using the 15% tax bracket

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RustyShackleford
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using the 15% tax bracket

Post by RustyShackleford »

For a person like me - retired or semi-retired, and comfortable but not wealthy - the 15% federal tax bracket (and the 10%) is very valuable; that's because it's a low rate (duh), and even lower (i.e. 0%) for long-term capital gains and qualified dividend income (QDI). So it's important to me, in my tax planning, to be certain to fully exploit this "resource".

The way I usually do this is to make two Roth conversions, EACH equal to the amount I'd need to more or less exactly "fill" the 15% bracket (that is, make my taxable income equal to the income at which the marginal rate goes from 15% to 25%). Usually this is $20K or so, in addition to my taxable investment interest and dividends, some small pension income, and perhaps a little earned income (minus whatever I can tax-shelter). Then I recharacterize the poorer performing Roth conversion before filing. I feel that converting TIRA money to Roth at a 15% rate is a no-brainer.

However, another way to exploit the 15% bracket (and the accompanying 0% bracket for LTCG and QDI) is to "harvest" long-term capital gains (as opposed to losses). Then they are taxed at 0%. I'm not inclined to do any more of this than necessary to re-balance my portfolio in these days of equity out-performance. But, with the perennial talk of raising capital-gains taxes, I'm thinking perhaps this is the year to not to any Roth conversions, and instead "fill" the 0% bracket with LTCGs.

So, I guess all this is an (extremely) long-winded way of asking what the consensus is on what's going to happen to LTCG rates, for those in the low tax brackets, in 2015 and thereafter. I've tried googling it, but it's hard to sort out, since there are a variety of predictions (and, naturally, opinions) written at various points in time. Thanks !
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cheese_breath
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Re: using the 15% tax bracket

Post by cheese_breath »

Nobody knows what's going to happen to LTCG, and we're not supposed to speculate.

But one thing you didn't mention is harvesting your LTCG with zero taxes when the markets are up gives you a higher basis which potentially could be advantageous in harvesting losses and reducing taxes if the markets decline.
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Re: using the 15% tax bracket

Post by Peter Foley »

Rusty

I think your basic premise, use the 15% tax bracket to your advantage is sound. How one can best use it will vary based on where assets are held, from where it makes sense to draw funds to live on, and the potential for stepped up basis for heirs.
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Re: using the 15% tax bracket

Post by RustyShackleford »

... what's going to happen to LTCG ... we're not supposed to speculate.
Oh, for heavens' sake ... (As long as we don't bring in politics)
But one thing you didn't mention is harvesting your LTCG with zero taxes when the markets are up gives you a higher basis which potentially could be advantageous in harvesting losses and reducing taxes if the markets decline.
For sure, thanks for pointing that out. I think harvesting LTCGs with zero taxes could be advantageous for a variety of reasons.
I think your basic premise, use the 15% tax bracket to your advantage is sound. How one can best use it will vary based on where assets are held, from where it makes sense to draw funds to live on, and the potential for stepped up basis for heirs.
Sure. I don't think I'm letting the tax tail wag the dog. I just think if I can harvest LTCGs with 0% tax, and there's some consensus that the 0% treatment for folks in the lower brackets is going to disappear, it'd probably argue for doing that now.

Thanks.
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Re: using the 15% tax bracket

Post by earlyout »

Peter Foley wrote:
...and the potential for stepped up basis for heirs.
Don't overlook Peter's point about the stepped up basis. Your heirs can inherit the appreciated stock and pay no tax on all that gain. It might be better to use that 10 and 15% space for Roth conversion.
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wshang
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Re: using the 15% tax bracket

Post by wshang »

Although I've brought up a variation of your Roth conversion strategy on this forum before, no one ever seems to get excited as I do. Take a look at the Callan Periodic Table and you can see that by splitting further and by filing an filing extension, you can easily get 40%+ on one of the converted portions:

http://seekingalpha.com/article/1967961 ... minus-2013

It is possible to do better than the best performing of these categories by adding in gold, a long-dated Treasury fund, etc.
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Re: using the 15% tax bracket

Post by cheese_breath »

