Which to do - Roth conversion or LTCG?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
User avatar
MN-Investor
Posts: 221
Joined: Mon May 02, 2011 9:04 am
Location: Twin Cities

Which to do - Roth conversion or LTCG?

Post by MN-Investor » Thu Dec 07, 2017 11:54 am

I think I just realized that we shouldn't do a Roth conversion, that, instead of being taxed at 15%, we'll get taxed at 30%. Is my math correct?

My husband retired last year so this is our first year with no wages. We have enough in taxable accounts so that we won't need to take Social Security until the first one turns 70 in 5 years. Basically there are six years with fairly low income. An ideal time to convert IRAs. However, complicating this is about $750,000 of stock sitting in a taxable account with a $25,000 basis. We have been selling that stock off in the past few years and sold $100,000 this year. It just keeps increasing in value. The $750,000 is the current balance.

I did a quick calculation today, assuming that we converted $40,000 from a conventional IRA to a Roth IRA. The federal tax went up by $12,000. A 30% tax!

Rough numbers -

Code: Select all

Ordinary income -   42,100
Qual Div + LTCG -  115,000

AGI                157,100

Itemized Ded    -   14,000
Personal Exemp  -    8,100

Taxable Income  -  135,000
So $20,000 would be taxed as ordinary income, $115,000 as capital gains. With the 15% tax bracket maxxing out at $75,900, the total tax would be $2,068 (tax on $20,000) + ($75,900-$20,000)*0% [i.e. the portion of the LTCG taxed at 0%] + [$115,000-($75,900-$20,000)]*15% [i.e., the portion of the LTCG taxed at 15%, or $59,100 LTCG * 15%], for a total of $2,068 + $0 + $8,865 = $10,933.

If I add in $40,000 Roth conversion, then $60,000 would be taxed at ordinary income rates, ($75,900-$60,000) at 0%, and $99,100 LTCG taxed at 15%, for a total tax of $8,068 + $0 + $14,865 = $22,933.

Ouch. A $12,000 tax on a $40,000 Roth conversion.

First, is my math correct? Did I miss something?

Next, what do you recommend going forward? Yes, $750,000 is a lot in a single stock, but if it went to $0 it would not affect our retirement. The company is a well run 100-year old American manufacturer. Should we just continue to sell it off $100K - $200K per year and not worry about Roth conversions? Should we dump all of it this year, then do Roth conversions in future years? What things should I consider in making this decision?
The key to success - Save early, save often, invest well.

livesoft
Posts: 57313
Joined: Thu Mar 01, 2007 8:00 pm

Re: Which to do - Roth conversion or LTCG?

Post by livesoft » Thu Dec 07, 2017 12:08 pm

I didn't go through your math, but it is generally well-known on the bogleheads.org forum that things get taxed at 30% once above the 15% marginal bracket limit.

See, for example, the Michael Kitces article: https://www.kitces.com/blog/understandi ... -in-basis/ Example 3 in particular.

So without a Roth conversion at all, what is the maximum amount of LTCG that you can have in 2017 and pay only 15% LTCG tax rate? I'd probably sell up to that limit and not worry about having 0% LTCG tax rate on all the gains.
This signature message sponsored by sscritic: Learn to fish.

Chip
Posts: 1655
Joined: Wed Feb 21, 2007 4:57 am

Re: Which to do - Roth conversion or LTCG?

Post by Chip » Thu Dec 07, 2017 12:18 pm

I didn't check your math closely, but the phantom 30% "bracket" is real for someone in your situation. Each additional $1 of ordinary income is taxed at 15% and it also pushes $1 of capital gains from being taxed at 0% to 15%. 15+15=30.

Note that this effect ends when ordinary income exceeds the top of the 15% bracket. Though at higher incomes other taxes kick in.

Tough decision. Are you willing to potentially suffer huge losses in the stock to avoid the roughly 100k in tax liability?

Have you looked at what your taxes will look like at age 71 when RMDs (and I assume social security) will kick in? This might tell you whether or not Roth conversions are the better idea.

Are you aware of the Medicare IRMAA tiers? Those might affect your planning as they act like an extra tax.

