Yet Another Roth Conversion Question

[bpgdeg1234]

Hello members,
We're seeking some advice on Roth conversions. 59 and 56 MFJ and retired. We have $1.4M in TIRA and only $35K in Roth accounts to this point. Have significant amount in taxable savings, mostly in CDs with ordinary income and a portion in stock mutual index funds with roughly $5K per year of qualified dividends.

Presently in 12% tax bracket but only have $25K available of headroom in 2019 to top of 12% tax bracket for Roth conversion so considering going into the 22% tax bracket. Our main concern is RMDs at age 72 which would put us clearly in the top end of the 22% tax bracket and potentially 24% (or higher if tax brackets revert to 25% and 28% or go even higher in the future), as well as IRMAA surcharges. We also will pay roughly 5% state tax on any conversion and no current plans to relocate to a state with no income tax.

We have a non-COLA pension that I was considering taking at age 60 which would add $60K to our current income next year but would put us immediately into the 22% tax bracket.

So we're considering potentially waiting until age 65 to begin taking non-COLA pension which would increase annual pension amount to $80K by deferring 5 years but keep our income base starting in the 12% tax bracket and allowing for an additional 5 years for Roth conversions with some of it starting in the 12% tax bracket.

If we keep conversions into only the top of the 12% bracket though we won't put much of a dent into our TIRA which is why we're considering going into the 22% tax bracket. Our current plan is to wait until 70 to take SS (~$44K) with spouse taking 1/2 of my amount at age 67.

So does it make sense for us to delay taking the pension until 65 and bite the tax bullet and start doing Roth conversions into the 22% tax bracket beginning this year or perhaps it doesn't really matter much as we will always at least be in the 22%/24% or whatever new tax brackets comes up after 2025?

Please apprise if additional information is needed. Thanks in advance.

 

[dtbach]

you are close to my condition (although you are better off) in that it's "pay me now, or pay me later". I would just do whatever keeps you in 12% as it really won't pay much to go to the 22% tax now vs 24% later.

 

[RunningBum]

I'd remove as much of the uncertainty about future taxes and convert to the top of 24%. I'd be inclined to hold off on the pension to get a larger amount, for longevity insurance. I didn't run the numbers at all, so if it seems to come out better taking it now, go ahead. I wouldn't let taxes dictate when to take it.

So there you have it, contrasting opinions on what to do, both valid.

 

[Animorph]

Paying the same 22% tax now with a Roth conversion versus later with RMDs is a benefit only if moving some of your taxable accounts value into a Roth gives you a tax advantage. Some of the CD interest or MF dividends could be tax free within the Roth. Sounds like that could be an advantage in this case.

Of course if the 22% tax rate increases you're better off paying 22% now.

If delaying the pension increases it's payout, it should be beneficial to delay for Roth conversions and 0% CG's.

I have found that in my case large Roth conversions early, even with equal tax rates now and for RMDs, were most advantageous. That maximizes the time your formerly taxable funds spend in the Roth. After 2020 I'll be switching over to smaller conversions and going for 0% CG's instead.

So I'd say top of 22% (or $250k AGI most likely) for a few years, followed by 0% capital gains. Retain some tIRA if any post-RMD income below 22% is possible.

 

[RetireBy90]

So I would suggest threads by midpack, reasons to convert into 22% or even 24% are laid out along with reasons not to hit a higher bracket. I would also suggest delay of the pension if it were to allow you higher conversions, provided you have plenty to pay the bills and play as you wish.

There are some milestones which impact your level of conversions for you and DW such as Medicare and IRMAA, Current tax rates due to expire at end of 2025, and of course RMDs once you hit 72 (The way I read it it will be year you reach 72, not 72 1/2).
DW and I are 63 and 66, and this is our first year doing conversions. I'm doing conversions into 24% bracket of about $35K for a total conversion of about $125K each year to 1) Avoid higher taxes when I am required to take RMDs; 2) Avoid higher taxes when I start SS at 70; 3) Avoid potential higher taxes when rates go up; and 4) Get tax man out of decisions on how to spend our savings. In a Roth I can spend it all one year or spend nothing.

