Converting from a traditional to a roth

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smc1234
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Converting from a traditional to a roth

Post by smc1234 »

Hi everyone! I've been lurking on Bogleheads.org for a while and I've learned a lot. I'm not real good on the computer, but I thought I'd join here to be able to ask a question. In regard to converting from a traditional to a roth, generally speaking if you have to take additional money from the traditional to pay the taxes, or by converting, it put you in a higher tax bracket, isn't it unwise to do so? Almost all our money is in tax deferred accounts. We get social security, but we spend that each month. My wife and I are in our late 60's, retired, own our home, and have no debt. I'll thank you for any responses now in case I can't figure out how to do it later. Thanks!
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arcticpineapplecorp.
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Re: Converting from a traditional to a roth

Post by arcticpineapplecorp. »

depends upon the difference in tax rate when contributed and when converted.

for instance, say you're in the 12% now, but you plan to convert and it pushes the money converted into 22% it still could be ok if when the money went in you saved more than 22% (i.e., you were in a higher tax bracket when the money went in. i.e., say you contributed while working and saved 25% and now are going to pay 22%. The conversion costs, but still saved you 3% overall, not to mention the time delayed of actually paying the taxes, right?).
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FiveK
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Re: Converting from a traditional to a roth

Post by FiveK »

smc1234 wrote: Sat Oct 17, 2020 6:23 pm In regard to converting from a traditional to a roth, generally speaking if you have to take additional money from the traditional to pay the taxes
Paying taxes from the traditional amount isn't "bad" (it actually reduces the math to the Simplest situation). It's just not as good as if one uses taxable funds to pay the tax on a conversion, even if it makes the math a bit more complicated.
or by converting, it put you in a higher tax bracket, isn't it unwise to do so?
At this point, what matters is the marginal tax rate you would pay now, vs. the marginal tax rate that would apply when withdrawn/converted later.
Almost all our money is in tax deferred accounts. We get social security, but we spend that each month. My wife and I are in our late 60's, retired, own our home, and have no debt. I'll thank you for any responses now in case I can't figure out how to do it later. Thanks!
Might not matter much in that situation, unless RMDs might push you over an IRMAA tier if you do nothing now, but some conversions now would reduce RMDs enough to avoid the IRMAA tier.
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Re: Converting from a traditional to a roth

Post by abuss368 »

It is not so much that it is “bad”, it is just not as good. At your age, it may not make much sense to convert either.
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ivgrivchuck
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Re: Converting from a traditional to a roth

Post by ivgrivchuck »

smc1234 wrote: Sat Oct 17, 2020 6:23 pm In regard to converting from a traditional to a roth, generally speaking if you have to take additional money from the traditional to pay the taxes, or by converting, it put you in a higher tax bracket, isn't it unwise to do so?
No, not necessarily. All the money which exists in Traditional account is pretax, it's not fully yours, at some point somebody (whether it's you or your heir) needs to pay the deferred income tax.

Your task is to try to minimize the deferred income tax.

If the tax rate in a higher tax bracket is lower (or at least not higher) than what you (or your heir) will need to pay in the future to get the money out of Traditional, then it's perfectly fine.
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ivgrivchuck
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Re: Converting from a traditional to a roth

Post by ivgrivchuck »

arcticpineapplecorp. wrote: Sat Oct 17, 2020 6:57 pm depends upon the difference in tax rate when contributed and when converted.
Actually the tax rate when contributed shouldn't impact your plan in any way.
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tibbitts
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Re: Converting from a traditional to a roth

Post by tibbitts »

You don't mention amounts, but since you said almost all your investments are in deferred, you have to make sure that you don't have so much that you'll be forever stuck in high tax brackets and have to deal with IRMAA and NIIT forever. Sometimes taking a big swing at conversion in one year may be necessary to get a large deferred balance down to an acceptable level.
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Re: Converting from a traditional to a roth

Post by tibbitts »

ivgrivchuck wrote: Sat Oct 17, 2020 8:31 pm
arcticpineapplecorp. wrote: Sat Oct 17, 2020 6:57 pm depends upon the difference in tax rate when contributed and when converted.
Actually the tax rate when contributed shouldn't impact your plan in any way.
Exactly: the rate at contribution is water under the bridge. Now it's just a matter of assumptions you make about future returns, tax rates, etc. and comparing different conversion scenarios based on those.
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celia
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Re: Converting from a traditional to a roth

Post by celia »

smc1234 wrote: Sat Oct 17, 2020 6:23 pm Almost all our money is in tax deferred accounts. We get social security, but we spend that each month. My wife and I are in our late 60's, retired, own our home, and have no debt.
This is all we know about you and your finances, so you have to realize that all replies to you, even mine, are generalized. (ie, we don't know your tax bracket, balance in your tax-deferred accounts, or if you are leaving your assets to your kids when you die.) That said, have you done any projections on what will happen when you start RMDs (Required Minimum Distributions) and don't convert and also if you do convert?