Are these shares from a lump sum retirement plan distribution where the NUA rules were applied? If so, be aware that there is no stepped up basis on death.

Obviously these shares would be an excellent choice for donation to charities.

Soon2BXProgrammer
Posts: 316
Joined: Mon Nov 24, 2014 11:30 pm

Re: Which to do - Roth conversion or LTCG?

Post by Soon2BXProgrammer » Thu Dec 07, 2017 12:19 pm

Lets make sure we are talking about the same problem...

Are you looking for estate optimization?

Are you going to have more RMD's then you know what to do with?

i'd be tempted to pay the LTCG tax on the stock in an accelerated manner, to create options. (potentially).

i would also be tempted to not burn taxable (taxable gets stepped up basis at death)... but spend out of pretax/401k types accounts if RMDs are a real problem...

Need some more info about total picture, to come up with an estate optimization strategy.

User avatar
MN-Investor
Posts: 221
Joined: Mon May 02, 2011 9:04 am
Location: Twin Cities

Re: Which to do - Roth conversion or LTCG?

Post by MN-Investor » Thu Dec 07, 2017 12:39 pm

livesoft wrote:
Thu Dec 07, 2017 12:08 pm
I didn't go through your math, but it is generally well-known on the bogleheads.org forum that things get taxed at 30% once above the 15% marginal bracket limit.

See, for example, the Michael Kitces article: https://www.kitces.com/blog/understandi ... -in-basis/ Example 3 in particular.

So without a Roth conversion at all, what is the maximum amount of LTCG that you can have in 2017 and pay only 15% LTCG tax rate? I'd probably sell up to that limit and not worry about having 0% LTCG tax rate on all the gains.
Thanks for the article. I had missed the articles about the 30% rate, so this was an eye-opener for me.
The key to success - Save early, save often, invest well.

packerguy
Posts: 4
Joined: Thu Dec 07, 2017 12:31 pm

Re: Which to do - Roth conversion or LTCG?

Post by packerguy » Thu Dec 07, 2017 12:44 pm

Here is another link explaining the 30% tax bracket.

https://earlyretirementnow.com/2016/07/ ... x-bracket/

I did some preliminary tax estimates for this year and I am going to be hit by this. The things I am doing to try to minimize the effects of this is to reduce my ordinary income as much as possible (max out 401K, HSA), maximize my deductions (by moving some charitable giving to this year), and selling stock at a loss. I would be interested in hearing any other ideas for avoiding this "sneaky" 30% bracket.
Last edited by packerguy on Thu Dec 07, 2017 4:15 pm, edited 1 time in total.

User avatar
MN-Investor
Posts: 221
Joined: Mon May 02, 2011 9:04 am
Location: Twin Cities

Re: Which to do - Roth conversion or LTCG?

Post by MN-Investor » Thu Dec 07, 2017 12:50 pm

Chip wrote:
Thu Dec 07, 2017 12:18 pm

Have you looked at what your taxes will look like at age 71 when RMDs (and I assume social security) will kick in? This might tell you whether or not Roth conversions are the better idea.

RMDs + Social Security will be significant. That's one reason we considered Roth conversions.

Are you aware of the Medicare IRMAA tiers? Those might affect your planning as they act like an extra tax.

I just applied for Medicare (I turn 65 this month) and the SSA was nice enough to inform me that the IRMAA rules will apply to me for both 2017 and 2018.

Are these shares from a lump sum retirement plan distribution where the NUA rules were applied? If so, be aware that there is no stepped up basis on death.

Yes, they are. I wasn't aware of the no step up in basis, but at least they will be taxed at LTCG rates for the heirs.

Obviously these shares would be an excellent choice for donation to charities.

The year we started selling this stock, we also started funding a donor advised fund with this stock.
The key to success - Save early, save often, invest well.

itstoomuch
Posts: 4837
Joined: Mon Dec 15, 2014 12:17 pm
Location: midValley OR

Re: Which to do - Roth conversion or LTCG?

