Conversion to Roth In Retirement @ 25%

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
User avatar
Ozonewanderer
Posts: 691
Joined: Mon Apr 12, 2010 12:27 am
Location: Southwest FL

Re: Conversion to Roth In Retirement @ 25%

Post by Ozonewanderer »

BL wrote:http://www.amazon.com has a 2012 Basic TurboTax for $4.19 and Deluxe for $16.01. They also have other brands.
Thanks for this tip! I got the Premier version for $23.15 including shipping and tax. I thought I needed the premier to cover buying/selling of stocks and mutual funds.
User avatar
Ozonewanderer
Posts: 691
Joined: Mon Apr 12, 2010 12:27 am
Location: Southwest FL

Re: Conversion to Roth In Retirement @ 25%

Post by Ozonewanderer »

bsteiner wrote:
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).
Blsteiner,
Thank you for taking the time to share these insights.

Do I understand you correctly that you believe it may still be advantageous to pass on my estate to my children through a trust (that they can manage as trustees) even if I do not exceed the estate tax limit ($10.5M)? If my children are the trustees of their own trusts, wouldn't the administration costs drop to essentially the additional trust tax filing costs?
jebmke
Posts: 25474
Joined: Thu Apr 05, 2007 2:44 pm
Location: Delmarva Peninsula

Re: Conversion to Roth In Retirement @ 25%

Post by jebmke »

Ozonewanderer wrote:
BL wrote:http://www.amazon.com has a 2012 Basic TurboTax for $4.19 and Deluxe for $16.01. They also have other brands.
Thanks for this tip! I got the Premier version for $23.15 including shipping and tax. I thought I needed the premier to cover buying/selling of stocks and mutual funds.
The basic version of most tax software will cover Schedules D and 8949.

You might also try taxcaster - I don't recall what it covers but it should be free.

Keep in mind that these are using 2012 tax law. Any decisions you make for this year are affected by 2013 tax law. Before you do anything in December, it would pay to get a preliminary release of a 2013 software (by then taxcaster may be switched to 2013 but check) to update your analysis.
Don't trust me, look it up. https://www.irs.gov/forms-instructions-and-publications
The Wizard
Posts: 13356
Joined: Tue Mar 23, 2010 1:45 pm
Location: Reading, MA

Re: Conversion to Roth In Retirement @ 25%

Post by The Wizard »

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
As others said, there must be earned income to contribute to IRAs.
But my thought was, at age 68 or so, I'll have a good idea what my tax situation during early RMDs will be.
So do I just wait and pay 28% fed tax on my entire RMD amount, and then invest the remainder in my taxable account?
Or do I make partial conversions to Roth IRA, paying 25 to 28% fed tax now and never pay taxes on growth of those investments again?
Doing at least some of the latter makes sense...
Attempted new signature...
manwithnoname
Posts: 1584
Joined: Mon Jul 22, 2013 7:52 pm

Re: Conversion to Roth In Retirement @ 25%

Post by manwithnoname »

I have been moving over about 50k of TIRA funds for the each of last 3 years to stay within the 15% marginal bracket at an effective rate of about 6%. My goal is to transfer 50% of my DC funds to a roth IRA by the time MRDs commence so that I will remain in the 15% bracket. Roth IRAs will be passed to heirs as tax free income. They will also get capital assets with stepped up basis since I am only spending the income. I cant think of better estate planning than to give my heirs tax free income and stepped up basis on investments.
User avatar
Topic Author
Ged
Posts: 3945
Joined: Mon May 13, 2013 1:48 pm
Location: Roke

Re: Conversion to Roth In Retirement @ 25%

Post by Ged »

Well, with my investigations into this I've found an interesting optimization.

My wife has part of her tax deferred money in a 457(b). The deal with this is that it is not tax deferred from a NJ point of view. Therefore converting this will not affect my NJ tax liability. So I will be distributing this over the conversion period to lower the NJ state taxes I'll be incurring.
Post Reply