Roth Conversions Trial Balloon

[Midpack]

Midpack, thanks for the references and willingness to share all of the reserach you are doing on this topic. Definitley agree a minor subscription cost considering the decisions being made.

Any idea how long it takes to enter one's personal data into Income Strategy ?

Has anyone else used the Right Capital system?

5-10 minutes at most.

 

[audreyh1]

Are you referring to making our kids tIRA beneficiaries rather than DW?

In part. For us we will probably use that approach given our low % in tIRAs compared to taxable investments. One can also split beneficiaries between spouse and other heirs in whichever proportions seem best.

I’m also referring to the stepped up cost basis in joint taxable accounts. In our case that should significantly reduce the taxable income from investments provided the surviving spouse can take advantage.

 

[googily]

I'm in a similar situation that you are (just with a smaller number to work with) and this is pretty much where I ended up with my calculations as well! The numbers do add up but for me retirement (and life in general) is not only about the numbers. In US we tend to measure our "success" by assessing our finances and we extend this way of thinking into our retirement. I'd rather maximize my enjoyment over time than the overall amount of money I'll have at my disposal. So I start with my budget per year and run the simulations making sure I'll be able to cover my expenses until more or less 90. It turns out that whatever I do, I'll have enough disposable income to live the way I want. The only difference is the amount of money I'll pay in taxes. Yes, it'll be more if I don't maximize ROTH conversions but those tax payments will occur later in life leaving me with more to play now. And I'm not sure about you guys but I'd rather take advantage of my late fifties than count on having as much fun in my early 70s (as a gay dude I've just graduated to a hot daddy category but how long is that going to last? You get my drift...) I will still convert - just to diversify my income streams in the future but not as aggressively as the pure math would have me do it.

After posting my numbers that you quoted, I actually found that converting to the top of 22% (especially once I stop working) and then nothing after that once the tax rates revert has the lowest amount of taxes paid while still doing conversions. That plus maxing out the mega backdoor gets me a decent amount of Roth without over-prepaying taxes. And I'm also going to try to not let the tax tail wag my spending dog, so to speak, since I can access the inherited IRA now without penalty, but just paying income tax. Because, in line with what you said, I don't expect to be quite so high-spending in my 70s, unless it's for my health care.

But, really, who knows what the future brings. A very good friend in his late 50s was just diagnosed with advanced pancreatic cancer, giving me PTSD flashbacks to DH's similar diagnosis. Lightning bolts can strike at any time.

 

[rkser]

Calculate your MAGI too

Some nice advise by Midpack,

In addition, please keep calculating your MAGI also, because if the MAGI goes beyond $170 k it could lead to a Medicare Premium Surcharge after 2 yrs when the present taxes will be reviewed for setting up the Premium

We often see posts encouraging Roth conversions to fill to the 12% bracket, and that seems a no brainer. If you convert to 12% and find yourself forced into the 22% bracket from 70 on, you may regret it. Is there more universal advice?

*** Knowing everyone has to assess all the other factors that go into the Roth conversion decision. ***

After the analysis I’ve been though, and though people have probably already said it (and I missed it) - I’m thinking a slightly better starting point might be:

Convert to the fill whatever bracket you’ll be in from age 70 on if you hadn’t done any conversions.

IOW if you do NO conversions and that will put you in the 22% (24%, 32%...) bracket from age 70 on due to Soc Sec, RMD, distributions, cap gains and other income, you’ll probably reduce taxes by converting up to the 22% (24%, 32%...) income bracket every year before age 70. If tax rates don’t change, your nest egg final amount will be about the same - you’ll pay less in federal taxes overall, but you’ll forego the returns on the money used to pay taxes on conversions. However, there are other worthwhile $ benefits to widows, heirs, etc. And if future tax rates take more (as I expect long term), you’ll save even more on federal taxes and increase your nest egg final amount some. State taxes you’ll have to consider separately.


https://www.betterment.com/resources/common-roth-conversion-mistakes/

 

[Midpack]

Maybe it doesn't warrant repeating, but reducing taxes through Roth conversions may not make much difference to your ending portfolio balance or funds available for spending (presumably the primary goal). Just focusing on taxes alone is probably a mistake.

I thought if I reduced lifetime taxes by X amount through Roth conversions, my portfolio ending amount would increase by most of X - not true, the ending balance is a small fraction higher than X and I tried several conversion schemes.

Although you are avoiding a big chunk of taxes, you are also foregoing the returns on all the money you put into taxes before 70 that could have compounded another 20-30 years (less annual taxes).

