Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

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BonziBuddy
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Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by BonziBuddy »

I am single, 36 and will have two low-income years (2018 and 2019) where I have a lot of room in my 12% tax bracket to perform IRA Roth conversions or realize 0% long term capital gains. I am unsure of which I should do.

I have a ~$230,000 pre-tax 401k balance that I could perform IRA Roth conversions from. Since I am only 36, any Roth conversions will have a lot time to grow tax free. However, since I follow a 80/20 AA, they will forever hold bonds and don't have a large growth potential.

I have ~$70,000 of long term capital gains in my taxable account. My long term capital gains will continue to grow every year, as I have ~$800,000 in a taxable account and will continue making large contributions to this (until I reach my $3MM goal).

For 2020 and beyond, I will almost certainly never again be in the 12% tax bracket for ordinary income and the 0% tax bracket for long term capital gains.

Should I perform IRA Roth conversions or should I realize 0% long term capital gains during my two low income years?
PFInterest
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by PFInterest »

Why are they going to hold bonds in the rIRA? You will still have a 401 in the future.
KlangFool
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by KlangFool »

OP,

1) Why pay 12% tax when you can pay 0%?

2) Your taxable is significantly larger than your tax-deferred account. So, you should have plenty of opportunities to do Roth conversion later.

KlangFool
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GrowthSeeker
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by GrowthSeeker »

BonziBuddy wrote: Sat Nov 17, 2018 2:16 pm I am single, 36 and will have two low-income years (2018 and 2019) where I have a lot of room in my 12% tax bracket to perform IRA Roth conversions or realize 0% long term capital gains. I am unsure of which I should do.

I have a ~$230,000 pre-tax 401k balance that I could perform IRA Roth conversions from. Since I am only 36, any Roth conversions will have a lot time to grow tax free. However, since I follow a 80/20 AA, they will forever hold bonds and don't have a large growth potential.

I have ~$70,000 of long term capital gains in my taxable account. My long term capital gains will continue to grow every year, as I have ~$800,000 in a taxable account and will continue making large contributions to this (until I reach my $3MM goal).

For 2020 and beyond, I will almost certainly never again be in the 12% tax bracket for ordinary income and the 0% tax bracket for long term capital gains.

Should I perform IRA Roth conversions or should I realize 0% long term capital gains during my two low income years?
Suppose your income for those low income years is $10,000 less than the top of the 12% bracket. I think that is the same as the top of the 0% LTCG bracket.
So then suppose you TGH $10,000 worth of capital gains. You just reset your basis so that some day in the future when you DO realize a LTCG on that stock/ETF/fund, you'll save $1,500. The longer that is in the future, the lower the present day value is of that future $1,500.
Instead suppose you Roth convert $10,000. You PAY $1,200 in tax. But you now get a (kind of) higher ROI in the ROTH vs in the IRA due to the future income tax on withdrawals from the tIRA.
So far, the Roth conversion puts you behind by $1,200 plus the present value of the future $1,500. (so, under $2,700).

Your Roth value will have to be greater than the "after tax" value of your tIRA at some point in the future to make the Roth conversion a better deal. I think the after tax value of the IRA is simply value times (1-t) where t is the tax rate you'll be paying when you take a distribution from it.

You may or may not invest in the same thing whether in tIRA or Roth IRA, but suppose the Roth Growth rate is "R" and the tIRA growth rate is "A". R for Roth; A for irA. The number of years is N. Your future IRA distributions will be taxed at tax rate "t".
Future Roth value (of the original 10,000):
X = 10000*(1+R)^N

Future tIRA value (of the original 10,000):
Y = (1-t)*10000*(1+A)^N
breakeven year is when X-Y >= 2700

-----
edit: OTOH, you might never sell the appreciated stock and thus never have to pay the LTCG tax; your heirs will inherit it with a stepped up basis. Similarly, the money in the IRA might never get distributed until the day you die, then your heirs get it; I think they then pay tax on the distributions at their tax rate.
Last edited by GrowthSeeker on Sat Nov 17, 2018 3:58 pm, edited 1 time in total.
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tenkuky
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by tenkuky »

What will you do once you realize the cap gains in the taxable?
Is your asset allocation off that you have to purchase something else?
Or you going to repurchase substantially similar holdings?

Curious because I've not touched my gainers as they fit my AA nicely and don't like timing sales if no loss to harvest.
Katietsu
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by Katietsu »

Not commenting on your current dilemma. But I would not put bonds in a Roth. If you convert to a Roth, it is likely that you should fill it with your highest growth assets. This is true even if it means that you are moving bonds to taxable. There are a few discussions on here if you are interested. Obviously, nothing is universal but something to consider.
Topic Author
BonziBuddy
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by BonziBuddy »

For those that asked questions:
PFInterest wrote: Sat Nov 17, 2018 2:41 pm Why are they going to hold bonds in the rIRA? You will still have a 401 in the future.
Fair point.
KlangFool wrote: Sat Nov 17, 2018 2:45 pm OP,

1) Why pay 12% tax when you can pay 0%?

