Roth Conversions and taxes

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veyron
Posts: 18
Joined: Thu Apr 13, 2017 11:28 am

Roth Conversions and taxes

Post by veyron » Wed Sep 20, 2017 8:17 am

Bogleheads,
I am in a conundrum regarding how much Roth Conversions I should do. Here is my situation. Any advice would be greatly appreciated.

Emergency funds: yes
Debt: none
Tax Filing Status: Married Filing Jointly
Tax Rate: 15% Federal, 6% State
State of Residence: WI
Age: me-60, wife-60
Desired Asset allocation: 70% stocks / 30% bonds
Desired International allocation: 0% of stocks
Social Security: will both start taking at age 70 (in today’s dollars will be: me-$42,000, wife-$30,000)

Wife is retired, I am part-time considering full retirement but am the type who is always concerned about running out of money, so I can't seem to pull the trigger.

Taxable:
$23,000 cash
$828,000 at TD Ameritrade (individual stocks purchased 30+ years ago; Amex, Bristol Myers, Coke, GE, McDonalds, Microsoft, Walgreens); total cost basis = $282,000
$377,000 VG Tax Exempt Bond Fund (VWIUX)
$542,000 VG Total Stock Fund (VTSAX)

His Traditional IRA at Vanguard:
$918,000 VG Total Stock Fund (VTSAX)
$506,000 VG Total Bond Fund (VBTLX)

His Roth IRA at Vanguard:
$113,000 VG Total Stock Fund (VTSAX)

Her Traditional IRA at Vanguard:
$323,000 VG Total Stock Fund (VTSAX)
$153,000 VG Total Bond Fund (VBTLX)

Her Roth IRA at Vanguard:
$37,000 VG Total Stock Fund (VTSAX)

Total of All Accounts = $3,820,000

Questions:
1. I want to start doing Roth conversions, but am not sure how much to do:
a. If I do approx $40k-$60k each year for the next 10 years, I could stay at the top of the 15% tax bracket which would also mean no taxes on qualified divs and cap gains (which are approx $30k/year right now)
b. Or I could do approx $125k - $150K each year (enough to put me in the top of the 25% tax bracket)
2. I am considering doing the larger amount (putting us in the 25% bracket) for the following reasons:
a. If we don’t start significantly reducing our IRAs, our RMDs + social security + other income may eventually put us in the 28% or 33% bracket
b. When one of us passes on, the taxes at the single rate could be quite high for the survivor
c. Medicare Part B & D premiums for both of us will be higher if MAGI is too high later down the road
d. I don’t want to trigger AMT, PEP, Pease or NIIT in the future
3. Please advise whether I should keep us in the 15% bracket now and pay all the taxes later or do enough Roth conversions now (putting us in the 25% bracket) and paying a significant amount of taxes now
4. Any other general investment advice would also be appreciated

Thanks for your help!

Chip
Posts: 1650
Joined: Wed Feb 21, 2007 4:57 am

Re: Roth Conversions and taxes

Post by Chip » Wed Sep 20, 2017 8:56 am

Given that you're sure you'll ultimately be in the 28% or 33% bracket I think the top of the 25% makes the most sense. Top of the 28% might be reasonable as well. Though I know the up front taxes are a bitter pill to swallow.

At age 63 & up you might examine whether it is worth it to go all the way to the top of the 25% or stay under the Medicare IRMAA limit (170k MAGI).

I would recommend moving your all of your bond investments into your tIRAs. So, sell tax-exempt funds in your taxable accounts and replace with VTSAX. Sell VTSAX in tIRAs and buy VBTLX. This will likely reduce the size of future RMDs due to the lower expected return of the bond funds.

If you haven't already done a detailed proforma of what taxes will look like at age 71, you should do so. And do it with both conversion scenarios.

While I'm a fan of conversions, it takes a LOT of converting to significantly reduce RMDs. For example, converting 100k only reduces first year RMD by $3,700 in a no growth scenario.

smitcat
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Re: Roth Conversions and taxes

Post by smitcat » Wed Sep 20, 2017 9:01 am

We have a similarly complicated situation with late SS and the choices with Roth conversions. I have found that there is no substitute for modeling what the scenarios might yield in after tax spending money both when MFJ and then when their is one spouse left.
In order to do that modeling reasonably quickly and accurately we have used both the IROP and RPM tools both of which take time to input your variables carefully. When we get close to a scenario that we like the looks of in the IORP we confirm it with the same inputs on the RPM and then confirm some of the RPMS tax outputs with actual tax software.
This is what works well for us and we are very near beginning Roth conversions.
FWIW - making sure you inputs are correct is not so easy as we got them 'wrong' more that a few times before we got them correct.

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dodecahedron
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Re: Roth Conversions and taxes

Post by dodecahedron » Wed Sep 20, 2017 9:15 am

Chip wrote:
Wed Sep 20, 2017 8:56 am
Given that you're sure you'll ultimately be in the 28% or 33% bracket I think the top of the 25% makes the most sense.
Nobody can be *sure* that they will "ultimately be in 28% or 33% bracket" ten (and more) years down the road. Even leaving completely aside the possibility of future tax legislation, there is always the possibility that one spouse may sooner or later need significant LTC expenses, potentially generating large tax deductions for unreimbursed medical expenses. Another factor not mentioned are state income taxes. OP is currently in Wisconsin (which has a significant income tax) but ten years down the road a warmer state with no (or lower) income tax might appeal.

Also, one or both spouses may decide to work part-time (possibly very part-time) at an employer that will allow the tIRA balances to be rolled into their 401k plan, further delaying the onset of required minimum distributions (and giving additional years with room for additional Roth conversions.)

I am a bit older and farther along than the OP (turning 64 soon) but have part-time jobs I enjoy (with room to scale one or both of them up or down) and taking it relatively slow on the Roth conversions for reasons described above. I have rolled all my traditional IRAs into a 403b at one of my part-time employers, leaving me in control of when rmd's begin.

Another factor in my decision making is that I have plans for significant charitable donations, and can manage future tax brackets somewhat either by giving appreciated securities and/or making qualified charitable donations (QCDs).

In the OP's shoes, I'd be inclined to stay in 15% bracket. Note that the *effective* marginal tax rate can be quite a bit higher than 25% as soon as you get just barely beyond the 15% bracket, due to the way that qualified dividends are treated.

Edited to add: my perspective may be colored by the fact that my late husband and I had a business with up and down years that allowed for a lot of opportunistic Roth conversions in the past, plus our Roth assets were relatively aggressively invested with good performance while my husband was alive, so my Roth/traditional balance is already over 50% Roth. (Currently both Roth and traditional are conservatively invested. Equities are concentrated in my taxable account for tax efficiency reasons, due to good treatment for charitable giving, bequests, and TLH.)
Last edited by dodecahedron on Wed Sep 20, 2017 9:33 am, edited 2 times in total.

livesoft
Posts: 57281
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Re: Roth Conversions and taxes

Post by livesoft » Wed Sep 20, 2017 9:25 am

I don't think anyone can answer the questions asked at the start of this thread with any degree of certainty.