And those prepaid taxes will reduce your portfolio, and you won't breakeven until well into your 80's in my case for example. That was true if I converted to 22% or 24%.

Caveat: That assumes taxes revert to pre TCJA levels and stay there - I don't believe that for a minute, but YMMV. If taxes become more confiscatory long term as I expect, Roth conversions become more financially attractive from a tax reduction and ending balance POV.

 

[sengsational]

Just reading this, much less doing all the math, makes my head hurt...I'm glad I've got a 'hard stop' on conversion level due to the PPACA cliff. Since i-orp was telling me to convert, even if I moved to a no income tax retirement state, I'm converting up to the cliff.



One saving grace for those of us not doing the detailed math is that the magnitude of the savings from an 'optimal strategy' (if such a thing really exists, given how many assumptions must be made) isn't really all that big, methinks.



A long while ago I ran some numbers and accidentally left-off the state income tax. Flipping that bit had a huge impact when compared to the difference between various Roth conversion strategies and no conversions at all. This was confirmed by noticing the difference in i-orp when flipping conversions on and off vs moving to a no income tax state. Of course those states, have other ways to getcha, but I've looked at my Florida relatives' books, and it compares favorably. The 'problem' is DW doesn't want to move

 

[anethum]

Just reading this, much less doing all the math, makes my head hurt...I'm glad I've got a 'hard stop' on conversion level due to the PPACA cliff. Since i-orp was telling me to convert, even if I moved to a no income tax retirement state, I'm converting up to the cliff.

I'm another one for whom the ACA cliff is the overriding consideration in my Roth conversions. Because I had tax deductions well in excess of the standard deduction last year as well as an HSA contribution, my Roth conversion didn't even take me to the top of the 12% tax bracket. For me, not going over the ACA cliff was the "no-brainer", rather than converting up to the top of the 12% bracket, much less calculations about my future tax bracket.

 

[bingybear]

I'm another one for whom the ACA cliff is the overriding consideration in my Roth conversions. Because I had tax deductions well in excess of the standard deduction last year as well as an HSA contribution, my Roth conversion didn't even take me to the top of the 12% tax bracket. For me, not going over the ACA cliff was the "no-brainer", rather than converting up to the top of the 12% bracket, much less calculations about my future tax bracket.

I seem to be the odd man out. I forgo the subsidy, but do pick up my HSA contribution. I do roth conversions near the top of the 24% tax bracket. I ran my case with boglehead's retiree portfolio model and it still seems to be the right approach.

Most of the threads make it seem like like most have fairly static retirement plans. I seem to have things changing around my plans.

 

[anethum]

A lot depends on the size of the ACA subsidy. I didn't take a subsidy in the first few years of the ACA, and I did substantial LTCG harvesting and some Roth conversions. But then premiums exploded as I approached Medicare age, and my potential ACA subsidy also increased significantly. If I had gone over the ACA cliff last year, I would have lost an $8,000 annual subsidy. I still paid more than $8,000 for my share of the premium, and that was for a Bronze plan with a $6,550 deductible.

 

[Ed_The_Gypsy]

PLEASE BE AWARE:
If you are planning to convert into a Roth this year, do not wait until the last minute. The customer service lines get very busy later. I had trouble with this. Suggest start no later than mid- Dec.

 

[Ed_The_Gypsy]

My problem was trying to simply move mutual funds straight into my Roth. Not fast. Problem getting a valuation for taxes, IIRC. I finally had to convert to cash, move the cash and pay the taxes. That was fast.

 

[bingybear]

I don't move MF for roth conversions typically. But I would expect you'd have the amount before the next day open as they get priced after the close.

I usually do ETF's, individual bonds, or CEF's. Most of these price during the day.. thus I will know the amount shortly after the move.

I can move it myself or have a rep from the brokerage do it for me.

 

[RunningBum]

PLEASE BE AWARE:
If you are planning to convert into a Roth this year, do not wait until the last minute. The customer service lines get very busy later. I had trouble with this. Suggest start no later than mid- Dec.

Which lines are these? Mid-Dec is too early for me, as the 4Q dividends for most Vanguard funds usually don't come out until around Dec 21. I update my spreadsheet and tax program, and over the next couple of days I make sure it's right, since we can no longer recharacterize and I don't want to go over the ACA subsidy cliff. The last two years I've done my final conversion on line at VG on Dec 26 and Dec 22. No need to call anyone. I'd feel very uncomfortable relying on that if I had to. I'd probably move my money to somewhere that I didn't have to.

