Roth Conversion and/or Roth Contribution for those with Few Taxable Assets?

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hawkfan55
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Roth Conversion and/or Roth Contribution for those with Few Taxable Assets?

Post by hawkfan55 » Thu Dec 07, 2017 1:24 am

Edit: I'm changing the title of this thread to better describe who this thread may interest. This thread applies more to retirees in pre-retirement and early retirement who have saved primarily in tax deferred accounts (401k, 403b, Rollover IRA, tIRA), who are considering Conversion to tax free accounts (Roth IRA) and who have small to no taxable assets from which to pay taxes on conversions/contributions.

Hi Bogleheads! I'm hoping you can help me decide on this end of year investment decision. Details are as follows...
I retired this year at Age 62 and have withdrawn 50k from my rollover IRA account, approx. 3.6% of our retirement portfolio.
DW, 58, is still working for another 1.5 years. She will contribute 24k to her 403b this year reducing her taxable income to approx. 46k.
With the above earnings and withdrawals, less deductions, we will be at the top of the federal 15% marginal tax bracket and in the 8.9% bracket for state tax.

We are considering one or both of the following Roth transactions prior to the end of year ...
1. Contribute 6.5k to each of our Roth IRAs before end of year. This 13k would come from our earnings/rollover IRA withdrawals already taken this year.
AND/OR
2. Convert a portion of my rollover IRA to Roth IRA taking tax payments from the same withdrawal. This Roth Conversion would be taxed at 25% federal and 8.9% state. iORP tells me that conversions from deferred to Roth IRA are recommended.

Would you recommend either or both of these transactions? Would one of these transactions be preferred over the other?

Edit:
We do not have taxable savings, other than about 6 months expenses in a 1.25% savings account, from which we draw monthly to pay living expenses. I am withdrawing twice a year from my Rollover IRA to replenish this income stream. DW's take home salary is combined with my Rollover IRA withdrawals to meet our yearly expenses. Yearly expenses are 90-95k in today's dollars.
We have 980k in tax deferred (r/o IRA and 403b), me @ 670k and DW @ 310k
We have 415k in Roth IRA.
I will start Pension at age 65, approx. 13k
DW must start Pension upon retirement at age 60, approx. 41k
I plan to start SS at FRA, age 66 (possibly later), approx. 33k at FRA
DW plans to start SS at FRA, age 67 (possibly sooner), approx. 23k at FRA

As a retiree, I am trying to figure out, while my wife has income from working and we could contribute to our Roth IRAs, if it would be worthwhile to do so? In essence, any contribution or conversion to our Roth IRAs would come from and have taxes paid from my r/o IRA account withdrawals. We are not planning on withdrawing from our Roth IRAs until after we have depleted our deferred retirement accounts or reduced them to a level where, combined with pensions, social security, and RMDs, we can keep our taxes in the 15% bracket.

I-ORP says if we do conversions over the next 7-8 years in the 25% fed and 8.9% state brackets, we will then be in the 15% bracket for the balance of our planned retirement. If we do not do conversions, we will be in the 25% bracket for 20+ years.

Again, thank you for your thoughts.
Last edited by hawkfan55 on Fri Dec 08, 2017 1:53 pm, edited 6 times in total.

Thesaints
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Re: Roth Conversion and/or Roth Contribution?

Post by Thesaints » Thu Dec 07, 2017 3:00 am

Those 13k you may contribute to a Roth will be taxed no matter what.
Instead, you may chose not to tax your rollover IRA.
Unless you have pressing needs to invest more than 13k in a Roth, I’d say the choice is straightforward.

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celia
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Re: Roth Conversion and/or Roth Contribution?

Post by celia » Thu Dec 07, 2017 3:49 am

It's hard to give specific advice as you did not give enough specifics. It seems you may have $1.4M in retirement accounts (since 1.4M * 3.6% = 50K) but we don't know if that is all tax-deferred or a good part of it is Roth. As it stands now, your tax liability is based on both of your wages for the year, the $50K withdrawal, and interest and dividends in taxable accounts. If you also do a Roth conversion this year, the amount withdrawn from the tax-deferred account, even if it is withheld for taxes, will increase your taxable income. I am also puzzled as to why DW is putting 24K into her tax-deferred account in the same year you are withdrawing more than that. You could have just withdrawn $26K and not added anything to the 403b if you needed 50K for something.
hawkfan55 wrote:
Thu Dec 07, 2017 1:24 am
I-ORP says if we do conversions over the next 8 years in the 25% fed and 8.9% state brackets, we will then be in the 15% bracket for the balance of our planned retirement. If we do not do conversions, we will be in the 25% bracket for 20+ years.
It's also hard to tell if I-ORP is correct since we don't know what inputs you gave it and how much you would be converting each year. A similar thread about figuring out how much to convert can be found here:
http://www.bogleheads.org/forum/viewtop ... &p=2962376

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FiveK
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Re: Roth Conversion and/or Roth Contribution?

