Opinions on a large Roth conversion if we have a 30-40% correction.

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Housedoc
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Opinions on a large Roth conversion if we have a 30-40% correction.

Post by Housedoc » Thu Oct 11, 2018 12:40 pm

I am asking for opinions on if it is a good idea in the long run to do a one time large traditional to Roth conversion if markets tank.
Currently have 1.3 million in a traditional and wife has 800,000 in her traditional. Age is 61 and 60, drawing a pension that covers all our expenses. 2 children in their 20's. By large I mean anywhere from 100,000 to 300,000 conversion at a 30 to 40 pct discount.
I have non-IRA money to pay taxes out of. Currently in a 15%ish tax bracket .
Thoughts??

bradpevans
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by bradpevans » Thu Oct 11, 2018 12:46 pm

Housedoc wrote:
Thu Oct 11, 2018 12:40 pm
I am asking for opinions on if it is a good idea in the long run to do a one time large traditional to Roth conversion if markets tank.
Currently have 1.3 million in a traditional and wife has 800,000 in her traditional. Age is 61 and 60, drawing a pension that covers all our expenses. 2 children in their 20's. By large I mean anywhere from 100,000 to 300,000 conversion at a 30 to 40 pct discount.
I have non-IRA money to pay taxes out of. Currently in a 15%ish tax bracket .
Thoughts??
If the tax rates favor the conversion (tax rate now via conversion vs. tax rate later doing nothing),
then yes, the logic is there: assuming the the values comes back.

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sometimesinvestor
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by sometimesinvestor » Thu Oct 11, 2018 12:59 pm

If the market is really going to drop 30% (unlikely ) it will take it time to do so. We are near the end of the year. Try 50k now and 50k early next year.That way you may not raise your tax bracket all that much

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David Jay
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by David Jay » Thu Oct 11, 2018 1:02 pm

I would certainly convert to the top of, say, the 22% tax bracket.

But hundreds of thousands - you need to look at whether or not it actually saves (net) on taxes.
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by Alan S. » Thu Oct 11, 2018 1:13 pm

It makes some sense, but since you have no way to "call the bottom" of a bear market anyway, you might want to split the conversions over two tax years or more to keep your marginal rate from spiking too much. Along with that you might look at the top of the 12% (fed) bracket as a no brainer amount, but how far into the 22% bracket you go needs to be studied. Not sure if your reference to 15% bracket includes state income taxes or not.

And you have to be careful with the amounts because you cannot recharacterize conversions any longer, so no do-over. However, you are considering converting about 15% of your pre tax retirement assets after a -35% bear market and if you have NO Roth assets now, this will provide you with an 85-15 pre tax breakdown and some degree of tax diversification for the long run.

If the markets continue down for the rest of this year, in December you could consider a small conversion based more on topping off your current bracket, since we are not likely to be down anywhere near 35% by then. Remember that each dollar converted is more beneficial than the next dollar converted, because you will be reducing your RMDs from the top down and eventually your marginal rates deeper in retirement would drop since your RMDs would be smaller. Whatever strategy you adopt, it will need to be revisited annually and more often if the market dislocates. The reduced marginal rates also may not last, may not even last to 2025. Just because they expire then does not mean that they necessarily will last until then.

TravelforFun
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by TravelforFun » Thu Oct 11, 2018 7:10 pm

Are you going to need the Roth IRA money within the next 7-10 years. If you're not then I would convert. That money will gain back over time and all the gain would be tax free.

TravelforFun

rkhusky
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by rkhusky » Thu Oct 11, 2018 7:36 pm

The state of the market has no bearing on whether to do a conversion or not. It is the same Traditional vs Roth analysis. It depends on the tax rate you are paying now versus what you will pay when withdrawing in retirement. Since it appears that you would pay taxes out of a taxable account, the analysis would be similar to the situation where you are maxing all tax-advantaged accounts and are putting the rest in a taxable account. So, you have to consider the drag of the taxable account into consideration, which provides on the order of an additional 5% advantage to the Roth. You would also need to look at the effect of SS and RMD's on your marginal tax rate in retirement.

Suppose you are in essentially the same tax bracket now as you were 5 years ago. What was the Traditional vs Roth decision back then? Suppose the market drops tomorrow to what it was back then. How would tomorrow after the drop be any different than it was 5 years ago?