 

[pb4uski]

PLEASE BE AWARE:
If you are planning to convert into a Roth this year, do not wait until the last minute. The customer service lines get very busy later. I had trouble with this. Suggest start no later than mid- Dec.

My problem was trying to simply move mutual funds straight into my Roth. Not fast. Problem getting a valuation for taxes, IIRC. I finally had to convert to cash, move the cash and pay the taxes. That was fast.

I dunno. I do it online the last few days of the year every year for the last 6 years and have never had a problem.

 

[audreyh1]

Maybe it doesn't warrant repeating, but reducing taxes through Roth conversions may not make much difference to your ending portfolio balance or funds available for spending (presumably the primary goal). Just focusing on taxes alone is probably a mistake.

I thought if I reduced lifetime taxes by X amount through Roth conversions, my portfolio ending amount would increase by most of X - not true, the ending balance is a small fraction higher than X and I tried several conversion schemes.

Although you are avoiding a big chunk of taxes, you are also foregoing the returns on all the money you put into taxes before 70 that could have compounded another 20-30 years (less annual taxes).

And those prepaid taxes will reduce your portfolio, and you won't breakeven until well into your 80's in my case for example. That was true if I converted to 22% or 24%.

Caveat: That assumes taxes revert to pre TCJA levels and stay there - I don't believe that for a minute, but YMMV. If taxes become more confiscatory long term as I expect, Roth conversions become more financially attractive from a tax reduction and ending balance POV.

Wow - that’s great insight!

 

[bingybear]

the old rule of thumb on IRA/RIRA contribution was a wash when assumptions were followed. So not a real surprise.

I look at a recent thread of someone who had make it to FIRE ready and then finds he will inherit another FIRE portfolio.... If he knew well before RMD time or getting the portfolio... that should be a good time to convert.

 

[LRDave]

I converted with FIDO from my 401(K) as opposed to my IRA. For Fido, you have to call and speak to someone at the 401(K) desk to do a Roth conversion. It took about 15 minutes - mostly me holding while the rep checked details in the plan.

 

[Gumby]

In our case, the vast majority of our 401k/403b/457 contributions were put in to avoid marginal tax rates of 28% or more (some years it was 35%). Only the last two years did we put money in at the 24% rate. So my view is that if I Roth convert to fully occupy the 22% bracket, I will always come out ahead on the tax arbitrage. It also so happens that a 4% WR piled on top of our pensions and SS will do just that -- fully occupy the 22% bracket with a little in the 12% bracket. Unless we start doing crazy things, we will never spend that much in a year, even net of the tax.

Right now, I am debating whether I should just leave the unspent conversion amount in cash (CD laddered) or whether I should reinvest it in the market. FIRECalc still gives us 100% even if we spent it all, so I see keeping it in cash as risk reduction. We don't have any heirs, so ending balance is irrelevant.

 

[csylvester]

Conversions, RMDs, and taxes

Some noted the conversion could be a wash. Maybe. We start conversions this month and will continue for the next 7 years. Our motivation is taxes on the surviving spouse. Income will go done when SS is reduced to the higher of the two coming in when both were are alive and the survivor will file as a single thereby paying much more in taxes. In our case taxes would double for the survivor without the conversions.

 

[Perryinva]

If I was single & my situation was like googily’s where there is only a $5k difference between no conversion and top of 22/25 through age 80, I’d say the same thing. Fuggetaboutit. $5k is almost noise over almost 20 years.

 

[Midpack]

Some noted the conversion could be a wash. Maybe. We start conversions this month and will continue for the next 7 years. Our motivation is taxes on the surviving spouse. Income will go done when SS is reduced to the higher of the two coming in when both were are alive and the survivor will file as a single thereby paying much more in taxes. In our case taxes would double for the survivor without the conversions.

Though I've said as much along with others, that assumes taxes remain pretty much as is. I don't believe that for a minute - so I expect tax savings to be greater and the impact on ending portfolio balance to be more significant though never 1:1 with tax savings. And the surviving spouse, heirs, charity impact is another good reason - though it sounds like audreyh1 knows ways around that with estate planning?

 

[On My Own]

Midpack, your comment "you are also foregoing the returns on all the money you put into taxes before 70 that could have compounded another 20-30 years (less annual taxes) " is exactly what I was hoping to get to in terms of understanding the full costs of paying taxes "early...i.e. Roth conversions". Perhaps this is one of the reasons that I haven't found professionals ( CPAs etc.) who routinely provide these types of analysis to the point they could be relied on to have worked out all of the nuances.

Very much appreciate your continued insights into this complicated analysis.

