Conversion to Roth In Retirement @ 25%

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Conversion to Roth In Retirement @ 25%

Postby Ged » Fri Aug 30, 2013 11:02 am

So looking at my retirement, if I delay my SS there is going to be a period between 65 and 70 that I will be able to convert some of my tIRA to Roth at a 15% tax rate. So I will do that.

Once I hit 70.5 though between RMD and SS I will be in a 25% bracket. No way around that I can see.

I'm not a huge fan of the idea of passing on a tIRA to my children though. And I'd like to simplify things in retirement, part of which means getting rid of RMDs.

So is there any particular reason why I shouldn't go up to the 25% income max for converting my tIRAs to Roths? Does this sound like a reasonable strategy? Or are there disadvantages I am missing?
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Re: Conversion to Roth In Retirement @ 25%

Postby livesoft » Fri Aug 30, 2013 11:33 am

I think one should do a TurboTax run.

Bob'sNotMyName has disclosed that many older people in assisted living do not pay income taxes, so maybe your 25% is way too high?
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Conversion to Roth In Retirement @ 25%

Postby Sidney » Fri Aug 30, 2013 11:36 am

livesoft wrote:I think one should do a TurboTax run.


Agree and it is easy to do. Many people have their IRAs in bonds so with zero-ish real returns, you can just take the current balance and calculate the RMD and run it through TT with other income and deductions.

In fact, I try to do this every year just as a check. About the time I get my regular return done (in the next 6 weeks) it is a good time to look at conversion for the current year and start to get things measured. All I have to do is add an extra 1099 to simulate conversion.
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Re: Conversion to Roth In Retirement @ 25%

Postby BigFoot48 » Fri Aug 30, 2013 12:06 pm

Run your numbers through my model and see if that provides any insights. Retiree Roth Conversion Decision Model

From the Wiki:
Forum member BigFoot48 has created a spreadsheet for use by retirees, or those nearing retirement, which will estimate the financial impact on your portfolio and income taxes from doing Roth conversions. Use this spreadsheet to determine if a Roth IRA conversion may be worthwhile for your personal situation.

Yearly results are provided (such as income, expenses, taxes, inheritances, and asset sales over a selectable time period) for both doing conversion, and not doing the conversion, so an easy comparison can be made.
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Re: Conversion to Roth In Retirement @ 25%

Postby kaneohe » Fri Aug 30, 2013 12:11 pm

Be aware of the higher medicare (pt B/D) premiums at higher incomes. http://www.ssa.gov/pubs/EN-05-10536.pdf
Kind of a complex problem.......if you convert in one swoop, you only get the higher premiums for 1 yr but in the conversion yr, you may be in a much higher tax bracket. If you never convert, you may get some level of elevated premiums forever.
Somewhere in between and intermediate results. Probably depends............
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Re: Conversion to Roth In Retirement @ 25%

Postby bsteiner » Fri Aug 30, 2013 12:13 pm

If the distributions would otherwise be taxable at 25%, then the conversion, to the extent you can convert at 25% or 28%, is likely to be beneficial. You didn't say what your beneficiaries' tax rates are likely to be.

The principal benefits of the conversion are:

1. If you have other money with which to pay the tax on the conversion, you're effectively making a substantial additional contribution to your IRA.

2. No required distributions after age 70 1/2.

3. If you're in a state with a state estate tax, you avoid the double tax problem with respect to the state estate tax. The problem is that recipient of a traditional IRA gets an income tax deduction for the Federal estate tax, but not for the state estate tax. If you convert, there's no double tax at all, since the entire income tax is out of your estate.

4. Unless the amount involved is too small to warrant administering trusts, our clients almost always provide for their children (in their Wills) in separate trusts for their benefit rather than outright. That keeps the inheritance out of the children's estates, and protects it against the children's creditors and spouses. In the case of a traditional IRA, the trustees have to choose between accumulating the money in the trust and paying income tax at high rates, or distributing the money and giving up the protections of the trust. In the case of a Roth IRA, that tradeoff is eliminated.
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Re: Conversion to Roth In Retirement @ 25%

Postby Sidney » Fri Aug 30, 2013 12:39 pm

bsteiner,

Excellent points, thanks.
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Re: Conversion to Roth In Retirement @ 25%

Postby The Wizard » Fri Aug 30, 2013 12:57 pm

Ged wrote:So is there any particular reason why I shouldn't go up to the 25% income max for converting my tIRAs to Roths? Does this sound like a reasonable strategy? Or are there disadvantages I am missing?

I'm in a similar boat, 25% federal bracket at age 63 and I'll never be lower, assuming brackets stay as they are.
So the logic goes as follows: either move money from tIRA to Roth IRA now and pay 25% fed tax on it...
Or wait till age 70 and take (larger) RMDs and pay 25% fed tax on that.
Except that RMDs can only be reinvested in taxable.
Once you realize you're up against the wall like this, the decision is easier...
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Re: Conversion to Roth In Retirement @ 25%

Postby Ged » Fri Aug 30, 2013 1:01 pm

Some good points, thanks. The Medicare MAGI limit will have to be considered for sure when I convert.