I will say that one can reduce the growth of potential RMDs by putting low-growth investments in the traditional IRAs. That means use bond funds in tax-deferred accounts and don't use stock funds. This was also mentioned by Chip. We haven't had any tax-exempt bond funds in our taxable accounts since the 1990s.

Our stock index funds are in our taxable accounts where we don't pay capital gains taxes and unrealized capital gains are not taxed.

It looks like the OP has tried to have both stocks and bonds in each of their accounts. We do not do that, but have fixed income and equity funds in tax-deferred, equity funds in Roths, and equity funds in taxable. We also practice tax-loss harvesting in taxable judiciously.

We have only done Roth conversions up to the top of the 15% tax bracket, but I don't know if we should go to top of 25% or even higher. In reality, we will have more than enough money to pay expenses including taxes going forward, so it won't really matter.

Eta: Don't forget that tax-exempt bond interest is used in the calculation of your taxes on Social Security income and probably a few other things.
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#Cruncher
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Re: Roth Conversions and taxes

Post by #Cruncher » Wed Sep 20, 2017 12:11 pm

veyron wrote:
Wed Sep 20, 2017 8:17 am
a. If we don’t start significantly reducing our IRAs, our RMDs + social security + other income may eventually put us in the 28% or 33% bracket
Unless you or your wife is still working at age 70, I doubt you'd reach the 28% bracket even if you did no Roth conversions between now and then. Based on the following assumptions I estimate you'd need $115,000 of non-SS ordinary income (in 2017 dollars) to reach the 28% bracket. Your IRAs currently total $1,900,000. Assuming no real growth and dividing that by 27.4 or 26.5 gives an RMD at age 70 or 71 of about $70,000. You'd need $45,000 of wages, taxable interest income, and non-qualified dividends on top of that to reach the 28% bracket. Assumptions:
  • 2017 tax brackets and standard deduction for a couple age 65+. (These will be inflation adjusted.)
  • 50% and 85% SS thresholds reduced to reflect 10 years of assumed 2% annual inflation. (Necessary since these are not inflation adjusted. See the Wiki's Taxation of Social Security benefits for how SS is taxed.)
  • $10,000 of tax exempt interest
  • $30,000 of qualified dividends and long term capital gains (LTCG)
  • $72,000 of social security benefits
The following table shows the different marginal tax rates you'd pass through as non-SS oridnary income rises from $0 to $115,200:

Code: Select all

 From      To      Range  Marginal  Bracket       Description
-------  -------   -----  --------  -------  -------------------------------------
      0    1,595   1,595   18.50%     10%    85% SS taxable
  1,595   16,324  14,730   27.75%     15%    85% SS taxable
 16,324   26,118   9,794   55.50%     15%    85% SS taxable / LTCG pushed into 15%  
 26,118   38,000  11,882   30.00%     15%     0% SS taxable / LTCG pushed into 15%
 38,000  115,200  77,200   25.00%     25%
115,200                    28.00%     28%
This can be better visualized on the Main sheet of my Marginal Tax Rates spreadsheet. To use it, change the $32,000 and $44,000 Social Security thresholds to $26,000 and $36,000 in the 2017Joint column on the far right of the Tables sheet. Then enter the following in the yellow cells on the Main sheet:

Code: Select all

Tax year                         2017
Single or Joint Return          Joint
Number filers age 65 or older       2
Tax exempt interest            10,000 
Non-SS Ordinary Income         <blank>
LTCG & QDI                     30,000 
Social Security Benefit        72,000 
Deductions                     <blank>
Exemption                      <blank>
Here is the detailed tax computation for the start of each marginal tax rate as prepared with the Compare sheet of my spreadsheet:

Code: Select all

Social Security 50% threshhold    26,000   -------------- (32,000 / 1.02 ^ 10) -------------->
Social Security 85% threshhold    36,000   -------------- (44,000 / 1.02 ^ 10) -------------->
Ord Income Tax Bracket 15%        18,650   -------------------------------------------------->
Ord Income Tax Bracket 25%        75,900   -------------------------------------------------->
Ord Income Tax Bracket 28%       153,100   -------------------------------------------------->
Tax exempt interest               10,000   10,000   10,000   10,000   10,000   10,000   10,000
Non-SS Ordinary Income                 0    1,595   16,324   26,118   38,000  115,200  116,200
LTCG & QDI                        30,000   30,000   30,000   30,000   30,000   30,000   30,000
Social Security Benefit           72,000   72,000   72,000   72,000   72,000   72,000   72,000
SS Relevant Income                76,000   77,595   92,324  102,118  114,000  191,200  192,200
50% SS taxable                     5,000    5,000    5,000    5,000    5,000    5,000    5,000
85% SS taxable                    34,000   35,355   47,876   56,200   56,200   56,200   56,200
Total SS taxable                  39,000   40,355   52,876   61,200   61,200   61,200   61,200

Code: Select all

Adjusted gross income             69,000   71,950   99,200  117,318  129,200  206,400  207,400
Deductions plus Exemptions        23,300   23,300   23,300   23,300   23,300   23,300   23,300
Taxable Income                    45,700   48,650   75,900   94,018  105,900  183,100  184,100
LTCG & QDI Taxable                30,000   30,000   30,000   30,000   30,000   30,000   30,000
Ordinary Taxable                  15,700   18,650   45,900   64,018   75,900  153,100  154,100
Ordinary taxable @ 28%               -        -        -        -        -        -      1,000
Ordinary taxable @ 25%               -        -        -        -        -     77,200   77,200
Ordinary taxable @ 15%               -        -     27,250   45,368   57,250   57,250   57,250
Ordinary taxable @ 10%            15,700   18,650   18,650   18,650   18,650   18,650   18,650
LTCG & QDI taxable @ 15%             -        -          0   18,118   30,000   30,000   30,000
LTCG & QDI taxable @ 0%           30,000   30,000   30,000   11,882      -        -        -  

Code: Select all

Ordinary tax @ 28%                   -        -        -        -        -        -        280
Ordinary tax @ 25%                   -        -        -        -        -     19,300   19,300
Ordinary tax @ 15%                   -        -      4,088    6,805    8,588    8,588    8,588
Ordinary tax @ 10%                 1,570    1,865    1,865    1,865    1,865    1,865    1,865
LTCG & QDI tax @ 15%                 -        -          0    2,718    4,500    4,500    4,500
Total tax                          1,570    1,865    5,953   11,388   14,953   34,253   34,533

Increased non-SS ordinary income        1,595   14,730    9,794   11,882   77,200    1,000
Increased taxable SS                    1,355   12,520    8,324      -        -        -  
Increased tax                             295    4,088    5,435    3,565   19,300      280
Marginal SS taxable                    85.00%   85.00%   85.00%    0.00%    0.00%    0.00%
Marginal tax rate                      18.50%   27.75%   55.50%   30.00%   25.00%   28.00%

veyron
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Re: Roth Conversions and taxes

Post by veyron » Wed Sep 20, 2017 12:44 pm

Chip wrote:
Wed Sep 20, 2017 8:56 am
Given that you're sure you'll ultimately be in the 28% or 33% bracket I think the top of the 25% makes the most sense. Top of the 28% might be reasonable as well. Though I know the up front taxes are a bitter pill to swallow.