The first thing to consider is that your tax-deferred balance is probably growing each year. (Calculate how much it's grown each separate year since you retired by looking at the year-end balances.) If you don't withdraw the yearly growth each year (via RMDs or Roth conversions), the account will continue to compound, making future RMDs even bigger. That might sound great, but remember you have to pay tax on the withdrawal and Roth conversions each year, eventually having larger RMDs push you into higher tax brackets.

Then, you need to remember that the percentage you must withdraw for RMDs will increase each year and will be about:
4% at age 72
5% at age 78
6% at age 83
7% at age 86
8% at age 88
etc
This also contributes to your RMD increasing, even if your assets in the tax-deferred account didn't grow.

Next consider that if you are married, you likely file as MFJ. When one of you dies, the survivor will have to file as Single. The space in the Single tax brackets are half as big as for MFJ and the survivor will still have to take the same RMD as when married. That's another way your tax bracket will jump.

Lastly, consider your heirs who are likely younger than you and may inherit while in their prime working years. They will have to empty out the tax-deferred accounts within 10 years and pay for the withdrawals as ordinary income on top of their own income.

And another thing I almost forgot is that we are currently at historically low tax rates. They are due to return to 2017 levels in 2026 unless Congress makes the current rates permanent. Or they could change them anyways.

So... to mitigate the impact of future RMDs on your taxes, I suggest you first estimate what your RMDs and taxes would be at age 72 and later. Then consider converting a good chunk this year, like 3 or 4 times your expected RMD and see what that does to your taxes this year and what impact it then has on your age 72 taxes and later. You can use last year's tax software for an estimate to see what happens. Many people find that it is likely best if they convert enough to keep their taxes level from the current year all the way into the future instead of having a few years of low taxes in your 60s followed by higher taxes for your remaining years.

You can also search the forum for similar threads using the search box in the upper right corner to search for things like "RMDs Roth conversion", "convert IRA retirement", or "Roth conversion SS".
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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FiveK
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Re: Converting from a traditional to a roth

Post by FiveK »

ivgrivchuck wrote: Sat Oct 17, 2020 8:28 pm Your task is to try to minimize the deferred income tax.
Even better, to maximize the spendable amount remaining after tax. The tax rate matters more than the tax amount.
If the tax rate in a higher tax bracket is lower (or at least not higher)....
Not sure what was intended...?
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celia
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Re: Converting from a traditional to a roth

Post by celia »

ivgrivchuck wrote: Sat Oct 17, 2020 8:31 pm
arcticpineapplecorp. wrote: Sat Oct 17, 2020 6:57 pm depends upon the difference in tax rate when contributed and when converted.
Actually the tax rate when contributed shouldn't impact your plan in any way.
+1 You are past the working year vs retirement year comparison. At this point, you are at the pre-RMD vs RMD year comparison with and without conversions. Doing conversions now (or not) is about the only thing you can change. Once you start RMDs, you will have to take them out (or give them to charity via QCDs) before you do Roth conversions each year.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
bradinsky
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Re: Converting from a traditional to a roth

Post by bradinsky »

OP,
My DW & I are retired. We’re both on S.S. & we have a little interest income & some dividends. We are converting enough $ from my TIRA to take us to the top of the 12% bracket this year. That’s about all the tax I want to pay this year :happy

Brad
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smc1234
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Re: Converting from a traditional to a roth

Post by smc1234 »

I am very appreciative of all the responses. It's giving me a lot to think about and do. I thought I would give out more info if it makes for an easier answer. We have about 1.6 million in our traditional iras. We take out less than 2% each year to go with our social security. We have two adult children to leave our money to. We are at the top of the 12% tax bracket. Do these facts change any opinions? Thank you.
Last edited by smc1234 on Sat Oct 17, 2020 11:32 pm, edited 1 time in total.
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FiveK
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Re: Converting from a traditional to a roth

Post by FiveK »

smc1234 wrote: Sat Oct 17, 2020 9:51 pm I am very appreciative of all the responses. It's giving me a lot to think about and do. I thought I would give out more info if it makes for an easier answer. We have about 1.6 million in our traditional iras. We take out less than 2% each year to go with our social security. We have two adult children to leave our money to. We are at the top of the 12% tax bracket. Do these facts change any opinions. Thank you.
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Re: Converting from a traditional to a roth