I haven't decided about trusts yet. I have two children, it is likely the estate would be around 2M in current dollars, split equally between them. Is this large enough to bother with trusts about?

I am hoping they will be in the 25% bracket.
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Re: Conversion to Roth In Retirement @ 25%

Postby BL » Fri Aug 30, 2013 1:17 pm

If you give to charities, withdrawals which count as RMDs can currently be given taxfree, up to $100,000 per year. Unfortunately, Washington can't seem to decide on this until the last minute, so who knows what will transpire in the future. Otherwise it is a bit of a toss-up.
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Re: Conversion to Roth In Retirement @ 25%

Postby bsteiner » Fri Aug 30, 2013 3:34 pm

Ged wrote:...I haven't decided about trusts yet. I have two children, it is likely the estate would be around 2M in current dollars, split equally between them. Is this large enough to bother with trusts about?

I am hoping they will be in the 25% bracket.


If I were preparing your Will, I would very strongly recommend that you provide for your children in separate trusts for their benefit rather than outright.

The risk that one child (i) does well and has a taxable estate, (ii) gets divorced, (iii) outlives his/her spouse and remarries, (iv) has a creditor problem, or (v) goes into a nursing home and wants Medicaid outweighs the costs of administering the trusts (including the additional income taxes), particularly since each child's share will be about $1 million. If that turns out not to be the case, the trustees can always terminate the trusts. However, once the children inherit outright, it's too late to set up the trusts.

Money in a trust is like toothpaste in a tube. You can take it out, but once you do, you can't put it back in. When you buy a tube of toothpaste, you don't squeeze out all the toothpaste at once. Instead, you take it out as you need it. Until you need it, you leave it in the tube.

Each child can effectively control his/her trust. The child can be a trustee, can have the power to remove and replace his/her co-trustee (provided the replacement is not a close relative or subordinate employee), and can have the power to give or leave the trust assets to anyone he/she wants (except the child or his/her estate or creditors). (Eric has suggested a slight variation of this structure, which would work equally well in keeping the trusts out of the children's estaets for estate tax purposes.)
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Re: Conversion to Roth In Retirement @ 25%

Postby The Wizard » Fri Aug 30, 2013 3:46 pm

bsteiner wrote:...Money in a trust is like toothpaste in a tube. You can take it out, but once you do, you can't put it back in. When you buy a tube of toothpaste, you don't squeeze out all the toothpaste at once. Instead, you take it out as you need it. Until you need it, you leave it in the tube.

I always smile when lawyers talk like this. Mine tends to do this also...
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Re: Conversion to Roth In Retirement @ 25%

Postby SGM » Fri Aug 30, 2013 4:50 pm

I am now 80% Roth 20% tIRA. I don't see my income tax going down. The gifting aspect and possibly the need for medical care later on in life with large deductions, argue for leaving something in the tIRA.

I am in the process of setting up trusts for my children. I do worry about the tax implications. Presently, I will be a trustee for my children's trusts. Our attorney thinks we should set up trusts for ourselves. I cannot see letting anyone being the trustee now except us grown ups. I have had some experience with banks acting as trustees for a deceased person's trust. Not a happy experience. Banks changed and the new one seems to be quite expensive.

From the above posts it appears that trust earnings must be taken out of the trust to avoid higher taxes. I will have to study this before committing.
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Re: Conversion to Roth In Retirement @ 25%

Postby Bill M » Fri Aug 30, 2013 6:10 pm

I'm in a similar situation to OP, and plan to use those low-income years before age 70 to do significant Roth conversions (up to the top of the tax bracket I'll be in once I turn 70). Retiree medical benefits from MegaCo cap the medical expenses, so I'm not likely to get a huge deduction from that route. I can't conceive of a reasonable situation where the Roth conversion would be a bad move.

I only have one hesitation, though.... A few years ago I got a terrific piece of advice from a financial planner, "Don't do anything with everything." It sort of sums up the world of investing in just five words. And I worry that I'm about to ignore this excellent advice by converting my tIRA completely to Roth.
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Re: Conversion to Roth In Retirement @ 25%

Postby manwithnoname » Fri Aug 30, 2013 6:21 pm

I always find it amusing to read posts by investors who think that the funds which will be inherited by their children should be placed into a trust so that it will not be squandered or given away to ex spouses even though they inherited funds outright from their parents who trusted them. And of course the lawyers are there to feed off this insecurity by offering complex products like trusts which will cost thousands of $ in legal fees plus a couple of % asset value each year plus additional fees to interpret and understand, all to protect the heirs from themselves.

It is really idiotic to ask a poster what his heirs tax rates will be since no one can know the answer now. If your income is going to be 60% or less than your income at the time you retire you retire you will be in a lower tax bracket. Best time to do a Roth Conversion is right after you stop working and before you start taking pensions, SS and MRDs. Of course this assumes that todays tax rates will be in effect at retirement.
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Re: Conversion to Roth In Retirement @ 25%

Postby abuss368 » Fri Aug 30, 2013 9:21 pm

I think many folks make this a difficult decision. You will find many responses that favor the Roth and many that favor Traditional (or a combination of the two). The fact is the tax rates are in a constant flux and can not be predicted.