At age 63 & up you might examine whether it is worth it to go all the way to the top of the 25% or stay under the Medicare IRMAA limit (170k MAGI).

I would recommend moving your all of your bond investments into your tIRAs. So, sell tax-exempt funds in your taxable accounts and replace with VTSAX. Sell VTSAX in tIRAs and buy VBTLX. This will likely reduce the size of future RMDs due to the lower expected return of the bond funds.

If you haven't already done a detailed proforma of what taxes will look like at age 71, you should do so. And do it with both conversion scenarios.

While I'm a fan of conversions, it takes a LOT of converting to significantly reduce RMDs. For example, converting 100k only reduces first year RMD by $3,700 in a no growth scenario.
Thanks for all the good advice Chip.

I'm not absolutely sure I'll be in the 28% or 33% bracket down the road (depends on how the market does of course), I just think it's a possibility and I wanted to be prepared for that.

I do plan to increase our bond holdings and decrease our stock holdings in our tIRA over time to try to keep our RMDs down, but for now, the reason I keep that much in bonds in my taxable account is if/when the market corrects, I can use those bonds for living expenses instead of having to take distributions from the bonds in my tIRA.

I actually do keep a very detailed spreadsheet of what taxes may look like each year for the next 30 years, but there is so much speculation inherent in those figures, I'm not sure how realistic it is.

Thanks again for your help. Its really appreciated.

veyron
Posts: 18
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Re: Roth Conversions and taxes

Post by veyron » Wed Sep 20, 2017 12:47 pm

smitcat wrote:
Wed Sep 20, 2017 9:01 am
We have a similarly complicated situation with late SS and the choices with Roth conversions. I have found that there is no substitute for modeling what the scenarios might yield in after tax spending money both when MFJ and then when their is one spouse left.
In order to do that modeling reasonably quickly and accurately we have used both the IROP and RPM tools both of which take time to input your variables carefully. When we get close to a scenario that we like the looks of in the IORP we confirm it with the same inputs on the RPM and then confirm some of the RPMS tax outputs with actual tax software.
This is what works well for us and we are very near beginning Roth conversions.
FWIW - making sure you inputs are correct is not so easy as we got them 'wrong' more that a few times before we got them correct.
I have played with IORP and you're right, it is time consuming and quite complicated and if your input is bad, your output is even "more bad". I may have to further investigate that. Thanks!

livesoft
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Re: Roth Conversions and taxes

Post by livesoft » Wed Sep 20, 2017 12:53 pm

veyron wrote:
Wed Sep 20, 2017 12:44 pm
..., but for now, the reason I keep that much in bonds in my taxable account is if/when the market corrects, I can use those bonds for living expenses instead of having to take distributions from the bonds in my tIRA.
We don't do that because

1. When we sell equities in taxable, we simply exchange bond fund into equity fund in tax-advantaged in order to keep our asset allocation where we want it.

2. If we "sell low" in taxable, then we are "buying low" in tax-advantaged.

3. At age 60, there is no penalty anyways for withdrawing from tax-deferred, so there is no point in keeping bonds in taxable I think.

4. Bonds in taxable means less tax-loss harvesting opportunities ... although I realize last December that TLH of tax-exempt munis was the subject of about 138 threads on bogleheads.org.
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DSInvestor
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Re: Roth Conversions and taxes

Post by DSInvestor » Wed Sep 20, 2017 12:54 pm

veyron wrote:
Wed Sep 20, 2017 12:44 pm

I do plan to increase our bond holdings and decrease our stock holdings in our tIRA over time to try to keep our RMDs down, but for now, the reason I keep that much in bonds in my taxable account is if/when the market corrects, I can use those bonds for living expenses instead of having to take distributions from the bonds in my tIRA.
To use bonds when taxable account is filled with stocks simply place to two trades:
1) Sell stocks in taxable
2) Exchange bonds for stocks in IRA.


Combined these two actions will allow to spend down a taxable account, avoid IRA distribution and sell bonds. If the stock sale and exchange happens on the same day, you both trades will happen at same NAV.

veyron
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Re: Roth Conversions and taxes

Post by veyron » Wed Sep 20, 2017 1:00 pm

dodecahedron wrote:
Wed Sep 20, 2017 9:15 am
Chip wrote:
Wed Sep 20, 2017 8:56 am
Given that you're sure you'll ultimately be in the 28% or 33% bracket I think the top of the 25% makes the most sense.
Nobody can be *sure* that they will "ultimately be in 28% or 33% bracket" ten (and more) years down the road. Even leaving completely aside the possibility of future tax legislation, there is always the possibility that one spouse may sooner or later need significant LTC expenses, potentially generating large tax deductions for unreimbursed medical expenses. Another factor not mentioned are state income taxes. OP is currently in Wisconsin (which has a significant income tax) but ten years down the road a warmer state with no (or lower) income tax might appeal.

Also, one or both spouses may decide to work part-time (possibly very part-time) at an employer that will allow the tIRA balances to be rolled into their 401k plan, further delaying the onset of required minimum distributions (and giving additional years with room for additional Roth conversions.)

I am a bit older and farther along than the OP (turning 64 soon) but have part-time jobs I enjoy (with room to scale one or both of them up or down) and taking it relatively slow on the Roth conversions for reasons described above. I have rolled all my traditional IRAs into a 403b at one of my part-time employers, leaving me in control of when rmd's begin.

Another factor in my decision making is that I have plans for significant charitable donations, and can manage future tax brackets somewhat either by giving appreciated securities and/or making qualified charitable donations (QCDs).

In the OP's shoes, I'd be inclined to stay in 15% bracket. Note that the *effective* marginal tax rate can be quite a bit higher than 25% as soon as you get just barely beyond the 15% bracket, due to the way that qualified dividends are treated.

Edited to add: my perspective may be colored by the fact that my late husband and I had a business with up and down years that allowed for a lot of opportunistic Roth conversions in the past, plus our Roth assets were relatively aggressively invested with good performance while my husband was alive, so my Roth/traditional balance is already over 50% Roth. (Currently both Roth and traditional are conservatively invested. Equities are concentrated in my taxable account for tax efficiency reasons, due to good treatment for charitable giving, bequests, and TLH.)
You are correct, I really have no idea if I will ever be in the 28% or 33% tax bracket, I'd like to do everything in my power not to be. And having my qualified divs and cap gains taxed at 15% as opposed to 0% is one major concern for diving into the 25% tax bracket now because, yes, if I do that, my effective marginal tax rate would be >25%. Paying the extra $30,000 in taxes per year for the next 10 years is definitely a hard pill to swallow. Thanks for the valuable input.

veyron
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Re: Roth Conversions and taxes

Post by veyron » Wed Sep 20, 2017 1:07 pm

livesoft wrote:
Wed Sep 20, 2017 9:25 am
I don't think anyone can answer the questions asked at the start of this thread with any degree of certainty.