RustyShackleford wrote:
I think your basic premise, use the 15% tax bracket to your advantage is sound. How one can best use it will vary based on where assets are held, from where it makes sense to draw funds to live on, and the potential for stepped up basis for heirs.
Sure. I don't think I'm letting the tax tail wag the dog. I just think if I can harvest LTCGs with 0% tax, and there's some consensus that the 0% treatment for folks in the lower brackets is going to disappear, it'd probably argue for doing that now.
Other things to consider that might argue for doing more of it now even if the laws don't change... Consider the possibility of an unforeseen need forcing you to sell a large enough portion of your investments to force you out of the 15% bracket if you haven't raised their basis first by harvesting LTCGs. Also consider possible state tax ramifications. For example relating to myself, in MI LTCGs don't receive special tax treatment, but because my retirement income isn't taxed I have an approximate $6,000 exemption window before I have to pay taxes. If I run into an unforeseen need like above I could incur state tax on some of my LTCGs, but if I harvest about $6,000 per year first I might escape the tax. This might be specific to me, but there may be other cases where it's better to eat the elephant a bite at a time rather than trying it in one big gulp.

edit: I don't mean this to sound like I'm recommending this over Roth conversions. After all Roths guarantee you zero tax on their gains after you've satisfied the holding time criteria. But if you can't do Roths IMO there are some conditions where it may make sense to harvest LTCGs now rather than waiting.
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Re: using the 15% tax bracket

Post by Pocket Cruiser »

wshang wrote:Although I've brought up a variation of your Roth conversion strategy on this forum before, no one ever seems to get excited as I do. Take a look at the Callan Periodic Table and you can see that by splitting further and by filing an filing extension, you can easily get 40%+ on one of the converted portions:

http://seekingalpha.com/article/1967961 ... minus-2013

It is possible to do better than the best performing of these categories by adding in gold, a long-dated Treasury fund, etc.
Would you elaborate on this please?
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Re: using the 15% tax bracket

Post by RustyShackleford »

earlyout wrote:Don't overlook Peter's point about the stepped up basis. Your heirs can inherit the appreciated stock and pay no tax on all that gain. It might be better to use that 10 and 15% space for Roth conversion.
Thanks for reminding me, because I DID miss his point at first. If I understand the idea, if I use tax-gain harvesting to increase my basis, but then those assets get passed on to my heirs, I've essentially wasted that increase in basis, because the basis my heirs see will be the value when I die, regardless of what my basis was at that time. Of course, that's assuming I buy back those assets after I've taken the gain, which I might not do, given that I seem to keep needing to sell equities to keep my AA in balance - and also, perhaps I'll want to decrease my equity allocation somewhat as I get even older. You could argue I'll buy back something, but that might not be true either if I'm using the proceeds for income (I'm in draw-down phase).

And the contrary factors, of increased basis being good if I need to sell a lot or for later tax-loss harvesting, are ones I hadn't thought of either. So thanks, guys.
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Re: using the 15% tax bracket

Post by RustyShackleford »

wshang wrote:Although I've brought up a variation of your Roth conversion strategy on this forum before, no one ever seems to get excited as I do. Take a look at the Callan Periodic Table and you can see that by splitting further and by filing an filing extension, you can easily get 40%+ on one of the converted portions:

http://seekingalpha.com/article/1967961 ... minus-2013

It is possible to do better than the best performing of these categories by adding in gold, a long-dated Treasury fund, etc.
Sorry, but I ain't seeing it either (and the seekingalpha article cannot be read without subscription). No matter how many Roth conversions you do, splitting the asset classes finer and finer, how can you possibly do better than the best-performing asset class ?

Yeah, no one gets excited when I describe my two-class strategy either. Reckon it's too much trouble I guess. I'm starting to think that too, as I invariably keep the equity conversion. Of course, I've only employed the strategy since 2010, and one of these days the equity will under-perform. But (with only a single conversion), I can always choose to use the 15%-bracket headroom for LTCG instead, assuming I know of the underperformance by the end of the conversion year. If it occurs between then and the extended-filing deadline (i.e. Oct 15), then I'm screwed - in the sense that I must choose between "wasting" the 15% bracket or paying higher than 15% effective tax on the depreciated conversion.
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Re: using the 15% tax bracket

Post by Pocket Cruiser »

What two asset classes do you use in your conversion strategy? Total bond market/total stock?
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Re: using the 15% tax bracket

Post by LongerPrimer »

+1 OP.
Ultimately, it is the Big Pee question. :annoyed
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Re: using the 15% tax bracket

Post by bnes »

To emphasize that point:

A traditional IRA gets no "step up" in basis. So to the extent you want to pass money to heirs, stuffing the Roth makes sense. A heir might pay 25% Federal tax on IRA withdrawals, but 0% on Roth withdrawals.