I plan to convert the same amount every year for next 6 years provided our income stays where I figure it will. However, if there is a significant market decline (and I'm sure there will be) I will review the numbers and may up the conversion that year to take advantage of it.


Just one view, there are those on the board that know a lot more than I and I'm sure you will hear from them or read the posts on other threads.

 

[Done]

I’ve been studying our Roth conversion options and have also played with Income Strategy online software. Our tax brackets sound similar to yours except we have rental income rather than a pension. DW and I have an age difference so for us the big kicker (so to speak) is the widow's tax trap. If one passes, the survivor will quickly be paying higher taxes because the single brackets are less deep. In such a situation, would your pension survive or be reduced?

For us, conversions make sense to 22% for several years, followed by several years of increased distributions from an inherited IRA. This would end up saving the survivor taxes and IRMAA for, potentially, decades. Even if we both live a long time, Roth conversions are beneficial to moderate taxes and IRMAA later. I also believe that tax rates are likely to increase and/or benefits may become means-tested. The Income Strategy results made it clear that we should attempt to shift our tax liability to earlier years to better equalize tax brackets and avoid ugly peaks later.

If you are planning to leave the IRA to non-spouse heirs, the new SECURE law may require them to distribute the IRA (with resulting tax implications) in 10 years. Doing Roth conversions now may make your gift more valuable, if that is important to you.

You mentioned holding mostly CDs in taxable accounts. To minimize taxes, you may consider revamping your asset location over time to hold equities in taxable accounts and fixed income in tax-deferred. If you need income before the pension starts, you can consider tapping the IRAs at age 59 1/2. This will also help shift the taxes earlier and reduce future RMDs, although Roth conversions are even better if you pay taxes from the taxable account.

 

[target2019]

We just discussed delaying her pension for siz months. This would create more headroom for conversion of my IRA to Roth.

The problem is, her employer then does not pay accumulated sick leave if you delay the date. It happened to a friend of hers last year. It was quite disappointing.

 

[bpgdeg1234]

Thanks everyone for your perspectives to date. I have read the midpack thread and agree that converting into the 22% tax bracket and paying taxes out of our taxable account makes a lot of sense. The fact that we only get around $5K in qualified dividends provides a manageable tax bump as we go above the 12% into the 22% bracket.

As for the conversion itself we have a combination of stock index funds, bond funds, brokered CDs and money market funding in our TIRA that we can choose for this year's initial conversion.

Knowing the recommendation is to place the highest growth assets such as the stock index funds into the Roth we should convert them first. With the market, however at all time highs and recharacterization no longer available I am finding it hard to convert that asset class and pay the taxes on the higher valuation so am leaning towards converting some of the fixed income fund instead at this time.

One other potential thought is to proceed with converting some of the stock index fund but to only move 75% into the Roth stock index fund and the rest into a Roth fixed income which would then more closely maintain our present true stock exposure since the government no longer participates in the loss with the funds in the Roth.

By converting it all into the stock index fund while paying taxes out of our taxable account we would be increasing our stock exposure which I'm less inclined to do at today's market level.

Perhaps I'm overthinking this but would appreciate any perspectives. Thanks again in advance.

 

[Animorph]

I've been increasing our taxable/tIRA stock exposure and buying more bonds in the Roth, but trying to keep the overall AA within limits. Less capital gains or more shares to Roth if the market goes down. And really, more in taxable accounts means a little longer before withdrawing from the Roth. But I sure don't know what will happen, so I try to avoid any big moves.

 

[Sunset]

This year, I converted bond funds and cash from the IRA into the ROTH.
Thinking that if the stock market crashes next year, then I'll convert the bond funds in the IRA into stocks. (A little DMT).

My feeling is why convert something that has risen a LOT, better to convert the things that have risen a little.