We started to convert all of our accounts to Roth and are thankful we made that decision. The flexibility of the Roth is to overwhelming for us to turn down.

Another motivation is any distributions from Roth IRA's are not counted in the calculation to determine how much Social Security is taxable each year!

Once the IRA's are converted, we plan to convert my 401K to a Roth 401K.
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Re: Conversion to Roth In Retirement @ 25%

Postby Ged » Fri Aug 30, 2013 10:54 pm

abuss368 wrote:Another motivation is any distributions from Roth IRA's are not counted in the calculation to determine how much Social Security is tax each year!


That's a good one.

I am leaning towards keeping a bit for possible payment of LTC expenses. Otherwise it's getting all converted.
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Re: Conversion to Roth In Retirement @ 25%

Postby Watty » Fri Aug 30, 2013 11:43 pm

Or are there disadvantages I am missing?


If you are single now then if you get married someday then you might be in a lower tax bracket when you start filing a joint return.

There is only a 50/50 chance that you will live longer than average for someone your age. If you convert in the 25% tax bracket then you need to look at what tax bracket your heirs will likely be in. If they will likely be in lower tax brackets than 25% then that would favor keeping more only in the IRA.
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Re: Conversion to Roth In Retirement @ 25%

Postby ObliviousInvestor » Sat Aug 31, 2013 7:29 am

livesoft wrote:I think one should do a TurboTax run.

Strongly agree.

The key question isn't how your current tax bracket compares to your future tax bracket but rather how the marginal tax rate you would pay on the conversion compares to the marginal tax rate you (or your heir) would pay on distributions. Due to things like phaseouts of various tax breaks and the way Social Security benefits are taxed, your marginal tax rate is often different from your tax bracket.
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Re: Conversion to Roth In Retirement @ 25%

Postby manwithnoname » Sat Aug 31, 2013 11:54 am

ObliviousInvestor wrote:
livesoft wrote:I think one should do a TurboTax run.

Strongly agree.

The key question isn't how your current tax bracket compares to your future tax bracket but rather how the marginal tax rate you would pay on the conversion compares to the marginal tax rate you (or your heir) would pay on distributions. Due to things like phaseouts of various tax breaks and the way Social Security benefits are taxed, your marginal tax rate is often different from your tax bracket.


In retirement marginal tax rates are meaningless because most income will be from periodic payments such as retirement plans, MRDs, dividends, interest and SS where the first payments and last payments are paid periodically throughout the year or, in the case of MRDs for an entire year even if only one payments is received. Effective tax rate averages the payments over 12 months and provides a more accurate reading of how much income is taxed. My marginal rate is 25% but my effective rate is 6%.
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Re: Conversion to Roth In Retirement @ 25%

Postby Sidney » Sat Aug 31, 2013 12:20 pm

So, if your income increases by $100, your tax bill will only increase by $6?
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Re: Conversion to Roth In Retirement @ 25%

Postby Ged » Sat Aug 31, 2013 1:29 pm

ObliviousInvestor wrote:Due to things like phaseouts of various tax breaks and the way Social Security benefits are taxed, your marginal tax rate is often different from your tax bracket.


I am not aware of any phaseouts of tax breaks that apply in the 25% bracket except SS. Anyone know different?

As far as SS benefit taxation, I'm deferring my SS while most of the conversions are happening so that shouldn't be an issue. After conversion all I'll have as income is a much smaller RMD and some pension income so hopefully taxation of SS will be lots lower than if I hadn't converted.

The idea of running TurboTax simulations is a good one that I'll certainly do.

The issue of tax brackets of my heirs is a difficult one to predict. I'm reluctant to try to drive current decisions from speculation on a 20-30 year plus future circumstance.
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Re: Conversion to Roth In Retirement @ 25%

Postby MnD » Sat Aug 31, 2013 2:46 pm

I'm in the middle of the 28% now and will be in the middle of the 25% bracket immediately upon retirement.
I don't plan to do any conversions from traditional to Roth, although I would if I had any space in the 15% bracket (which i will not).
SS will be taxable for us every year - conversions would not affect that.

I'm a believer that unless you know with some confidence that you'll be in a higher tax bracket later, that it's best to defer paying taxes for as long as possible.
I've read this thread carefully and I don't find any of the arguments for conversion to be compelling in our situation.
Lots of people tax loss harvest but I don't know many folks that tax gain harvest.
Seems like conversions, unless you have space in a lower tax bracket now versus the future, is tax gain harvesting.
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Re: Conversion to Roth In Retirement @ 25%

Postby ObliviousInvestor » Sat Aug 31, 2013 2:52 pm

manwithnoname wrote:
ObliviousInvestor wrote:
livesoft wrote:I think one should do a TurboTax run.

Strongly agree.

The key question isn't how your current tax bracket compares to your future tax bracket but rather how the marginal tax rate you would pay on the conversion compares to the marginal tax rate you (or your heir) would pay on distributions. Due to things like phaseouts of various tax breaks and the way Social Security benefits are taxed, your marginal tax rate is often different from your tax bracket.


