Tax planning: Convert Roth or zero tax due?

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luke_airig
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Joined: Tue Dec 12, 2017 5:38 pm

Tax planning: Convert Roth or zero tax due?

Post by luke_airig » Thu Dec 14, 2017 1:28 pm

I am a California resident and I am in the process of projecting my 2017
tax liability using HRBlock tax software. I am restricting this
discussion to federal taxes because the state software update will not
be available until January 2018, so the state projection is not possible.

I retired in May 2016, so 2017 is the first year that I have had
12 full months of social security income ($30,000 per annum). My only
other income source is an $8,000 annual pension.

I am 67 and I have TIRA account balances that I want to convert to my
existing Roth IRA over the next 3 years, before age 70.5, when RMDs
will commence.

So here is my dilemma for my 2017 tax plan. If I convert $50,000 from
my TIRA to my Roth, my tax liability is $12,000 (tax rate of 19%) but
then I have another $50,000 in my tax-free Roth account. On the other
hand, if I convert $7,000, my federal tax liability is ZERO.

From age 70.5 onward I am estimating that my annual taxable income
will be in the $80,000 range (social security, pension and RMDs),
25% marginal tax rate.

Paying zero tax makes me feel like I am part of an elite club along
with Apple and Facebook but that giddiness may be clouding my judgement. :happy

Any one have any thoughts on how best to proceed?

TIA

Luke

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David Jay
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Re: Tax planning: Convert Roth or zero tax due?

Post by David Jay » Thu Dec 14, 2017 1:32 pm

Do you want to go with Math or Feelings? That, detective, is the correct question.

Math: 19% is less than 25%
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

livesoft
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Re: Tax planning: Convert Roth or zero tax due?

Post by livesoft » Thu Dec 14, 2017 1:34 pm

I go for the Roth conversion myself and choose not to pay $0 in taxes even though I could I suppose.
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David Jay
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Re: Tax planning: Convert Roth or zero tax due?

Post by David Jay » Thu Dec 14, 2017 1:41 pm

I understand the allure of feelings, "no taxes" would feel good.

I am also looking at paying zero taxes in retirement but that leaves a bunch of tax-deferred funds in a tIRA that will be taxable for my wife (with her reduced standard deduction of filing single after I am gone). The alternative is paying about 10% in taxes every year and leaving my wife with only Roth funds by my late 70s.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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grabiner
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Re: Tax planning: Convert Roth or zero tax due?

Post by grabiner » Thu Dec 14, 2017 9:38 pm

You should make the Roth conversion to fill up the 15% bracket. You are going to pay tax on the IRA money at some time, so it's better to pay 15% (19% including state tax) now to avoid losing 25% (31% including state tax) later.

A further benefit is that converting will reduce your RMDs. If you don't need the money from the RMDs, you will have to take it out of your IRA and reinvest it in a taxable account, losing the tax deferral. Once the money is in a Roth IRA, there are no RMDs during your life.
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GerryL
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Re: Tax planning: Convert Roth or zero tax due?

Post by GerryL » Thu Dec 14, 2017 9:55 pm

I was aiming to do Roth conversions for the first 4 years of retirement before I hit RMD age. I was only going to be converting to the top of the 15% bracket, $35k a year, and the CPA I consulted noted that it would not make a significant impact on the size of my RMDs, but I went ahead with the plan. Midway through year 2, with $25k converted, I thought about what my plans were for the Roth. I am unlikely to ever need the money, so it will go to charity or my nephew, or maybe both. My nephew, an only child with well-off parents, is doing just fine. Charity will get much of my estate. Why should I be giving the government money to keep growing the Roth? So I quit converting and am taking advantage of a couple of low/no tax years to sell off some company stock with 0 tax on the capital gains.

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grabiner
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Re: Tax planning: Convert Roth or zero tax due?

Post by grabiner » Thu Dec 14, 2017 10:01 pm

GerryL wrote:
Thu Dec 14, 2017 9:55 pm
I was aiming to do Roth conversions for the first 4 years of retirement before I hit RMD age. I was only going to be converting to the top of the 15% bracket, $35k a year, and the CPA I consulted noted that it would not make a significant impact on the size of my RMDs, but I went ahead with the plan. Midway through year 2, with $25k converted, I thought about what my plans were for the Roth. I am unlikely to ever need the money, so it will go to charity or my nephew, or maybe both. My nephew, an only child with well-off parents, is doing just fine.
If the money is going to charity, make those donations as qualified charitable distributions from the IRA after you become eligible. This will eliminate the tax on the RMDs, the donated amount will also not count as income for making SS taxable or increasing your Medicare premium, and you get the tax deduction even if you don't itemize.
Wiki David Grabiner

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FiveK
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Re: Tax planning: Convert Roth or zero tax due?

Post by FiveK » Thu Dec 14, 2017 10:48 pm

luke_airig wrote:
Thu Dec 14, 2017 1:28 pm
...social security income ($30,000 per annum). My only
other income source is an $8,000 annual pension.
I am 67....
If I convert $50,000 from my TIRA to my Roth, my tax liability is $12,000....
On the other hand, if I convert $7,000, my federal tax liability is ZERO.
Might be worth checking those numbers.