Harvesting in states like California is expensive, as there's no 0% bracket and no LTCG rate.
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Re: using the 15% tax bracket

Post by Bob's not my name »

cheese_breath wrote:Also consider possible state tax ramifications.
Yes. If you're in the 15% federal bracket your state tax burden can easily be more than a third of your marginal rate on conversions and 100% of your marginal rate on LTCG. State tax treatment of LTCG and IRA conversions varies, with most (but not all) states with state income tax favoring the latter over the former. Many states like Michigan have age-based taxation of IRA conversions, so the right choice in one year may be the wrong choice in another.
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Re: using the 15% tax bracket

Post by wshang »

Pocket Cruiser wrote:
wshang wrote:Although I've brought up a variation of your Roth conversion strategy on this forum before, no one ever seems to get excited .
Would you elaborate on this please?
http://www.bogleheads.org/forum/viewtop ... ilit=+roth
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Re: using the 15% tax bracket

Post by gerrym51 »

Our goal is to never pay more than the 15 percent bracket. We are removing some money now from retirement accounts to use up gap of no taxes and get into 15 percent. this is to try to avoid more than 15 percent when we both have to takr RMd's. I have not figured out how to avoid all income tax.
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Re: using the 15% tax bracket

Post by dickenjb »

I don't think it is even close. I would favor filling the 10% and 15% bracket with Roth conversions which in addition to allowing TIRA money to come out in a low bracket will lower your RMD's when those come to pass at age 70.5

Lots of ways to avoid paying any tax at all on LTCG:

1) Stepped up at death

2) Gift to kids or grandkids and let them sell at their lower CG rate (perhaps 05)

3) Donate highly appreciated shares to charity, either directly or through DAF

4) Offset gains with cap losses
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Re: using the 15% tax bracket

Post by heyyou »

For Married Filing Jointly, the top of the 15% bracket has an effective tax rate of 10.8% overall, so it is okay to dribble some into the next higher bracket if you are willing to pay a few more dollars at the higher marginal rate. That marginal tax rate is important on other investment purchases, but considering equity growth rates inside your Roth, paying a little more tax now on slightly larger conversions is not completely out of the question. Much depends upon your current age and expected longevity.
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Re: using the 15% tax bracket

Post by RustyShackleford »

Pocket Cruiser wrote:What two asset classes do you use in your conversion strategy? Total bond market/total stock?
Yes, in theory. In practice, whatever is in my TIRA (which is only about 15-20% of my egg) that seems un-correlated. For 2013 it was DBC (commodities) for one, and cash in the other, which I then invested in PPT and PFF for some quick yield; it's looking like I'll be re-char'ing the DBC one, unless something wacky happens in the next month or so. For 2014, it is BIV in one and RWX + VTV in the other. All I have left now in my TIRA is some individual TIPS, some ISM (another inflation-linked bond), and more DBC; so not sure what I'll do in 2015.
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Re: using the 15% tax bracket

Post by Bob's not my name »

I've done it with brokered CDs on the one hand and stock funds on the other. Recharacterized the CDs IRA and reconverted in the next tax year. This was for a wealthy elderly person with headroom in the 0% bracket.
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Re: using the 15% tax bracket

Post by RustyShackleford »

Also consider possible state tax ramifications. ... If you're in the 15% federal bracket your state tax burden can easily be more than a third of your marginal rate on conversions and 100% of your marginal rate on LTCG. State tax treatment of LTCG and IRA conversions varies, with most (but not all) states with state income tax favoring the latter over the former
NC now has a 5.8% flat tax, and conversions and LTCG are both treated as ordinary income. So state tax really has no effect on the decision between filling my 15% federal bracket with conversions versus LTCG. Put another way, my overall marginal rate will be 15+5.8%, but that's still a lot lower than 25+5.8%, so who cares ?. (Or, for LTCG, my marginal rate will be 0+5.8% versus 15+5.8%, so again, who cares (about state tax's effect on this decision-making process) ?
Harvesting in states like California is expensive, as there's no 0% bracket and no LTCG rate.
Same in NC. I assume you're talking about state tax only; AFAIK, even in California, federal income taxes are the same :-)
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Re: using the 15% tax bracket

Post by RustyShackleford »

dickenjb wrote:I don't think it is even close. I would favor filling the 10% and 15% bracket with Roth conversions which in addition to allowing TIRA money to come out in a low bracket will lower your RMD's when those come to pass at age 70.5

Lots of ways to avoid paying any tax at all on LTCG:

...
That's kind of always been my thinking too. So far. But if LTCG taxes were going to go up in 2015 and thereafter, and especially if the 0% bracket were going to go away, it might change my thinking. Hence my asking of the forbidden question.