In retirement marginal tax rates are meaningless because most income will be from periodic payments such as retirement plans, MRDs, dividends, interest and SS where the first payments and last payments are paid periodically throughout the year or, in the case of MRDs for an entire year even if only one payments is received. Effective tax rate averages the payments over 12 months and provides a more accurate reading of how much income is taxed. My marginal rate is 25% but my effective rate is 6%.

For budgeting purposes, effective tax rate is important. But I really don't see how you can make the case that marginal tax rate is meaningless. It's very helpful information for a whole list of planning related decisions. (Though, yes, there are multiple marginal tax rates to be concerned with -- one for LTCGs, one for tax-deferred distributions, etc.)
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Re: Conversion to Roth In Retirement @ 25%

Postby Sidney » Sat Aug 31, 2013 2:53 pm

The ability to increase the part of the tax deferred space that belongs to me is compelling. My RMD will come out at least at 33% tax rate. Another way to state this is that the IRS owns 1/3 of my IRA. If I convert, even at the same rate (I would probably stop at 25/28, but for the sake of argument, assume constant), I have essentially bought out the IRS' share and can keep that share in tax advantaged status.
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Re: Conversion to Roth In Retirement @ 25%

Postby BigFoot48 » Sat Aug 31, 2013 3:42 pm

MnD wrote:I'm a believer that unless you know with some confidence that you'll be in a higher tax bracket later, that it's best to defer paying taxes for as long as possible.

I like deferring taxes too! I test my personal data against my model every year and it shows a disadvantage to doing conversions, although starting SS benefits at 62 helped create that disadvantage. The sooner people can evaluate the conversion consequences the better, as it may also help with the SS benefit starting date decision.
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Re: Conversion to Roth In Retirement @ 25%

Postby MnD » Sat Aug 31, 2013 4:26 pm

Sidney wrote: If I convert, even at the same rate (I would probably stop at 25/28, but for the sake of argument, assume constant), I have essentially bought out the IRS' share and can keep that share in tax advantaged status.


But you can only keep that share if you have a big pile of money elsewhere, and used that big pile of money to pay the tax liability that you accelerated by conversion.
It fun to think about "oh look, I turned my big IRA into a big same size Roth IRA", but what were you doing or planning to do with the very available and flexible cash pile you used to pay the 30-33% tax on the conversion? That big other pile of money is now gone. 33% (28+5) would be my hit now to convert anything and 30% (25+5) in early retirement, assuming I kept the conversions limited to my now and future marginal rate. I just can't seem to find a compelling dollars and sense case to do that. I do see some psychological gains in the "I am now more the total commander of my money pile", but I'm confident I've got enough dials to turn that I'll have enough flexibility in retirement.

I'd love to see an example using numbers that describes how people in 28/25 working/retired marginal rate make more money by converting.
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Re: Conversion to Roth In Retirement @ 25%

Postby frugaltype » Sat Aug 31, 2013 4:48 pm

Keep in mind that whatever you do once you're receiving Social Security, that will be hit big time by having a higher taxable income. I did some dry runs for converting various amounts, and the loss from more of Social Security being taxable was significant.

Also,look at state taxes as well. My state really socks it to people with taxes as income increases.
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Re: Conversion to Roth In Retirement @ 25%

Postby Sidney » Sat Aug 31, 2013 4:48 pm

Yes, you need the cash to pay the tax.

I think at 25% (ie, converting through the 25% bracket) vs. a 33% bracket at RMD time, it makes sense. Have to run the full scenario through the tax software but that is an 8% spread + the earnings all go to you after conversion.

The brackets aren't that large so it isn't a huge amount of money either way. I don't think it makes or breaks anybody's plans.

It is really more of an opportunity for early retirees who find themselves in low brackets between retirement and SS/RMD. Over enough years I suppose it could add up.
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Re: Conversion to Roth In Retirement @ 25%

Postby grabiner » Sat Aug 31, 2013 5:42 pm

manwithnoname wrote:In retirement marginal tax rates are meaningless because most income will be from periodic payments such as retirement plans, MRDs, dividends, interest and SS where the first payments and last payments are paid periodically throughout the year or, in the case of MRDs for an entire year even if only one payments is received. Effective tax rate averages the payments over 12 months and provides a more accurate reading of how much income is taxed. My marginal rate is 25% but my effective rate is 6%.


The marginal rate is still important when you consider a potential change to your income, such as converting a traditional IRA to a Roth. If your marginal tax rate is 25%, it will cost you $2500 in tax to convert $10,000 of a traditional IRA to a Roth, so if you pay that tax out of the IRA, you can only convert $7500. And if the account doubles in value before you withdraw the money, then by converting, you will get an extra $15,000 of tax-free income, rather than $20,000 of taxable income; if you are still at a 25% marginal tax rate, this is break-even. Note that your effective tax rate doesn't matter here.

The effective tax rate is useful in budgeting; if you have a 6% effective tax rate, you can get $47,000 of after-tax income by withdrawing $50,000 from your IRA.
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Re: Conversion to Roth In Retirement @ 25%

Postby bsteiner » Sat Aug 31, 2013 9:04 pm

SGM wrote:...I am in the process of setting up trusts for my children. I do worry about the tax implications. Presently, I will be a trustee for my children's trusts. Our attorney thinks we should set up trusts for ourselves. I cannot see letting anyone being the trustee now except us grown ups. I have had some experience with banks acting as trustees for a deceased person's trust. Not a happy experience. Banks changed and the new one seems to be quite expensive.