People might say if you convert $30K it doesn't matter what you convert, and that would be true if everything remains at the same value as it is now.

 

[target2019]

By converting it all into the stock index fund while paying taxes out of our taxable account we would be increasing our stock exposure which I'm less inclined to do at today's market level.

Perhaps I'm overthinking this but would appreciate any perspectives. Thanks again in advance.

Earler today I added the same question and notes to our 10-year plan:

Which fund(s) or ETF(s) to add in RothIRA to "catch" converted money? SEP-IRA (account to convert) is currently invested 50/50. VSMGX (Vanguard LifeStrategy Moderate Growth) increases stock AA slightly (60/40).
Other Roth Choices: VASGX (80/20) or VGWLX (65/35).
Any other choices to consider?

Our overall target AA is 50/50. Whatever choice we make (Dec 2020), there may need to be adjustment(s) elsewhere. I don't necessarily want to have more funds overall, though. I look at this conversion as an opportunity to streamline (4) funds in SEP-Ira to (1) fund in Roth.

Interesting question which I thought I'd start a thread with, but this one will help me decide.

 

[RetireBy90]

By converting it all into the stock index fund while paying taxes out of our taxable account we would be increasing our stock exposure which I'm less inclined to do at today's market level.

Perhaps I'm overthinking this but would appreciate any perspectives. Thanks again in advance.

My AA is across Roth and TIRA accounts, so when I converted earlier this year, I just moved assets from TIRA to the Roth. Fidelity allows you to move funds rather than having to sell, move, buy so my AA didn't have any changes just some of the assets were in one account are now in the other.

 

[bpgdeg1234]

Thanks again for all of your views. I specifically have a question around the following from RetireBy90:

My AA is across Roth and TIRA accounts, so when I converted earlier this year, I just moved assets from TIRA to the Roth. Fidelity allows you to move funds rather than having to sell, move, buy so my AA didn't have any changes just some of the assets were in one account are now in the other.

When you "just moved assets from TIRA to the Roth" you needed to pay taxes on the amount converted from the TIRA so you effectively increased your stock allocation in the Roth if taxes were paid from taxable account since you previously shared ownership of the TIRA with the government who participated in either the gain or loss in the stock fund with amount based on your tax bracket.

As such, that is my concern with just converting an entire amount in a TIRA stock index fund in kind at today's all-time-high market and instead considering one of the two options I outlined in my original post - convert only fixed income holdings or proceed with converting the stock fund but only put 75% into a Roth stock fund and the other 25%, which was previously the governments in the TIRA, into a Roth fixed income.

This would effectively make my real stock exposure similar in the Roth to what it was in the TIRA and if the market goes down or up I will basically be in a similar place in either case. Just a potential option for me to consider and trying to gauge other's perspectives if I'm missing something in the thought process.

 

[RunningBum]

Any sales or exchanges in a TIRA or Roth are not taxable events, so you can reallocate your holdings however you see fit. Just because you transfer a stock fund from your TIRA to your Roth doesn't mean you have to keep a stock fund there. I'm not getting why you're hung up on this.

 

[CRLLS]

Considering that RMD's will put us firmly in the 22% bracket later, I feel comfortable converting into the 22% bracket now. Money is fungible as re taxes IMO. Tax me now vs tax me later is close to a wash. However, when one of us passes on, the conversion will help the survivor. Not only that, any leftover moneys after we both pass will have lower tax impact on those beneficiaries. So a wash now helps the surviving spouse and their heirs (our kids and grandkids).

 

[bpgdeg1234]

Any sales or exchanges in a TIRA or Roth are not taxable events, so you can reallocate your holdings however you see fit. Just because you transfer a stock fund from your TIRA to your Roth doesn't mean you have to keep a stock fund there. I'm not getting why you're hung up on this.

Agree sales/exchanges within a TIRA or a Roth are not taxable events but the conversion of funds from the TIRA to a Roth is a taxable event. That is what I'm referencing.