 

[RunningBum]

Taxes are an expense. Any expense I can reduce by $X puts $X in my pocket. If I spend $10K on a vacation instead of $5K, I have $5K more in my pocket. It's just that simple.

The conversion question is more complicated because you don't know how much you are saving by converting today, or if you are even saving anything. You don't know what $X really is.

For one thing, you don't know what future tax rates will be, both federal and state. Long term financial planning requires making some assumptions. If you are moving to an income tax free state, maybe your overall future tax rate will be lower, so you shouldn't convert now. Similarly, if you're still working, your income tax rate is probably higher now, and you shouldn't convert. For most of us, the conversion window is the time between your early retirement date and when you start collecting SS and taking RMDs.

For another thing, you don't know how much the deferred account will grow if you don't convert. However, for however much that account grows, you will pay a corresponding additional tax on it. If it grows a lot it might even push you into a higher tax bracket. If you convert, you have less money growing, but it grows tax free.

There is no crossover point. If you die with money in your deferred account, there are still deferred taxes that someone will pay*. If you think this will happen, part of your assumptions should be what tax bracket your heirs will be in. It may be quite high if the laws change and they need to liquidate the inherited IRA account in 5 or 10 years.

Let's suppose your assumptions are spot on, and you really do save $X in taxes. That will increase your net worth or ability to spend by $X. It has to. I suspect any calculations that say otherwise are leaving some amount in the tax deferred account, and aren't considering the deferred tax liability that someone still has to pay*. The money is a tax deferred account is never all yours or your heirs. Someone has to pay that tax liability before the money can be spent.

Now, $X saved may not be a very high percentage of your wealth and spending. Maybe you can cut your lifetime taxes by 10% and save $5000, but that may only be 1% of your net worth. Does that mean it's not worth it? That's up to you. I see a lot of activity in the 2019 Tax Software thread and other similar threads where people are trying hard to save $10 or at lot less than $5000, so at least to those people $5000 is worth a lot. And unlike the trip I mentioned in the first paragraph where you saved $5000, you didn't give up any comfort to get this $5000.

It's very true that unless you have extreme differences in your current ER tax rate and future tax rate, or have $Millions at stake, this probably isn't life altering money. Make your best estimate, and go with it. If you're wrong, it's probably not going to be by much at all. If you're still not convinced about paying off some of the deferred tax liability now with a conversion, don't. Just remember this decision you made to do nothing in the likely case you are paying higher tax rates later with RMDs, SS, and maybe a pension.

* If you plan to leave your remaining balance of your deferred income account to charity, and/or using your RMDs to give to charity through QCDs, that changes the picture quite a bit since you've successfully avoided the deferred taxes. I can't say by how much but it does bring back the crossover point, and probably favors not converting if you are generous with your charitable giving. It's another piece you'll have to factor into your calculations.

 

[Midpack]

Midpack, your comment "you are also foregoing the returns on all the money you put into taxes before 70 that could have compounded another 20-30 years (less annual taxes) " is exactly what I was hoping to get to in terms of understanding the full costs of paying taxes "early...i.e. Roth conversions". Perhaps this is one of the reasons that I haven't found professionals ( CPAs etc.) who routinely provide these types of analysis to the point they could be relied on to have worked out all of the nuances.

Very much appreciate your continued insights into this complicated analysis.

Even if you find a CPA with ultimate knowledge, there are several assumptions that have to be made, and that's on the client. The CPA can lay out the variables and maybe even probabilities, but it's your choice, and you're the only one who will actually live with the outcome. The CPA has zero skin in the game once you part company.

And anyone can lay out scenarios where Roth conversions would have been a mistake, but you can't know that in advance. No different than basic investing where an unexpected sequence of returns can foil the best plans. If you let sequence of returns scare you, you won't invest in anything much less do Roth conversions.

 

[googily]

If I was single & my situation was like googily’s where there is only a $5k difference between no conversion and top of 22/25 through age 80, I’d say the same thing. Fuggetaboutit. $5k is almost noise over almost 20 years.

I'm not a fan of noise, that's for sure.

I did subsequently find that converting to the top of 22/15 (or, in all likelihood, 22% and then no more conversions once that rate expires) gets me probably the best result, but still not much outside of noise. If 22% still exists when I quit working, I will probably fill it up, but otherwise, will just depend on max'ing out Roth 401k and after-tax conversions to build up my Roth. That's still almost $60k a year as long as I'm working (though that big chunk of paycheck gets replaced with money from taxable and probably some from the IRA I inherited from DH, so it's not a clean parallel compared to the remaining paycheck being able to cover my expenses, but better than not).