From the above posts it appears that trust earnings must be taken out of the trust to avoid higher taxes. I will have to study this before committing.


If you create a trust for a child, and you're the trustee, the trust will be included in your estate for estate tax purposes. However, you could create a trust for a child and name your spouse as trustee, or vice versa (but not both ways).

If you create a trust for a child, most likely it will be a grantor trust for income tax purposes during your lifetime. In other words, you will be taxable on the trust's income and gains. This is a good thing -- by paying the income tax on the trust's income and gains, you're effectively shifting additional wealth out of your estate without any estate or gift tax consequences.

After your death, the child's trust pays its own taxes. There's a tradeoff between the estate tax and asset protection benefits of accumulating the income in the trust versus the income tax benefits of distributing the income. However, given your net worth, your children might be in relatively high income tax brackets. Also, the trust might not be in the top tax bracket. A trust reaches the 39.6% bracket (20% on capital gains) at $11,950, while an individual doesn't until $400,000 (single) or $450,000 (joint). A trust is subject to the 3.8% Medicare tax at $11,950, while an individual isn't until $200,000 (single) or $250,000 (joint). However, even if a trust has $1 million of assets, invested 60% in stocks paying 2% and 40% in tax-exempt bonds, it will only have $12,000 of income, or $11,900 after the $100 exemption.

Why would you create a trust for yourself? While there are situations where that might make sense, in most cases it won't accomplish anything.

Occasionally someone will name a bank or trust company as a trustee. While most clients name family members, or other individuals, occasionally it makes sense to name a bank or trust company, notwithstanding the cost (about 1% per year, a bit more on smaller trusts and less on larger trusts).

manwithnoname wrote:I always find it amusing to read posts by investors who think that the funds which will be inherited by their children should be placed into a trust so that it will not be squandered or given away to ex spouses even though they inherited funds outright from their parents who trusted them. And of course the lawyers are there to feed off this insecurity by offering complex products like trusts which will cost thousands of $ in legal fees plus a couple of % asset value each year plus additional fees to interpret and understand, all to protect the heirs from themselves.

It is really idiotic to ask a poster what his heirs tax rates will be since no one can know the answer now. If your income is going to be 60% or less than your income at the time you retire you retire you will be in a lower tax bracket. Best time to do a Roth Conversion is right after you stop working and before you start taking pensions, SS and MRDs. Of course this assumes that todays tax rates will be in effect at retirement.


Almost all of our clients provide (in their Wills) for their children in separate trusts for their benefit rather than outright. If the children are otherwise capable, each child will control his/her trust. The purpose isn't to prevent the child from squandering the money or giving it to his/her spouse. Indeed, the child will usually have the power to give or leave the trust assets to his/her spouse. After all, suppose the child is happily married for a long time and is supporting his/her spouse. Rather, the purpose is to keep the inheritance out of the child's estate, and to protect it from potential creditors, including spouses. In other words, with the trust, the child can give the money to his/her spouse, but the spouse can't take it in a divorce, or if the child outlives his/her spouse and remarries and then dies.

The cost of preparing a Will containing trusts for the children is only slightly more than the cost of preparing a Will in which the children take outright. After death, it shouldn't cost a couple of percent a year to administer the trust. Members of this group know how to invest at a low cost. The trust can be sufficiently flexible so that the trustees have discretion to distribute the income and principal, or to accumulate the income, so that they can distribute whatever amounts are appropriate from time to time. The trustees will have to file an annual income tax return for the trust, but these returns usually aren't very complicated.

You are correct that for many people, the time between retirement and the commencement of required distributions is a good window for Roth conversions (making sure to leave behind enough money in the traditional IRA to take advantage of the 15% bracket afterwards). Clients of modest means often convert up to the top of the 15% bracket. Clients who have enough other income and assets that they'll always be in the top bracket often converted their entire IRA before this year to take advantage of the 35% top bracket.

In considering a possible Roth conversion, it's not idiotic to make some assumption as to the income tax rates that would otherwise apply when the IRA owner or his/her beneficiaries would otherwise receive distributions. You have to make some assumption as to the income tax rates that would otherwise apply to the distributions. If the history of the tax law is any guide, the tax law will change many times between now and when your beneficiaries take their last required distribution. Since I think the tax law is relatively stable at the moment (though it could change at any time), I do my projections based on the law as it is now. However, you're free to make whatever assumptions you want.

MnD wrote:I'm in the middle of the 28% now and will be in the middle of the 25% bracket immediately upon retirement.
I don't plan to do any conversions from traditional to Roth....

I'm a believer that unless you know with some confidence that you'll be in a higher tax bracket later, that it's best to defer paying taxes for as long as possible.
...
Seems like conversions, unless you have space in a lower tax bracket now versus the future, is tax gain harvesting.


