Should I Do A Roth Conversion Tutorial

[rayvt]

If someone does do a tutorial on Roth conversions, it would be helpful to include a chapter on distribution considerations. Specifically, if a younger person is doing conversions and may want to take some distributions prior to age 59.5, they should keep careful documentation on how much was converted and when so they can avoid having a penalty caused by dipping into earnings as opposed to conversions. I recently saw advise to create a brand new Roth account each year so that this is crystal clear.

The "A" in Roth IRA stands for "arrangement", not "account".

The five-year period starts on the first day of the tax year for which you made a contribution to any Roth IRA account, not necessarily the one you're withdrawing from.

This was settled a few years ago when the Supreme Court & IRS ruled that you have only ONE IRA (and one Roth IRA) no matter how many different accounts it is spread amount.

Figuring the earnings is simple. Current value of ALL Roth accounts minus the total amount you have contributed to the Roths.

Same as for RMDs from taxable IRA accounts. You don't have to take an RMD from each account, you just have to take the total RMD from whichever account(s) you like.

 

[pb4uski]

The "A" in Roth IRA stands for "arrangement", not "account"....

Do you have a citation for that claim?

Title III of the Taxpayer Relief Act of 1997 suggests it is accout:

Title III: Savings and Investment Incentives - Subtitle A: Retirement Savings - Increases the income limits for active participants with respect to the IRA (Individual Retirement Account) deduction. ...

 

[rayvt]

"The "A" in Roth IRA stands for "arrangement", not "account".
Do you have a citation for that claim?

Title III of the Taxpayer Relief Act of 1997 suggests it is accout:

https://www.irs.gov/retirement-plans/individual-retirement-arrangements-iras


Roth IRA Qualified Distribution
https://www.irs.gov/publications/p590b#en_US_2022_publink100089626

"It is made after the 5-year period beginning with the first tax year for which a contribution was made to a Roth IRA set up for your benefit."
Figure 2.1

Note that it says "a" not "the". The 5-year period starts when you do the very first contribution to any Roth account. There is only ONE 5-year period, not one for each account you have. Which makes sense, once you understand that legally the "a" is "arrangement" not "account".

Googling brings up many hits that lay all these arcane details.

I will say that almost everyone says "account", because when you go to open one you open an account. But legally they are all considered just components of your one and only "arrangement". That's why you are limited to doing just one tax-free rollover per year, and not one such rollover for every account you have.

 

[Dash man]

When considering Roth conversions, you’re typically looking at the marginal tax rate. The idea being to pay a lower tax rate for the conversion funds now rather than a higher tax bracket you may be in later.

 

[RetireBy90]

When considering Roth conversions, you’re typically looking at the marginal tax rate. The idea being to pay a lower tax rate for the conversion funds now rather than a higher tax bracket you may be in later.

While agree with your take on the purpose of Roth conversions, there are many times that your marginal rate can change. These have been mentioned several times I know. Things such as spouse paying taxes at single rate after one passes and the tax rate once RMDs kick in. Then there can be additional IRMAA charges or ACA that cost you if you breach your current bracket. And this would also fall on surviving spouse.

One other item to note, if you need a new car or other large purchase, you can draw funds from a Roth without considering taxes where if you take it from TIRA it will add to your income.

 

[Dash man]

While agree with your take on the purpose of Roth conversions, there are many times that your marginal rate can change. These have been mentioned several times I know. Things such as spouse paying taxes at single rate after one passes and the tax rate once RMDs kick in. Then there can be additional IRMAA charges or ACA that cost you if you breach your current bracket. And this would also fall on surviving spouse.

One other item to note, if you need a new car or other large purchase, you can draw funds from a Roth without considering taxes where if you take it from TIRA it will add to your income.

Yes, there are other considerations including IRMAA and NIIT. But as I said, typically it’s the marginal rate since IRMAA is not computed on the 1040, though NIIT is.

 

[SecondCor521]

Yes, there are other considerations including IRMAA and NIIT. But as I said, typically it’s the marginal rate since IRMAA is not computed on the 1040, though NIIT is.