$8K from the pension, plus $7K from the tIRA, will make $2500 of the SS taxable. $17500 AGI becomes $5550 taxable and that causes $555 tax.
$8K from the pension, plus $50K from the tIRA, will make $25500 of the SS taxable. $83500 AGI becomes $71550 taxable and that causes $13626 tax.

At least, that's assuming the tax calculation in the personal finance toolbox spreadsheet is correct and I didn't give it bad input.

Chart below shows the marginal rates on the tIRA withdrawal dollars (again assuming as above):
Image

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GerryL
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Re: Tax planning: Convert Roth or zero tax due?

Post by GerryL » Fri Dec 15, 2017 1:36 am

grabiner wrote:
Thu Dec 14, 2017 10:01 pm
GerryL wrote:
Thu Dec 14, 2017 9:55 pm
I was aiming to do Roth conversions for the first 4 years of retirement before I hit RMD age. I was only going to be converting to the top of the 15% bracket, $35k a year, and the CPA I consulted noted that it would not make a significant impact on the size of my RMDs, but I went ahead with the plan. Midway through year 2, with $25k converted, I thought about what my plans were for the Roth. I am unlikely to ever need the money, so it will go to charity or my nephew, or maybe both. My nephew, an only child with well-off parents, is doing just fine.
If the money is going to charity, make those donations as qualified charitable distributions from the IRA after you become eligible. This will eliminate the tax on the RMDs, the donated amount will also not count as income for making SS taxable or increasing your Medicare premium, and you get the tax deduction even if you don't itemize.
Yup. That's the plan.

RetiredCSProf
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Re: Tax planning: Convert Roth or zero tax due?

Post by RetiredCSProf » Fri Dec 15, 2017 2:09 am

I realize that you asked only about Fed tax and not state. Just thought I would mention that CA charges no income tax on SS income.

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kramer
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Re: Tax planning: Convert Roth or zero tax due?

Post by kramer » Fri Dec 15, 2017 3:13 am

In addition to FiveK's post, all of your long term capital gains and qualified dividends in your taxable account go from 0% to 15% tax if you convert a large sum.

Another strategy would be to stay in the 15% bracket but max it out by taking taxable capital gains, which would be taxed at 0%. You will lose that chance after RMDs start. It's possible you would want to leave big capital gains holdings to your heirs, though, since it sounds like your RMDs will be plenty to live on and so you might never spend your taxable holdings.

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catdude
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Re: Tax planning: Convert Roth or zero tax due?

Post by catdude » Fri Dec 15, 2017 3:37 am

grabiner wrote:
Thu Dec 14, 2017 10:01 pm
GerryL wrote:
Thu Dec 14, 2017 9:55 pm
I was aiming to do Roth conversions for the first 4 years of retirement before I hit RMD age. I was only going to be converting to the top of the 15% bracket, $35k a year, and the CPA I consulted noted that it would not make a significant impact on the size of my RMDs, but I went ahead with the plan. Midway through year 2, with $25k converted, I thought about what my plans were for the Roth. I am unlikely to ever need the money, so it will go to charity or my nephew, or maybe both. My nephew, an only child with well-off parents, is doing just fine.
If the money is going to charity, make those donations as qualified charitable distributions from the IRA after you become eligible. This will eliminate the tax on the RMDs, the donated amount will also not count as income for making SS taxable or increasing your Medicare premium, and you get the tax deduction even if you don't itemize.
You guys have given me something to think about. My situation is quite similar to Gerry's. I don't think I'll need my TIRA or Roth money... my nieces are the beneficiaries of my Roth, but they're doing well and will no doubt be getting a tidy inheritance from their parents. I've done Roth conversions the past couple years, but I think I may stop doing so (I'm not doing one this year because I'm taking advantage of the 0% LTCG rate in the 15% bracket). QCD's sound like an excellent option for charitable giving once I hit age 70.5....

Thanks, guys, for the discussion....
catdude | | All generalizations are false, including this one.

retiredjg
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Re: Tax planning: Convert Roth or zero tax due?

Post by retiredjg » Fri Dec 15, 2017 9:39 am

luke_airig wrote:
Thu Dec 14, 2017 1:28 pm
I am a California resident and I am in the process of projecting my 2017
tax liability using HRBlock tax software. I am restricting this
discussion to federal taxes because the state software update will not
be available until January 2018, so the state projection is not possible.

I retired in May 2016, so 2017 is the first year that I have had
12 full months of social security income ($30,000 per annum). My only
other income source is an $8,000 annual pension.

I am 67 and I have TIRA account balances that I want to convert to my
existing Roth IRA over the next 3 years, before age 70.5, when RMDs
will commence.

So here is my dilemma for my 2017 tax plan. If I convert $50,000 from
my TIRA to my Roth, my tax liability is $12,000 (tax rate of 19%) but
then I have another $50,000 in my tax-free Roth account. On the other
hand, if I convert $7,000, my federal tax liability is ZERO.

From age 70.5 onward I am estimating that my annual taxable income
will be in the $80,000 range (social security, pension and RMDs),
25% marginal tax rate.