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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by MotoTrojan » Thu Oct 11, 2018 8:01 pm

rkhusky wrote:
Thu Oct 11, 2018 7:36 pm

Suppose you are in essentially the same tax bracket now as you were 5 years ago. What was the Traditional vs Roth decision back then? Suppose the market drops tomorrow to what it was back then. How would tomorrow after the drop be any different than it was 5 years ago?
How is an extra 5 years of growth on the money used to pay the taxes even close to not being different/better?

delamer
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by delamer » Thu Oct 11, 2018 9:08 pm

rkhusky wrote:
Thu Oct 11, 2018 7:36 pm
The state of the market has no bearing on whether to do a conversion or not. It is the same Traditional vs Roth analysis. It depends on the tax rate you are paying now versus what you will pay when withdrawing in retirement. Since it appears that you would pay taxes out of a taxable account, the analysis would be similar to the situation where you are maxing all tax-advantaged accounts and are putting the rest in a taxable account. So, you have to consider the drag of the taxable account into consideration, which provides on the order of an additional 5% advantage to the Roth. You would also need to look at the effect of SS and RMD's on your marginal tax rate in retirement.

Suppose you are in essentially the same tax bracket now as you were 5 years ago. What was the Traditional vs Roth decision back then? Suppose the market drops tomorrow to what it was back then. How would tomorrow after the drop be any different than it was 5 years ago?
I was confused about why a market dip would make a conversion more attractive, as implied by the OP.

My guess is that it is the concept that you can convert more shares when there is a price drop.

Say you can convert $10,000 and stay in the same bracket. If you have 100 shares worth $200, then you can convert half of the shares. But if the price falls to $100, then you can convert all 100 shares.

Chip
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by Chip » Fri Oct 12, 2018 4:49 am

I did it in 2009 and am obviously happy with the results. However, I had the option of recharacterizing if the market kept going down. That option is no longer available.

If you do it you need to understand ALL of the taxes you may be hit with. I'm thinking of the NIIT (Form 8960) in particular. AMT was an issue for me though I'm not sure where that kicks in now with the new tax law. I'm sure there are other taxes to consider but they don't come to mind immediately. Though if you execute this two years from now you would have consider Medicare IRMAA impacts since you will be 63.

rkhusky
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by rkhusky » Fri Oct 12, 2018 7:10 am

MotoTrojan wrote:
Thu Oct 11, 2018 8:01 pm
rkhusky wrote:
Thu Oct 11, 2018 7:36 pm

Suppose you are in essentially the same tax bracket now as you were 5 years ago. What was the Traditional vs Roth decision back then? Suppose the market drops tomorrow to what it was back then. How would tomorrow after the drop be any different than it was 5 years ago?
How is an extra 5 years of growth on the money used to pay the taxes even close to not being different/better?
You have the money that went from Traditional to Roth, which you don't have to pay taxes on in withdrawal. And you have the money that was in taxable that you used to pay the taxes when moving the money from Traditional to Roth. Both get the same amount of growth, whether it is 5x, 10x or 20x. There is some tax drag on the taxable funds, so if the tax rate you paid to move from Traditional to Roth is the same as the tax rate you would pay to withdraw the funds from Traditional in retirement, then moving to Roth is somewhat better due to the tax drag (i.e. Roth is better than Traditional + taxable if the marginal rates are the same).

Retired2013
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by Retired2013 » Fri Oct 12, 2018 7:29 am

Housedoc wrote:
Thu Oct 11, 2018 12:40 pm
I am asking for opinions on if it is a good idea in the long run to do a one time large traditional to Roth conversion if markets tank.
Currently have 1.3 million in a traditional and wife has 800,000 in her traditional. Age is 61 and 60, drawing a pension that covers all our expenses. 2 children in their 20's. By large I mean anywhere from 100,000 to 300,000 conversion at a 30 to 40 pct discount.
I have non-IRA money to pay taxes out of. Currently in a 15%ish tax bracket .
Thoughts??
About the same situation. Same age, no pension and a little less combine traditional balance. I'd be doing conversions every year to the top of the 12% bracket except we are keeping our income low to qualify for ACA. For us, it doesn't make sense to do a conversion and then pay an additional $15k for healthcare on top of the Federal and State taxes. I'm waiting for us to be on Medicare and then I will be doing conversions every year to the top of the 12% bracket to help lower the RMDs coming. I plan on even doing small conversions after age 70. However, if the market dropped 30% - 40% I will be taking a second look at it if that happens in the next 4 years.

