Who has not/will NOT do Roth Conversions?

[Exchme]

Another way to look at this is that you (likely inadvertently) changed your exposure to equities when you made the conversion you did. It would have been possible to rearrange your overall holdings to make it irrelevant (on an after-tax basis) whether you had made a conversion or not: https://www.bogleheads.org/wiki/Tax-adjusted_asset_allocation

The effect you mentioned is real that when preferentially loading up bonds in tax deferred, it is sort-of equivalent to using an overall stock/bond allocation that is several points higher in stocks.

But I think eyenitnoy's regret was simply that had he been a better market timer, he could have done the conversions in the current market downturn, rather than at the peak. I did the same thing, figuring that on average doing my conversions early in the year would be better than waiting - oops! that didn't work this year.

 

[Out-to-Lunch]

The effect you mentioned is real that when preferentially loading up bonds in tax deferred, it is sort-of equivalent to using an overall stock/bond allocation that is several points higher in stocks.

But I think eyenitnoy's regret was simply that had he been a better market timer, he could have done the conversions in the current market downturn, rather than at the peak. I did the same thing, figuring that on average doing my conversions early in the year would be better than waiting - oops! that didn't work this year.

I think it is very revealing that you mention that the results that eyenitnoy obtained depended on his timing. I still contend that this is because he changed his risk profile when he did the conversions. It is easy to lose sight of this, particularly when one does not consider funds in cash in a taxable account as part of one's portfolio.

To vastly oversimplify, he had some stock in a tIRA, and some cash in, say, a savings acount. He converted some of the stock to Roth, and paid for the taxes fom the cash. Clearly, he now has fewer safe assets, and more (on an after-tax basis) risky ones.

To put some crude numbers, assume he had $400k in tIRA stocks, and $100k in taxable cash, for a total of nominal dollars of $500k. Let's say that his tax rate is 25%. Let's assume he coverted $200k in stocks.

Before the conversion, he had a tax-adjusted portfolio of $400k*75% = $300k in stocks (all in tIRA), and $100k in cash, for a total of $400k in spendable, after-tax money.

After the conversion, he nominally had $200k in Roth stocks, $200k in tIRA stocks, and ($100k - 0.25*$200k)=$50k in taxable cash. His tax-adjusted portfolio is now ($200k*75% tIRA stocks + $200k Roth stocks) = $350k in stocks; and cash reserves of $50k computed above, for a total of $400k spendable, after-tax money. This is as it should be: the conversion does not change his spendable, after-tax total.


However, note that his risk profile has changed. Before conversion, his tax-adjusted AA was something like 75/25 (stock/cash). After the conversion, his tax-adjusted AA was 87.5/12.5 (stock/cash). He has taken on more risk. A downturn affected him worse, and an updraft would have made him more happy.

He could have mitigated this risk by maintaining the same tax-adjusted AA after converting that he deemed proper before converting. Then the timing would not have mattered.

The mistake being made here is to focus on individual parts of the portfolio, rather than the overall portfolio.

 

[UpQuark]

I'm not doing Roth conversions. When I use a calculator it doesn't seem to make more than a few hundred dollars difference either way. When I used ORP it looked like I would benefit from from doing Roth conversions but the benefit appeared to be the last few years of life, and I don't have much confidence living that long.
I probably will have to pay taxes when RMDs start, but not at a higher rate than when I was working, so I guess there is not much point to doing the conversions.

But just to make an effort, this year I recharacterized my 2021 IRA contributions to change to Roth type. Normally I need to do the traditional in order to get a tax refund in order to have any money to put in the IRA at all, but this year worked out okay.

 

[Out-to-Lunch]

I was kinda right, kinda wrong. Quoting myself for context:

To vastly oversimplify, he had some stock in a tIRA, and some cash in, say, a savings acount. He converted some of the stock to Roth, and paid for the taxes fom the cash. Clearly, he now has fewer safe assets, and more (on an after-tax basis) risky ones.

etc., etc.

I realized that in the above, I merely restated what Exchme agreed to be true. I did not establish that the order of crash and conversion did not matter, as I claimed. I ran the numbers this morning, and it does matter in a way, but not to your spendable wealth.

I am not going to lay out all the numbers here, but I considered two cases: (A) You convert, then rearrange your portfolio to get the same tax-adjusted AA as before, then the market crashes; and (B) The market crashes, you convert, then then rearrange your portfolio to get the same tax-adjusted AA as before.

In both cases, you get the same after-tax spending ability, and the same AA. However, in case (A), you have more more raw funds, but less in your Roth. Case (B) gets you more in your Roth, but much less in your tIRA. So I was wrong about that, and Exchme and eyenitnoy were right. However, as I said, you have the same spending power after paying taxes on what is left in your tIRA, so one should be agnostic about the order.

 

[Exchme]

I was kinda right, kinda wrong. Quoting myself for context:



I realized that in the above, I merely restated what Exchme agreed to be true. I did not establish that the order of crash and conversion did not matter, as I claimed. I ran the numbers this morning, and it does matter in a way, but not to your spendable wealth.

I am not going to lay out all the numbers here, but I considered two cases: (A) You convert, then rearrange your portfolio to get the same tax-adjusted AA as before, then the market crashes; and (B) The market crashes, you convert, then then rearrange your portfolio to get the same tax-adjusted AA as before.