Also agree I don't have to convert stock and can choose fixed income for the Roth as I indicated in original post but it is recommended by many to put stock into Roth since it's a higher growth vehicle and pay the income taxes due from the conversion out of my taxable account. When considering this option though I see that I will effectively increase my overall true stock risk exposure on the Roth end.

As an example using $80K of a stock fund in the TIRA I wish to convert to a Roth. Prior to the conversion I realistically only own $60K of it as the federal and state governments have claim via income tax due upon distribution to roughly 25% or $20K of it.

After the Roth conversion and by paying the income tax out of my taxable account I then own all $80K or 100% of it so basically purchased another $20K of the stock index fund in Roth from my taxable savings account.

So considering options of just doing fixed income Roth conversion for the $80K or breaking a stock fund conversion of the $80K to say 75% or $60K stock and 25% or $20K fixed income on the Roth end to maintain present stock risk exposure.

 

[RunningBum]

Yes, I agree that $80K in stock in a Roth is worth more than $80K pre-tax in a tIRA. When I calculate my AA I adjust my tIRA and taxable accounts for the estimated tax liability in those, so I'm in full understanding of what you are saying.

I just think you're fretting too much about this detail. Unless your AA happens to be right where you want it, you probably need to do more than just make this transaction match your AA. I treat these as two separate actions. Make the conversion, then adjust your AA accordingly, taking into account other things like market growth, dividends, etc that also likely threw your AA off.

 

[capjak]

I'd remove as much of the uncertainty about future taxes and convert to the top of 24%. I'd be inclined to hold off on the pension to get a larger amount, for longevity insurance. I didn't run the numbers at all, so if it seems to come out better taking it now, go ahead. I wouldn't let taxes dictate when to take it.

So there you have it, contrasting opinions on what to do, both valid.

+1. I have no idea what the tax rates will be in 5 years, so convert to 24%....and let it grow tax free in a stock fund, let the IRA slow grow with bonds and taxable stock fund plus 5 years expenses MM/CD or whatever your AA is....

 

[RetireBy90]

Thanks again for all of your views. I specifically have a question around the following from RetireBy90:

When you "just moved assets from TIRA to the Roth" you needed to pay taxes on the amount converted from the TIRA so you effectively increased your stock allocation in the Roth if taxes were paid from taxable account since you previously shared ownership of the TIRA with the government who participated in either the gain or loss in the stock fund with amount based on your tax bracket.

As such, that is my concern with just converting an entire amount in a TIRA stock index fund in kind at today's all-time-high market and instead considering one of the two options I outlined in my original post - convert only fixed income holdings or proceed with converting the stock fund but only put 75% into a Roth stock fund and the other 25%, which was previously the governments in the TIRA, into a Roth fixed income.

This would effectively make my real stock exposure similar in the Roth to what it was in the TIRA and if the market goes down or up I will basically be in a similar place in either case. Just a potential option for me to consider and trying to gauge other's perspectives if I'm missing something in the thought process.

I have AA for my retirement accounts and don’t count in my after tax funds. After tax is only about 12% of our investable assets and I use it where I think best, spend, buy BA, or pay taxes on conversions. After thinking about your posting, I should pay more attention to how taxes affect the AA. Thanks for pointing that out.

 

[RunningBum]

It's an interesting question about placement. As bpgdeg said, normally you put stocks in a Roth and bonds in a tIRA. But if you think stocks are really due for a fall, do you do a bit of "market timing"--not selling off stocks necessarily, but holding them in the tIRA instead. If they go up, oh well, you just have to pay a little more in taxes when converting or withdrawing. But if they go down as you think they might, you can convert at a lower price.

 

[Perryinva]

Agree sales/exchanges within a TIRA or a Roth are not taxable events but ......
As an example using $80K of a stock fund in the TIRA I wish to convert to a Roth. Prior to the conversion I realistically only own $60K of it as the federal and state governments have claim via income tax due upon distribution to roughly 25% or $20K of it.

