Roth Conversions in Pictures

On the flip side, Mike Piper in his Bogleheads talk on Roth conversion points out that there is an effect in the opposite (positive) direction - selling taxable to pay for Roth conversions effectively shifts assets from taxable to Roth, which means that money goes from a tax draggy account to a tax free account.

The effect is probably small in most situations but does compound over time. His argument is that this effect is a reason to Roth convert even when rates are equal.

I think it would depend on the tradeoff between how much in cap gains you have to realize vs. the ongoing improvement in tax drag effect.

Personally the only thing I have left in taxable is Vanguard index funds I bought in October 2016, so my unrealized gain percentage is over 50% now. So it's starting to be something I've noticed. I'm still doing Roth conversions though because the arbitrage and my remaining life expectancy means it still makes sense.
Yes, the reduction in tax drag due to pulling down the taxable balance is an important part of the return of doing Roth Conversions, especially if you do them early so the tax drag reduction has time to compound.

Over a retirement it can be the same as converting at several percent lower tax bracket. Roth Conversions can also reduce tax drag later if RMDs beyond spending needs would otherwise be arriving in taxable.

Plus of course, Roth assets stay out of your heirs' taxable accounts for an average of another 5 years after you pass.

So there are lots of small sources of return that add up to a significant boost that folks often overlook. As you are now experiencing with having to pay increasing capital gains taxes, there are also some sources of cost you have to account for too.
 
While not complaining in any way, I cannot keep up with the rate of growth/conversions. We converted $95k this year but the tIRAs increased in value over $300k. Uncle Sam is licking his chops!
Your IRA should hold your most conservative assets, such as CD, Treasury’s, balanced funds. Your Roth IRA should hold your more aggressive funds, such as growth funds, SP500 fund, etc. This will keep your RothIRA growing at a faster rate than your IRA
 
Your IRA should hold your most conservative assets, such as CD, Treasury’s, balanced funds. Your Roth IRA should hold your more aggressive funds, such as growth funds, SP500 fund, etc. This will keep your RothIRA growing at a faster rate than your IRA
Absolutely. Unfortunately our taxable account is all stock funds with huge gains - and I don’t have any room to take the capital gains hit, so no room for more in my Roth. I post this only for others who can still plan accordingly unlike me…
 
So the unanswerable question is would your total net worth have been more if you did not do roth conversions and just paid the tax from the traditional ira accounts as they came due and just paid the increased irma costs?

A lot of unknown variables have to be correctly forecast: tax rates, rate of return, tax brackets, life expectancy. tax filing status, and so on for the conversion to work out.

Finally, the popular thought has been that marginal tax rates will increase in future years although they have fallen somewhat over the past 40 years.

Me: I'll pay the tax later and if I get hit harder by taxes it just means I have won the game....that is, I will be able to pay more tax on the amounts because i have larger amounts of money.

Finally, a lot of financial planner encourage Roth conversions because they charge fees for modeling the expectant results which quite frankly cannot be determined until after the fact.

I find this conversion calculator as good as any:


One final point I believe you can offset rmds against long-term care costs which cannot be offset from a roth.
 
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So the unanswerable question is would your total net worth have been more if you did not do roth conversions and just paid the tax from the traditional ira accounts as they came due and just paid the increased irma costs?

You're right in that it's unanswerable ahead of time, and useless in retrospect. Still, I make my best guess and convert as much as is "obviously" a winning play.

Me: I'll pay the tax later and if I get hit harder by taxes it just means I have won the game....that is, I will be able to pay more tax on the amounts because i have larger amounts of money.

This asymmetry is partly why I'm conservative.

Finally, a lot of financial planner encourage Roth conversions because they charge fees for modeling the expectant results which quite frankly cannot be determined until after the fact.

Yup, this does seem to be a cottage industry now. Although the fee would be paid even if the customer doesn't Roth convert, so I don't think it's that much of a factor.

One final point I believe you can offset rmds against long-term care costs which cannot be offset from a roth.

Sort of.

RMDs are required starting at age 73 or 75, and add taxable ordinary income. In probably many cases here, the RMDs may be unwanted but unavoidable income. Roth conversions, if done early and often enough, will generally reduce RMDs.

Long term care costs, if they meet the requirements in IRS Pub 502, are an itemized deduction. Itemized deductions, to the extent that they (a) exceed the standard deduction, and (b) exceed 7.5% of AGI, reduce taxable income. Once you exceed both of those, then any other itemized deductions become useful from a tax perspective: charitable contributions, state and local taxes, etc.

But the previous two paragraphs operate independently: RMDs are taxed the same way regardless of LTC costs, and LTC costs are deductible whether or not you have RMDs. They do intersect in terms of AGI and the fact that one adds to taxable income and the other reduces it.

(Because my Dad has large medical expenses, it actually did make sense to do a Roth conversion for him on top of his RMD because he was in a relatively speaking lower bracket this year.)