In both cases, you get the same after-tax spending ability, and the same AA. However, in case (A), you have more more raw funds, but less in your Roth. Case (B) gets you more in your Roth, but much less in your tIRA. So I was wrong about that, and Exchme and eyenitnoy were right. However, as I said, you have the same spending power after paying taxes on what is left in your tIRA, so one should be agnostic about the order.

There are several subtleties here. Your example focused on the first one that if you hold different allocations in types of account, you have to tax adjust to understand what you really own vs. what you are just keeping track of for the government. As you noted, I already agreed with that.

The second subtlety, that I hadn't considered and that will help me in the future is that I had missed the step of immediately rebalancing in taxable when I do a Roth conversion to account for the fact that some of my cash in taxable now belongs to the government, even though I haven't yet written the check. I did not in fact do that rebalancing and it left me open to more downside market risk than intended, so thank you for helping me see that.

I've attached an example of how the portfolios can mostly avoid market timing risk, ending at the same value if we tax adjust and rebalance. In this toy example, taxable and tax deferred both start with a balance of 100, using a 50/50 allocation in each account type and converting half. In one case we convert and then stocks drop by half and in the other case, stocks drop by half and then we convert.

This brings up the third subtlety in that the example assumes a tax bracket. The place where correctly "market timing" and doing a conversion after a drop is a real effect is by reducing AGI and taxable income, so allowing more conversions within a given income tax bracket (or whatever other use of the tax space makes sense). Since I can't hope to successfully market time, I did the bulk of my conversions at the start of the year, as that will be best on average, but so far this year that wasn't the best choice.

I learned something that can help me in the future from this, so I count this exchange as "win" for my portfolio.

All the best!

 

[Out-to-Lunch]

There are several subtleties here. Your example focused on the first one that if you hold different allocations in types of account, you have to tax adjust to understand what you really own vs. what you are just keeping track of for the government. As you noted, I already agreed with that.

The second subtlety, that I hadn't considered and that will help me in the future is that I had missed the step of immediately rebalancing in taxable when I do a Roth conversion to account for the fact that some of my cash in taxable now belongs to the government, even though I haven't yet written the check. I did not in fact do that rebalancing and it left me open to more downside market risk than intended, so thank you for helping me see that.

I've attached an example of how the portfolios can mostly avoid market timing risk, ending at the same value if we tax adjust and rebalance. In this toy example, taxable and tax deferred both start with a balance of 100, using a 50/50 allocation in each account type and converting half. In one case we convert and then stocks drop by half and in the other case, stocks drop by half and then we convert.

This brings up the third subtlety in that the example assumes a tax bracket. The place where correctly "market timing" and doing a conversion after a drop is a real effect is by reducing AGI and taxable income, so allowing more conversions within a given income tax bracket (or whatever other use of the tax space makes sense). Since I can't hope to successfully market time, I did the bulk of my conversions at the start of the year, as that will be best on average, but so far this year that wasn't the best choice.

I learned something that can help me in the future from this, so I count this exchange as "win" for my portfolio.

All the best!

Ahh, very nice! Two things: Thanks for making the clear document. (Mine was similar, but I was too lazy to work to present it that well). But more importantly, it did not occur to me that one could simply choose to convert less in the event of a market crash, and then come to the same result. Good spy.

My case this year was very similar to yours. I did convert the bulk of my intended yearly Roth conversion in January, and, so far, it has not worked out optimally. I also did a rebalancing, not explicitly in response to the conversion, but just as part of beginning-of-year housekeeping.

Cheers!

 

[RockyMtn]

I'm doing Roth conversions equal to my donations to my DAF. Otherwise, tax rate is still pretty steep hit (still have consulting income and a pension coming in). I suppose when I stop the consulting gigs I may ramp the Roth conversions up a bit or just do QCD's when the RMD's kick in.

 

[BubbaChris]

Sticking with OP's original question. We're both age 61, ER and getting ACA Premium Tax Credits. Our split is 70% tax deferred, 30% taxable, and 10% ROTH (all ROTH contributions were pre-ER).

We are not doing ROTH conversions because of the ACA benefit, and we won't consider conversions until we're on Medicare. I believe we are not overly likely to do them at that time. This is because we're currently taking some income from our tIRA, and will step that up once the ACA drops away. This strategy may slowly eat away at the size of our RMDs, unless compound growth in the tIRA becomes a good problem to have.

Every time I take a hard look at IRMAA, I usually come away feeling it's a modest penalty for winning the game. I look at the maximum increase in premium and compare it to how much the value of our portfolio moves in any given week - And I determine there isn't a lot of value in jumping through big hoops with the hope of creating more control more than a decade from now. OTOH, I seriously dislike how narrow the tranches are, and will likely put forth some effort to stay in whatever bracket works best for us.

I'll admit I spent years being too cash-flow sensitive to see any value in earning over $,1300 to net each $1,000 invested in a ROTH at a 24% marginal tax rate. Today I see the value of having some assets in a ROTH so you can deal with unexpected lumpy expenses with zero negative tax impact.

Best regards,
Chris

 

[yakers]

Doing only occasional $5K to $10K conversions from tIRA to Roths for DW & I. Our 'plan' as stated to our two sons is that we plan that our 2 Roths will go to them an they will be the last thing we spend if we have to. We have taxable and tIRAs to draw down and paid off condo so likely much more than Roths will remain but that is our plan and not regularly making significant conversions.