2) Your taxable is significantly larger than your tax-deferred account. So, you should have plenty of opportunities to do Roth conversion later.

KlangFool
After 2020, I will never be in the 12% tax bracket again (I'll have too high income an income from work or my investments will be generating too much income). And since I will have to pay taxes on the 401k at some point (even if it is RMDs at 70.5), my thought process was I might want to pay the taxes now and let the Roth IRA grow tax-free.
tenkuky wrote: Sat Nov 17, 2018 3:55 pm What will you do once you realize the cap gains in the taxable?
Is your asset allocation off that you have to purchase something else?
Or you going to repurchase substantially similar holdings?

Curious because I've not touched my gainers as they fit my AA nicely and don't like timing sales if no loss to harvest.
I would repurchase substantially similar holdings. I do not have to rebalance.
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Earl Lemongrab
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by Earl Lemongrab »

How much actual room will you have? One thing to remember is the 0% qualified dividend situation. The bracket for that almost overlaps the 12% marginal bracket. So if you have significant taxable stock holdings (presumably based on the question) then some of the QDIVs are sitting in the 0% space.

In my case, the entire space is filled. If I realize a dollar of ordinary income, it's taxed at 12% AND it shoves a dollar of QDIVs out of the 0% bracket into 15%. So I have a "shadow" bracket of 27% federal tax. Also state of course.
gclancer
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by gclancer »

I would do the Roth conversions, and here’s why. If you’re aggressively contributing to your taxable account going forward, you’ll eventually hit a point in time where you’re tax loss harvesting which will also allow you to do corresponding tax gain harvesting. On the contrary, your ordinary income tax rate won’t be this low again, so you won’t have the opportunity to do Roth conversions in the future like you’ll have the opportunity to do tax gain harvesting.
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dodecahedron
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by dodecahedron »

You could do Roth conversions and hang onto your appreciated securities.

Those appreciated securities can be handily tax-efficient down the road when you want to make charitable donations OR gifts to relatives in lower tax brackets than you (e.g., wedding or graduation presents to younger folks, helping out elderly relatives.)
CRTR
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by CRTR »

KlangFool wrote: Sat Nov 17, 2018 2:45 pm OP,

1) Why pay 12% tax when you can pay 0%?

2) Your taxable is significantly larger than your tax-deferred account. So, you should have plenty of opportunities to do Roth conversion later.

KlangFool
+1
I guess the devil is in the details and depends on how long you will work/have income. I am retired and living off my taxable account right now. I have another 10+ years until I collect social security. I've been doing Roth conversions for a couple years. Last year I converted $61k and paid ~$6k tax (I set a 10% effective tax limit on my conversions). On the other hand, if you plan to keep working or will have passive income sources in the future, this type of conversion plan won't work for you and I would recommend doing the 12% now.
Last edited by CRTR on Sat Nov 17, 2018 8:49 pm, edited 2 times in total.
bsteiner
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by bsteiner »

No one knows what the future will bring. But Roth conversions at 12% are likely to add substantial value.
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FiveK
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by FiveK »

See the '0% LTCG or t->R' tab in the personal finance toolbox spreadsheet if you would like to evaluate your specific situation.

As several posters have suggested, the traditional->Roth conversion is likely to be better for most in the long run. You can check whether you are part of "most" using that tool.
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by Dottie57 »

bsteiner wrote: Sat Nov 17, 2018 8:40 pm No one knows what the future will bring. But Roth conversions at 12% are likely to add substantial value.
+1
randomguy
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by randomguy »

KlangFool wrote: Sat Nov 17, 2018 2:45 pm OP,

1) Why pay 12% tax when you can pay 0%?

2) Your taxable is significantly larger than your tax-deferred account. So, you should have plenty of opportunities to do Roth conversion later.

KlangFool
A) cause paying 12% now and 15% later is better than paying 0% now and 30% and 15% later. Obviously figuring out these numbers exactly is impossible. You make your guesses for your situation

b) impossible to say. Depends a lot on expected retirement date and expected income sources.

This choice doesnt matter much. I tend to favor not paying taxes when the choice is borderline but I know a lot of people here prefer paying taxes ealier.
KlangFool
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by KlangFool »

randomguy wrote: Sun Nov 18, 2018 8:14 am
KlangFool wrote: Sat Nov 17, 2018 2:45 pm OP,

1) Why pay 12% tax when you can pay 0%?

