Roth conversions

[Scuba]

The advice we’ve received from our tax CPA as well as an FA is not to do Roth conversions in our situation. We don’t have heirs and what we were told is Roths are great for passing on wealth to heirs but most people never spend the money in their Roth accounts. Also our taxable portfolio is over 60% of our assets with T-IRA assets only about 20-25% of our total so our RMD’s won’t be huge. We also have a fair amount of taxable income so far in ER so not worth it to pay the taxes on Roth conversions.

As others have said, YMMV.

 

[RetireBy90]

my thinking is it only matters what tax rate you pay today and what rate you will pay in the future. For example, let’s say you have $100 inan IRA, and pay 20% taxes today and in 9 years when you need the money, and 8% return.
$100 * 20% tax = 80 to Roth. In 9 years at 8% will double to $160
$100 converted to Roth, in 9 years at 8% = $200 * 20% tax leaves $160

The advice we’ve received from our tax CPA as well as an FA is not to do Roth conversions in our situation. We don’t have heirs and what we were told is Roths are great for passing on wealth to heirs but most people never spend the money in their Roth accounts. Also our taxable portfolio is over 60% of our assets with T-IRA assets only about 20-25% of our total so our RMD’s won’t be huge. We also have a fair amount of taxable income so far in ER so not worth it to pay the taxes on Roth conversions.

So in the case of Scuba, future tax rate is 0% since if they don't spend it before they leave. Therefore it doesn't make financial sense to pay whatever rate today rather than 0% sometime in the very distant future.

 

[bingybear]

Interesting question. Let's say in early December I sell $40,000 of ticker X in my taxable account at a $20,000 loss.

Then in late December, I do a Roth conversion that reduces my holdings of ticker X in my tIRA by $30,000 and simultaneously increases my holding of ticker X in my Roth by $30,000.

Does the Roth conversion create a wash sale. I suspect not but it is an interesting question.

Now if the second part was to just buy $30,000 of ticker X in my Roth then the answer is obviously yes.

Your example is a transfer in kind. I was referring to a transfer not in kind so there is a unique purchase.

So the first is part of the conversion is I do a Roth conversion that reduces my holdings of ticker Y in my tIRA by $30,000 then you are purchasing more X in the over all roth conversion.

 

[RunningBum]

The advice we’ve received from our tax CPA as well as an FA is not to do Roth conversions in our situation. We don’t have heirs and what we were told is Roths are great for passing on wealth to heirs but most people never spend the money in their Roth accounts. Also our taxable portfolio is over 60% of our assets with T-IRA assets only about 20-25% of our total so our RMD’s won’t be huge. We also have a fair amount of taxable income so far in ER so not worth it to pay the taxes on Roth conversions.

As others have said, YMMV.

Is your goal to maximize post-death charitable contributions? Otherwise I don't see how this makes good sense. If the rationale is based on what "most people" do with a Roth, I don't buy it because most people don't ER and have an ideal time to do partial conversions like many of us do. But maybe there's something else about your situation that makes it work for you.

 

[Scuba]

Is your goal to maximize post-death charitable contributions? Otherwise I don't see how this makes good sense. If the rationale is based on what "most people" do with a Roth, I don't buy it because most people don't ER and have an ideal time to do partial conversions like many of us do. But maybe there's something else about your situation that makes it work for you.

The other variable is that our tax bracket has still been high so far in ER.

 

[GrayHare]

So in the case of Scuba, future tax rate is 0% since if they don't spend it before they leave. Therefore it doesn't make financial sense to pay whatever rate today rather than 0% sometime in the very distant future.

Except that many people here are facing the "tax torpedo" when RMDs start, so taxes will be paid on the IRA money eventually. Roth can reduce that tax torpedo since it has no RMDs.

 

[RetireBy90]

Except that many people here are facing the "tax torpedo" when RMDs start, so taxes will be paid on the IRA money eventually. Roth can reduce that tax torpedo since it has no RMDs.

Your not supposed to give out my secrets. This is my case precisely. At 70 my plan has us not needing any funds from the IRA but required by law to take the RMDs. In my case, I will retire this fall. Then our tax should be in 22% range, so I will be making the Roth conversions. However, each case should be based on projected tax rate now and in the future, along with other criteria unique to you.

 

[RunningBum]

The other variable is that our tax bracket has still been high so far in ER.

"High" by itself is a meaningless term for this purpose. If it's going to be a higher tax bracket later than it is now, conversions are probably worthwhile.

 

[mpeirce]

Except that many people here are facing the "tax torpedo" when RMDs start, so taxes will be paid on the IRA money eventually. Roth can reduce that tax torpedo since it has no RMDs.

And especially so if you and your spouse don't kick the bucket at the same time. For many folks who may not expect their bracket to change after RMD arrive may well get hit with a rate increase when they have to file as single.

 

[walkinwood]

And especially so if you and your spouse don't kick the bucket at the same time.