If you don't expect to drop below the 25% bracket, and you have other money with which to pay the tax on the conversion, you may want to reconsider whether it makes sense to convert at least to the top of the 28% bracket each year.

It's not the same as tax gain harvesting. The best way to look at your traditional IRA is that it's part yours and part the government's. Assuming a constant 28% tax rate (ignoring the possible drop to 25%), if you have a $100,000 traditional IRA, it's $72,000 yours and $28,000 the government's. In other words, if you withdrew the money now, you'd only get to keep $72,000. If it doubles to $200,000, and you withdraw the money, you get to keep $144,000 (or $150,000 if you withdraw it when you're in the 25% bracket). Suppose you have another $28,000 cash. If you convert, you have a $100,000 Roth IRA. If it doubles to $200,000, it's all yours. If you don't convert, you'll still have your $28,000 taxable account. However, it will have grown to something less than $56,000, since the income and gains on it will be taxable each year. If it grows to more than $50,000, you might be better off not converting, ignoring the other benefits of the conversion. The other benefits of the conversion include no required distributions after age 70 1/2, no double tax problem (the recipient of a traditional IRA gets an income tax deduction for the Federal estate tax, but not the state estate tax), and if you leave your IRA to your children or grandchildren in trust rather than outright, you don't have to worry about the IRA distributions being taxable at the trust's tax rates).
Last edited by bsteiner on Mon Sep 02, 2013 10:58 am, edited 1 time in total.
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Re: Conversion to Roth In Retirement @ 25%

Postby Ozonewanderer » Sat Aug 31, 2013 11:22 pm

ObliviousInvestor wrote:
livesoft wrote:I think one should do a TurboTax run.

Strongly agree.

When you all say "do a Turbo Tax run" are you recommending that one should purchase the Turbo Tax software or is there a free service that would suffice? thanks.
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Re: Conversion to Roth In Retirement @ 25%

Postby The Wizard » Sat Aug 31, 2013 11:26 pm

Ozonewanderer wrote:
ObliviousInvestor wrote:
livesoft wrote:I think one should do a TurboTax run.

Strongly agree.

When you all say "do a Turbo Tax run" are you recommending that one should purchase the Turbo Tax software or is there a free service that would suffice? thanks.

Free should suffice since you can do it all online for free except hit the final button to transmit it electronically...
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Re: Conversion to Roth In Retirement @ 25%

Postby 2beachcombers » Sun Sep 01, 2013 9:58 am

I decided to keep a portion of my IRA so the RMD amounts could be used for medical tax deductions in the future. Tax = 0 :D

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Re: Conversion to Roth In Retirement @ 25%

Postby kaneohe » Sun Sep 01, 2013 10:24 am

2beachcombers wrote:I decided to keep a portion of my IRA so the RMD amounts could be used for medical tax deductions in the future. Tax = 0 :D

jerry


not sure I understand how this works.......could you elaborate? Thanks.
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Re: Conversion to Roth In Retirement @ 25%

Postby livesoft » Sun Sep 01, 2013 10:30 am

Ozonewanderer wrote:
ObliviousInvestor wrote:
livesoft wrote:I think one should do a TurboTax run.

Strongly agree.

When you all say "do a Turbo Tax run" are you recommending that one should purchase the Turbo Tax software or is there a free service that would suffice? thanks.

Yes, I am recommending you purchase the TurboTax software. I haven't filed yet for 2012, but will do so in the next few weeks.

By having a copy to run whenever I feel like it, I can plan my taxes exquisitely. I can keep several scenarios or "what if" files on my computer to test hypotheses about Roth conversions, deductions, when to withdraw from 529 versus pay college out of checking, etc. This may be more than what most folks do, but I want to pay zero taxes in retirement.
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Conversion to Roth In Retirement @ 25%

Postby Prokofiev » Sun Sep 01, 2013 10:32 am

kaneohe wrote:
2beachcombers wrote:I decided to keep a portion of my IRA so the RMD amounts could be used for medical tax deductions in the future. Tax = 0 :D

jerry


not sure I understand how this works.......could you elaborate? Thanks.



Well, in my case I was going to convert my parents $250k IRA to a Roth over several years at 25% +10% state. I calculated they would always be in the 25% bracket, so why not?

Lucky I never did it. My father died and my mother entered a nursing home. Over the next 3+ years I was able to convert almost 100% at 0 taxes since she now had $35k income each year and over $100k in deductible expenses.
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Re: Conversion to Roth In Retirement @ 25%

Postby zzcooper123 » Sun Sep 01, 2013 11:44 am

livesoft. What version of TurboTax do you use? Does the Vanguard site offer this?
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Re: Conversion to Roth In Retirement @ 25%

Postby BL » Sun Sep 01, 2013 11:57 am

http://www.amazon.com has a 2012 Basic TurboTax for $4.19 and Deluxe for $16.01. They also have other brands.
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Re: Conversion to Roth In Retirement @ 25%

Postby 2beachcombers » Sun Sep 01, 2013 12:19 pm

kaneohe wrote:
2beachcombers wrote:I decided to keep a portion of my IRA so the RMD amounts could be used for medical tax deductions in the future. Tax = 0 :D

jerry




Here is a good example from Prokofiev

jerry



Well, in my case I was going to convert my parents $250k IRA to a Roth over several years at 25% +10% state. I calculated they would always be in the 25% bracket, so why not?