When you are both 70 and required to take RMD, that would be around $77k ($2.1M with no growth for 9 yrs) on top of your SS and pension. 85% of SS will be taxed. IRMAA is an extra charge added to your premium. It's $187.50 each at $170k for MFJ . Project out your portfolio growth and income. Look at what your income could be when your both 70. We have no pension and we'll be over the top of the 12% bracket when taking RMD and SS.

I think if I were you (not fully knowing your pension, SS strategy or healthcare) I would be converting to the top of the 12% tax bracket each year now. If when you do the conversion, the market is down any percentage, that's a better option but the amount would still be the same.
The markets are down now 6% but it still would have been better to do your conversion back in January when the market was still down another 2%.

GrowthSeeker
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by GrowthSeeker » Fri Oct 12, 2018 9:56 am

rkhusky wrote:
Thu Oct 11, 2018 7:36 pm
The state of the market has no bearing on whether to do a conversion or not.
That's what I was thinking too; but the difference is in how you look at it.
If you think about Roth converting a certain number of dollars, then the state of the market doesn't matter.
If you think about Roth converting a certain number of shares, or a certain percentage of your tIRA total value, then the state of the market does matter.
Just because you're paranoid doesn't mean they're NOT out to get you.

MotoTrojan
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by MotoTrojan » Fri Oct 12, 2018 6:44 pm

rkhusky wrote:
Fri Oct 12, 2018 7:10 am
MotoTrojan wrote:
Thu Oct 11, 2018 8:01 pm
rkhusky wrote:
Thu Oct 11, 2018 7:36 pm

Suppose you are in essentially the same tax bracket now as you were 5 years ago. What was the Traditional vs Roth decision back then? Suppose the market drops tomorrow to what it was back then. How would tomorrow after the drop be any different than it was 5 years ago?
How is an extra 5 years of growth on the money used to pay the taxes even close to not being different/better?
You have the money that went from Traditional to Roth, which you don't have to pay taxes on in withdrawal. And you have the money that was in taxable that you used to pay the taxes when moving the money from Traditional to Roth. Both get the same amount of growth, whether it is 5x, 10x or 20x. There is some tax drag on the taxable funds, so if the tax rate you paid to move from Traditional to Roth is the same as the tax rate you would pay to withdraw the funds from Traditional in retirement, then moving to Roth is somewhat better due to the tax drag (i.e. Roth is better than Traditional + taxable if the marginal rates are the same).
Option 1: 5 years ago the market was at X and you performed your conversion, which cost you $1000 in taxes. Yay.

Option 2: You did not do this because you chose to invest the $1000. The market goes up and then crashes back down to X. You decide to withdraw the taxable assets, which have now grown to $1500 after-tax, and perform the conversion at the same levels as 5 years ago, costing you the same $1000 in taxes.

Is option 2 not $500 better? I am not saying this is a sound strategy to try to implement, as nobody knows if/when the market will crash, but you stated that this was equivalent and it simply is not.

rkhusky
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by rkhusky » Fri Oct 12, 2018 7:13 pm

MotoTrojan wrote:
Fri Oct 12, 2018 6:44 pm
Option 1: 5 years ago the market was at X and you performed your conversion, which cost you $1000 in taxes. Yay.

Option 2: You did not do this because you chose to invest the $1000. The market goes up and then crashes back down to X. You decide to withdraw the taxable assets, which have now grown to $1500 after-tax, and perform the conversion at the same levels as 5 years ago, costing you the same $1000 in taxes.

Is option 2 not $500 better? I am not saying this is a sound strategy to try to implement, as nobody knows if/when the market will crash, but you stated that this was equivalent and it simply is not.
If the market crashes back to X, won't you be back at $1000?