Paying zero tax makes me feel like I am part of an elite club along
with Apple and Facebook but that giddiness may be clouding my judgement. :happy

Any one have any thoughts on how best to proceed?

TIA

Luke
It appears you are single. I would convert up to a little less than $85k total. If you go over $85k total, your Medicare Part B and D premiums (if you have them) will increase for the year 2019. The increase can be steep, depending on how much you go over. If you are not familiar with IRMAA, you need to get started on that before planning large conversions.

Here's a thread to get you started. viewtopic.php?t=170477

JW-Retired
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Re: Tax planning: Convert Roth or zero tax due?

Post by JW-Retired » Fri Dec 15, 2017 10:25 am

luke_airig wrote:
Thu Dec 14, 2017 1:28 pm
I retired in May 2016, so 2017 is the first year that I have had
12 full months of social security income ($30,000 per annum). My only
other income source is an $8,000 annual pension.

I am 67 and I have TIRA account balances that I want to convert to my
existing Roth IRA over the next 3 years, before age 70.5, when RMDs
will commence.
As FiveK's post and graph shows beautifully above, doing Roth conversions when you are drawing your social security is folly because of the huge taxes.

You might think about suspending your SS until age 70, and meanwhile living on the tIRA and/or doing Roth conversions to the top of the 15% or 25% bracket until then. A 3 year suspension would increase your SS payments by 24%, and I'm guessing it would reduce your tIRA balance and hence RMDs a lot. Just what you need.

California does not tax SS, so making the portion of your income that is SS bigger and the other income like tIRA RMDs smaller, is definitely the way to get you more total Fed+State after-tax income.
JW
Retired at Last

smitcat
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Re: Tax planning: Convert Roth or zero tax due?

Post by smitcat » Fri Dec 15, 2017 10:37 am

luke_airig wrote:
Thu Dec 14, 2017 1:28 pm
I am a California resident and I am in the process of projecting my 2017
tax liability using HRBlock tax software. I am restricting this
discussion to federal taxes because the state software update will not
be available until January 2018, so the state projection is not possible.

I retired in May 2016, so 2017 is the first year that I have had
12 full months of social security income ($30,000 per annum). My only
other income source is an $8,000 annual pension.

I am 67 and I have TIRA account balances that I want to convert to my
existing Roth IRA over the next 3 years, before age 70.5, when RMDs
will commence.

So here is my dilemma for my 2017 tax plan. If I convert $50,000 from
my TIRA to my Roth, my tax liability is $12,000 (tax rate of 19%) but
then I have another $50,000 in my tax-free Roth account. On the other
hand, if I convert $7,000, my federal tax liability is ZERO.

From age 70.5 onward I am estimating that my annual taxable income
will be in the $80,000 range (social security, pension and RMDs),
25% marginal tax rate.

Paying zero tax makes me feel like I am part of an elite club along
with Apple and Facebook but that giddiness may be clouding my judgement. :happy

Any one have any thoughts on how best to proceed?

TIA

Luke
I would populate the RPM model/spreadsheet with your situation and look at the options it can present for Roth conversions.
Once loaded you cam easily see and compare various amounts of Roth conversions with direct numbers charts on taxes paid , portfolio value and amount of dollars that you can spend (after taxes).
In our case the Roth conversions modeled show a 9% increase in the amount of money we can spend over time.
Each case is different so you will need to go through the work to figure out your case.

retiredjg
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Re: Tax planning: Convert Roth or zero tax due?

Post by retiredjg » Fri Dec 15, 2017 10:46 am

JW-Retired wrote:
Fri Dec 15, 2017 10:25 am
You might think about suspending your SS until age 70....JW
Are you sure you can still do that? I thought that had been stopped a few years ago.

CnC
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Re: Tax planning: Convert Roth or zero tax due?

Post by CnC » Fri Dec 15, 2017 10:54 am

retiredjg wrote:
Fri Dec 15, 2017 10:46 am
JW-Retired wrote:
Fri Dec 15, 2017 10:25 am
You might think about suspending your SS until age 70....JW
Are you sure you can still do that? I thought that had been stopped a few years ago.
I think that only for couples. A guy can't file then his unworking spouse file.


Then he suspends and let's it grow while she withdraws 50%

JW-Retired
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Re: Tax planning: Convert Roth or zero tax due?

Post by JW-Retired » Fri Dec 15, 2017 11:00 am

retiredjg wrote:
Fri Dec 15, 2017 10:46 am
JW-Retired wrote:
Fri Dec 15, 2017 10:25 am
You might think about suspending your SS until age 70....JW
Are you sure you can still do that? I thought that had been stopped a few years ago.
Yes, you can still suspend when you have reached FRA. The only change is it now suspends the payments of everyone on your account. So the "file and suspend" ploy won't be effective in allowing your spouse to continue collecting spousal while you are suspended.
JW
Retired at Last

retiredjg
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Re: Tax planning: Convert Roth or zero tax due?

Post by retiredjg » Fri Dec 15, 2017 11:18 am

Oh. Might be something to look at - I'd like to convert more myself!

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