I will say that one can reduce the growth of potential RMDs by putting low-growth investments in the traditional IRAs. That means use bond funds in tax-deferred accounts and don't use stock funds. This was also mentioned by Chip. We haven't had any tax-exempt bond funds in our taxable accounts since the 1990s.

Our stock index funds are in our taxable accounts where we don't pay capital gains taxes and unrealized capital gains are not taxed.

It looks like the OP has tried to have both stocks and bonds in each of their accounts. We do not do that, but have fixed income and equity funds in tax-deferred, equity funds in Roths, and equity funds in taxable. We also practice tax-loss harvesting in taxable judiciously.

We have only done Roth conversions up to the top of the 15% tax bracket, but I don't know if we should go to top of 25% or even higher. In reality, we will have more than enough money to pay expenses including taxes going forward, so it won't really matter.

Eta: Don't forget that tax-exempt bond interest is used in the calculation of your taxes on Social Security income and probably a few other things.
What you are saying makes a lot of sense. As in my reply to Chip above, I keep some bonds in my taxable account to use during a market correction. As time goes by I will exchange stock holdings for bonds in my tIRA to maintain my 70/30 ratio. By the time I'm 70, I plan to have all my bond holdings in our tIRA. Unfortunately, up until that time, my tIRA will keep growing such that my RMDs will also become higher (I guess that's not entirely unfortunate). Thanks for your input.

Chip
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Re: Roth Conversions and taxes

Post by Chip » Wed Sep 20, 2017 1:12 pm

dodecahedron wrote:
Wed Sep 20, 2017 9:15 am
Nobody can be *sure* that they will "ultimately be in 28% or 33% bracket" ten (and more) years down the road. Even leaving completely aside the possibility of future tax legislation, there is always the possibility that one spouse may sooner or later need significant LTC expenses, potentially generating large tax deductions for unreimbursed medical expenses. Another factor not mentioned are state income taxes. OP is currently in Wisconsin (which has a significant income tax) but ten years down the road a warmer state with no (or lower) income tax might appeal.
[...]
Edited to add: my perspective may be colored by the fact that my late husband and I had a business with up and down years that allowed for a lot of opportunistic Roth conversions in the past, plus our Roth assets were relatively aggressively invested with good performance while my husband was alive, so my Roth/traditional balance is already over 50% Roth. (Currently both Roth and traditional are conservatively invested. Equities are concentrated in my taxable account for tax efficiency reasons, due to good treatment for charitable giving, bequests, and TLH.)
I agree with everything you wrote. And #Cruncher has done some of the tax work to show that the 28% bracket is unlikely (though I would quibble with the no-growth scenario chosen for the tIRAs).

My perspective is colored as well. DW and I are of a similar age as you, have been converting for years, and also have over 50% in Roth accounts. We also have equities concentrated in taxable accounts. I have been evaluating the future tax picture using mortality tables to give probabilities of different filing statuses for each year. For example, about 15 years from now there is a 50% probability that both of us will be alive, and an 8% probability that neither will be alive. So a 42% chance that one of us will be around. Charities (tax rate = 0%) will get the tIRAs after both of us are worm food. So I calculate probable taxes in that year as 50%*MFJ + 42%*Single + 8%*0%.

I used this calculator from the Kitces website to come up with the probabilities.

I haven't evaluated the LTC probabilities. We don't have LTC insurance, so it is certainly a factor. For right now I would evaluate our health as much better than average for our age cohort, which would argue for more years at MFJ and less likelihood of a zero tax rate due to LTC expenses. Perhaps there's a bit of a balance there. Though I realize health status can turn on a dime, and that the longer you live the more likely it is that LTC will be required.

There aren't any exact answers, but it certainly helps to try to understand all the factors involved.

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Re: Roth Conversions and taxes

Post by hushpuppy » Wed Sep 20, 2017 1:19 pm

delete
Last edited by hushpuppy on Fri Nov 17, 2017 10:33 am, edited 1 time in total.
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DSInvestor
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Re: Roth Conversions and taxes

Post by DSInvestor » Wed Sep 20, 2017 1:37 pm

veyron wrote:
Wed Sep 20, 2017 1:07 pm
As in my reply to Chip above, I keep some bonds in my taxable account to use during a market correction.
Just because all the bonds are in the IRA, it doesn't mean that you can't use bonds to meet a cash need while withdrawing from taxable account. It just requires an extra trade.

1. In taxable, sell 50K stocks in taxable.
2. In IRA, Exchange 50K bonds for 50K stocks.

The cash is raised by the sale of stocks and the exchange replenishes the stocks in the IRA. Your stock position is maintained. The net effect is that you've sold bonds to meet the cash need. No IRA withdrawal was required even though all the bonds are in IRA.
Last edited by DSInvestor on Wed Sep 20, 2017 1:39 pm, edited 1 time in total.

veyron
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Re: Roth Conversions and taxes

Post by veyron » Wed Sep 20, 2017 1:38 pm

livesoft wrote:
Wed Sep 20, 2017 12:53 pm
veyron wrote:
Wed Sep 20, 2017 12:44 pm
..., but for now, the reason I keep that much in bonds in my taxable account is if/when the market corrects, I can use those bonds for living expenses instead of having to take distributions from the bonds in my tIRA.
We don't do that because

1. When we sell equities in taxable, we simply exchange bond fund into equity fund in tax-advantaged in order to keep our asset allocation where we want it.

2. If we "sell low" in taxable, then we are "buying low" in tax-advantaged.

3. At age 60, there is no penalty anyways for withdrawing from tax-deferred, so there is no point in keeping bonds in taxable I think.

4. Bonds in taxable means less tax-loss harvesting opportunities ... although I realize last December that TLH of tax-exempt munis was the subject of about 138 threads on bogleheads.org.
1. & 2. That makes sense, however, I would then be increasing the stock portion (and decreasing the bond portion) of my tIRA, which is what I wanted to avoid since in the long run, our RMDs would then increase (especially after the market rebounds). In my situation, I would think it would be best to have stock funds in taxable accounts after a correction so all that growth won't be in a tax advantaged account. Or am I missing something?

3. That's correct, but I'd have ordinary taxable income on any distributions, or my available Roth conversion amount would have to be reduced to avoid increasing taxable income.

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Re: Roth Conversions and taxes

Post by Chip » Wed Sep 20, 2017 1:48 pm

veyron wrote:
Wed Sep 20, 2017 1:38 pm
1. & 2. That makes sense, however, I would then be increasing the stock portion (and decreasing the bond portion) of my tIRA, which is what I wanted to avoid since in the long run, our RMDs would then increase (especially after the market rebounds). In my situation, I would think it would be best to have stock funds in taxable accounts after a correction so all that growth won't be in a tax advantaged account. Or am I missing something?
I think you're missing something. We're talking about swapping 377k of stocks for bonds in your tIRA right now. That's the thing that will likely reduce your future RMDs.