Besides, the main point is that if the conditions that led one to choose Traditional over Roth 5 years ago, when the market was much lower, are the same as they are now, why would you change your strategy? That is, 5 years ago Traditional over Roth was chosen when the market was at X. The market is now at X+Y and presumably one is still choosing Traditional over Roth. Why would you choose Roth over Traditional if the market then goes back to X, when you chose Traditional over Roth before? That's assuming the tax situation is essentially the same as it was 5 years ago. If the tax situation has changed, then choosing a different course is understandable. But not simply the fact that market has gone back down to where it was 5 years ago.

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Peter Foley
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by Peter Foley » Fri Oct 12, 2018 8:48 pm

There are numerous other factors to consider such as:

Will you spend your Roth during your lifetime or is this for your heirs?
Are RMD's an issue?
Medicare B premium increases for some individuals, perhaps 2 increases for some couples.
Estate planning for those potentially subject to state and federal estate taxes.
Etc.

From a practical standpoint consider the following: A very large decline in the market triggers reallocation to adjust your AA. You will be buying stocks. Would you want to sell bonds in traditional and replace them there or buy them in your Roth?

MotoTrojan
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by MotoTrojan » Fri Oct 12, 2018 9:14 pm

rkhusky wrote:
Fri Oct 12, 2018 7:13 pm
MotoTrojan wrote:
Fri Oct 12, 2018 6:44 pm
Option 1: 5 years ago the market was at X and you performed your conversion, which cost you $1000 in taxes. Yay.

Option 2: You did not do this because you chose to invest the $1000. The market goes up and then crashes back down to X. You decide to withdraw the taxable assets, which have now grown to $1500 after-tax, and perform the conversion at the same levels as 5 years ago, costing you the same $1000 in taxes.

Is option 2 not $500 better? I am not saying this is a sound strategy to try to implement, as nobody knows if/when the market will crash, but you stated that this was equivalent and it simply is not.
If the market crashes back to X, won't you be back at $1000?

Besides, the main point is that if the conditions that led one to choose Traditional over Roth 5 years ago, when the market was much lower, are the same as they are now, why would you change your strategy? That is, 5 years ago Traditional over Roth was chosen when the market was at X. The market is now at X+Y and presumably one is still choosing Traditional over Roth. Why would you choose Roth over Traditional if the market then goes back to X, when you chose Traditional over Roth before? That's assuming the tax situation is essentially the same as it was 5 years ago. If the tax situation has changed, then choosing a different course is understandable. But not simply the fact that market has gone back down to where it was 5 years ago.
I didn’t say what the $1000 was invested in :). We are arguing different things. I agree entirely with you. Just don’t think they are unequivocally the same. The $1000 in taxes might not have existed 5 years ago so no ability to do it then.

Osprey
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by Osprey » Sat Oct 13, 2018 6:56 am

I’ve been thinking about this scenario as well. I have pension income and will be in 24% bracket now and in the future.

If market drops substantially it would appear to me to be an opportune time to convert up to 24% tax bracket limit. Benefit is paying at 24% level for some ira funds (avoid risk that the rate could revert higher in future, while still having large sum left in traditional ira) and I pay tax on lower value with likelihood that market will recover after I convert.

If I have 1000 shares of s&p 500 etf worth 200k and market goes down so it is worth 140k or less, it would seem to be a good time to transfer the shares to my Roth account and pay the tax and then have the shares in Roth account for eventual market recovery.

Some people have commented that market correction shouldn’t be a factor in timing of conversion to Roth, could u please elaborate on this. I recognize that market could continue to go lower and I might spread the conversion out over the year and continue converting the following year too.

rkhusky
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by rkhusky » Sat Oct 13, 2018 7:10 am

Osprey wrote:
Sat Oct 13, 2018 6:56 am
If I have 1000 shares of s&p 500 etf worth 200k and market goes down so it is worth 140k or less, it would seem to be a good time to transfer the shares to my Roth account and pay the tax and then have the shares in Roth account for eventual market recovery.
The money that you would pay the taxes with will be gone too and it would have also increased with a market recovery.

Scenario 1a: You currently have $100K in a Traditional account. The market goes down by 50% (you have $50K left). You convert to Roth and pay 20% in taxes (you have $40K in Roth). Market doubles (you have $80K in Roth).