Post by itstoomuch » Thu Dec 07, 2017 12:52 pm

Do a leap option for 2018 to protect value of stock
Then do your conversion of your IRA to Roth in 2018.
You will pay in the option a relatively small insurance expense as compared to the marginal taxes you'd pay in the conversion.
Or you can do the leap on the IRA for latter conversion and sell stock in 2018.
There is another alternative I can think of but some BH won't like it😚. YMMV
See accountant, broker specialist.
YMMV
Rev90517; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax 25%. Early SS. FundRatio (FR) >1.1 67/70yo

User avatar
MN-Investor
Posts: 221
Joined: Mon May 02, 2011 9:04 am
Location: Twin Cities

Re: Which to do - Roth conversion or LTCG?

Post by MN-Investor » Thu Dec 07, 2017 1:02 pm

Soon2BXProgrammer wrote:
Thu Dec 07, 2017 12:19 pm
Are you looking for estate optimization?

Are you going to have more RMD's then you know what to do with?

i'd be tempted to pay the LTCG tax on the stock in an accelerated manner, to create options. (potentially).

i would also be tempted to not burn taxable (taxable gets stepped up basis at death)... but spend out of pretax/401k types accounts if RMDs are a real problem...
The issue is more of income tax minimization instead of estate optimization. We don't have children and the nephews and nieces who will inherit are not expecting anything.

Yes, we will have more RMDs than we know what to do with.

I'll run some more calculations. Things I know I need to also consider - the extra 3.9% tax, how the increase in income affect the Medicare IRMAA tiers, how much Minnesota taxes will be (high!), plus the benefit of having a state tax deduction in 2017 (will the final tax bill eliminate that deduction?).
The key to success - Save early, save often, invest well.

drzzzzz
Posts: 120
Joined: Sat Sep 22, 2012 9:56 pm

Re: Which to do - Roth conversion or LTCG?

Post by drzzzzz » Thu Dec 07, 2017 1:39 pm

We have a similar issue about large RMD when retired, social security, etc and have been giving to charity to give us some increased tax space to convert greater amounts of our retirement accounts - not an ideal solution (and I think you are already doing that), but it helps rather than it being taxed. What is even more depressing is what happens with RMDs when one of us dies and our tax bracket changes.

Chip
Posts: 1655
Joined: Wed Feb 21, 2007 4:57 am

Re: Which to do - Roth conversion or LTCG?

Post by Chip » Thu Dec 07, 2017 1:41 pm

I suppose if you are in a situation where you are extremely likely to never need to sell the stock, and you're not worried about its value to your heirs, you might just consider keeping it. I sure hope the Diversification Police don't come after me! :D

If you do decide to keep selling, I would follow livesoft's suggestion: minimize all other income in that year and take capital gains up to some limit. Maybe AGI=170k which is just below the first IRMAA tier. You could do that for 3 years and sell about half of the stock. Then do Roth conversions in the other years to the same limit. Since you said RMDs will be significant I assume that won't really move the needle a lot. e.g. 100k in Roth conversions only reduces 1st year RMD by $3,650.

It's not great, but it's something. As is often said here, first world problem.

Note that the upper IRMAA tier thresholds are being significantly revised in 2018. Kitces article here.

I should have said in the other reply that there is no step-up in basis on the NUA portion of the gain. Any post-distribution gains will receive a step-up.

Soon2BXProgrammer
Posts: 316
Joined: Mon Nov 24, 2014 11:30 pm

Re: Which to do - Roth conversion or LTCG?

Post by Soon2BXProgrammer » Thu Dec 07, 2017 1:45 pm

MN-Investor wrote:
Thu Dec 07, 2017 1:02 pm

The issue is more of income tax minimization instead of estate optimization. We don't have children and the nephews and nieces who will inherit are not expecting anything.

Yes, we will have more RMDs than we know what to do with.