Roth withdrawals neither add to nor deduct from taxable income, regardless of whether they are used for LTC or any other expense.

So in terms of LTC (and medical costs in general), whether Roth conversions are a good idea or not will in part depend on your spending relative to your RMDs, your other itemized deductions that might get activated by LTC costs, and how much you want to spend on stuff other than LTC.
 
Absolutely. Unfortunately our taxable account is all stock funds with huge gains - and I don’t have any room to take the capital gains hit, so no room for more in my Roth. I post this only for others who can still plan accordingly unlike me…
This is why it's good to have $100k+ in Ordinary Income from other sources to give you flexibility in deciding what to use it for...
 
A lot of unknown variables have to be correctly forecast: tax rates, rate of return, tax brackets, life expectancy. tax filing status, and so on for the conversion to work out.
Life expectancy is a lot less of an issue than many people think. Unless a charity gets your tIRA, someone is going to pay taxes on the IRA you leave behind.

Some say they'll be damned if they will pay taxes on behalf of their heirs, but another way to look at it is that you can't spend tIRA money until the tax is paid. Paying taxes actually makes more money available for you to spend. Paying $22K more in taxes doesn't sound good until you realize it actually makes $100K more money available for you to spend. Not saying that's always the right move, but it is something to consider.

It's still a bit of an issue as you want to consider your tax rate vs. your heirs' rates to try to make the most of your money for you and your heirs.
 
How do you think about this article?

Why the case against a Roth conversion gets stronger if Trump’s tax cuts continue​

That’s a fair point, though I will probably be retired for 20-30 years, and I don’t believe extending TCJA or further cuts can last 20-30 years - so it’s just forestalling. The window for any of to act is between the time you retire (when your income is probably at a low), and when all your income sources kick in - so between age 65 to 73 or so for example.

But the article only mentions the savings between paying 22% now vs 25% later, essentially the same tax bracket.

As I noted in post #1, and several times over the years - in my case I was paying under the 12% bracket year after year. We had sizeable TIRAs. Then I realized we would be paying into the 24%/28% tax bracket plus IRMAA penalties every year for the rest of our lives once Soc Sec and RMDs kicked in! Fortunately it came to me at 65 yo while there was still time to do Roth conversions. I have already converted enough to stay well within the 22%/25% bracket and avoid IRMAA penalties as of now. I’ll continue to do smaller conversions to hedge my bet, but I’ve already improved our outlook.

The charts actually show all that - that’s why I posted them…

So again,
- Roth conversions aren’t for everyone (again in post #1)
- The only way to know is do the math, and it doesn’t have to be hard to start. What are your taxes now? What will your taxes be when all your passive income kicks in (SS, RMDs, pensions/annuities, other)? For some of us it’s pretty obvious, others not.
- Yes you have to make some assumptions, like most things in life. Those who say “who knows,” are welcome to take that chance - doesn’t make it the best approach.
 
How do you think about this article?

Why the case against a Roth conversion gets stronger if Trump’s tax cuts continue​


I don't respect McQuarrie's credentials, and I think his logic presented in the article is horrifically flawed. I think McQuarrie starts off opposed to Roth conversions and then tries to create an analysis to support his position, rather than analyze the situation objectively and then reach a conclusion.

Aside from that, to the extent that the TCJA is extended and tax rates are lower, then sure, that makes Roth conversions less attractive.
 
I think the major thing he did not address was the tax situation when one spouse dies. He presumed that tax rates stayed essentially even but in the case of one spouse dying, the tax rates (brackets) change significantly. That realization is one of the main reasons I chose to continue with conversions even though DW and are both on SS and in the 22% bracket. I wish I could have taken better advantage of the 12% bracket but that’s water under the bridge now.
 
The great thing about the internet is you can find a seemingly credible source to reinforce ANY position you already hold - e.g. for or against Roth conversions. Most people just leave it at that. Or decide any uncertainty makes analysis pointless. Until you do your own math with your own assumptions - then it’s usually much clearer.
 
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Any uncertainty about future tax rates and brackets is more of a reason to convert some now and take the bird in the hand. If you don't convert you are subjecting more of your deferred income to that uncertainty. Unless you think it's more likely your rates will be lower at RMD time.
 
With current tax code I am 22% for the conversion and 24% when RMD kicked in which will be in about 11 years. Without TCJA, I will be in 35% with RMD.
I guess my case is quite common for many people here.

Yeah we don't know how long TCJA will last.
 
I don't respect McQuarrie's credentials, and I think his logic presented in the article is horrifically flawed. I think McQuarrie starts off opposed to Roth conversions and then tries to create an analysis to support his position, rather than analyze the situation objectively and then reach a conclusion.

Aside from that, to the extent that the TCJA is extended and tax rates are lower, then sure, that makes Roth conversions less attractive.
100% Agree.
McQuarrie's premise only makes sense if math stops when you pass away. He wrote about the same article a couple years ago, but then at least threw in a few paragraphs acknowledging that there is a wee possibility that if you pass before you might wish, that you might prefer your heirs get the money instead of the government.

