IRA Conversions, the ACA, and Dividend/Interest Income

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Random Poster
Posts: 1680
Joined: Wed Feb 03, 2010 10:17 am

IRA Conversions, the ACA, and Dividend/Interest Income

Post by Random Poster » Wed Feb 28, 2018 4:11 pm

The recent thread* by Sandtrap regarding his travails with having an AGI just barely over the threshold amounts for ACA-subsidy eligibility has got me wondering:

Is it possible to have saved too much that one becomes unable to perform any meaningful IRA conversions and still remain eligible for ACA-subsidies?

Consider the following:

An married couple (aged 40, if it matters) have a $3.5M portfolio, with $2.75M in a taxable account and $750K in mostly Traditional and Rollover IRA accounts. The taxable account throws off around $55,000 in dividends and interest (tax-exempt or taxable, I'm not sure that it matters) a year (or roughly 2% of the account's value). No capital gains are taken.

To be eligible for ACA subsidies, their modified adjusted gross income must be less than $64,080, which leaves them with only $9,080 in "spare income" space to presumably effect an IRA conversion.

But with a $750K IRA balance, it would take almost 83 years to fully convert it if you can only convert $9,080 a year.

So what should this couple do? Forget about converting an IRA altogether? Convert just the $9,080 to at least reduce some future tax hits? Wait until they are on Medicare and no longer need ACA-insurance and then convert like crazy then (although I doubt they'd still be able to fully draw down the balance of the traditional IRA in time to avoid RMDs)? Somehow reduce the value of their taxable portfolio so that the dividends and interest that it throws off are reduced? Convert with wild abandon, ignoring any effect that the same may have on eligibility for ACA-subsidies, and just pay a ton of money for health insurance? Something else?

Thanks.


* Thread can be found here: viewtopic.php?f=2&t=242273

User avatar
MP123
Posts: 794
Joined: Thu Feb 16, 2017 3:32 pm

Re: IRA Conversions, the ACA, and Dividend/Interest Income

Post by MP123 » Wed Feb 28, 2018 5:31 pm

It's also likely that the portfolio you outline would throw off significant but unpredictable capital gains distributions in addition to the interest and dividends. So that $9k buffer before the ACA cliff could easily disappear with a year end CG distribution from a fund for example.

They could hold nothing but bonds in the IRA and nothing but individual non-dividend paying stocks in taxable. Not very Boggleheaded but it would lower their income or at least allow more control over it. I'm not sure it's worth the compromises though. Torturing their portfolio into producing no income might cost them more than just paying the premiums. Muni bond interest counts towards ACA too BTW.

As you know ACA premiums can be very high and certainly deserve consideration in financial planning at least for now. And especially right around the cliff where one extra dollar of income can cost you tens of thousands in healthcare subsidies. Getting hit with $10, $15, $20K in health insurance is a pretty hefty "tax".

I suppose if it became apparent that they were over the cliff one year that would be a great time to do some big conversions. If it looked possible to stay under the cliff then be sure not to endanger that. Probably a year by year decision.

curmudgeon
Posts: 1655
Joined: Thu Jun 20, 2013 11:00 pm

Re: IRA Conversions, the ACA, and Dividend/Interest Income

Post by curmudgeon » Wed Feb 28, 2018 6:28 pm

I'm working with those limitations. Just like the folks wanting midwest-style housing walking distance from Google, you have to make some compromises.

The most important point is: I wouldn't expect ACA to persist in current form for the long term. There are a ton of pressures on it in various directions. If I get to ride it for the next six years, I'll consider myself lucky. It may settle into stability, but I'm only making serious plans based on it year-to-year. It's certainly quite possible that subsidies will get tweaked in ways that make them less valuable, or the cliff less steep.

If you use an HSA-eligible plan, that can get you another ~9K of conversion space by making HSA contributions which come off of the AGI rather than being deductions.

At a certain point, a large enough taxable portfolio will just take you out of subsidy range for any appropriate investment mix (unless you went all BRKA, but then, what are you living on). That's life. You can also end up stuck if you taxable portfolio is all tied up with large cap gains, so you can't access living money without generating gains that show up on the AGI. We sold a house and downsized at retirement, which takes care of our spending needs for the years until we draw SS.

In my case, while we don't have a large space to do Roth conversions and stay under the ACA cliff, we can do a chunk between now and age 65, then step up quite a bit more between 65 and 70 (starting SS then). But who knows what tax and SS benefits laws will look like when we get there.

I don't see any real need to convert ALL our IRA/401K to Roth. I'll be happy if I can get half of it done. I don't view having some amount of RMDs as a problem (yes, today it might push us into the SS "tax hump" marginal rates, but who knows what that will look like a few year from now). There will probably still be a few levers available, such as QCDs, doing some alternating years of large donations and additional Roth conversions or larger distributions.