I'll run some more calculations. Things I know I need to also consider - the extra 3.9% tax, how the increase in income affect the Medicare IRMAA tiers, how much Minnesota taxes will be (high!), plus the benefit of having a state tax deduction in 2017 (will the final tax bill eliminate that deduction?).
income tax minimization is estate optimization.. if you care about how much you give uncle sam after you pass away. If your planning to spend/give to charity all your money, then that changes a few things...

i can only made guesses based on the current law... but think like qualified charitable distribution directly from your pretax account, are a way to give less to uncle sam.... or donating your appreciated taxable stock to chartity is another way.. (or via a donor advised fund)

its time to get serious about what your life goals are.. maybe donate the 750k to a DAF that you administer the rest of your life, and allow your heirs to carry on in your name... and then gift them whats left out of your other accounts..... this would solve the taxes on the 750, and have you start drawing out of your IRA immediately...

if your IRA balances are substantial, taxes are going to be a real problem. especially on top of social security.. i suggest you read:
https://www.bogleheads.org/wiki/Social_ ... calculator

User avatar
MN-Investor
Posts: 221
Joined: Mon May 02, 2011 9:04 am
Location: Twin Cities

Re: Which to do - Roth conversion or LTCG?

Post by MN-Investor » Thu Dec 07, 2017 2:39 pm

drzzzzz wrote:
Thu Dec 07, 2017 1:39 pm
What is even more depressing is what happens with RMDs when one of us dies and our tax bracket changes.
Yeah, I’ve told my husband that he’s not allowed to die.
The key to success - Save early, save often, invest well.

User avatar
MN-Investor
Posts: 221
Joined: Mon May 02, 2011 9:04 am
Location: Twin Cities

Re: Which to do - Roth conversion or LTCG?

Post by MN-Investor » Thu Dec 07, 2017 2:41 pm

Our estate is not large enough to be a Federal estate tax issue.
The key to success - Save early, save often, invest well.

BigJohn
Posts: 1421
Joined: Wed Apr 02, 2014 11:27 pm

Re: Which to do - Roth conversion or LTCG?

Post by BigJohn » Thu Dec 07, 2017 3:51 pm

While this is the one that catches a lot of people, there are many other jumps and discontinuities in the actual incremental tax rate you can see. Here are a couple of discussions on this topic

viewtopic.php?p=2645133#p2645133
viewtopic.php?p=2570101#p2570101

The reality is that for many, saying "I'm in the x% marginal tax bracket" is not a very good basis for these types of decisions.

Soon2BXProgrammer
Posts: 316
Joined: Mon Nov 24, 2014 11:30 pm

Re: Which to do - Roth conversion or LTCG?

Post by Soon2BXProgrammer » Thu Dec 07, 2017 4:05 pm

MN-Investor wrote:
Thu Dec 07, 2017 2:41 pm
Our estate is not large enough to be a Federal estate tax issue.
Thats not what i meant.. i meant.. income tax issue for those that recieve the funds..

pretax ira's = recipient has to pay income tax at their top bracket...
roth = tax free for recipient
taxable funds = step up basis at death = tax free for recipient mostly like roth.

DrGoogle2017
Posts: 690
Joined: Mon Aug 14, 2017 12:31 pm

Re: Which to do - Roth conversion or LTCG?

Post by DrGoogle2017 » Thu Dec 07, 2017 4:41 pm

I’ve been looking at this, with inherited IRA, it can be stretched. With Roth IRA, my hiers have to withdraw within 5 years. Which is better worse? Or better?
I think if you think you are going to live long then Roth is better, if not inherited IRA is better. I run my Roth simulation until I’m 90 and my husband till 99. But I’m not sure either one of us will live that long.
OP, I would do some Roth conversion while not selling to exercise the LTCG for a while, at least until you can reduce your IRA balance.

kaneohe
Posts: 4446
Joined: Mon Sep 22, 2008 12:38 pm

Re: Which to do - Roth conversion or LTCG?

Post by kaneohe » Thu Dec 07, 2017 8:29 pm

DrGoogle2017 wrote:
Thu Dec 07, 2017 4:41 pm
I’ve been looking at this, with inherited IRA, it can be stretched. With Roth IRA, my hiers have to withdraw within 5 years. ..........................
Why do you think Roth IRAs can't be stretched too? Got a link?

DrGoogle2017
Posts: 690
Joined: Mon Aug 14, 2017 12:31 pm

Re: Which to do - Roth conversion or LTCG?