2) Your taxable is significantly larger than your tax-deferred account. So, you should have plenty of opportunities to do Roth conversion later.

KlangFool
A) cause paying 12% now and 15% later is better than paying 0% now and 30% and 15% later. Obviously figuring out these numbers exactly is impossible. You make your guesses for your situation

b) impossible to say. Depends a lot on expected retirement date and expected income sources.

This choice doesnt matter much. I tend to favor not paying taxes when the choice is borderline but I know a lot of people here prefer paying taxes ealier.
randomguy,

1) OP is 36 years old. He is 34 years from 70 years old.

2) OP will have a few million in a few years.

The chances of OP retiring early is very high.

KlangFool
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randomguy
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by randomguy »

KlangFool wrote: Sun Nov 18, 2018 9:54 am
randomguy wrote: Sun Nov 18, 2018 8:14 am
KlangFool wrote: Sat Nov 17, 2018 2:45 pm OP,

1) Why pay 12% tax when you can pay 0%?

2) Your taxable is significantly larger than your tax-deferred account. So, you should have plenty of opportunities to do Roth conversion later.

KlangFool
A) cause paying 12% now and 15% later is better than paying 0% now and 30% and 15% later. Obviously figuring out these numbers exactly is impossible. You make your guesses for your situation

b) impossible to say. Depends a lot on expected retirement date and expected income sources.

This choice doesnt matter much. I tend to favor not paying taxes when the choice is borderline but I know a lot of people here prefer paying taxes ealier.
randomguy,

1) OP is 36 years old. He is 34 years from 70 years old.

2) OP will have a few million in a few years.

The chances of OP retiring early is very high.

KlangFool
Sure and when he retires is he better off paying 15% on his gains and 22% on his IRA distributions or is he better to have 0% roth gains and 15% LTGC on a bit more money? Probably the second case. Don't forget to factor in tax drag. The problem isn't remotely as easy as saying 12% versus 0 unless you are a very short term thinker.

Granted he should probably reconsider bonds in tax deferred but that is a whole other article:)
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celia
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by celia »

BonziBuddy wrote: Sat Nov 17, 2018 4:11 pm For those that asked questions:
KlangFool wrote: Sat Nov 17, 2018 2:45 pm 1) Why pay 12% tax when you can pay 0%?
After 2020, I will never be in the 12% tax bracket again (I'll have too high income an income from work or my investments will be generating too much income). And since I will have to pay taxes on the 401k at some point (even if it is RMDs at 70.5), my thought process was I might want to pay the taxes now and let the Roth IRA grow tax-free.
+1 Good answer!

This is exactly why I started converting while working, except that my tax rate (under the old rules) was higher.

Since the general rule is to convert/contribute to Roth when your tax rate is lowest, that is what I would do.
KlangFool
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by KlangFool »

randomguy wrote: Sun Nov 18, 2018 11:58 pm
KlangFool wrote: Sun Nov 18, 2018 9:54 am
randomguy wrote: Sun Nov 18, 2018 8:14 am
KlangFool wrote: Sat Nov 17, 2018 2:45 pm OP,

1) Why pay 12% tax when you can pay 0%?

2) Your taxable is significantly larger than your tax-deferred account. So, you should have plenty of opportunities to do Roth conversion later.

KlangFool
A) cause paying 12% now and 15% later is better than paying 0% now and 30% and 15% later. Obviously figuring out these numbers exactly is impossible. You make your guesses for your situation

b) impossible to say. Depends a lot on expected retirement date and expected income sources.

This choice doesnt matter much. I tend to favor not paying taxes when the choice is borderline but I know a lot of people here prefer paying taxes ealier.
randomguy,

1) OP is 36 years old. He is 34 years from 70 years old.

2) OP will have a few million in a few years.

The chances of OP retiring early is very high.

KlangFool
Sure and when he retires is he better off paying 15% on his gains and 22% on his IRA distributions or is he better to have 0% roth gains and 15% LTGC on a bit more money? Probably the second case. Don't forget to factor in tax drag. The problem isn't remotely as easy as saying 12% versus 0 unless you are a very short term thinker.

Granted he should probably reconsider bonds in tax deferred but that is a whole other article:)
randomguy,

You are correct.

My confusion was with a few million in the taxable account, it might be possible to generate a fair amount of TLH to offset all that and provide room for Roth conversion. This does not have to be when he retired. The part that I made a mistake on is TLH can only reduce ordinary income by 3K per year. Hence, it will not work out.

KlangFool
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Topic Author
BonziBuddy
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Re: Perform 12% Roth conversions or realize 0% long term capital gains during low income years???

Post by BonziBuddy »

Thank you all for all your help.

I will fill my 10% and 12% tax bracket with Roth Conversions.

I will also use my Roth accounts to hold stocks instead of bonds.
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