Scenario 1b: You currently have $100K in a Traditional account and $20K in a taxable account. The market goes down by 50% (you have $50K in Traditional and $10K in taxable). You convert to Roth and pay 20% in taxes from the taxable account (you have $50K in Roth and $0K in taxable). Market doubles (you have $100K in Roth and $0K in taxable).

Scenario 2a: You currently have $100K in a Traditional account. You convert to Roth and pay 20% in taxes (you have $80K in Roth - same as 1a).

Scenario 2b: You currently have $100K in a Traditional account and $20K in a taxable account. You convert to Roth and pay 20% in taxes from the taxable account (you have $100K in Roth and $0K in taxable - same as 1b).

This is obviously simplistic, but it shows that Roth conversions when the market goes down are not a slam dunk money maker.

If you are in the 24% bracket now and in the future (including RMD's and SS) and you can pay the taxes from a taxable account, then Roth conversions to the top of the 24% bracket would be a benefit, no matter what the market does. So, you really shouldn't wait for a big market downturn before converting. A market downturn would let you convert more of your Traditional account without bumping into the next bracket, but that's about the only benefit, so there is no reason to wait to convert.

Osprey
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by Osprey » Sat Oct 13, 2018 7:44 am

Thanks for your explanation. For my situation, the difference is that I would be using taxable cash to pay taxes so waiting for correction to do large conversion would decrease my tax bill.

cas
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by cas » Sat Oct 13, 2018 8:28 am

Osprey wrote:
Sat Oct 13, 2018 7:44 am
Thanks for your explanation. For my situation, the difference is that I would be using taxable cash to pay taxes so waiting for correction to do large conversion would decrease my tax bill.
Vanguard has a recent paper out that you (and others considering Roth conversions) may be interested in. Along with words, it has graphical representations of some of these concepts, which I often find helps my understanding.

Vanguard white paper (2018): "A “BETR” approach to Roth conversions" https://personal.vanguard.com/pdf/ISGBETR.pdf

Of particular note to this discussion,

p 2 has discussion and graphic of what rhusky has been saying - that marginal tax rates (See Note 1) are the determining factor when
- the taxes for the conversion are paid out of the traditional IRA (as opposed to a separate taxable account)
- the trad IRA is all pre-tax (no post-tax basis)
- this situation is not a factor: a need to clear out a pre-tax traditional IRA so that backdoor Roth contributions can be done

p 4-5 has discussion and graphics showing the beneficial effects (See Note 2) of paying conversion taxes out of a taxable account (as opposed to out of the trad IRA)



Assorted disclaimers, since certain nuances of this topic are hotly debated on the forums:

Note 1: Note that there are many threads of debate on this forum pointing out that determining, many years in advance, the after-retirement (or at-RMD) marginal tax rate on any given chunk of money in a traditional IRA has more complexities to it than first meets the eye.

Note 2: the "beneficial" adjective applies when assuming the market eventually shows a gain after the taxes are paid from the taxable account

rkhusky
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by rkhusky » Sat Oct 13, 2018 8:32 am

Osprey wrote:
Sat Oct 13, 2018 7:44 am
Thanks for your explanation. For my situation, the difference is that I would be using taxable cash to pay taxes so waiting for correction to do large conversion would decrease my tax bill.
I am assuming that your asset allocation remains the same during the process. If you use cash to pay taxes and don't replenish it, then your portfolio has become riskier. The same would be true if you only used bonds to pay the taxes and didn't rebalance afterwards.

rkhusky
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Re: Opinions on a large Roth conversion if we have a 30-40% correction.

Post by rkhusky » Sat Oct 13, 2018 8:44 am

cas wrote:
Sat Oct 13, 2018 8:28 am
Vanguard has a recent paper out that you (and others considering Roth conversions) may be interested in. Along with words, it has graphical representations of some of these concepts, which I often find helps my understanding.
Figure 2 shows the effects of the tax drag in a taxable account. This can occur during the contribution phase after one has maximized all tax-advantaged accounts and is investing the excess in a taxable account. If the marginal tax rates are the same during contribution and withdrawal, Roth > Traditional + taxable. This corresponds to a Roth conversion, where the tax rates for conversion and withdrawal are the same and one is paying taxes out of a taxable account.

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