Lucky I never did it. My father died and my mother entered a nursing home. Over the next 3+ years I was able to convert almost 100% at 0 taxes since she now had $35k income each year and over $100k in deductible expenses.
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Re: Conversion to Roth In Retirement @ 25%

Postby kaneohe » Sun Sep 01, 2013 2:17 pm

2b......thanks for that example. Makes more sense now........more like having high medical expenses making for a low (or negative) AGI/taxable income allowing the conversion at 0%.......nothing necessarily related to RMDs....that's where I got confused. Thanks for clarifying.
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Re: Conversion to Roth In Retirement @ 25%

Postby Prokofiev » Sun Sep 01, 2013 4:08 pm

Despite all that has been written here about getting IRA money out at 0-15%, one has to think about exactly how this could happen in your particular case.
Where exactly will the deductions come from? How will future taxable income be reduced?

In my example, the deductions were for nursing home, dental, medical transport and a small amount of medical cost/deductibles. No LTC policy or dental insurance.
She did have Medicare + excellent Medigap policy, so uncovered medical costs were very minor. The nursing home cost of $85k-$95k /yr was the determining factor. Also the death of my father reduced her income substantially. SS, his pension income and a disability payment all were reduced or eliminated upon his death.

But what if you have a good LTC policy? That changes the calculus substantially. People talk about mortgage deductions, children's educational expenses and charitable giving. But I would think that for most Bogleheads, mortgages and child expenses are a thing of the past by retirement. And I never make tax decisions based upon the option of giving my money away. I would just as soon pay the government my charitable giving. They need it more.

Remember that once you convert and pay the tax, you can never get that money back. You are essentially pre-paying taxes today that you may or may not need to pay in the future. That extra tax payment might come in handy should you incur some extraordinary medical expense and/or market loss. In my Mom's case we would have wasted about $85k. I would always be on the conservative side and up to this year I have only converted to the top of the 15% bracket. Starting in 2013, I will now convert to the top of the 25% bracket. I can no longer foresee any combination of sickness, nursing home, market melt-down or loss that would ever get me below the 25-28% bracket during RMDs. But that's because I have a very large IRA.

But beware the "one size fits all" advice. You need to consider your personal situation, insurance policies, size of your estate, yearly taxable income and size of your IRA.
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Re: Conversion to Roth In Retirement @ 25%

Postby gerntz » Sun Sep 01, 2013 7:40 pm

If you're in the 15% income tax bracket & have LTCG available, why wouldn't you take the cap gains at 0% tax till you reach the 25% income bracket - where LTCG rate becomes 15% - over withdrawing from an IRA at 15% income tax? 0% seems better than 15% to me.
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Re: Conversion to Roth In Retirement @ 25%

Postby Garco » Sun Sep 01, 2013 9:03 pm

bsteiner wrote:If the distributions would otherwise be taxable at 25%, then the conversion, to the extent you can convert at 25% or 28%, is likely to be beneficial. You didn't say what your beneficiaries' tax rates are likely to be.

The principal benefits of the conversion are:

1. If you have other money with which to pay the tax on the conversion, you're effectively making a substantial additional contribution to your IRA.

2. No required distributions after age 70 1/2.

3. If you're in a state with a state estate tax, you avoid the double tax problem with respect to the state estate tax. The problem is that recipient of a traditional IRA gets an income tax deduction for the Federal estate tax, but not for the state estate tax. If you convert, there's no double tax at all, since the entire income tax is out of your estate.

4. Unless the amount involved is too small to warrant administering trusts, our clients almost always provide for their children (in their Wills) in separate trusts for their benefit rather than outright. That keeps the inheritance out of the children's estates, and protects it against the children's creditors and spouses. In the case of a traditional IRA, the trustees have to choose between accumulating the money in the trust and paying income tax at high rates, or distributing the money and giving up the protections of the trust. In the case of a Roth IRA, that tradeoff is eliminated.

Thank you, lawyer Steiner, especially for point #1. I'm in the penultimate year of employment (and on cusp of 25% and 28% brackets) and hope to convert part of a supplemental 401k to a Roth IRA to keep that money out of the RMD process. Eventually this money will go to the kids in equal proportion, but at this time one of them makes 10x the income of the other (who, however, makes a 6 figure income). For either of them, receiving money from my Roth will be advantageous, however.
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Re: Conversion to Roth In Retirement @ 25%

Postby Prokofiev » Mon Sep 02, 2013 1:15 am

gerntz wrote:If you're in the 15% income tax bracket & have LTCG available, why wouldn't you take the cap gains at 0% tax till you reach the 25% income bracket - where LTCG rate becomes 15% - over withdrawing from an IRA at 15% income tax? 0% seems better than 15% to me.



That is an interesting question that made me think.

In my case, the answer is easy. I had almost no LTCG's in my taxable account to harvest. I also had no LTC loss carry-forwards. But I should have decent cap gains in the next several years (I hope), so this idea interests me.