Post by FiveK » Thu Dec 07, 2017 4:10 am

hawkfan55 wrote:
Thu Dec 07, 2017 1:24 am
We will have pensions and social security.
When will you have those?
SS can (and probably should) be deferred. If you can get higher annual pension payments in return for deferring that as well, it is worth considering pension deferral also.

Deferring one or both of SS+pension would provide more room for Roth conversions at lower marginal rates.

If one has the cash flow, paying taxes on traditional -> Roth conversions from taxable funds is usually better than paying the taxes from the traditional funds. E.g., starting with $10K in traditional, $2500 extra in a checking/savings account), and paying 25% tax, it would be better to end with $10K in Roth and $0 extra in checking/savings, vs. $7500 in Roth and $2500 extra in checking/savings.

hawkfan55
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Re: Roth Conversion and/or Roth Contribution?

Post by hawkfan55 » Thu Dec 07, 2017 1:59 pm

Thesaints wrote:
Thu Dec 07, 2017 3:00 am
Those 13k you may contribute to a Roth will be taxed no matter what.
Instead, you may chose not to tax your rollover IRA.
Unless you have pressing needs to invest more than 13k in a Roth, I’d say the choice is straightforward
Thesaints, thank you for your reply. We do not have pressing needs to contribute more than 13k in our Roth IRAs or, for that matter, to even contribute to our Roth IRAs.

We do not have taxable savings, other than about 6 months expenses in a 1.25% savings account, from which we draw monthly to pay living expenses. I am withdrawing twice a year from my r/o IRA to replenish this income stream. DW's take home salary is combined with my r/o IRA withdrawals to meet our yearly expenses.

As a retiree, I am trying to figure out, while my wife has income from working and we could contribute to our Roth IRAs, if it would be worthwhile to do so? In essence, any contribution or conversion to our Roth IRAs would come from and have taxes paid from my r/o IRA account withdrawals. We are not planning on withdrawing from our Roth IRAs until after we have depleted our deferred retirement accounts or reduced them to a level where, combined with pensions, social security, and RMDs, we can keep our taxes in the 15% bracket.
Again, thank you for your thoughts.
Last edited by hawkfan55 on Thu Dec 07, 2017 6:11 pm, edited 1 time in total.

hawkfan55
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Re: Roth Conversion and/or Roth Contribution?

Post by hawkfan55 » Thu Dec 07, 2017 4:46 pm

Hi Celia and FiveK, thank you for replying to my questions.
It seems you may have $1.4M in retirement accounts (since 1.4M * 3.6% = 50K) but we don't know if that is all tax-deferred or a good part of it is Roth.
We have 980k in tax deferred (r/o IRA and 403b), me @ 670k and DW @ 310k
We have 415k in Roth IRA.
If you also do a Roth conversion this year, the amount withdrawn from the tax-deferred account, even if it is withheld for taxes, will increase your taxable income.
Yes, you are correct. We are currently at the top of the 15% bracket and, if we do the Roth Conversions, we will withdraw the conversion and taxes from my R/O IRA account up to the top of the 25% fed tax bracket. The state taxes of 8.9% will also be withdrawn. It's basically a pay me 25% now or later decision. We may or may not move to a state where taxes are less. I am three years from Medicare so premium cost would not be affected.
I am also puzzled as to why DW is putting 24K into her tax-deferred account in the same year you are withdrawing more than that. You could have just withdrawn $26K and not added anything to the 403b if you needed 50K for something.
Since, I am 62 and DW is 58, I am drawing down my deferred r/o IRA to reduce/defer RMDs. DW has four years longer before her deferred retirement accounts will be subject to RMDs so she is deferring 24k of her income this and next year. All we are really doing is deferring income subject to RMDs. :happy
When will you have those?
SS can (and probably should) be deferred. If you can get higher annual pension payments in return for deferring that as well, it is worth considering pension deferral also.
I will start Pension at age 65, approx. 13k
DW must start Pension upon retirement at age 60, approx. 41k
I plan to start SS at FRA, age 66 (possibly later), approx. 33k at FRA
DW plans to start SS at FRA, age 67 (possibly sooner), approx. 23k at FRA
Deferring one or both of SS+pension would provide more room for Roth conversions at lower marginal rates.
This would normally be true, however, our expenses/spending will be approx. 90-100k each year in today's dollars. We still have a $130k mortgage at 2.75% for the next 10 years. House is worth $525k. Property taxes are 8+k per year. We may relocate in 2-4 years to a warmer location where we can be active year round. Another advantage may be lower state taxes. Vehicles and travel are/will be other big expenses.
Most, if not all, Conversions from deferred to Roth will occur at 25% if we decide to do them. If we don't do Roth Conversions, we will be in the 25% tax bracket for most of our retirement years.
Advantages of doing Roth Conversions would be:
*Reducing RMDs
*Gains in Roth would be ours alone and we would not have to share with Uncle Sam
*If one of us died, the survivor would avoid being taxed at higher single bracket rates.
*Beneficiaries would not have to pay taxes on Roth funds