Personally I calculate a marginal rate based on everything - federal, state, ACA subsidy loss, FAFSA SAI/EFC impact, IRMAA, NIIT, etc. The all look like taxes to me.

 

[rayvt]

Personally I calculate a marginal rate based on everything - federal, state, ACA subsidy loss, FAFSA SAI/EFC impact, IRMAA, NIIT, etc. The all look like taxes to me.

Of course. I don't know why so many people want to use another rate, like the favorite "average rate". I'd guess because they want to use a lower number because that makes them feel better.

The right rate is marginal rate, because an additional $100 of taxable income only increases your cash-in-hand by $XX.

 

[pb4uski]

Nomenclature is important. I look at what I call the effective rate on my conversion... in other words the increase in taxes due to the conversion (or RMD) divided by the amount of the conversion.

For many years, our income before Roth conversions would be nil as the standard deduction exceeds our income, so the effective rate of converting to the top of the 12% tax bracket is a mix of 0%, 10% and 12% so there are multiple marginal rates in my case.

If I had ACA subsidy, IRMMA and other such considerations I would include those as well.

 

[SevenUp]

Nomenclature is important. I look at what I call the effective rate on my conversion... in other words the increase in taxes due to the conversion (or RMD) divided by the amount of the conversion.

Yes, (change in tax)/(change in income) is of course the correct calculation, regardless of what one calls it. Unfortunately "effective rate" is often used to mean (total tax)/(total income). E.g., see Marginal Vs Effective Tax Rates And When To Use Each.

For many years, our income before Roth conversions would be nil as the standard deduction exceeds our income, so the effective rate of converting to the top of the 12% tax bracket is a mix of 0%, 10% and 12% so there are multiple marginal rates in my case.

For someone in that situation, and particularly if we add, say, a 22% (or the 27% "hidden" rate) option, the choice can (and should) be made one step at a time:
- the amount subject to a 0% rate, then
- the amount subject to a 10% rate, then
- the amount subject to a 12% rate, then
- the amount subject to a 27% rate, etc.
One should not "blend" the amounts to reach, say, a 16% rate on the whole conversion and think that's good if expecting to pay, say, a 22% rate later. The amount converted at a 27% rate would have been a losing proposition.

 

[pb4uski]

To be clear, the blend is the result from a conscious decision the convert to the top of the 12% tax bracket based on knowing that after my SS starts but before RMDs we will be deep into the 12% bracket so RMDs will be a mix of the rest of the 12% bracket and the 22% bracket.

Our effective rate on conversion is currently a 0%, 10% and 12% blend only because I haven't yet started SS.

 

[Koolau]

To be clear, the blend is the result from a conscious decision the convert to the top of the 12% tax bracket based on knowing that after my SS starts but before RMDs we will be deep into the 12% bracket so RMDs will be a mix of the rest of the 12% bracket and the 22% bracket.

Our effective rate on conversion is currently a 0%, 10% and 12% blend only because I haven't yet started SS.

And note to younger members: Start your conversions before SS and other sources of income if you can. If you wait, it makes less and less sense.

 

[Alex The Great]

And note to younger members: Start your conversions before SS and other sources of income if you can. If you wait, it makes less and less sense.

True. But for younger members, SS may be changed in coming years and we don't know yet what changes are going to be. There is a chance Roth income is included into the tax liability which would reduce SS. I would not rush too much with those conversions.

 

[SecondCor521]

True. But for younger members, SS may be changed in coming years and we don't know yet what changes are going to be. There is a chance Roth income is included into the tax liability which would reduce SS. I would not rush too much with those conversions.

Being conservative with the amount converted and starting at a younger age are not necessarily in conflict.

I started Roth conversions at age 47 the year I retired and have done them every year since. I know people's situations differ, but in my case every dollar converted so far is saving perhaps 20 cents in taxes. That adds up quickly and is something that I'm highly confident will turn out to be a good decision in nearly any future we end up in.

Starting at 47 and waiting on SS until 70 has given me a *lot* more flexibility in my Roth conversion plans. Converting, say, $25K for a decade when the market is growing might easily end up with $400K ("probably") tax free in a Roth, at practically no or an extraordinarily low tax bracket.