Post by Katietsu »

smc1234 wrote: Sat Oct 17, 2020 9:51 pm I am very appreciative of all the responses. It's giving me a lot to think about and do. I thought I would give out more info if it makes for an easier answer. We have about 1.6 million in our traditional iras. We take out less than 2% each year to go with our social security. We have two adult children to leave our money to. We are at the top of the 12% tax bracket. Do these facts change any opinions. Thank you.
I am getting a number of over $85k a year in social security to put you at the top of the 12% bracket. Is this right?
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smc1234
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Re: Converting from a traditional to a roth

Post by smc1234 »

We get around $43,000 in social security a year before deductions. Then we might spend $25,000 to $30,000 out of our iras. So, I guess we aren't at the top of the 12% bracket.
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Re: Converting from a traditional to a roth

Post by celia »

smc1234 wrote: Sat Oct 17, 2020 9:51 pm I am very appreciative of all the responses. It's giving me a lot to think about and do. I thought I would give out more info if it makes for an easier answer. We have about 1.6 million in our traditional iras. We take out less than 2% each year to go with our social security. We have two adult children to leave our money to. We are at the top of the 12% tax bracket. Do these facts change any opinions. Thank you.
Wow. You definitely need to convert... yesterday. Let's say your balance is 1.8M at age 72 (will probably be more unless the market tanks---which also is an excellent time to convert since you can convert more (cheaper) shares for the same tax hit. At 4% withdrawal, your RMD would be $72K and you will never be in the 12% bracket after that. So bite the bullet and convert something like $200K this year and send $20-$30K more along to the IRS. You will be hit by the IRMAA surcharge in 2022, but you will be lowering your chances of being subject to it every year after that.

But, please run all the numbers through tax software first, so you can get used to the shock you were going to experience anyway in a few years. And read Medicare Premiums According to Your Income (2 years ago).

Not only will the Medicare premiums be higher, but so will your Drug Plan Premiums. These costs get adjusted each year, so keep that in mind. Also note that if your MAGI is $1 over a limit, you will pay the same premiums as someone who is tens of thousands higher than you. So watch the boundaries. I just consider the higher premiums an additional tax for each of you but it is not due for two years. But compared to always being in a higher tax bracket once RMDs start, it is worth doing huge conversion for a few years, then your RMDs and tax bracket can be more stable for a long time.

Added:
smc1234 wrote: Sat Oct 17, 2020 11:26 pm We get around $43,000 in social security a year before deductions. Then we might spend $25,000 to $30,000 out of our iras. So, I guess we aren't at the top of the 12% bracket.
Great! Then your large conversion can finish using up the 12% bracket, fill the 22% bracket, and have some of it taxed in the 24% bracket. Again, tax software is your friend.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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smc1234
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Re: Converting from a traditional to a roth

Post by smc1234 »

So many great replies, especially Celia who wrote in such detail. I think we will take your advice. For the first year we are considering converting $80,000, setting $16,000 aside for federal and state taxes. Then we can see how that goes and adjust. My ira is much smaller than my wife's. I will turn 72, two years before her. The money that I will be required to take the first couple of years will be money that we will be spending anyway. We will do all the conversions in her account and that will give us six years before she will be required to take RMD's. That way maybe we won't have to worry about IRMAA. Thank you.
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Re: Converting from a traditional to a roth

Post by MJS »

smc1234 wrote: Sun Oct 18, 2020 3:16 am ... I think we will take your advice. For the first year we are considering converting $80,000, setting $16,000 aside for federal and state taxes. Then we can see how that goes and adjust. ...
Just another possibility that might make this decade's tax hit less onerous: Social Security causes very uneven taxation, and people in certain zones are hit with 40.7% marginal tax rates. From your details, when one of you is single, that could kick in. See https://www.bogleheads.org/wiki/Taxatio ... y_benefits >> Heat map representation.
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FiveK
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Re: Converting from a traditional to a roth

Post by FiveK »

smc1234 wrote: Sat Oct 17, 2020 9:51 pmWe have about 1.6 million in our traditional iras.
smc1234 wrote: Sat Oct 17, 2020 11:26 pmWe get around $43,000 in social security a year before deductions.
If you also have taxable accounts that provide income, say, $4000/yr in qualified dividends, the first ~$20K/yr in traditional withdrawals is free for federal taxes.

Amounts above that go through various ups and downs in the marginal tax rates, but for the most part stay in the 18%-22% range, until you hit the first IRMAA tier at $174K AGI. If you can pay the conversion tax from cash on hand, it would not be unreasonable to convert up to that first IRMAA tier.
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smc1234
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Re: Converting from a traditional to a roth

Post by smc1234 »

Thanks FiveK and MJS. I definitely need to read and learn more about this.
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