Post by DrGoogle2017 » Thu Dec 07, 2017 9:52 pm

kaneohe wrote:
Thu Dec 07, 2017 8:29 pm
DrGoogle2017 wrote:
Thu Dec 07, 2017 4:41 pm
I’ve been looking at this, with inherited IRA, it can be stretched. With Roth IRA, my hiers have to withdraw within 5 years. ..........................
Why do you think Roth IRAs can't be stretched too? Got a link?
Here is the link, note the RMD for Roth is after initial IRA owner’s death.
https://www.irs.gov/pub/irs-tege/roth_differences.pdf

kaneohe
Posts: 4446
Joined: Mon Sep 22, 2008 12:38 pm

Re: Which to do - Roth conversion or LTCG?

Post by kaneohe » Thu Dec 07, 2017 9:58 pm

DrGoogle2017 wrote:
Thu Dec 07, 2017 9:52 pm
kaneohe wrote:
Thu Dec 07, 2017 8:29 pm
DrGoogle2017 wrote:
Thu Dec 07, 2017 4:41 pm
I’ve been looking at this, with inherited IRA, it can be stretched. With Roth IRA, my hiers have to withdraw within 5 years. ..........................
Why do you think Roth IRAs can't be stretched too? Got a link?
Here is the link, note the RMD for Roth is after initial IRA owner’s death.
https://www.irs.gov/pub/irs-tege/roth_differences.pdf
All I see is this: says nothing about 5 yrs

Required minimum
distributions
Only after the original IRA
owner’s death

DrGoogle2017
Posts: 690
Joined: Mon Aug 14, 2017 12:31 pm

Re: Which to do - Roth conversion or LTCG?

Post by DrGoogle2017 » Thu Dec 07, 2017 10:03 pm

kaneohe wrote:
Thu Dec 07, 2017 9:58 pm
DrGoogle2017 wrote:
Thu Dec 07, 2017 9:52 pm
kaneohe wrote:
Thu Dec 07, 2017 8:29 pm
DrGoogle2017 wrote:
Thu Dec 07, 2017 4:41 pm
I’ve been looking at this, with inherited IRA, it can be stretched. With Roth IRA, my hiers have to withdraw within 5 years. ..........................
Why do you think Roth IRAs can't be stretched too? Got a link?
Here is the link, note the RMD for Roth is after initial IRA owner’s death.
https://www.irs.gov/pub/irs-tege/roth_differences.pdf
All I see is this: says nothing about 5 yrs

Required minimum
distributions
Only after the original IRA
owner’s death
Maybe this link from Fidelity, it depends whether you die before 70.5 or after
https://www.fidelity.com/building-savin ... ed-ira-rmd

DrGoogle2017
Posts: 690
Joined: Mon Aug 14, 2017 12:31 pm

Re: Which to do - Roth conversion or LTCG?

Post by DrGoogle2017 » Thu Dec 07, 2017 10:15 pm

DrGoogle2017 wrote:
Thu Dec 07, 2017 10:03 pm
kaneohe wrote:
Thu Dec 07, 2017 9:58 pm
DrGoogle2017 wrote:
Thu Dec 07, 2017 9:52 pm
kaneohe wrote:
Thu Dec 07, 2017 8:29 pm
DrGoogle2017 wrote:
Thu Dec 07, 2017 4:41 pm
I’ve been looking at this, with inherited IRA, it can be stretched. With Roth IRA, my hiers have to withdraw within 5 years. ..........................
Why do you think Roth IRAs can't be stretched too? Got a link?
Here is the link, note the RMD for Roth is after initial IRA owner’s death.
https://www.irs.gov/pub/irs-tege/roth_differences.pdf
All I see is this: says nothing about 5 yrs

Required minimum
distributions
Only after the original IRA
owner’s death
Maybe this link from Fidelity, it depends whether you die before 70.5 or after
https://www.fidelity.com/building-savin ... ed-ira-rmd
I was wrong, there are 3 options, see link from Schwartz, much clearer.
https://www.schwab.com/public/schwab/in ... awal_rules

Option 1) life expentency
Option 2) 5 year
Option 3) Lump sum distribution

So you can stretch as inherited IRA with Option 1.

Post Reply