There is a whole 'nother angle that occurred to me. If I get preferential tax treatment (0% + state) on $10,000 of LTCGs, and re-buy the fund thereby simply increasing my basis by $10K, that's ALL I get; when I go to sell that fund, my LTCGs will be $10,000 lower than they would have been. BUT, if I get preferential tax treatment on $10,000 of Roth conversion, I have effectively gotten that preferential treatment on the $10K conversion PLUS its gains once it's in the Roth.

So even more strongly leaning towards using the 15% federal bracket for Roth conversions (instead of LTCG harvesting). Unless, the 0% LTCG bracket goes away ...
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Re: using the 15% tax bracket

Post by dickenjb »

RustyShackleford wrote:There is a whole 'nother angle that occurred to me. If I get preferential tax treatment (0% + state) on $10,000 of LTCGs, and re-buy the fund thereby simply increasing my basis by $10K, that's ALL I get; when I go to sell that fund, my LTCGs will be $10,000 lower than they would have been. BUT, if I get preferential tax treatment on $10,000 of Roth conversion, I have effectively gotten that preferential treatment on the $10K conversion PLUS its gains once it's in the Roth....
Yes, plus you reduce future RMD's from TIRA which may turn your 15% bracket into a 22.5% effective rate - or even a 27.75% effective rate as your SS benefits become taxable....
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Re: using the 15% tax bracket

Post by Electron »

We already had two different increases in the capital gains tax rate quite recently. The 15% CG bracket increases to 20% for some taxpayers, and the 3.8% Medicare tax on investment income also applies to capital gains for some taxpayers. I'm assuming that the lower capital gains tax brackets are safe for quite a while.

Despite that, it may still be wise to hedge one's bets. Many have suggested a balance between Traditional IRA and Roth IRA simply based on the fact that we can't predict future tax rates or tax policy. With a balance one should realize a benefit from one or the other.

If one does want to make maximum use of the 0% capital gains bracket, it may be desirable to reduce ordinary income as much as possible and replace it with some combination of qualified dividends, capital gains, and tax exempt income. Note also that ordinary income can be offset with itemized deductions.
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Re: using the 15% tax bracket

Post by harmony »

There is another way to save a chunk on LTCG taxes prior to one's death. That is the Schedule A medical expenses deduction which one might take for the same year that one's POA-F would take out a taxable distribution for the purpose of paying one's long-term care expenses. This deduction has been around since Franklin Roosevelt. Though it has been through numerous revisions, it remains. It might be one of the less likely laws to be removed because it helps people be able to afford their own long-term care. I'd rather still have some untaxed growth that my POA-F can make use of than to take funds out of Roth IRAs for which I've already paid taxes years ago. If a person isn't in the nursing home primarily to receive medical care, then only the portion of the fee that is for actual medical care qualifies as a deductible medical expense. Once a person becomes chronically ill, all of the individual's qualified long-term care services are deductible.

Here is the definition of a chronically ill individual from IRA Publication 502 "Medical and Dental Expenses":
An individual is chronically ill if, within the previous 12 months, a licensed health care practitioner has certified that the individual meets either of the following descriptions.

1. He or she is unable to perform at least two activities of daily living without substantial assistance from another individual for at least 90 days, due to a loss of functional capacity. Activities of daily living are eating, toileting, transferring, bathing, dressing, and continence.

2. He or she requires substantial supervision to be protected from threats to health and safety due to severe cognitive impairment.
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Re: using the 15% tax bracket

Post by Electron »

RustyShackleford wrote:BUT, if I get preferential tax treatment on $10,000 of Roth conversion, I have effectively gotten that preferential treatment on the $10K conversion PLUS its gains once it's in the Roth.
A key factor in Roth conversions is whether one's tax bracket is higher or lower in retirement. Note also that a large RMD is actually taxed at multiple rates. The first dollars are not taxed at all with additional portions taxed at 10%, 15%, and then any higher rates.

If our Roth conversion was done at a tax rate of 15%, we could also assign a similar dollar amount to the 15% bracket for a later TIRA withdrawal for the case where we didn't do the Roth conversion in the first place.

I think one also needs to review carefully the benefits of a Roth conversion. The benefits may not be quite as much as many expect. A lot depends on one's current tax bracket and their future tax brackets. The benefits may also be less for those closer to retirement age.

There are actually two general cases for Roth conversions. Case 1 pays the conversion tax from the IRA resulting in a smaller Roth IRA balance. Surprisingly, the two accounts are identical on an after tax basis if one's tax rate for conversion is the same as the tax rate for withdrawal. There would be an advantage to the conversion, however, if one's tax rate is higher in retirement.

