nydad wrote:Would be useful to share actually - I could use a similar spreadsheet...
jdjd2 wrote:Ignoring having to pay the Medicare penalties, but keeping taxable income in the 33% tax bracket took 6 years (so 2 years into RMD), saved 14.0% in taxes compared to doing it all at once. This is even taking into account the additional Medicare monthly income penalties, but not the 3.8% penalty that was not triggered.
Of the half dozen scenarios I ran, all based on holding taxes to a certain level, this scenario resulted in the least amount of taxes. And after these 6 years, my Medicare monthly premium costs would return to the typical Medicare costs.
4. A few other scenarios were slightly higher in taxes than this last, best case, one.
5. I compared these scenarios with NEVER doing a conversion. The cross over point for taxes was age 84. That is, with no conversion, it takes until I am 84 to pay as much taxes as the best case and several other conversion scenarios. So a tax savings in the initial 18 years. But by the age of 95, I will have paid 89.4% more in taxes than the conversion scenarios. This scenario also had the downside that once the RMD starts, my income increases significantly putting me in the 28% tax bracket. It is also more income than I need to live on yearly.
. If you are going to compare performance, you must start with the same amount of $$ before conversion. $10,000 invested in a TIRA is equal to $6600 invested in the Roth for 33% tax bracket. When you do it properly, the after tax value of the withdrawal will be identical if the tax rate is the same as when contributed.
However, the main feature of this "partnership" is that your share of the TIRA will vary over time with your tax bracket. Thus you would want to "buy out" your partner when the tax bracket (cost) is as low as possible. For many of us this occurred in the period between retirement and the beginning of RMDs. For others it can occur while still filing joint returns, before willing it to a heir in a high tax bracket, before taking social security, etc.
JDJD2 wrote:If I choose to not convert, then my taxes for the next 5 years are close to nothing. But then they quickly go up to 28% and stay there for the foreseeable future.
• If I choose to convert, then the best scenario (from some 6-10 I ran) seems to be to take advantage of my pre RMD and pre taking SS status (for the next 5 years) and convert the TIRA over this time.
Converting this fast does push me into the 33% marginal tax bracket, but after 5 years, my taxes will drop significantly, as in < 25%. And yes, I will pay (what I refer to as) a penalty on my Medicare Part B and Part D premiums for 5 years (also accounted for in my calculations), but then it will drop to the normal rate.
JW Nearly Retired wrote:Lets see, you have $100k and pay 33% now to convert leaving you $67k after paying $33k tax. Say in x years that $67k grows by 50% tax free in a Roth to 1.5 x $67k = $100.5k to spend. That's OK. Suppose you don't convert and leave the $100k in the same funds in the IRA to grow by the same 50% tax free = $150k. Then you take it out at your 28% tax rate leaving you $150k x (1.-0.28) = $108k to spend. That's better! True that the taxes you eventually pay will be more, 0.28(150) = $42k instead of $33k, but the money you get to keep will be more too.
bsteiner wrote:JW Nearly Retired wrote:Lets see, you have $100k and pay 33% now to convert leaving you $67k after paying $33k tax. Say in x years that $67k grows by 50% tax free in a Roth to 1.5 x $67k = $100.5k to spend. That's OK. Suppose you don't convert and leave the $100k in the same funds in the IRA to grow by the same 50% tax free = $150k. Then you take it out at your 28% tax rate leaving you $150k x (1.-0.28) = $108k to spend. That's better! True that the taxes you eventually pay will be more, 0.28(150) = $42k instead of $33k, but the money you get to keep will be more too.
It's worth converting at a somewhat (but not too much) higher rate than you or your beneficiaries would otherwise pay on the distributions if you have other money with which to pay the tax.
In your example, the tax rate on the conversion would be 33%, but only 28% on the distributions if you don't convert. Suppose you have a $100 traditional IRA and $33 of other money. If you convert, you have a $100 Roth IRA. Over some period of time, it grows to $200. If you don't convert, your traditional IRA grows to $200, or $144 after tax at 28%. If, over the same period of time, your $33 of other money grows to less than $56, you're better off converting. Remember that the IRA can continue for a long time: your life expectancy, your spouse's life expectancy, and your beneficiaries' life expectancy.
Other benefits of the Roth conversion include no required distributions after age 70 1/2 (of greater value to those with sufficient other assets or income), better creditor protection in many states, and avoiding the problem of the income tax deduction for the estate tax only covering the Federal (but not the state) estate tax in those states that still have a state estate tax.
In order to quantify this, you would have to make assumptions as to a number of factors, including the tax rate that would otherwise apply to distributions, the investment return within the IRA, the after-tax investment return on the taxable account, when your death will occur, when your spouse's death will occur (if you're leaving your IRA to a spouse). However, it's safe to say that converting will usually make sense if you can convert at a tax rate less than, equal to, or not too much higher than the tax rate that would otherwise apply to the distributions.
JW Nearly Retired wrote:Taxable money in equities has a low tax rates and gets a stepped up basis for heirs. I think they might prefer leaving it in taxable.
That is a good point about the Roth lasting until beneficiary's life expectancy, so you need to project out a long time. I did convert some IRA up to the top of the 28% bracket this year. I think I will take a look at BigFoot48's referenced calculator and explore doing some more.
I'm mainly just thinking the OP is overdoing this. He said he will convert so much at 33% he will be in a <25% tax bracket by the time he takes SS/RMDs. I wasn't viewing that tax rate difference as in the "not too much higher" category.
jdjd2 wrote:From the bigfoot48 spreadsheet I used (btw - I went through his spreadsheet thoroughly to understand how it worked and verify i was not doing a "garbage in garbage out" exercise), if I lived to be 100 I would still have almost a 7 figure # in the IRA, all taxable to my heirs, and a much much larger # in my taxable account.
So I'm back to "I'm trying to find a reason why doing a Roth conversion is a bad idea, but have not found one yet."
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