If (when) we have another 2008-9 crash you'll swap SOME of those tIRA bonds for stocks. But you're still better off from an RMD standpoint than if you'd left 377k of bonds in taxable.

Also, if we have another crash, convert like crazy. If we're lucky enough to get a quick rebound you will have effectively stuffed a bunch into your Roth at a low tax cost. You can always recharacterize if it doesn't work out as you hoped.

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Re: Roth Conversions and taxes

Post by celia » Wed Sep 20, 2017 2:38 pm

veyron wrote:
Wed Sep 20, 2017 8:17 am
Wife is retired, I am part-time considering full retirement but am the type who is always concerned about running out of money, so I can't seem to pull the trigger.
First, the more you continue to work, the more you fall into the "deep tax hole" you are digging for yourself. So stop it. :oops:
Why make future taxes worse?


#Cruncher above did some calcs above using inflation-adjusted estimates. Yes, tax brackets, and SS increase each year, but your investments should increase more than that. As long as you have stock funds in a TIRA and the RMD withdrawal rate is less than the growth rate on your TIRAs, the value of the TIRAs (and RMDs) will increase.

If you and your wife were 70 today and had just started a full year of SS, your $72,000 of SS (of which $10,800 is tax-free) and your RMDs of $70,000 alone would give you an AGI of $131,200. After subtracting a Married standard deduction and 2 exemptions, your Taxable Income (line 43 of the 1040) is $110,400, which is in the 25% tax bracket already. And that is without considering any other income such as pensions or LTC gains in taxable! So, yes, you will be in at least that tax bracket, unless you start converting or giving those RMDs to charity after you turn 70.5.

What I suggest is for you to start converting to the top of the 28% tax bracket until you turn 63, then re-evaluate. Once you get some assets in Roths, you can pump up the IRA growth there, not in TIRAs. But you have to get more dollars in there first. Be sure you convert into new (empty) Roths so that you can recharacterize in the future, should the markets drop and you want to re-do your Roth conversion (ie, get more shares converted for the same tax hit). And you may have to sell some of your taxable assets to cover the taxes. So take that into account when looking at remaining room in the tax bracket.

But you also need to stop working. If you have an emotional or social need to work, how about doing volunteer work for some non-profits until you find the situation that feels most satisfying to you?

------------------------

A word about the taxes that might seem huge to you:
While you were working, you tax-deferred some of your income which brought down your taxes in your working years. The taxes were not avoided, just deferred until later. The "later" is now approaching. When you put money into the TIRA (or employer plans), you were agreeing to give Uncle Sam and your state the taxes later. Some of your tax-deferred money really belonged to them. You have been investing it for them and for yourself all these years. It was never all yours, even though your statements just had your name on it. The IRA really belonged to you, Uncle Sam, and the state.

As you start to withdraw from the TIRA, Uncle Sam and the state want their shares. You could even estimate how much of each TIRA actually belongs to them now. Obviously, you (and your wife) own part of those TIRAs, but not their entirety. So, if you keep in mind that the TIRAs were never all yours to begin with, you will be more aware that you are just paying back what you owe them from your working years. This is on top of your current year taxes you would normally owe.

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Re: Roth Conversions and taxes

Post by livesoft » Wed Sep 20, 2017 3:42 pm

Yes, my spouse is still working and really messes up all my Roth conversion plans even though I ask her to retire. But for the most part, I can treat her income like a "pension" and just deal with it.
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Re: Roth Conversions and taxes

Post by The Wizard » Wed Sep 20, 2017 5:11 pm

The OP is a good candidate for creating a home grown spreadsheet projecting annual AGI or Taxable Income for each year from now to age 70.
Then do Roth conversions each year to level your AGI to a degree, perhaps allowing 3% to 5% growth in AGI each year.
Goal is to keep the age 70 jump in AGI modest.

This approach ignores marginal bracket tops, which seems to be a key point of some people's methods.
This explains why I do Roth conversions in the low end of the 28% Federal bracket.

This personal spreadsheet approach is aiming at a moving target since we don't know how Mr Market will do from year to year.
And in my case, I don't know how much, if any, part-time income I might have each year in retirement.
But by December, I have good idea of part-time income and can tweak Roth conversion amount to keep AGI roughly where I want it.

I do update my spreadsheet in January each year with the actual numbers that will impact future taxable income, such as tax deferred portfolio size...
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Re: Roth Conversions and taxes

Post by #Cruncher » Wed Sep 20, 2017 8:14 pm

celia wrote:
Wed Sep 20, 2017 2:38 pm
If you and your wife were 70 today ..., your $72,000 of SS ... and your RMDs of $70,000 alone would give you an AGI of $131,200. After subtracting a Married standard deduction and 2 exemptions, your Taxable Income (line 43 of the 1040) is $110,400, which is in the 25% tax bracket already.
Taxable income in this case is only $105,400, Celia, for the following two reasons:
  • With only $70,000 of other income, less than 85% of the $72,000 SS is taxable.
  • If both filers are age 65 or more, the standard deduction is $2,500 higher.
continuing, celia wrote:And that is without considering any other income such as pensions or LTC gains in taxable!
The 25% bracket is broad: from $75,900 to $153,100 on a joint return. It would take a lot of other ordinary income, like a pension, to reach the 28% bracket. Moreover, no amount of Long Term Capital Gains or Qualified Dividends would cause ordinary income to reach the 28% bracket. This is because they sit on top of ordinary income as shown in the chart prepared by member tfb in this post.

It is also shown in the following table prepared with the Compare sheet of my Marginal Tax Rates spreadsheet and confirmed with TaxAct Calculator.

Code: Select all

Social Security 50% threshhold    32,000   -------------------------------->
Social Security 85% threshhold    44,000   -------------------------------->
Ord Income Tax Bracket 15%        18,650   -------------------------------->
Ord Income Tax Bracket 25%        75,900   -------------------------------->
Ord Income Tax Bracket 28%       153,100   -------------------------------->

Code: Select all

                                  Case A   Case B   Case C   Case D   Case E <- Cases explained below
Non-SS Ordinary Income            70,000   72,941   72,941  115,200  116,200
LTCG & QDI                           -        -     30,000   30,000   30,000
Social Security Benefit           72,000   72,000   72,000   72,000   72,000
SS Relevant Income               106,000  108,941  138,941  181,200  182,200
50% SS taxable                     6,000    6,000    6,000    6,000    6,000
85% SS taxable                    52,700   55,200   55,200   55,200   55,200
Total SS taxable                  58,700   61,200   61,200   61,200   61,200 <- Case B reaches max 85% 
Adjusted gross income            128,700  134,141  164,141  206,400  207,400
Deductions plus Exemptions        23,300   23,300   23,300   23,300   23,300
Taxable Income                   105,400  110,841  140,841  183,100  184,100
LTCG & QDI Taxable                   -        -     30,000   30,000   30,000
Ordinary Taxable                 105,400  110,841  110,841  153,100  154,100 <- unaffected by LTCG