Case 2 pays the conversion tax from a separate taxable account. This case is much more difficult to analyze since you now need to consider how the taxable assets would have been invested had they remained in the taxable account. That single factor can influence whether the conversion provides any benefit. You must compare a Roth IRA to a TIRA plus taxable side account. The two alternatives would be equivalent if the after tax return on the taxable account potentially used to pay the conversion taxes was the same as the return in either IRA. The analysis is also complicated by the withdrawal strategy in retirement from that same taxable account. Depending on income needs, one might or might not need to withdraw from the taxable account in any given year. One also needs to realize that the RMD percentage increases every year and the account value typically starts declining at some point depending on the investment returns. The dollar amount of the RMD itself typically starts declining some number of years following the peak in account value.
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Re: using the 15% tax bracket

Post by RustyShackleford »

Electron wrote: A key factor in Roth conversions is whether one's tax bracket is higher or lower in retirement.
That's why I refuse to do any conversions that are taxed at higher than 15%. Of course, I have that luxury since I have little other taxable income in my semi-retirement. I can't really imagine having a lower than 15% marginal bracket going forward. And I really wonder at folks that do conversions that are taxed in the 25% or 28% marginal brackets. (As an aside, I sometimes feel like all this Roth conversion fever is a revenue shell game, where taxes are paid today - on conversions - that will steal from taxes tomorrow - as people withdraw all that Roth money tax-free).
Note also that a large RMD is actually taxed at multiple rates. The first dollars are not taxed at all with additional portions taxed at 10%, 15%, and then any higher rates.
I'm VERY confused by this. Are RMDs taxed is some different way than ordinary TIRA withdrawals (that is, as ordinary income) ? Or are you simply pointing out that a certain amount of ordinary income is untaxed because of personal exemption and standard deduction, and some more only taxed at 10% ? I don't think that'll be a factor for me, as a SPIA and some lifetime-annuitized TIAA-CREF money (in the future) will pretty much get me up through the 10% bracket (nothwithstanding, gods forbid, some very large medical deductions, as an earlier poster pointed out).
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Re: using the 15% tax bracket

Post by RustyShackleford »

wshang wrote:
Pocket Cruiser wrote:
wshang wrote:Although I've brought up a variation of your Roth conversion strategy on this forum before, no one ever seems to get excited .
Would you elaborate on this please?
http://www.bogleheads.org/forum/viewtop ... ilit=+roth
Sure, this explains the basic strategy, although I personally feel that there's a point of diminishing returns after the number of conversions equals two. And I still don't see how "it is possible to do better than the best performing of these categories".
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Re: using the 15% tax bracket

Post by Electron »

RustyShackleford wrote:Are RMDs taxed in some different way than ordinary TIRA withdrawals (that is, as ordinary income) ?
RMDs are taxed the same as any ordinary income. My point is that one's actual tax percentage is less than their marginal tax bracket as a result of deductions and exemptions and the progressive tax rate structure.

Take a look at your actual tax last year divided by your AGI. That percentage will be less than your marginal tax rate for any additional income. The reason is that the first dollars are not taxed, some dollars are taxed at 10%, and the balance would be taxed in the higher brackets.
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Re: using the 15% tax bracket

Post by kaneohe »

Electron wrote: A key factor in Roth conversions is whether one's tax bracket is higher or lower in retirement. Note also that a large RMD is actually taxed at multiple rates. The first dollars are not taxed at all with additional portions taxed at 10%, 15%, and then any higher rates.
.
This is a useful concept if you have little other income so the RMD is taxed at "effective" rates. However if you have signifcant other income (pensions/SS/interest/div/etc),
that other income will swamp the lower brackets and the RMDs would then be taxed at much higher "effective" rates?
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Re: using the 15% tax bracket

Post by Electron »

kaneohe wrote:This is a useful concept if you have little other income so the RMD is taxed at "effective" rates. However if you have significant other income (pensions/SS/interest/div/etc), that other income will swamp the lower brackets and the RMDs would then be taxed at much higher "effective" rates?
Some of this is just mental accounting. It is true that the first dollars are not taxed and additional dollars are taxed in different brackets. The bottom line of total tax divided by AGI is what really matters to our pocketbook. However, I agree with your statement because the 10% bracket is relatively small and has diminished impact when income gets high enough.

I just ran some numbers in my tax spreadsheet for a single retiree just transitioning from the 10% bracket to the 15% bracket. The total tax divided by AGI in this example was 4.35% when a little under the 15% bracket. Adding $100 of income pushed the individual into the 15% bracket. The total tax percentage then increased to 4.38%.