I have done spreadsheets which indicate no real difference in after tax spending dollars during retirement as the result of doing Roth Conversions. The spreadsheets do show less tax being paid if conversions are done during the first 7-8 years with the result of being in a lower tax bracket after doing the conversions.

If you have additional questions, please ask. Thanks for your help!




.

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celia
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Re: Roth Conversion and/or Roth Contribution?

Post by celia » Fri Dec 08, 2017 3:00 am

Thank you for the additional information. It is now possible to give specific suggestions.
I-ORP says if we do conversions over the next 7-8 years in the 25% fed and 8.9% state brackets, we will then be in the 15% bracket for the balance of our planned retirement. If we do not do conversions, we will be in the 25% bracket for 20+ years.
First, I question if you are in the 15% tax bracket this year. Have you done a dry run of your taxes using tax software? (2016 software is close enough)
To be in the 15% bracket in 2017, Taxable Income (line 43) needs to be $75,900 or less for MFJ. If it is over that but below $153,100, you are in the 25% bracket. Note that this number is AFTER you subtract your exemptions and itemized/standardized deductions from your AGI. (It is NOT the same as saying that 15% of your AGI goes to pay taxes.)

After you have taken in all the suggestions in this thread, I recommend you build a chart like I did in this post:
viewtopic.php?f=1&t=194462&p=2971816#p2971816
and the one after it. The goal is to do long range planning into your mid-70s (after you are both on SS) while looking at different conversion options while you still have time to change things. (I would hate to be filing my taxes for the first time after DH and I have turned 70.5 and be totally surprised by the tax situation. At that point, there’s not much you can change.)

When doing this exercise, be aware that if your MAGI goes over $170K**, your and your wife will be subject to higher Medicare premiums and Drug Plan premiums in the year 2 years after the affected tax return year. (If your 2017 MAGI is $171K, in 2019 you would pay the surcharges, since your tax return might not be filed until October 2018.) But luckily neither you nor your wife are expected to be on Medicare in 2019, so this year may be the best year to make a larger conversion.
** (the MAGI of $170K could put the tax return below the top of the 25% bracket for MFJ since you haven't subtracted exemptions or deductions yet)
https://www.ssa.gov/pubs/EN-05-10536.pdf

When you get done making your chart(s), you can post them here for further comments. (We likely won’t verify your calculations, but can tell you about anything that doesn’t seem right.)


Do your stated living expenses of $90-95K include income taxes that need to be paid? If you convert anything this year, you will have a good idea of what your taxes will be for the next 8 years and can then plan for it. I always pay taxes out of my taxable account (or an income stream) and encourage others to do that when converting (so they don’t lose the space in the tax-advantaged account--let it all go to Roth). So, excuse me, if I overlook something while your taxes come out of a withdrawal from tax-deferred.

As long as we are discussing tax withholding from a withdrawal from tax-deferred, a big reason we prefer to not do this is that it limits your ability to recharacterize the conversion. (You can’t take money back from the IRS and put it back in your tax-deferred plan.)

A second reason to not pay your taxes from a tax-deferred withdrawal is that the withdrawal adds to your tax liability. That means another withdrawal may be necessary to pay for the taxes on the first withdrawal And possibly another withdrawal would be needed for taxes on the second withdrawal....

