Having 2nd thoughts about Roth conversion, please check my logic

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Topic Author
HotRod
Posts: 121
Joined: Thu Feb 12, 2015 11:56 am

Having 2nd thoughts about Roth conversion, please check my logic

Post by HotRod »

Hi fellow BH's,

I am 58 years old and 2018 will be my first complete calendar year of retirement.

My financial overview is:

Total savings = $2.2 Million
Annual Expenses = $50K

Some of my savings include:
  • Taxable in IVV (S&P 500) = $953,000
  • Traditional IRA in BND (Total Bond) = $387,000
  • Roth IRA in BND = $145,000
  • Ally Savings Account = $100,000
The remainder is not really relevant to this question.

At the start of 2018 I decided that I had too much in my Ally savings so I decided to spend down $50K (1 years living expenses) which leaves me with virtually no taxable income for the year. (I will receive approximately $12K dividends from the S&P 500 in taxable).

So my initial thought was that at the end of the year I would total all my taxable income and then do a Roth conversion up to the max of the 15% tax rate.

But now I question that logic.

If I do a conversion I will pay 15% tax and I will lose the gains that I would have made on that money for the next 12 years. I did some rough math as such (I've used round numbers for simplicity):

Let's say I convert $10K, at 15% tax, I will pay $1,500.

I used an online compound interest calculator and plugged in $1,500 at 2.5% for 12 years and that returned $2017.33 - Money that I would not make.

However, if I leave the $10K in my traditional IRA until 70 and have to take it out as an RMD @ 25% I will pay $2,500 in taxes.

So we are talking about less than $500. Yeah, I would love to stumble on $500 free tomorrow, but in the big picture, it doesn't seem to be a big deal.

Am I missing something here ?

Thanks as always !!
terpfan71
Posts: 15
Joined: Mon Jan 10, 2011 10:13 am

Re: Having 2nd thoughts about Roth conversion, please check my logic

Post by terpfan71 »

In my humble opinion, anytime you can convert IRA to Roth at a lower tax rate than your normal rate, you should do it. If you are able to take advantage of the increased std deduction and the lower tax rate (12%), its a no brainer.
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spangineer
Posts: 89
Joined: Sat Feb 24, 2007 8:39 am

Re: Having 2nd thoughts about Roth conversion, please check my logic

Post by spangineer »

Seems like you are forgetting that the $10k in your Traditional IRA will grow by the same amount – so when you pay 25% taxes at age 70, it will be on ~$13.5k, and you'll pay over $3000 in taxes.

Convert: $10k at 15% becomes 8,500. After 12 years at 2.5%, that becomes $11,432, tax free.

Don't convert: $10k becomes $13,450. Pay 25% tax on that, for $10,087, after taxes.

Net difference of almost $1,400.
Topic Author
HotRod
Posts: 121
Joined: Thu Feb 12, 2015 11:56 am

Re: Having 2nd thoughts about Roth conversion, please check my logic

Post by HotRod »

spangineer wrote: Thu Mar 08, 2018 2:32 pm Seems like you are forgetting that the $10k in your Traditional IRA will grow by the same amount – so when you pay 25% taxes at age 70, it will be on ~$13.5k, and you'll pay over $3000 in taxes.

Convert: $10k at 15% becomes 8,500. After 12 years at 2.5%, that becomes $11,432, tax free.

Don't convert: $10k becomes $13,450. Pay 25% tax on that, for $10,087, after taxes.

Net difference of almost $1,400.
Ahhh, excellent point !!
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FiveK
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Joined: Sun Mar 16, 2014 2:43 pm

Re: Having 2nd thoughts about Roth conversion, please check my logic

Post by FiveK »

HotRod wrote: Thu Mar 08, 2018 2:20 pm Am I missing something here ?
If you are talking federal tax only, then it may be only 12% instead of 15%.

See Traditional versus Roth - Bogleheads for some of the math behind the choice. Don't look at the amount of tax paid - instead, look at the amount of spendable income left after tax.