Random Poster
Posts: 1680
Joined: Wed Feb 03, 2010 10:17 am

Re: IRA Conversions, the ACA, and Dividend/Interest Income

Post by Random Poster » Wed Feb 28, 2018 8:50 pm

curmudgeon wrote:
Wed Feb 28, 2018 6:28 pm
At a certain point, a large enough taxable portfolio will just take you out of subsidy range for any appropriate investment mix (unless you went all BRKA, but then, what are you living on). That's life. You can also end up stuck if you taxable portfolio is all tied up with large cap gains, so you can't access living money without generating gains that show up on the AGI.
I think that is what I am suddenly start to realize.

And given the harshness of hitting and going over the subsidy cliff by just $1, it sure is a perverse way to reward someone for their decades of thrift and investing.

The flip side of it all though is that I'm also starting to wonder if it even makes sense to keep working and saving, because saving more might, oddly enough and due to the ACA or the like, just foreclose options instead of expand them. I guess if you have a $10M portfolio it might not matter as much, but if your portfolio is, say, between $3M and 4.5M, you could really get squeezed between higher health insurance costs and limited ways to avoid future tax bills.

curmudgeon
Posts: 1655
Joined: Thu Jun 20, 2013 11:00 pm

Re: IRA Conversions, the ACA, and Dividend/Interest Income

Post by curmudgeon » Wed Feb 28, 2018 9:24 pm

Random Poster wrote:
Wed Feb 28, 2018 8:50 pm
The flip side of it all though is that I'm also starting to wonder if it even makes sense to keep working and saving, because saving more might, oddly enough and due to the ACA or the like, just foreclose options instead of expand them. I guess if you have a $10M portfolio it might not matter as much, but if your portfolio is, say, between $3M and 4.5M, you could really get squeezed between higher health insurance costs and limited ways to avoid future tax bills.
If you've got money, you'll always have a target on your back. You will also have a lot more options than someone without money.

This particular anomaly is not something to be making long term plans on. A few years ago, I was budgeting $20K/yr for health insurance in early retirement. I still do; each year that shows up with a big subsidy I treat as a one-time bonus and add it to my travel funds. A few years ago I was planning to do "horse race" Roth conversions up until I took SS. No chance of that now. Similarly, I was planning to do "file and suspend" for SS. That's gone too. If it weren't for the current political deadlock over ACA, I suspect the cliff would have been adjusted (and not necessarily in our favor). For that matter, it's entirely possible that some form of means testing will be added based on net worth, not just income, in the future.

marcopolo
Posts: 1270
Joined: Sat Dec 03, 2016 10:22 am

Re: IRA Conversions, the ACA, and Dividend/Interest Income

Post by marcopolo » Thu Mar 01, 2018 12:09 pm

curmudgeon wrote:
Wed Feb 28, 2018 9:24 pm
Random Poster wrote:
Wed Feb 28, 2018 8:50 pm
The flip side of it all though is that I'm also starting to wonder if it even makes sense to keep working and saving, because saving more might, oddly enough and due to the ACA or the like, just foreclose options instead of expand them. I guess if you have a $10M portfolio it might not matter as much, but if your portfolio is, say, between $3M and 4.5M, you could really get squeezed between higher health insurance costs and limited ways to avoid future tax bills.
If you've got money, you'll always have a target on your back. You will also have a lot more options than someone without money.

This particular anomaly is not something to be making long term plans on. A few years ago, I was budgeting $20K/yr for health insurance in early retirement. I still do; each year that shows up with a big subsidy I treat as a one-time bonus and add it to my travel funds. A few years ago I was planning to do "horse race" Roth conversions up until I took SS. No chance of that now. Similarly, I was planning to do "file and suspend" for SS. That's gone too. If it weren't for the current political deadlock over ACA, I suspect the cliff would have been adjusted (and not necessarily in our favor). For that matter, it's entirely possible that some form of means testing will be added based on net worth, not just income, in the future.

This pretty well sums up my planning as well. Manage income to take subsidy while it is still available, but budget as if it will not be there very long (early retirement budget has $24k for Healthcare insurance + $6k in out of pocket expense). Each year i get the subsidy, consider it a bonus that gets mentally "banked" for future years when the actual cost may be higher due to the high inflation in medical costs.

Question for anyone who has done a deeper analysis on ACA subsidy vs Roth conversions. It seems like an easy decision to stay below the subsidy cliff. But, do Roth conversions make sense below the cliff? let's say your other income come to $40k, leaving you about $25k in head room to do Roth conversions. This would be at the 12% federal rate, but the way the subsidies work, you would also be losing about 9.5% in subsidy for your conversions. Does it make sense to do Roth conversions at the effective 21.5% federal rate? What are you doing?
Once in a while you get shown the light, in the strangest of places if you look at it right.