That's the conclusion I reached too. I created a spreadsheet using static returns for equities & bonds, and current tax laws. The amount we saved during our lifetime (to age 90) by starting ROTH conversions now was not a lot. But if one of us were to go first and early, the survivor would get hit hard. We are solidly in the 12% bracket now, but will jump to the 22% bracket when RMDs & SS start (planning to start SS at 70)



My plan is to try for ACA subsidies. If income exceeds that number & there is little I can do to control for that since I use mutual funds, then I'll do a ROTH conversion to the top of the 12% bracket for that year. After we get to 65, we'll do ROTH conversions every year till RMDs hit.

 

[COcheesehead]

What about the length of time that your IRA could be growing tax-free? If you hold it for 10 years, instead of paying taxes today, you could be compounding earnings on the entire amount, rather than a reduced amount. I think it's a bit more complicated than the formula above.

That is why you should pay the taxes from outside the transfer so you still get the advantage of the entire amount rolled over.

 

[joylesshusband]

Another aspect, often missed in such discussions (and I did not see a word about it in this thread), is the cost of opportunity paid during Roth conversions.

The goal of the conversions is not merely to minimize income taxes paid during retiree's lifetime (as many of the more simple-minded individuals wrongly see it), but is instead to maximize the efficiency of one's portfolio.
Which is done by ensuring that most of the portfolio ends up in one's pocket to spend, give away, or simply waste. The money not ending in one's pocket are just friction losses and include portfolio expenses, income taxes paid, and whatnot...

Thus, if the retiree aimed at higher efficiency, (s)he would also take into account that all extra income taxes paid due to conversions are amounts which disappear from one's possession annually, and once each of them does, it is unable to produce any future income.
Were these amounts not spent on income taxes for conversions, they would have been generating future income streams, a very welcome state of affairs.

This cost of the lost opportunity would need to also go into the equation.
Most people ignore it. I don't.

 

[RunningBum]

Another aspect, often missed in such discussions (and I did not see a word about it in this thread), is the cost of opportunity paid during Roth conversions.

The goal of the conversions is not merely to minimize income taxes paid during retiree's lifetime (as many of the more simple-minded individuals wrongly see it), but is instead to maximize the efficiency of one's portfolio.
Which is done by ensuring that most of the portfolio ends up in one's pocket to spend, give away, or simply waste. The money not ending in one's pocket are just friction losses and include portfolio expenses, income taxes paid, and whatnot...

Thus, if the retiree aimed at higher efficiency, (s)he would also take into account that all extra income taxes paid due to conversions are amounts which disappear from one's possession annually, and once each of them does, it is unable to produce any future income.
Were these amounts not spent on income taxes for conversions, they would have been generating future income streams, a very welcome state of affairs.

This cost of the lost opportunity would need to also go into the equation.
Most people ignore it. I don't.

That's wrong, but since you apparently think you're not simple-minded and we are, I'll let you figure it out.

 

[COcheesehead]

Another aspect, often missed in such discussions (and I did not see a word about it in this thread), is the cost of opportunity paid during Roth conversions.

The goal of the conversions is not merely to minimize income taxes paid during retiree's lifetime (as many of the more simple-minded individuals wrongly see it), but is instead to maximize the efficiency of one's portfolio.
Which is done by ensuring that most of the portfolio ends up in one's pocket to spend, give away, or simply waste. The money not ending in one's pocket are just friction losses and include portfolio expenses, income taxes paid, and whatnot...

Thus, if the retiree aimed at higher efficiency, (s)he would also take into account that all extra income taxes paid due to conversions are amounts which disappear from one's possession annually, and once each of them does, it is unable to produce any future income.
Were these amounts not spent on income taxes for conversions, they would have been generating future income streams, a very welcome state of affairs.

This cost of the lost opportunity would need to also go into the equation.
Most people ignore it. I don't.

The money will be forced out of your account through ever increasing RMD's that you will have to pay taxes on. There is no free lunch.

 

[Cobra9777]

That's wrong, but since you apparently think you're not simple-minded and we are, I'll let you figure it out.

+1

Minus the insult, I might have taken some time to explain the flaw in his reasoning.

 

[RetireBy90]

Another aspect, often missed in such discussions (and I did not see a word about it in this thread), is the cost of opportunity paid during Roth conversions.
The goal of the conversions is not merely to minimize income taxes paid during retiree's lifetime (as many of the more simple-minded individuals wrongly see it), but is instead to maximize the efficiency of one's portfolio.
Which is done by ensuring that most of the portfolio ends up in one's pocket to spend, give away, or simply waste. The money not ending in one's pocket are just friction losses and include portfolio expenses, income taxes paid, and whatnot...
Thus, if the retiree aimed at higher efficiency, (s)he would also take into account that all extra income taxes paid due to conversions are amounts which disappear from one's possession annually, and once each of them does, it is unable to produce any future income.
Were these amounts not spent on income taxes for conversions, they would have been generating future income streams, a very welcome state of affairs.
This cost of the lost opportunity would need to also go into the equation.
Most people ignore it. I don't.