I read this as a re-hash of that previous article, but this time, he adds the use of a discount rate at the assumed rate of return of the portfolio to evaluate conversions. Since your tax liability in the t-IRA is also growing at the rate of return of the portfolio, that should make no difference at all - except for the previously mentioned magic trick where he tries to lead you to ignore tax consequences to heirs and ignore the possibility that you might pull more money from your t-IRA in order to spend it yourself.

I only skimmed the current article, but in the previous one, he made other "simplifications" that just so happen to hurt conversions too. His calculations ignored IRMAA and NIIT, so doing conversions to avoid these didn't count in his calcs. Then there were silly requirements like the conversion taxes must be paid for out of the t-IRA, so the reduction in tax drag in taxable that most people view as a major source of return didn't count. I don't recall evaluation of one spouse passing well before the other either and obviously that looms large in the mind of many.

If you concoct assumptions and simplifications that eliminate many of the largest benefits, there aren't many benefits. But folks should wonder whether piling up tilted assumptions mean it's a fair and accurate representation of reality or whether it's just an author seeking notoriety.

It's safe to ignore the article, use a competent calculation tool, make assumptions you think are most likely and evaluate your own situation.
 
Your IRA should hold your most conservative assets, such as CD, Treasury’s, balanced funds. Your Roth IRA should hold your more aggressive funds, such as growth funds, SP500 fund, etc. This will keep your RothIRA growing at a faster rate than your IRA
65% of my fixed income is in our tIRAs and 401k. We just put too much into those accounts when in the accumulation stage.
 
After more analysis and 6 years of very aggressive Roth conversions, I've settled on a plan to scale back conversions to stay under the first IRMAA tier. I don't regret past conversions, they prevented me from a lifetime in the 24% bracket and IRMAA penalties - and landing me well inside the 22% bracket with no penalties already. But going forward I'll convert to just inside the first IRMAA tier and call it a day. Thank goodness I woke up in 2019 to change course.

I also did a brief stint with Pralana Online and Boldin/New Retirement but neither changed my outlook. In all fairness, the die was largely cast and those packages are probably more useful to younger retirees.
 

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Midpack - Are you basing your annual withdrawals as the maximum the portofolio can sustain or are you using an estimate of what you think you'll actually spend (after fund distributions, SS & RMDs)?
 
Midpack - Are you basing your annual withdrawals as the maximum the portofolio can sustain or are you using an estimate of what you think you'll actually spend (after fund distributions, SS & RMDs)?
"Passive income" has reached the point we don't have need withdrawals at all anymore beyond dividends, interest and SS. I'll begin reinvesting dividends again this year, after taking them all as distributions for the past 13 years. :blush:
 
Thanks. It just dawned on me yesterday that my plan optimized for max withdrawals, but we are below that number now. I need to redo the plan with a realistic spend and see where I end up in tax brackets/IRMAA when SS & RMDs kick in.
 
I also did a brief stint with Pralana Online and Boldin/New Retirement but neither changed my outlook. In all fairness, the die was largely cast and those packages are probably more useful to younger retirees.
As younger retirees (DH is 53) we have been Roth converting about $75k/year for just 3 years so far mostly staying in the 12% or low end of the 22% bracket for now. But 50% of our assets are in IRAs/pre-tax. I am not sure we are converting at the optimum amount for our situation and am curious what those software packages might tell me -- having tried them for your analysis, would you recommend one over the other? Or both?
 
Thanks. It just dawned on me yesterday that my plan optimized for max withdrawals, but we are below that number now. I need to redo the plan with a realistic spend and see where I end up in tax brackets/IRMAA when SS & RMDs kick in.
With proper planning and strategic Roth conversions, you can be in approximately the same tax bracket and IRMAA tier now as when SS and RMDs begin...
 
As younger retirees (DH is 53) we have been Roth converting about $75k/year for just 3 years so far mostly staying in the 12% or low end of the 22% bracket for now. But 50% of our assets are in IRAs/pre-tax. I am not sure we are converting at the optimum amount for our situation and am curious what those software packages might tell me -- having tried them for your analysis, would you recommend one over the other? Or both?
The one I relied on Income Strategy was bought out by T Rowe, so no longer available to my knowledge.

But I will say I ran 5 scenarios through Boldin (former New Retirement) last week. When I compared our present accounts/holdings to a (retroactive) no Roth conversion equivalent, the total tax savings and final estate Boldin showed were similar to the much more detailed prediction I got (and acted on) from Income Strategy in 2019. FWIW.

Be aware Boldin, like most but not all retirement planners, just give you $ estate amounts without factoring in remaining tax liability. IOW $1MM in a tIRA will count the same as $1MM in a Roth for total estate amount - where the latter is worth a lot more with no remaining taxes.
 
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