If you delay SS until age 70 (or so), that gives you much time to do Roth conversions at low marginal rates. The taxation of Social Security benefits may otherwise hit your traditional withdrawals with high marginal rates.

Doing some "what if...?" tax calculations for different income scenarios, e.g., tIRA voluntary withdrawals, SS benefits, RMDs, etc., may be useful.
itstoomuch
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Joined: Mon Dec 15, 2014 11:17 am
Location: midValley OR

Re: Having 2nd thoughts about Roth conversion, please check my logic

Post by itstoomuch »

hotrod wrote:Some of my savings include:
Taxable in IVV (S&P 500) = $953,000
Traditional IRA in BND (Total Bond) = $387,000
Roth IRA in BND = $145,000
Ally Savings Account = $100,000
Look at your Roth?
You converted high total returns (IVV) in IRA into low returns (BND) in Roth for which you paid higher margin tax to get and with no relief for Bond Risk.
Does this make sense?
FWIW, I stopped conversions, a long time ago.
YMMV
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo
Topic Author
HotRod
Posts: 121
Joined: Thu Feb 12, 2015 11:56 am

Re: Having 2nd thoughts about Roth conversion, please check my logic

Post by HotRod »

itstoomuch wrote: Thu Mar 08, 2018 2:53 pm
hotrod wrote:Some of my savings include:
Taxable in IVV (S&P 500) = $953,000
Traditional IRA in BND (Total Bond) = $387,000
Roth IRA in BND = $145,000
Ally Savings Account = $100,000
Look at your Roth?
You converted high total returns (IVV) in IRA into low returns (BND) in Roth for which you paid higher margin tax to get and with no relief for Bond Risk.
Does this make sense?
FWIW, I stopped conversions, a long time ago.
YMMV
Huh ??

Please point out where I wrote anything for which you could draw this conclusion:

"You converted high total returns (IVV) in IRA into low returns (BND) in Roth for which you paid higher margin tax to get and with no relief for Bond Risk."

I haven't converted anything - yet or ever. :oops: :oops:

My question is should I convert from my traditional IRA to a Roth IRA. How could I convert from a taxable account to a Roth anyway ?? Is that even possible ? :confused :confused

If you stopped doing conversions a long time ago, I would be interested to know why.
itstoomuch
Posts: 5343
Joined: Mon Dec 15, 2014 11:17 am
Location: midValley OR

Re: Having 2nd thoughts about Roth conversion, please check my logic

Post by itstoomuch »

Sorry, I was under the impression that you have done conversions and rethinking the reason for doing more conversions.
The reason is kinda global in the general tax deferral philosophy.

No you are not missing anything.JMO
In addition, if you keep the converted funds in a low yielding Roth (BND), you may never recover the conversion tax. Today we may have relatively high Interest Rate Risk, so the BND values may go down
YMMV
Last edited by itstoomuch on Thu Mar 08, 2018 3:34 pm, edited 1 time in total.
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo
nolesrule
Posts: 2631
Joined: Thu Feb 26, 2015 9:59 am

Re: Having 2nd thoughts about Roth conversion, please check my logic

Post by nolesrule »

Tax gain harvest in your taxable account.
itstoomuch
Posts: 5343
Joined: Mon Dec 15, 2014 11:17 am
Location: midValley OR

Re: Having 2nd thoughts about Roth conversion, please check my logic

Post by itstoomuch »

nolesrule wrote: Thu Mar 08, 2018 3:32 pm Tax gain harvest in your taxable account.
This. :dollar
Rev012718; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax TBT%. Early SS. FundRatio (FR) >1.1 67/70yo
rts58
Posts: 88
Joined: Sat Jul 16, 2016 10:35 am

Re: Having 2nd thoughts about Roth conversion, please check my logic

Post by rts58 »

Congrats on retirement!!

I retired 2 years ago in a similar situation. I used the retirement planning model available on the wiki, to try to come up with the best solution. I ended up deciding to convert to match my future expected marginal tax rate (after 70).

I also decided not to hold bonds in the Roth. Returns are so low with bonds, I'd rather have something that was more aggressive.
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