Code: Select all

Ordinary taxable @ 28%               -        -        -        -      1,000 <- Case E in 28% bracket
Ordinary taxable @ 25%            29,500   34,941   34,941   77,200   77,200
Ordinary taxable @ 15%            57,250   57,250   57,250   57,250   57,250
Ordinary taxable @ 10%            18,650   18,650   18,650   18,650   18,650
LTCG & QDI taxable @ 15%             -        -     30,000   30,000   30,000
LTCG & QDI taxable @ 0%              -        -        -        -        -  
Ordinary tax @ 28%                   -        -        -        -        280 <- Case E in 28% bracket
Ordinary tax @ 25%                 7,375    8,735    8,735   19,300   19,300
Ordinary tax @ 15%                 8,588    8,588    8,588    8,588    8,588
Ordinary tax @ 10%                 1,865    1,865    1,865    1,865    1,865
LTCG & QDI tax @ 15%                 -        -      4,500    4,500    4,500
Total tax                         17,828   19,188   23,688   34,253   34,533

Code: Select all

Increased ord income LTCG & QDI         2,941   30,000   42,259    1,000
Increased taxable SS                    2,500        0      -        -  
Increased tax                           1,360    4,500   10,565      280
Marginal SS taxable                    85.00%    0.00%    0.00%    0.00%
Marginal tax rate                      46.25%   15.00%   25.00%   28.00%
  • Case A: $70,000 RMD and $72,000 SS posited by Celia.
  • Case B: Add $2,941 of non-SS ordinary income. This makes 85% of SS benefit taxable ($61,200).
  • Case C: Add $30,000 of LTCG & QDI. This does not move ordinary income any closer to the 28% bracket.
  • Case D: Add $42,259 of non-SS ordinary income. Ordinary income is now $153,100, the top of the 25% bracket.
  • Case E: Add $1,000 of non-SS ordinary income just to show that am now in 28% bracket.

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Re: Roth Conversions and taxes

Post by smitcat » Thu Sep 21, 2017 8:22 am

The Wizard wrote:
Wed Sep 20, 2017 5:11 pm
The OP is a good candidate for creating a home grown spreadsheet projecting annual AGI or Taxable Income for each year from now to age 70.
Then do Roth conversions each year to level your AGI to a degree, perhaps allowing 3% to 5% growth in AGI each year.
Goal is to keep the age 70 jump in AGI modest.

This approach ignores marginal bracket tops, which seems to be a key point of some people's methods.
This explains why I do Roth conversions in the low end of the 28% Federal bracket.

This personal spreadsheet approach is aiming at a moving target since we don't know how Mr Market will do from year to year.
And in my case, I don't know how much, if any, part-time income I might have each year in retirement.
But by December, I have good idea of part-time income and can tweak Roth conversion amount to keep AGI roughly where I want it.

I do update my spreadsheet in January each year with the actual numbers that will impact future taxable income, such as tax deferred portfolio size...
Wizard - Have you tried the RPM spreadsheet/calculator that was developed by a member on this board? It lays all of that out for you as well as dozens of other outputs and also offers the ability to set a base case and make comparisons quickly yielding not only the results of the comparison but have it charted as well.
We had a spreadsheet we were using to do nearly the sane as whet your described but have abandoned it for the most part after seeing the value of the RPM.

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Re: Roth Conversions and taxes

Post by The Wizard » Thu Sep 21, 2017 8:42 am

smitcat wrote:
Thu Sep 21, 2017 8:22 am

Wizard - Have you tried the RPM spreadsheet/calculator that was developed by a member on this board? It lays all of that out for you as well as dozens of other outputs and also offers the ability to set a base case and make comparisons quickly yielding not only the results of the comparison but have it charted as well.
We had a spreadsheet we were using to do nearly the sane as whet your described but have abandoned it for the most part after seeing the value of the RPM.
I downloaded the RPM file a month or two ago but haven't populated it with my own numbers yet.
I should...
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Re: Roth Conversions and taxes

Post by smitcat » Thu Sep 21, 2017 11:06 am

The Wizard wrote:
Thu Sep 21, 2017 8:42 am
smitcat wrote:
Thu Sep 21, 2017 8:22 am

Wizard - Have you tried the RPM spreadsheet/calculator that was developed by a member on this board? It lays all of that out for you as well as dozens of other outputs and also offers the ability to set a base case and make comparisons quickly yielding not only the results of the comparison but have it charted as well.
We had a spreadsheet we were using to do nearly the sane as whet your described but have abandoned it for the most part after seeing the value of the RPM.
I downloaded the RPM file a month or two ago but haven't populated it with my own numbers yet.
I should...
It does what you want and so much more - perhaps just review the template with all the charts and options and see how it may apply to your situation.
It takes a bunch of time to set it up correctly but I find it was definitely worth it now that we can update it swiftly.

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Re: Roth Conversions and taxes

Post by veyron » Fri Sep 22, 2017 8:22 am

OP here. Thanks everyone for all your valuable advice, input and comments.

This is what I’m going to do right now:
-In our taxable account: Exchange the $377k in TE bond fund for $377k in total stock fund.
-In our tIRA accounts: Exchange $377k in total stock fund for $377k in total bond fund. I’m also going to exchange an additional $100k from stock fund to bond fund to get us closer to the 70/30 stock/bond ratio.
-These immediate changes have allowed me to reduce my projected annual market growth rate in our tIRA accounts from 6% to 4%, which made a significant reduction in future RMDs.

When we need to withdraw funds for living expenses: I will sell stock fund in taxable account then exchange an equal amount from bond fund in tIRA account into stock fund in tIRA account. Unfortunately, this will act to increase future RMDs and seems counterintuitive, and so I’m still not convinced about this one. However, I may not have any other options if I wish to maintain the 70/30 ratio.

During the next market correction: I will make Roth conversions up to the top of the 25% or 28% tax bracket, since, depending on how much the market drops, the long term savings from converting stocks at a devalued price should more than make up for the additional taxes. And of course this will also reduce future RMDs.

While in our 60’s: Each year I will monitor what our projected RMDs will look like and in some years may make Roth conversions into and up to the 25% tax bracket where prudent. But for the most part, I will keep us in the 15% tax bracket, allowing cap gains & QDI to escape taxation.

When we turn 70: Since we will be in the 25% tax bracket anyway (due to SSA & RMDs), I will consider making annual Roth conversions up to the top of the 25% tax bracket to further reduce future RMDs. Of course I will have to factor in the $170,000 MAGI limit for the Medicare premium surcharge and any AMT triggers, so this may not be possible.

Another consideration: For every additional year that I work now, I could make a Roth conversion up to the top of the 25% tax bracket with the thought that the money I earn would cover the additional taxes. Working also saves us a lot in health insurance premiums.

Thanks again to everyone for all the time and effort in helping me arrive at, what I hope is, a good strategy. Any additional comments or thoughts on the above philosophies would also be greatly appreciated.

veyron

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Re: Roth Conversions and taxes

Post by Chip » Fri Sep 22, 2017 9:50 am

I think it's generally a good plan.

Have you considered the tax rates of the beneficiaries of your IRAs after both you and your wife are gone? If those rates are low it might make sense to convert less than you would if their rates are high.