And that would still leave me with another 17 years to play with - I could do $0, or $10K, or $40K, or whatever the numbers and Roth/SS situation dictate at that time. I am happy enough with an iterative plan that does a Roth conversion each year to whatever level makes sense that year, and then the next year looking at the situation again with updated info on account balances, spending, health, etc. I also have a policy of not looking back and wondering if a different path would have turned out better or worse since I can't change the past.

 

[Koolau]

True. But for younger members, SS may be changed in coming years and we don't know yet what changes are going to be. There is a chance Roth income is included into the tax liability which would reduce SS. I would not rush too much with those conversions.

If I were "betting" I would look for SS to be pretty much as it is now in the next 20 years. Tweaks, here and there to be sure, but going all the way to changing the fundamentals of Roths would happen after some other pretty unpleasant changes, I would think. I wouldn't wait on that basis, though as always, YMMV.

 

[SecondCor521]

Yes, (change in tax)/(change in income) is of course the correct calculation, regardless of what one calls it. Unfortunately "effective rate" is often used to mean (total tax)/(total income). E.g., see Marginal Vs Effective Tax Rates And When To Use Each.

For someone in that situation, and particularly if we add, say, a 22% (or the 27% "hidden" rate) option, the choice can (and should) be made one step at a time:
- the amount subject to a 0% rate, then
- the amount subject to a 10% rate, then
- the amount subject to a 12% rate, then
- the amount subject to a 27% rate, etc.
One should not "blend" the amounts to reach, say, a 16% rate on the whole conversion and think that's good if expecting to pay, say, a 22% rate later. The amount converted at a 27% rate would have been a losing proposition.

Agree, and this is what I do. I conceptually Roth convert a dollar at a time - some years (including 2022) I've gotten it dialed in to within $1 of the actual tax bill I want to have (my case is complicated with refundable credits which creates a shadow 0% bracket, plus ACA subsidies which shift the sand as well).

On the last paragraph, although it doesn't currently apply to me, I can conceptualize that there are "tax hump" scenarios like the SS tax hump and the 27% shadow bracket where a somewhat narrow tax hump might be followed by a wide, low, plain of an appealing lower tax region. In situations like these, it might be worth powering through the tax hump and utilizing the lower plain to convert a relatively large amount.

To extend your example, if one expected a 26% marginal rate later (say, 25% plus some IRMAA) and the 27% shadow bracket were only $1K wide, it might be worth it to do an additional $15K in Roth conversions, paying 27% on that $1K to gain access to paying 22% on $14K.

That may be too fiddly for most people, possibly including me. At this point my marginal Roth conversion rates are monotonically increasing, and this year I expect mostly flat in the area of interest. So as long as I'm in the ballpark, getting in the right area is really good but optimizing to the last dollar isn't that critical.

 

[SevenUp]

To extend your example, if one expected a 26% marginal rate later (say, 25% plus some IRMAA) and the 27% shadow bracket were only $1K wide, it might be worth it to do an additional $15K in Roth conversions, paying 27% on that $1K to gain access to paying 22% on $14K.

Yes it could. Worth pushing through the Social Security hump and/or IRMAA cliffs? discusses that issue.

 

[pb4uski]

.... There is a chance Roth income is included into the tax liability which would reduce SS. I would not rush too much with those conversions.

WADR, the chance that Roth income is taxable is between slim and none.

There isn't any proposed legislation that would do that so it is foolish to suggest it.

The closest thing was a 2021 Biden administration proposal that would prohibit Roth conversion by individuals with more than $400,000 in income... but it seems unlikely to me that anyone with over $400,000 in income would even be considering doing Roth conversions so it was a tooth-less tiger.

 

[TheWizard]

WADR, the chance that Roth income is taxable is between slim and none.

There isn't any proposed legislation that would do that so it is foolish to suggest it.

Totally agree.
It's already post-tax.
Cripes...

