Trad IRA RMD and Roth Conversion Strategies to Minimize Income Taxes

[heyyou]

Read on the topic at Fairmark.com. If your TIRA is not large, or you do not have longevity, you will have less of a tax problem with RMDs. Years ago, Scott Burns wrote about the "torpedo tax" on income of pension, plus SS, plus RMDs, so run the numbers to see what happens to your income tax starting after age 70.

Having retired at 55, and prior to starting SS, I have been doing partial conversions of my TIRA to RIRA each year.

In 2012, for Married Filing Jointly, 7600 of deductions, 11900 of exemption, and 70700 to the top of the 15% bracket, totals 90200 of income with 9735 of tax due, is an average tax rate of 10.8%. As others mentioned, do you think that rate will be less in the future?

If you guess slightly too high on the conversion amount, you pay only a little more tax when your income barely spills into the next higher tax bracket.

As Nords noted, your conversion must be done prior to the end of the calendar year, not the April 15th due date for IRA contributions. Your estimated tax payment on the conversion is due a couple of weeks after the end of the quarter, in this case, the end of year.

Someone wrote that Roth conversions are a form of tax loss harvesting of tax sheltered accounts. You can choose to convert shares of whatever is down the most, or whatever has the most expected long term growth.

Roth conversions is prepaying future taxes at a reduced rate. To me, that is not much different than saving job income for retirement spending. It is still delayed gratification with a future benefit.

 

[misty57]

Read on the topic at Fairmark.com. If your TIRA is not large, or you do not have longevity, you will have less of a tax problem with RMDs. Years ago, Scott Burns wrote about the "torpedo tax" on income of pension, plus SS, plus RMDs, so run the numbers to see what happens to your income tax starting after age 70.

Having retired at 55, and prior to starting SS, I have been doing partial conversions of my TIRA to RIRA each year.

In 2012, for Married Filing Jointly, 7600 of deductions, 11900 of exemption, and 70700 to the top of the 15% bracket, totals 90200 of income with 9735 of tax due, is an average tax rate of 10.8%. As others mentioned, do you think that rate will be less in the future?

If you guess slightly too high on the conversion amount, you pay only a little more tax when your income barely spills into the next higher tax bracket.

As Nords noted, your conversion must be done prior to the end of the calendar year, not the April 15th due date for IRA contributions. Your estimated tax payment on the conversion is due a couple of weeks after the end of the quarter, in this case, the end of year.

Someone wrote that Roth conversions are a form of tax loss harvesting of tax sheltered accounts. You can choose to convert shares of whatever is down the most, or whatever has the most expected long term growth.

Roth conversions is prepaying future taxes at a reduced rate. To me, that is not much different than saving job income for retirement spending. It is still delayed gratification with a future benefit.

+1

You have outlined our strategy to a "T". We will be doing this for several years before we reach age 70 and begin receiving SS.....or that is "the plan" until if/when we find a better one. LOL.

I am glad that this thread was revived. I enjoy reading the different perspectives that everyone has to share.

I wonder how many people never pay much attention to strategic tax planning until it is too late and they have no choice but to pay higher taxes.

 

[samclem]

In 2012, for Married Filing Jointly, 7600 of deductions, 11900 of exemption, and 70700 to the top of the 15% bracket . . .

If you are married there's another important reason to push money from a T-IRA to a Roth: When one spouse dies, the other must start filing as a single taxpayer. That drastically lowers the top of the tax bracket they'd been using as a couple and shakes up the whole "we'll be in about the same tax bracket after we retire" assumption. For example, for the couple you cited their 25% taxes would start at an income of $80200. But if the DW is carrying on alone after hubby dies, here's how it looks for DW:
$5950 standard deduction
$3800 personal exemption
$35,350 Top of 15% tax bracket
$45,100 total

So, as a couple they didn't have to worry about hitting the 25% bracket until they earned $80,200, as a single DW now pays 25% on everything over $45,100. But money taken from a Roth doesn't count toward this total, which is a good reason to convert a lot into the Roth earlier if you can do it and stay under your next tax bracket.

The corresponding figures for the beginning of the 15% bracket are:
MFJ: 36,900
Single: 18,450

Probably an obvious point, but it didn't hit home with me until I saw what is happening because of my MIL's MRDs after the death of my FIL.

 

[kaneohe]

If you guess slightly too high on the conversion amount, you pay only a little more tax when your income barely spills into the next higher tax bracket.

.

...true, tho as someone pointed out somewhere (possibly in another thread),
guessing slightly too high in the 15% bracket will push the some/all of the LTCG/QDIV into the "15+15 =30%" bracket. The fix for this and not having all the numbers in Dec (if you want to bother) is to take your best educated guess in Dec and overconvert In the new yr once you finalize taxes but before you file, you can recharacterize the excess.

 

[pb4uski]

...true, tho as someone pointed out somewhere (possibly in another thread),
guessing slightly too high in the 15% bracket will push the some/all of the LTCG/QDIV into the "15+15 =30%" bracket. The fix for this and not having all the numbers in Dec (if you want to bother) is to take your best educated guess in Dec and overconvert In the new yr once you finalize taxes but before you file, you can recharacterize the excess.

Rather than overconvert and recharacterize the excess, I'm thinking that I will do my best estimate as late as possible and then reduce the conversion amount by $1,000. While it is true that I might leave a bit on the table, the $1,000 provides a bit of cushion for estimating error or more importantly if I later get audited and some minor deductions get thrown out and push my TI into the next higher bracket so all my qualified dividends become taxable.

Just a different approach to the same end.

 

[Khufu]

Here's another benefit to Roth conversion. Since we now live abroad we do not pay state income taxes on Roth conversions. Although we do not plan to move back to the States, there is always the possibility that we will decide to do so at some point. If that were to happen, the Roth conversions we have done while abroad would never be subject to state income tax. The same would apply to someone who retired to a no-income-tax state, but considered the possibility of moving back to a state with income tax at some point.

Since I have a strong legacy motivation the strategy I have decided on is to convert the max up to the top of our bracket each year between age 62 and 70, when I will start taking SS. Otherwise the combination of RMDs and SS after 70 would have resulted in much higher taxes.

 

[heyyou]

Thank you SamClem for the widow/widower tax considerations. I've got longevity and she doesn't, so I do expect to become a Single tax payer starting sometime during the RMD years.