Rok said:
I'm having similar thoughts about Roth conversions..no one knows what the laws will be like in the future, but my guess is income tax rates will rise. The early, low tax years of retirement may be the best opportunity to lessen the "Tax Torpedo" effect of high marginal rates on combined IRA (+SS) distributions. A Roth conversion taxed at 0-15% could be a bargain compared to potential marginal rates 2-3 times that a few years down the road. These calculations could be tricky though and I'm not sure if there is consumer software available to model different scenarios? I'm guessing there must be "professional" financial planning software that could do the optimizing. This might require a (aargh) CFP. It's something to look into
There's a bezillion calculators out there, although some of the better ones are at Fairmark.com.
However the subject is a thought experiement:
- If your income will be roughly the same in retirement and you think that today's tax brackets can't get any lower, then a conversion may be a good idea. Your projected retirement income has to include IRA RMDs and SS receipts as well as the usual pensions, dividends, & cap gains.
- If retirement (including RMDs) will put you in a higher tax bracket than your current working tax bracket, then a conversion is probably a good idea.
- If retirement income (RMDs again) will subject your SS income to taxation, then a conversion is probably a good idea. Of course if your working income is the highest tax bracket and your retirement will be a couple brackets lower then SS taxes may not cost as much as you're "saving" by dropping down a couple brackets. This is a difficult assessment.
- If, between your working years and your commencement of SS & RMDs, your income will be very low for a few years, then small conversions during that low period are almost always a good idea. You'll be paying conversion taxes at no more than 15% or even 10%. We're doing that every year up to the top of the 15% bracket for the next 7-8 years.
- If the taxes on the IRA conversion can be paid from funds outside the IRA, then conversion is almost always a good idea. You're effectively transferring the amount of the tax from taxable funds to a Roth IRA which boosts its basis and its compounding. For example, instead of converting a $100K conventional IRA to an $80K Roth, when you pay the taxes outside the IRA then your Roth basis starts at $100K. Remember that conversions are taxed as regular income, not as cap gains or dividends. (Even if your IRA investment gains are cap gains & dividends, they're taxed as regular income.)
If someone can explain to me why anyone would be financially motivated to donate heavily to a congressional candidate who's sponsoring fair tax legislation, then I'm willing to listen. If you think that Congress will scrap the current tax code, with all its loopholes for special interest contributors groups, and replace it with a "fair tax" that has no special deals for anyone, then you're not thinking.