 

[CRLLS]

One can do nothing in fear that something MAY change, and it may change for the worse. There are always going on in DC, that could be detrimental to any retirement savings. There are also discussions that could be beneficial too. I follow the path of, if it makes sense now, I'll do it. IOW, deal with what is and don't be scared of what might be. That would be stagnation.

 

[BooBoo]

I'm having difficulty making the decision to convert.(Age 67) I have not started social security. The majority of our income is from our IRA. We withdrawal from the trad IRA up to the top of the 12%. Don't these withdrawals serve the same purpose as conversion by reducing the Trad IRA amount ? If we are lucky, we could have 2 million in the IRA by age 79 and more if really lucky. This would put us is the tax rate of 22% or whatever that rate would be in the future. Am I missing something?


Thanks,
Boo

 

[CardsFan]

I'm having difficulty making the decision to convert.(Age 67) I have not started social security. The majority of our income is from our IRA. We withdrawal from the trad IRA up to the top of the 12%. Don't these withdrawals serve the same purpose as conversion by reducing the Trad IRA amount ? If we are lucky, we could have 2 million in the IRA by age 79 and more if really lucky. This would put us is the tax rate of 22% or whatever that rate would be in the future. Am I missing something?


Thanks,
Boo

If you are withdrawing for your spending needs, you are at least reducing the tIRA. If you could get that spending money elsewhere (after tax savings) then conversions to the top of the 12% bracket "could" be more helpful.

Based on the comment that it "could be" 2 million in 12 years, I am guessing you have around 1 million now.

Without any more to go on, I think you might be in the range where conversions "might" give you an incremental boost, but nothing earth-shattering.

 

[NW-Bound]

To be clear, the blend is the result from a conscious decision the convert to the top of the 12% tax bracket based on knowing that after my SS starts but before RMDs we will be deep into the 12% bracket so RMDs will be a mix of the rest of the 12% bracket and the 22% bracket.

Our effective rate on conversion is currently a 0%, 10% and 12% blend only because I haven't yet started SS.

SS+RMD will push me deep into the 22% bracket, and maybe even into the 24% bracket. So, it just makes sense to at least use up the 12% bracket with Roth conversion.

In fact, I have been going deep into the 22% bracket too, because that's where we will be with SS+RMD. If 22% is unavoidable, I just want to pay sooner rather than later, because I will have more money in Roth to generate tax-free income. In fact, I have been doing Roth conversion up to close to the 24% MFJ bracket.

Looking at my brokerage acccounts, I see that the return on my tax-deferred accounts is so much better than that of my post-tax accounts. Why so? It's because I am reluctant to make trades on the latter accounts, due to tax complications. When I am free from tax considerations, I can make trades purely based on gain/loss aspects.

And I often wish my tax-deferred accounts were no-tax accounts (Roth). No longer the problem with the tail (tax) wagging the dog (return). I want a tail-less dog.

 

[SecondCor521]

I'm having difficulty making the decision to convert.(Age 67) I have not started social security. The majority of our income is from our IRA. We withdrawal from the trad IRA up to the top of the 12%. Don't these withdrawals serve the same purpose as conversion by reducing the Trad IRA amount ? If we are lucky, we could have 2 million in the IRA by age 79 and more if really lucky. This would put us is the tax rate of 22% or whatever that rate would be in the future. Am I missing something?


Thanks,
Boo

Yes, spending from the traditional IRA reduces the balance and produces a tax bill the same way a Roth conversion would.

You probably but might not know that you can both spend from and do Roth conversions from your traditional IRA.

The advantage to a Roth conversion over a withdrawal is that if those funds would otherwise be unspent, it is probably better that they end up in a tax free Roth account rather than a regular taxable account. Lower tax bill that way.

 

[NW-Bound]

Yes, spending from the traditional IRA reduces the balance and produces a tax bill the same way a Roth conversion would.

You probably but might not know that you can both spend from and do Roth conversions from your traditional IRA.

The advantage to a Roth conversion over a withdrawal is that if those funds would otherwise be unspent, it is probably better that they end up in a tax free Roth account rather than a regular taxable account. Lower tax bill that way.

Yes. Not the immediate tax bill, but future ones. I love to have gains in my Roth accounts.