Adding $1,000,000 to income in this example put the individual well into the 39.6% bracket but total tax divided by AGI came out at 35.07%. The lower brackets do help even in this case.
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Re: using the 15% tax bracket

Post by wshang »

RustyShackleford wrote:I still don't see how "it is possible to do better than the best performing of these categories".
Easy to explain. The Callan Periodic Table does not have gold or long-term Treasuries which outperformed the categories listed for some of the years followed.
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Re: using the 15% tax bracket

Post by kaneohe »

Electron wrote:
kaneohe wrote:This is a useful concept if you have little other income so the RMD is taxed at "effective" rates. However if you have significant other income (pensions/SS/interest/div/etc), that other income will swamp the lower brackets and the RMDs would then be taxed at much higher "effective" rates?
Some of this is just mental accounting. It is true that the first dollars are not taxed and additional dollars are taxed in different brackets. The bottom line of total tax divided by AGI is what really matters to our pocketbook. However, I agree with your statement because the 10% bracket is relatively small and has diminished impact when income gets high enough.

I just ran some numbers in my tax spreadsheet for a single retiree just transitioning from the 10% bracket to the 15% bracket. The total tax divided by AGI in this example was 4.35% when a little under the 15% bracket. Adding $100 of income pushed the individual into the 15% bracket. The total tax percentage then increased to 4.38%.
sorry, I left something out (and you're too fast! :happy )........if the decision is whether or not to do the Roth conversion (that will lower RMDs), then the Roth conversion should be thought of as being taken at a marginal tax rate and the do-nothng alternative of taking the RMD should also be considered at the marginal rate in order for a fair comparison, right?
I agree that if you aren't making that decision but just taking the RMD w/o thinking about it, it's just mental accounting and that "effective" rate is ok.
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Re: using the 15% tax bracket

Post by Electron »

kaneohe wrote:The Roth conversion should be thought of as being taken at a marginal tax rate and the do-nothing alternative of taking the RMD should also be considered at the marginal rate in order for a fair comparison, right? I agree that if you aren't making that decision but just taking the RMD w/o thinking about it, it's just mental accounting and that "effective" rate is ok.
I agree on using the marginal tax rate in that case for either the Roth Conversion or the T-IRA RMD in the event of no conversion. To actually lower a T-IRA RMD using a Roth Conversion I believe there would be a one year lag. The RMD would be based on the account value at the end of the previous calender year. This also highlights an interesting complication in the analysis since the marginal tax rate may vary in future years.

Hope you saw my edit above on the effective tax rate even in the case of high income. The lower brackets do help. Many people don't realize that we actually pay some taxes at all tax bracket rates leading up to our marginal bracket.

My comment on the mental accounting was incorrect. I may also have been trying to respond to the statement "preferential treatment on the $10K conversion PLUS its gains once it's in the Roth." It sounded as though there was a double benefit to the conversion. I tend to think of Roth Conversions as stated earlier where I described Case 1 and Case 2 in detail. The two Roth Conversion cases are difficult to understand unless you can experiment with them in a spreadsheet.
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Peter Foley
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Re: using the 15% tax bracket

Post by Peter Foley »

Rusty wrote:
Yeah, no one gets excited when I describe my two-class strategy either. Reckon it's too much trouble I guess. I'm starting to think that too, as I invariably keep the equity conversion. Of course, I've only employed the strategy since 2010, and one of these days the equity will under-perform.
I have been using the two class strategy as well since 2012. My version is just a bit simpler, I convert equities on the first trading day of the year and the wait to see if they are finishing the year positive in late December. If they are I do nothing. If they are finishing the year negative I would convert Total Bond at that point in time. I see no reason to take action that would require recharacterization of one of my two asset classes. I can essentially bet on one horse until just before it crosses the finish line. If it is going to lose, I can place a safe bet (cash or Total Bond).
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Re: using the 15% tax bracket

Post by RustyShackleford »

Peter Foley wrote:Rusty wrote:
Yeah, no one gets excited when I describe my two-class strategy either. Reckon it's too much trouble I guess. I'm starting to think that too, as I invariably keep the equity conversion. Of course, I've only employed the strategy since 2010, and one of these days the equity will under-perform.
I have been using the two class strategy as well since 2012. My version is just a bit simpler, I convert equities on the first trading day of the year and the wait to see if they are finishing the year positive in late December. If they are I do nothing. If they are finishing the year negative I would convert Total Bond at that point in time. I see no reason to take action that would require recharacterization of one of my two asset classes. I can essentially bet on one horse until just before it crosses the finish line. If it is going to lose, I can place a safe bet (cash or Total Bond).
Disagree. The finish line is not Jan 1 of the following year, or even April15; it's October 15, assuming you file an extension. So your strategy allows the race to only go one for 12 months, when you could have 21 months.