After the Roth conversion and by paying the income tax out of my taxable account I then own all $80K or 100% of it so basically purchased another $20K of the stock index fund in Roth from my taxable savings account....

I have not once ever seen anyone delineate their AA only counting the possible after tax value of that particular allocation. No one looks at it and says “Oh, I have a million bucks with 70/30, $300k in Roth and $400k in tIRA & $300k in bonds and but the reality is my real allocation is actually $648k/$264k after tax so it is REALLY only 71/29 with $912k. See the point? If it makes you feel better, than buy 1% of the total in bonds or fixed. All the same.

Or do what a lot do, claim we are at an all time high in equities and get out now and go mainly fixed/bonds and chance timing the market. After this long and hard bull, it is not exactly foolhardy to do this. I have greatly reduced my exposure. I way more than doubled my portfolios out of pocket input over the last 10 years, far better than I ever did the previous 25 years before that ,and luckily I had significant enough funds over the last 10 years to make it a major impact. If I had doubled my money when I was 30, it would have been $25k to $50k. Big woop! Mine did that in 4 months just this year. In the same vein when the crash caused me to lose 25% of that gain total at 30, I lost a whopping $12.5k. This year it would be over a $300k loss. Percents only are not a good way to look at it.

Remember that AA is not there to minimize taxes or the type of fund held. It is there to supposedly safeguard the increase of the average LONG TERM value to allow a higher average SWR. The OPs concern is as if he expects to liquidate 100% of his portfolio at any one time and he needs to make sure he does it with the correct AA. That makes no sense. The idea is that the AA allows extraction from the best fumd depending on markets at that time.

 

[pb4uski]

Hello members,
We're seeking some advice on Roth conversions. 59 and 56 MFJ and retired. We have $1.4M in TIRA and only $35K in Roth accounts to this point. Have significant amount in taxable savings, mostly in CDs with ordinary income and a portion in stock mutual index funds with roughly $5K per year of qualified dividends.

Presently in 12% tax bracket but only have $25K available of headroom in 2019 to top of 12% tax bracket for Roth conversion so considering going into the 22% tax bracket. Our main concern is RMDs at age 72 which would put us clearly in the top end of the 22% tax bracket and potentially 24% (or higher if tax brackets revert to 25% and 28% or go even higher in the future), as well as IRMAA surcharges. We also will pay roughly 5% state tax on any conversion and no current plans to relocate to a state with no income tax.

We have a non-COLA pension that I was considering taking at age 60 which would add $60K to our current income next year but would put us immediately into the 22% tax bracket.

So we're considering potentially waiting until age 65 to begin taking non-COLA pension which would increase annual pension amount to $80K by deferring 5 years but keep our income base starting in the 12% tax bracket and allowing for an additional 5 years for Roth conversions with some of it starting in the 12% tax bracket.

If we keep conversions into only the top of the 12% bracket though we won't put much of a dent into our TIRA which is why we're considering going into the 22% tax bracket. Our current plan is to wait until 70 to take SS (~$44K) with spouse taking 1/2 of my amount at age 67.

So does it make sense for us to delay taking the pension until 65 and bite the tax bullet and start doing Roth conversions into the 22% tax bracket beginning this year or perhaps it doesn't really matter much as we will always at least be in the 22%/24% or whatever new tax brackets comes up after 2025?

Please apprise if additional information is needed. Thanks in advance.

I would probably defer SS and pension as long as possible to take full advantage of 12% Roth conversions. Assuming that your health is good, the growth of the pension sounds like it is worth waiting... you would recover the $300k you forgo by waiting from 60 to 65 in 15 years... by age 80.

But with only $25k a year of 12% Roth conversions it won't make much of a dent in the $1.4m.... cover the annual growth and a little more. I would probably also consider going into the 22% tax bracket with conversions unless there is a way to expand that $25k headroom for 12% conversions (munis perhaps?).