Don't forget the Medicare IRMAA limits apply not just after you're 70; it kicks in at age 63. Any conversion to the top of the 25% bracket after that age will trip those limits.
Another consideration: For every additional year that I work now, I could make a Roth conversion up to the top of the 25% tax bracket with the thought that the money I earn would cover the additional taxes.
Well, money is fungible so I don't think it really matters whether you're working or not. It's a bit of mental accounting you're doing with this.

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Re: Roth Conversions and taxes

Post by veyron » Fri Sep 22, 2017 10:34 am

Chip wrote:
Fri Sep 22, 2017 9:50 am
I think it's generally a good plan.

Have you considered the tax rates of the beneficiaries of your IRAs after both you and your wife are gone? If those rates are low it might make sense to convert less than you would if their rates are high.

Don't forget the Medicare IRMAA limits apply not just after you're 70; it kicks in at age 63. Any conversion to the top of the 25% bracket after that age will trip those limits.
Another consideration: For every additional year that I work now, I could make a Roth conversion up to the top of the 25% tax bracket with the thought that the money I earn would cover the additional taxes.
Well, money is fungible so I don't think it really matters whether you're working or not. It's a bit of mental accounting you're doing with this.
All beneficiaries are in the 25% tax bracket at this time. Re Medicare IRMAA limits, I actually have a reminder in my spreadsheet to make sure MAGI is less than $170k once I turn 63. Chip, thanks for being so detail-oriented, it really helps to make sure nothing is overlooked.

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Re: Roth Conversions and taxes

Post by my name » Fri Sep 22, 2017 11:00 am

veyron wrote:
Fri Sep 22, 2017 8:22 am

When we turn 70: Since we will be in the 25% tax bracket anyway (due to SSA & RMDs),

veyron
This is an outstanding thread. My numbers are similar, the RDM and full SS begin next year. Veyron, you've done a good summary and plan that will be great food-to-thought. Thank you.

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Re: Roth Conversions and taxes

Post by #Cruncher » Fri Sep 22, 2017 11:05 am

veyron wrote:
Fri Sep 22, 2017 8:22 am
When we turn 70: Since we will be in the 25% tax bracket anyway (due to SSA & RMDs), I will consider making annual Roth conversions up to the top of the 25% tax bracket to further reduce future RMDs.
Because of the comlicated way SS benefits affect federal income tax (see Taxation of Social Security benefits in the Wiki), I suggest each year you wait until December and use a tax calculator before deciding how much Roth converting, if any, to do. For example, using the assumptions in my first post, you'd need $38,000 of non-SS ordinary income before you drop to a 25% marginal tax rate. Non-SS ordinary income below that could trigger a marginal tax rate much higher than 25%.

For an extreme illustration, assume before age 70 you'd converted your IRAs down so much that your non-SS ordinary income was only $16,300. The table in my first post shows that $21,700 of conversions would then trigger federal tax of $9,000, a marginal rate of over 40%.

Code: Select all

                               Non-SS             Mar-
                              Ordinary  Federal   ginal
                               Income     Tax     Rate
                               ------    -----    ----
Start of 55.5% marginal rate   16,324    5,953
Start of 25.0% marginal rate   38,000   14,953
                               ------   ------
Increase                       21,676    9,000    41.5%

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Re: Roth Conversions and taxes

Post by veyron » Fri Sep 22, 2017 12:07 pm

#Cruncher wrote:
Fri Sep 22, 2017 11:05 am
veyron wrote:
Fri Sep 22, 2017 8:22 am
When we turn 70: Since we will be in the 25% tax bracket anyway (due to SSA & RMDs), I will consider making annual Roth conversions up to the top of the 25% tax bracket to further reduce future RMDs.
Because of the comlicated way SS benefits affect federal income tax (see Taxation of Social Security benefits in the Wiki), I suggest each year you wait until December and use a tax calculator before deciding how much Roth converting, if any, to do. For example, using the assumptions in my first post, you'd need $38,000 of non-SS ordinary income before you drop to a 25% marginal tax rate. Non-SS ordinary income below that could trigger a marginal tax rate much higher than 25%.

For an extreme illustration, assume before age 70 you'd converted your IRAs down so much that your non-SS ordinary income was only $16,300. The table in my first post shows that $21,700 of conversions would then trigger federal tax of $9,000, a marginal rate of over 40%.

Code: Select all

                               Non-SS             Mar-
                              Ordinary  Federal   ginal
                               Income     Tax     Rate
                               ------    -----    ----
Start of 55.5% marginal rate   16,324    5,953
Start of 25.0% marginal rate   38,000   14,953
                               ------   ------
Increase                       21,676    9,000    41.5%
Thanks for pointing that out Cruncher, but in looking at my calculations and projections, I'm thinking my RMDs alone will be between $70k-$80K/year (and more as time goes by), so 85% of my SSA benefits will always be subject to tax. Unfortunately, I cannot escape those taxes.

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Re: Roth Conversions and taxes

Post by veyron » Fri Sep 22, 2017 12:08 pm

my name wrote:
Fri Sep 22, 2017 11:00 am
veyron wrote:
Fri Sep 22, 2017 8:22 am

When we turn 70: Since we will be in the 25% tax bracket anyway (due to SSA & RMDs),

veyron
This is an outstanding thread. My numbers are similar, the RDM and full SS begin next year. Veyron, you've done a good summary and plan that will be great food-to-thought. Thank you.
Thanks for the kind words!

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Re: Roth Conversions and taxes

Post by ChrisC » Fri Sep 22, 2017 1:10 pm

veyron wrote:
Fri Sep 22, 2017 10:34 am
Chip wrote:
Fri Sep 22, 2017 9:50 am
I think it's generally a good plan.

Have you considered the tax rates of the beneficiaries of your IRAs after both you and your wife are gone? If those rates are low it might make sense to convert less than you would if their rates are high.

Don't forget the Medicare IRMAA limits apply not just after you're 70; it kicks in at age 63. Any conversion to the top of the 25% bracket after that age will trip those limits.
Another consideration: For every additional year that I work now, I could make a Roth conversion up to the top of the 25% tax bracket with the thought that the money I earn would cover the additional taxes.
Well, money is fungible so I don't think it really matters whether you're working or not. It's a bit of mental accounting you're doing with this.
All beneficiaries are in the 25% tax bracket at this time. Re Medicare IRMAA limits, I actually have a reminder in my spreadsheet to make sure MAGI is less than $170k once I turn 63. Chip, thanks for being so detail-oriented, it really helps to make sure nothing is overlooked.
I'm similarly situated for the most part with the OP, except that our taxable pension income is $144k per year and that alone places us in the 25% bracket. Been doing conversions the last 3 years and been tripping over into the lower range of the 28% bracket, just enough to land below the second tier of IRMAA. But with a combined tIRA and 401k portfolio of $1.8 million, I'm thinking whether savings from being in a lower IRMAA tier is better financially than converting well into the 28% bracket. And in our case, only my spouse at 66 is covered by Medicare Part B and though I'm 64, I'm not Medicare eligible yet and when I become eligible at 65, next year, I probably won't enroll in Part B as my FEHB insurance will be sufficient for me.