BTW, lest anyone think "an extension is too much trouble", it's not. You do all the work of preparing your returns as though you were going to file by April 15. You know almost, or - if you assume the equity'ish conversion will outperform and you're right - exactly, how much your net Roth conversion will be; and therefore you know the bottom line on your taxes. You file for an extension, but that doesn't even require you to send in the 1/2-page form; you pay electronically at www.eftps.gov and that takes care of the federal, and many states (including mine) allow electronic online payments as well. If you were due a refund, just pay a buck else send in the form after all. Then, in September you recharacterize the conversion you choose and file your returns; it's a good idea to allow your brokerage a couple weeks for the recharacterization, because they cannot legally do it after the extended-filing deadline, and they tend to get backlogged.
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Re: using the 15% tax bracket

Post by kramer »

Thanks for the great discussion. I am a retiree in my late 40's whose taxable income consists almost entirely of qualified dividends. Less than one-third of my net worth is in an IRA and it is almost entirely in bonds. Most of the taxable account is in equities plus some of the higher rate I-bonds.

My plan this year is to do a T-IRA to ROTH conversion to fill up the rest of the 0% bracket and all of the 10% bracket. And then I capital gain harvest up to the top of the 15% bracket. I have two decades to do conversions, although at some point I will probably start converting into the 15% bracket once I am more sure I will still have a large taxable account in my old age (an assumption that I am unwilling to make at the moment).

One issue I didn't see mentioned is the foreign tax credit. I have been carrying this forward each year on form 1116 but I can't use it (the amount is well over the $300 limit) because I am paying no or little taxes up to this point because I have not been doing annual conversions, only cap gain harvesting.

Being able to use at least part of the foreign tax credit (I still can't use all of it during conversions because my tax rate is still not high enough) lowers my marginal conversion rate from about 10% to 8%. My overall rate is even lower thanks to the part of the 0% bracket I can fill up. My marginal rate on conversions into the 15% bracket is probably just 12% because of this issue. This concept is more beneficial for someone who is over 50% foreign equities in their taxable account like me.
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Re: using the 15% tax bracket

Post by gd »

RustyShackleford wrote: I just think if I can harvest LTCGs with 0% tax, and there's some consensus that the 0% treatment for folks in the lower brackets is going to disappear, it'd probably argue for doing that now.
I think you'll get consensus only that the LTCGT for lower brackets won't go down. I'd hope unanimous, but one never knows. I got consensus 5 or so years back that we were on the verge of inflation and interest rates couldn't possibly get lower, and I should keep a some CD-type instruments from a windfall short-term. I don't pay much attention to economic/political consensus any more-- it works better to pay attention to the people who have made accurate, not popular, predictions. In my opinion LTCG harvesting is a fine idea, I've been doing it for a few years, but because it fits my other circumstances. I also do it to clean up my record-keeping, by the way, trimming FIFO-basis funds with regular reinvestments going back 25 years. That's probably worth quite a bit to my future widow or executor. The point of money is to make life easier, and that certainly will to my tax-illiterate spouse.
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Re: using the 15% tax bracket

Post by Bob's not my name »

RustyShackleford wrote:
Also consider possible state tax ramifications. ... If you're in the 15% federal bracket your state tax burden can easily be more than a third of your marginal rate on conversions and 100% of your marginal rate on LTCG. State tax treatment of LTCG and IRA conversions varies, with most (but not all) states with state income tax favoring the latter over the former
NC now has a 5.8% flat tax, and conversions and LTCG are both treated as ordinary income. So state tax really has no effect on the decision between filling my 15% federal bracket with conversions versus LTCG. Put another way, my overall marginal rate will be 15+5.8%, but that's still a lot lower than 25+5.8%, so who cares ?. (Or, for LTCG, my marginal rate will be 0+5.8% versus 15+5.8%, so again, who cares (about state tax's effect on this decision-making process) ?
Harvesting in states like California is expensive, as there's no 0% bracket and no LTCG rate.
Same in NC. I assume you're talking about state tax only; AFAIK, even in California, federal income taxes are the same :-)
Here are some examples where state tax should be considered:
  • In NC it may have been beneficial for a couple to each make tax-exempt $2,000 conversions in tax years through 2013.
  • In Tennessee interest, dividends, and capital gains distributions are taxed at 6% if your income is over $59,000 (MFJ). So a Roth conversion might be taxed at 15% federal but also displace investment income above the $59,000 threshold, producing effectively a 21% marginal tax rate on the Roth conversion.
  • At least eight states, with tax rates ranging from 4.2% to 10.45%, have age thresholds for tax-exempt Roth conversions (55, 59.5, 60, 62, and 67, to name a few). Taxpayers in these states who haven't reached the threshold age might be better off harvesting gains in the pre-threshold years and then doing Roth conversions in the post-threshold years, depending of course on how much they'd like to convert before 70.5.
  • Some retirees will make a planned or unplanned move to another state that may have higher or lower tax rates on IRA distributions and capital gains.
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Re: using the 15% tax bracket