 

[bpgdeg1234]

I have not once ever seen anyone delineate their AA only counting the possible after tax value of that particular allocation. No one looks at it and says “Oh, I have a million bucks with 70/30, $300k in Roth and $400k in tIRA & $300k in bonds and but the reality is my real allocation is actually $648k/$264k after tax so it is REALLY only 71/29 with $912k. See the point? If it makes you feel better, than buy 1% of the total in bonds or fixed. All the same.

Or do what a lot do, claim we are at an all time high in equities and get out now and go mainly fixed/bonds and chance timing the market. After this long and hard bull, it is not exactly foolhardy to do this. I have greatly reduced my exposure. I way more than doubled my portfolios out of pocket input over the last 10 years, far better than I ever did the previous 25 years before that ,and luckily I had significant enough funds over the last 10 years to make it a major impact. If I had doubled my money when I was 30, it would have been $25k to $50k. Big woop! Mine did that in 4 months just this year. In the same vein when the crash caused me to lose 25% of that gain total at 30, I lost a whopping $12.5k. This year it would be over a $300k loss. Percents only are not a good way to look at it.

Remember that AA is not there to minimize taxes or the type of fund held. It is there to supposedly safeguard the increase of the average LONG TERM value to allow a higher average SWR. The OPs concern is as if he expects to liquidate 100% of his portfolio at any one time and he needs to make sure he does it with the correct AA. That makes no sense. The idea is that the AA allows extraction from the best fumd depending on markets at that time.

Thanks again all for your replies. In reading Perryinva's response, I see it a bit differently in that converting the recommended stock index from my TIRA to the Roth while paying 25% fed/state taxes due out of my taxable account means to me that I have basically purchased another $20K of stock. I effectively have increased my stock exposure and risk at today's high market value.

As such, I am leaning towards converting the $80K but then only putting $60K of it in the same index fund on the Roth end and the other $20K in a lower risk fixed income fund to maintain my present true risk profile as exists in the TIRA.

If market goes up I lose the additional appreciation on the $20K that I wouldn't own anyway on the TIRA end but am basically no worse off than if left in the TIRA and didn't do the conversion at all.

If market goes down then opportunity exists to shift the $20K at some point from fixed income into the stock index fund which effectively increases the value of the fed/state taxes I paid this year on the conversion.

Thanks again for all of your responses to date.

 

[bpgdeg1234]

I would probably defer SS and pension as long as possible to take full advantage of 12% Roth conversions. Assuming that your health is good, the growth of the pension sounds like it is worth waiting... you would recover the $300k you forgo by waiting from 60 to 65 in 15 years... by age 80.

But with only $25k a year of 12% Roth conversions it won't make much of a dent in the $1.4m.... cover the annual growth and a little more. I would probably also consider going into the 22% tax bracket with conversions unless there is a way to expand that $25k headroom for 12% conversions (munis perhaps?).

Thanks pb4uski as this is what I am thinking. I have considered a shift to munis but have a pretty hefty CD ladder which would take several years to unwind so going into the 22% tax bracket with conversions seems like the realistic available option at this point if we truly want to address our concern. Midpack's thread was a real eye-opener.

 

[RunningBum]

I have not once ever seen anyone delineate their AA only counting the possible after tax value of that particular allocation. No one looks at it and says “Oh, I have a million bucks with 70/30, $300k in Roth and $400k in tIRA & $300k in bonds and but the reality is my real allocation is actually $648k/$264k after tax so it is REALLY only 71/29 with $912k .

I do. It started for measuring my net worth when I had employee stock options that were likely to be taxed at 39% federal & 7% state, so they were really worth barely half of what they appeared to be worth. Since that was the bulk of my net worth in the mid/late 90s it kept things in perspective as to when I could retire. I carried it over to my other investments to be consistent, and since I had it that way I used it for my AA as well. It's probably doesn't make much of a difference anymore but I see no need to change.