+1

Minus the insult, I might have taken some time to explain the flaw in his reasoning.

I tend to agree in principal with Joy, but what number to put on the opportunity cost ? Since any factor or return that you assign is an educated guess, how reliable is the result ?
I don't factor it in, unless the 2 numbers are identical or so close you need something to break the tie.
What number would you use for opportunity cost ?

 

[COcheesehead]

I tend to agree in principal with Joy, but what number to put on the opportunity cost ? Since any factor or return that you assign is an educated guess, how reliable is the result ?
I don't factor it in, unless the 2 numbers are identical or so close you need something to break the tie.
What number would you use for opportunity cost ?

I don't think there is opportunity cost. Your RMD's just continue to increase until you are at 0 in the account. So the taxman gets his cut no matter what.

 

[joylesshusband]

The money will be forced out of your account through ever increasing RMD's that you will have to pay taxes on. There is no free lunch.

Not exactly.
You seem to be forgetting the time factor.
I will be pushing daisies up long before the annual RMDs reach values which demand income tax of ugly proportions.

What happens after that (RMDs imposed on heirs, etc.) is none of my concerns. I'm dead, remember?

 

[joylesshusband]

+1

Minus the insult, I might have taken some time to explain the flaw in his reasoning.

No insult was meant, it was simply a statement of fact.

I fail to see the flaw in my reasoning though.

 

[pb4uski]

I'm not sure what your reasoning was, but let's use a simple realistic example. Today, one has $10,000 in a tIRA and $1,200 in a taxable account. Tax rate today is 12%, but will be 22% after SS starts. Earnings rate is 7%.

Scenario 1: Do nothing. The $10,000 grows to $19,672 and the $1,200 grows to $2,182 in 10 years. The taxpayer withdraws the $19,672 pays $4,328 (22%) in tax... ending the day with $17,526.

Scenario 2: Convert the $10,000 to a Roth and pay $1,200 in tax. The $10,000 grows to $19,672 in 10 years.

Taxpayer ends up $2,146 ahead as a result of converting... mostly the $1,000 of tax savings, which grows over 10 years to $1,967 and then the tax savings on the after-tax account of $179.


-----------------------------------
$19,672 = $10,000 * (1+7%)^10
$2,182 = $1,200 * (1+(7%*(1-12%)))^10
$1,967 = $1,000 * (1+7%)^10
$179 = $1,200 * (1+7%)^10 - $1,200 * (1+(7%*(1-12%)))^10

 

[Montecfo]

I also do not see an opportunity cost. It is just tax rate arbitrage. Your investment returns are a constant. If you are paying the tax before you have to, you want to be very confident it will be at a lower rate than if paid later. And you want to try to manage the risk you pay taxes you might never have to pay.

The possibility that you may pass and leave a spouse paying taxes at single rates is enough to make conversion of some of your regukar IRA funds a reasonable strategy IMHO.

 

[Scuba]

"High" by itself is a meaningless term for this purpose. If it's going to be a higher tax bracket later than it is now, conversions are probably worthwhile.

Understood, but according to our CPA, that isn’t likely.

 

[pb4uski]

The advice we’ve received from our tax CPA as well as an FA is not to do Roth conversions in our situation. We don’t have heirs and what we were told is Roths are great for passing on wealth to heirs but most people never spend the money in their Roth accounts. Also our taxable portfolio is over 60% of our assets with T-IRA assets only about 20-25% of our total so our RMD’s won’t be huge. We also have a fair amount of taxable income so far in ER so not worth it to pay the taxes on Roth conversions.

As others have said, YMMV.

I guess that it depends on what ultimately happens to that Roth money because even if you don't spend it, it ultimately ends up in someone's pocket.

If any of the money ultimately ends up in the hands of an individual heir (vs a charity) then having it be tax free for the rest of time is a valuable benefit.

 

[COcheesehead]

Not exactly.
You seem to be forgetting the time factor.
I will be pushing daisies up long before the annual RMDs reach values which demand income tax of ugly proportions.

What happens after that (RMDs imposed on heirs, etc.) is none of my concerns. I'm dead, remember?

Hmmm, didn’t you just say you were concerned about efficiency of money passed to others (give away.)

 

[ncbill]

I also do not see an opportunity cost. It is just tax rate arbitrage. Your investment returns are a constant. If you are paying the tax before you have to, you want to be very confident it will be at a lower rate than if paid later. And you want to try to manage the risk you pay taxes you might never have to pay.

I've concluded after reading all these threads it makes no sense for us to convert to Roth.

We will have a relatively low SS benefit (~$25k combined with her waiting until 70, me @67 - spousal benefit) so even if withdrawing from tax-deferred to cover expenses I doubt we'd ever see the 22% bracket.