I also have LTCi so I don't expect big medical deductibles. Kids are in the 28 and 33 tax brackets so ramping up our Roths would be a good legacy play for them. I'm software challenged so the 2 applications mentioned in this thread would not be of any use to me. I really appreciate the input in this thread especially Cruncher, but is there some knowledgeable professional service that could take your data and tell you the most optimal strategy over a long term basis?

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Re: Roth Conversions and taxes

Post by Chip » Fri Sep 22, 2017 1:44 pm

I don't know who would do those calcs other than a financial planner. Or the Boglehead collective. :D

The first year RMD on your IRA/401k balance is 3.65%. So on your current balance it's 66k.

Think of the IRMAA tier as a lump sum "tax" you have to pay. Just throwing out some numbers, let's assume you're converting to a taxable income of 184k (214k MAGI less 30k of deductions/exemptions). If you were to go to the top of the 28% bracket (233k taxable income) your wife would have to pay another ~1000/year in Medicare premiums (12 * 80).

So your marginal rate to convert another 49k (233-184) is (28%*49+1)/49 = 30%. That's the best rate you'd get. If you convert less, but still above IRMAA, the marginal rate on the extra conversion goes up.

You will probably also incur the 3.8% Medicare surtax if MAGI is greater than 250k and you have net investment income. So that would enter into the equation as well.

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Re: Roth Conversions and taxes

Post by ChrisC » Fri Sep 22, 2017 2:43 pm

Chip wrote:
Fri Sep 22, 2017 1:44 pm
I don't know who would do those calcs other than a financial planner. Or the Boglehead collective. :D

The first year RMD on your IRA/401k balance is 3.65%. So on your current balance it's 66k.

Think of the IRMAA tier as a lump sum "tax" you have to pay. Just throwing out some numbers, let's assume you're converting to a taxable income of 184k (214k MAGI less 30k of deductions/exemptions). If you were to go to the top of the 28% bracket (233k taxable income) your wife would have to pay another ~1000/year in Medicare premiums (12 * 80).

So your marginal rate to convert another 49k (233-184) is (28%*49+1)/49 = 30%. That's the best rate you'd get. If you convert less, but still above IRMAA, the marginal rate on the extra conversion goes up.

You will probably also incur the 3.8% Medicare surtax if MAGI is greater than 250k and you have net investment income. So that would enter into the equation as well.
I might have to post my financial data and beg for input from the Bogelhead collective. :beer Your numbers aren't far off from what we've been doing so far, but it nonetheless gets more complicated when you have spouses with different ages with lopsided/unbalanced retirement accounts and social security retirement benefits. Also, my pension and distributions from TSP accounts are exempted from State income taxes as well. The last few years we've been converting from my wife's accounts, which now has a balance (in mostly equities) of $400K, leaving my balance of $1.4 million untouched. I have a Roth at $250K; wife has a Roth at $200K.

Perhaps, from what you're telling me, I should think about converting into the high range of the 28% bracket, even if it costs us another $1000 in IRMAA. Not worried that much about the Medicare surcharge tax of 3.8 percent, at this time, because my taxable position is mostly in cash, and investment income (from rentals and dividends) is not that great though I can see it rising rapidly in the next few years as we deploy our cash into higher income generating positions.

Thanks for the input.

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Re: Roth Conversions and taxes

Post by Nicolas » Fri Sep 22, 2017 4:40 pm

DSInvestor wrote:
Wed Sep 20, 2017 1:37 pm
veyron wrote:
Wed Sep 20, 2017 1:07 pm
As in my reply to Chip above, I keep some bonds in my taxable account to use during a market correction.
Just because all the bonds are in the IRA, it doesn't mean that you can't use bonds to meet a cash need while withdrawing from taxable account. It just requires an extra trade.

1. In taxable, sell 50K stocks in taxable.
2. In IRA, Exchange 50K bonds for 50K stocks.

The cash is raised by the sale of stocks and the exchange replenishes the stocks in the IRA. Your stock position is maintained. The net effect is that you've sold bonds to meet the cash need. No IRA withdrawal was required even though all the bonds are in IRA.
Great thread. I'm contemplating the move suggested in this example but I'm concerned there could be a flaw in logic regarding the amount to exchange in the tIRA to equalize the selling of stocks in taxable.

The tIRA is not all your money, it's part yours and part your Uncle Sam's. So it's not a dollar-for-dollar equivalence. If you expect to draw down the tIRA at a 25% federal tax rate eventually, wouldn't you have to exchange 67K in the tIRA to equal the 50K sale in the taxable account (since 67K - 25% = 50K, roughly)? Otherwise the value to you personally is not the same. Your portfolio will be out of balance.

Chip
Posts: 1650
Joined: Wed Feb 21, 2007 4:57 am

Re: Roth Conversions and taxes

Post by Chip » Sun Sep 24, 2017 10:51 am

Nicolas wrote:
Fri Sep 22, 2017 4:40 pm
Great thread. I'm contemplating the move suggested in this example but I'm concerned there could be a flaw in logic regarding the amount to exchange in the tIRA to equalize the selling of stocks in taxable.

The tIRA is not all your money, it's part yours and part your Uncle Sam's. So it's not a dollar-for-dollar equivalence. If you expect to draw down the tIRA at a 25% federal tax rate eventually, wouldn't you have to exchange 67K in the tIRA to equal the 50K sale in the taxable account (since 67K - 25% = 50K, roughly)? Otherwise the value to you personally is not the same. Your portfolio will be out of balance.
This is correct but you also have to consider the tax rate on the taxable account. And you have to decide if the entire tIRA will be withdrawn at a 25% marginal rate. See my example upthread about the probabilities of one or both being alive at a given year during tIRA withdrawal.

So many of us don't bother to tax adjust the way you described because these and other factors will likely overwhelm the seeming precision of the calculation. e.g. one spouse dying early, large LTC bills resulting in zero tax rate, market crash with length recovery (lower RMDs).

For my purposes I just assume a similar tax rate for taxable and tIRA. You can make a good case for tax-adjusting the Roth, but I don't bother with it.

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FiveK
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Re: Roth Conversions and taxes

Post by FiveK » Sun Sep 24, 2017 4:50 pm

Assuming $30K in qualified dividends and/or long term capital gains, and the $72K SS income expected, a 70 year old couple filing in 2017 would have the marginal rates shown below for the combination of federal income tax and Medicare premiums. With 25% being the minimum rate you are likely to pay (because the RMD will take you past the small section costing <20%), converting up through a 25% rate now is defensible.

Image

With the same $30K in QD+LTCG, and no SS, a 60 year old couple filing in 2017 would have the marginal rates shown below for federal income tax. Because the presence of QD+LTCG causes a 30% rate before one hits the 25% rate, if you are going to convert into the 25% bracket you might as well do so up to the very top.

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See Tools and calculators - Personal_finance_toolbox - Bogleheads if you would like to enter your own more accurate numbers.

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