I agree with someone above that you should consider delaying the start of your SS until age 70. You will get a guaranteed 8% increase for each year you delay past FRA until you turn 70. The increase will provide extra income for the rest of your life (and for your DW if she survives you)!
hawkfan55 wrote:
Thu Dec 07, 2017 1:24 am
I will start Pension at age 65, approx. 13k
DW must start Pension upon retirement at age 60, approx. 41k
I plan to start SS at FRA, age 66 (possibly later), approx. 33k at FRA
DW plans to start SS at FRA, age 67 (possibly sooner), approx. 23k at FRA
But even if you don't delay SS, these four income streams alone total $110K per year which likely puts you in the 25% bracket, even without RMDs added. The RMDs will continue to grow as long as the tax-deferred accounts continue to grow. This happens as long as the percentage of growth is more than the percentage that needs to be withdrawn each year. If you are currently itemizing on your taxes, you likely won't be doing that much longer as most of your mortgage payment is now principal, instead of interest. And in 10 years, the mortgage will be paid off, if I recall from above, making you even less likely to itemize then.
As a retiree, I am trying to figure out, while my wife has income from working and we could contribute to our Roth IRAs, if it would be worthwhile to do so? In essence, any contribution or conversion to our Roth IRAs would come from and have taxes paid from my r/o IRA account withdrawals.
Instead of continuing to contribute to Roths or a 403b, have your wife include all of her pay in your taxable accounts. Use some of it for taxes and some of it for living expenses so you don't have to withdraw as much from the tax-deferred. Here is my reasoning: Why contribute to a Roth only to have to withdraw from tax-deferred to pay the taxes? Why contribute to a 403b only to have to withdraw from tax-deferred for living expenses? They basically cancel each other out and make your thought process more complicated.

Instead, I suggest that you convert some of your tax-deferred and only withhold "half" of the taxes from the conversion. (The rest of the taxes should be paid from taxable.) You likely would prefer to be in a position to exert control over how much is converted each year rather than scrambling to cover income taxes through withdrawals. It will also simplify your thinking so you don’t do unnecessary steps to "cancel" previous steps. (For example, contribute to a 403b, then withdraw THE SAME AMOUNT from your tIRA. All this does is just change where things are located. It doesn’t change your net worth or the amount in tax-advantaged accounts.)

Important Note: Always convert into a new (empty) Roth account. If you are converting more than one fund, convert each fund into a separate new (empty) Roth. This will make recharacterizations much easier, if you decide that you want to "un-do" the conversion(s). Cases where you would consider recharacterizing include:
* after a significant market drop, you probably would not want to pay taxes on a conversion that is only worth half as much later in the year
* the taxes might be more than you originally planned for or you no longer have money for the taxes
* your income ends up being higher than you expected late in the year

Note to Readers: The advice in this post is meant for those who don't have many assets in taxable. It would be different if the OP had more money in taxable (or an income stream) to pay most of his current living expenses and taxes.

hawkfan55
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Re: Roth Conversion and/or Roth Contribution for those with Few Taxable Assets?

Post by hawkfan55 » Fri Dec 08, 2017 4:16 pm

First, I question if you are in the 15% tax bracket this year. Have you done a dry run of your taxes using tax software? (2016 software is close enough)
We are in the 15% bracket with DW taxable income and my Rollover IRA Withdrawals for 2017. I've yet to get the 2017 TurboTax program, however, am planning to do so this weekend. We have significant State, Property taxes and some mortgage interest which allows us to itemize taxes and, with the personal exemption, we have taxable income right up to $76,900. So if I do Roth Conversions, they will be taxed at 25% federal and 8.9% State.
Do your stated living expenses of $90-95K include income taxes that need to be paid?
No, we will need to withdraw both living expenses and income taxes from tax deferred. We always saved the maximum in our 401k and 403b and funded our Roths. There wasn't really anything left to invest in after tax investments. I always figured it was better to fill tax deferred and roth accounts first and, if there was anything left over, fund taxable. We feel as if we saved aggressively for retirement and enjoyed life as well. We're happy with what we've saved and feel we will have a good retirement. :happy

hawkfan55
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Re: Roth Conversion and/or Roth Contribution for those with Few Taxable Assets?

Post by hawkfan55 » Mon Dec 11, 2017 2:12 pm

Any other thoughts from the BH community? Thank you!

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