition" in doing this.

For me I think the RMD @70.5 would be put us in the upper part of the 25% bracket if we held full allocation was held in the IRAs (assuming historical average returns). Buy holding FI in the IRAs, I'm assuming this will be reduced a bit. Over all the accounts we still hold are desired allocation. This does not include SS.

 

[pb4uski]

Under ACA if the lowest cost bronze plan exceeds 8% of your income then you can buy into a cat plan. It is a bit of a convoluted process and I did it early and it took about 6 months to get things sorted but I suspect it is smoother now.

See http://www.early-retirement.org/for...ive-to-a-more-costly-bronze-policy-69160.html
http://www.early-retirement.org/forums/f38/were-you-successful-in-the-aca-signup-69845-13.html

My cat plan works exactly the same as the bronze plan I had... same company, same network, 5% higher deductibles, 43% lower premiums, same negotiated rates to my knowledge but some other differences that don't matter in our case... also NO medical underwriting so no worries about your pre-existing condition.

From what I can tell it is a little used provision in ACA, perhaps because the savings are less advantageous in age-rated states... our state banned age rating long ago so it works out well for us.

 

[MBSC]

I had just assumed I could not get a cat plan. Do cat plans also have "agreed upon rates" with the providers? I will have to check this out. I will have to consider my one "existing condition" in doing this.

You can find Cat Plans at the off-exchange health plan finder here. https://finder.healthcare.gov/

Cat Plans generally use the provider network and negotiated rates of the company's Bronze Plans to reduce administrative costs. They are compliant plans so they do not exclude pre-existing conditions. They are not HSA compatible. Those over age 30 must obtain the unaffordable exemption in advance from the exchange if they use the exemption on a Cat Plan.

The threshold is 8.13% MAGI for 2016 and provides an exemption to the individual mandate penalty allowing you to buy anything. If your market offers no savings on Cat Plans, those who are healthy and have no pre-existing conditions can accomplish similar results using non-compliant short-term medical plans and claiming the unaffordable exemption on your tax return at year end.

Unaffordable exemption: https://www.irs.gov/instructions/i8965/ch01.html

 

[bingybear]

Cat plans in my state are in the same range as bronze plans, so that idea is out for me unless I more while DW is not looking