And although many taxable investor Bogleheads DO have LTCG's, most also have LT loss carry-forwards from loss harvesting during the downturns in 2001-2003 and 2007-2009. And in some cases huge amounts. My understanding is any LTCG amounts reported MUST be offset with loss carry-forwards first. So a single tax-payer could take up to $46k in harvested LTCG and pay $0 tax. But it would still use-up $46k in carry-forwards if you have any, which sort of defeats the purpose. Am I right on that?

But suppose you had a sizable TIRA, NO income, huge LTCGs in your taxable account and NO loss carry-forwards. Would it then make sense just to forgo any Roth conversion and harvest $46k in cap gains at $0? I'm not so sure of that either, assuming future RMD rates of 25% or above.

I'll assume the taxpayer is single and use those brackets. The first $10k of income (standard deduction) is a 0% bracket. So the first $10k of either LTCG or Roth conversion income would be untaxed. The cap gains saves you 15% in future taxes, but the Roth conversion saves you 25%, 28% or maybe 33% - so that's a no-brainer. The next $8900 is taxed at 10%, so the Roth conversion will be at least as good as 0% LTCG (saving 15%,18% or 23%). However, the next $27,000 will be taxed at 15% - saving you 10%,13% or 18%. So maybe you could gain something if future RMDs are taxed at a 25 or 28% rate. But if you harvest more than $27,000 in LTCG, you will then pay 15% of each additional dollar harvested, saving you nothing more. You can't convert up to the top of the 15% bracket (46k) and still claim 0% on LTCG beyond that. You will pay the full 15%. SO maybe, there is some slight saving by Roth converting $19k and taking $27k in LTCGs, provided you have no loss carry-forwards. But I'm still not certain - and at $19k/yr I would make no real headway in lowering future RMDs. Also cap gains can be taken whenever a taxpayer likes and perhaps never if inherited, but RMDs have no such flexibility. You must pay them starting at 70 and your heirs will pay them on anything left. However, if you assume a future RMD rate of 15%, it might make sense to CG harvest instead of converting up to the top of the 15% bracket.

Maybe I am missing something here. I'm not much of a tax expert and this kind of analysis makes my head hurt. Thoughts??
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Re: Conversion to Roth In Retirement @ 25%

Postby Hexdump » Mon Sep 02, 2013 9:25 am

The Wizard wrote:
Except that RMDs can only be reinvested in taxable.
Once you realize you're up against the wall like this, the decision is easier...


Wiz, I am not sure I follow this.

I was thinking that I could take my RMD and invest it into my wife's IRA.
Are you saying this would not be permitted ?
I thought these monies were fungible.

thanks
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Re: Conversion to Roth In Retirement @ 25%

Postby Prokofiev » Mon Sep 02, 2013 10:31 am

Hexdump wrote:
The Wizard wrote:
Except that RMDs can only be reinvested in taxable.
Once you realize you're up against the wall like this, the decision is easier...


Wiz, I am not sure I follow this.

I was thinking that I could take my RMD and invest it into my wife's IRA.
Are you saying this would not be permitted ?
I thought these monies were fungible.

thanks


Once you take your RMD it is taxable money and you can spend it how you like. But you must pay the tax. You cannot transfer it directly to another deferred account. And I believe you can only invest it in your wife's IRA, if she has earned income and is eligible for an IRA or Roth.
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Re: Conversion to Roth In Retirement @ 25%

Postby House Blend » Mon Sep 02, 2013 10:32 am

Hexdump wrote:I was thinking that I could take my RMD and invest it into my wife's IRA.

If you are MFJ, and one of you has earned income, and your wife is not of RMD age, then you can make contributions to your wife's IRA (but not more than the amount of earned income).

If you are both of RMD age, that's a no-no.
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Re: Conversion to Roth In Retirement @ 25%

Postby House Blend » Mon Sep 02, 2013 11:29 am

Prokofiev wrote:
gerntz wrote:If you're in the 15% income tax bracket & have LTCG available, why wouldn't you take the cap gains at 0% tax till you reach the 25% income bracket - where LTCG rate becomes 15% - over withdrawing from an IRA at 15% income tax? 0% seems better than 15% to me.

That is an interesting question that made me think.

Thoughts??

I agree that this is tricky, and is going to depend on many variables and assumptions.

But suppose you are a 15percenter with a large taxable account in early retirement (no SS income, no RMDs) and expecting to be a 25percenter in later retirement after SS and RMDs kick in.

I would say that if you are typical Boglehead, you are planning on a 99% probability of not running out of money. So with high probability, you will have a large amount of money left over. That money will be going to heirs and charities.

So before you contemplate harvesting gains in this scenario, think about the odds that those gains were ever going to be taxed in the first place.
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Re: Conversion to Roth In Retirement @ 25%

Postby kaneohe » Mon Sep 02, 2013 12:00 pm

House Blend wrote:I would say that if you are typical Boglehead, you are planning on a 99% probability of not running out of money. So with high probability, you will have a large amount of money left over. That money will be going to heirs and charities.

So before you contemplate harvesting gains in this scenario, think about the odds that those gains were ever going to be taxed in the first place.


and some folks who know that charities will be involved don't Roth convert for the same reason
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