Post by RustyShackleford »

gd wrote:In my opinion LTCG harvesting is a fine idea, I've been doing it for a few years, but because it fits my other circumstances. I also do it to clean up my record-keeping, by the way, trimming FIFO-basis funds with regular reinvestments going back 25 years. That's probably worth quite a bit to my future widow or executor.
I wish to heck that, early in my investment career, someone had pointed out to me that you may not wish to do DRIPs in taxable accounts, because of basis-accounting headaches; but do 'em (DRIPs) in tax-sheltered accounts. The big-firm advisor, who I was then paying big front-end loads, never thought to mention it. And American Funds did a horrible job of accounting for it. When I finally got my act together, I had to go through all my American Funds annual statements BY HAND, to compute the basis when I sold them. Fortunately, many firms, Schwab and Vanguard at least, do an excellent job of keeping track of basis for you.
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Re: using the 15% tax bracket

Post by RustyShackleford »

gd wrote: I think you'll get consensus only that the LTCGT for lower brackets won't go down. I'd hope unanimous, but one never knows.
I feel pretty certain that the LTCG tax will never be negative :-)
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Re: using the 15% tax bracket

Post by Peter Foley »

Rusty wrote
Peter Foley wrote:
Rusty wrote:

Yeah, no one gets excited when I describe my two-class strategy either. Reckon it's too much trouble I guess. I'm starting to think that too, as I invariably keep the equity conversion. Of course, I've only employed the strategy since 2010, and one of these days the equity will under-perform.


I have been using the two class strategy as well since 2012. My version is just a bit simpler, I convert equities on the first trading day of the year and the wait to see if they are finishing the year positive in late December. If they are I do nothing. If they are finishing the year negative I would convert Total Bond at that point in time. I see no reason to take action that would require recharacterization of one of my two asset classes. I can essentially bet on one horse until just before it crosses the finish line. If it is going to lose, I can place a safe bet (cash or Total Bond).


Disagree. The finish line is not Jan 1 of the following year, or even April15; it's October 15, assuming you file an extension. So your strategy allows the race to only go one for 12 months, when you could have 21 months.

BTW, lest anyone think "an extension is too much trouble", it's not. You do all the work of preparing your returns as though you were going to file by April 15. You know almost, or - if you assume the equity'ish conversion will outperform and you're right - exactly, how much your net Roth conversion will be; and therefore you know the bottom line on your taxes. You file for an extension, but that doesn't even require you to send in the 1/2-page form; you pay electronically at http://www.eftps.gov and that takes care of the federal, and many states (including mine) allow electronic online payments as well. If you were due a refund, just pay a buck else send in the form after all. Then, in September you recharacterize the conversion you choose and file your returns; it's a good idea to allow your brokerage a couple weeks for the recharacterization, because they cannot legally do it after the extended-filing deadline, and they tend to get backlogged.
You are correct. I am aware of the possibility of using extensions to get a longer read on various conversions. I'm also aware that there are strategies to use many different Roth accounts and make multiple conversions in a given year and keep only the best. That is much too complicated for my taste. I am content to use a strategy that ensures not taking a loss on a conversion.
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Re: using the 15% tax bracket

Post by Electron »

kramer wrote:One issue I didn't see mentioned is the foreign tax credit. I have been carrying this forward each year on form 1116 but I can't use it (the amount is well over the $300 limit) because I am paying no or little taxes up to this point because I have not been doing annual conversions, only cap gain harvesting.
I have a similar situation with the foreign tax Credit. Fortunately, the credit can be carried forward up to ten years. If carried foreign tax credit is nearing expiration, one could consider giving up the 0% bracket for qualified dividends and capital gains and do a Roth Conversion to increase the allowable credit.

Actually, I don't worry a whole lot about foreign tax credit. I believe the credit is really only there to prevent double taxation on foreign dividend income. If a person bought a stock such as Royal Dutch Shell, a 15% tax is withheld from the dividend regardless of their income. That tax would go to the Netherlands in this case. We pay that money and it is never refunded. It is only when the dividend is also taxed by the IRS that the foreign tax credit comes into play. In that respect, it may not be that important if the credit can't be used.
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