User avatar
MP123
Posts: 794
Joined: Thu Feb 16, 2017 3:32 pm

Re: IRA Conversions, the ACA, and Dividend/Interest Income

Post by MP123 » Thu Mar 01, 2018 12:49 pm

marcopolo wrote:
Thu Mar 01, 2018 12:09 pm
Question for anyone who has done a deeper analysis on ACA subsidy vs Roth conversions. It seems like an easy decision to stay below the subsidy cliff. But, do Roth conversions make sense below the cliff? let's say your other income come to $40k, leaving you about $25k in head room to do Roth conversions. This would be at the 12% federal rate, but the way the subsidies work, you would also be losing about 9.5% in subsidy for your conversions. Does it make sense to do Roth conversions at the effective 21.5% federal rate? What are you doing?
That's a good point. I suppose it applies to all income too not just Roth conversions. Adding one additional dollar of income under the cliff reduces your subsidy by 9.5 cents and of course the 12 cents federal tax for a combined 21.5% "tax" rate assuming you were still under the cliff.

So I guess there really isn't a 12% bracket for anyone with subsidized ACA... :confused

vtMaps
Posts: 425
Joined: Tue Oct 14, 2008 12:05 pm
Location: central Vermont

Re: IRA Conversions, the ACA, and Dividend/Interest Income

Post by vtMaps » Thu Mar 01, 2018 1:47 pm

MP123 wrote:
Thu Mar 01, 2018 12:49 pm
So I guess there really isn't a 12% bracket for anyone with subsidized ACA... :confused
That's correct. DW just went on medicare (in 2018), but was on ACA for all of 2017. We will take $13k out of our IRAs this month (12% tax bracket). A day later we will make $13k contributions to the same IRAs, but they will be 2017 contributions. Thus we reduce our 2017 taxes by 22% of $13k and increase our 2018 taxes by 12% of $13k.

What a _____ tax system! [fill in the blank]

--vtMaps
The optimist proclaims that we live in the best of all possible worlds; and the pessimist fears this is true. --James Branch Cabell

curmudgeon
Posts: 1655
Joined: Thu Jun 20, 2013 11:00 pm

Re: IRA Conversions, the ACA, and Dividend/Interest Income

Post by curmudgeon » Thu Mar 01, 2018 1:49 pm

MP123 wrote:
Thu Mar 01, 2018 12:49 pm
marcopolo wrote:
Thu Mar 01, 2018 12:09 pm
Question for anyone who has done a deeper analysis on ACA subsidy vs Roth conversions. It seems like an easy decision to stay below the subsidy cliff. But, do Roth conversions make sense below the cliff? let's say your other income come to $40k, leaving you about $25k in head room to do Roth conversions. This would be at the 12% federal rate, but the way the subsidies work, you would also be losing about 9.5% in subsidy for your conversions. Does it make sense to do Roth conversions at the effective 21.5% federal rate? What are you doing?
That's a good point. I suppose it applies to all income too not just Roth conversions. Adding one additional dollar of income under the cliff reduces your subsidy by 9.5 cents and of course the 12 cents federal tax for a combined 21.5% "tax" rate assuming you were still under the cliff.

So I guess there really isn't a 12% bracket for anyone with subsidized ACA... :confused
Like many things in ACA, "it depends". We are going with a Bronze HSA plan (which gives us some more conversion room from the HSA contributions). Due to specific local pricing of the benchmark "SLCSP", in 2017 we had that 9.5% subsidy reduction cost between about $55K and the "cliff". For 2018, the gap between our plan and the benchmark has widened, and we can run all the way up to $64.9K MAGI without impacting the subsidy. I will probably aim a couple thousand below the cliff for safety, and I will do the Roth conversion in two parts, with the final one after I have seen distributions in December.

curmudgeon
Posts: 1655
Joined: Thu Jun 20, 2013 11:00 pm

Re: IRA Conversions, the ACA, and Dividend/Interest Income

Post by curmudgeon » Thu Mar 01, 2018 2:04 pm

vtMaps wrote:
Thu Mar 01, 2018 1:47 pm
MP123 wrote:
Thu Mar 01, 2018 12:49 pm
So I guess there really isn't a 12% bracket for anyone with subsidized ACA... :confused
That's correct. DW just went on medicare (in 2018), but was on ACA for all of 2017. We will take $13k out of our IRAs this month (12% tax bracket). A day later we will make $13k contributions to the same IRAs, but they will be 2017 contributions. Thus we reduce our 2017 taxes by 22% of $13k and increase our 2018 taxes by 12% of $13k.

What a _____ tax system! [fill in the blank]

--vtMaps
One other entertaining bump that falls into this range is the "Saver's Credit" phaseout at $62K (MFJ). If you have earned income and contribute to an IRA, that's potentially $400 of tax you can save.

Post Reply