Roth 457 conversion timing & amount questions

[PhrugalPhan]

Hello,

I am two years out from being eligible for a "full" pension where I work (local government), where "Full" means unreduced. I also have a moderately large 457b account and I have a goal of converting as much of my traditional 457 plan to Roth as makes sense. Due to my pension this will not be as easy as it might seem at lower rates, and while I have a plan of attack, I wanted to pass it by the readers and see if I am missing anything. (BTW, I did the analysis below with no accounting for inflation as this made the numbers work out easier. Since both accounts and brackets should increase similarly I figured this was safe for this early type of ballpark estimate.) Details are below.

Thanks for any thoughts on my plans (and sorry for the length - but trying to be thorough)

===================================================================

CURRENTLY...

• Age: 58, will be 60+ when I retire.
• Single, though in a relationship.
• Accounts: 457: $860k (of which $250k is Roth)
• Roth IRA: $190k
• Taxable investments: $200k
• HSA: $22k
• Other savings: $45k
• Expected pension: It will start at $65k/year when I am 60.5 y.o. until I am 67 y.o., then will drop to $44k/year thereafter. It also has a COLA, starting immediately.

Status: My current salary with pension & HSA deductions has me at the very top of the 22% tax bracket right now. I am eligible for full pension Dec. 2022. I can get an early pension right now, but only with a major haircut (~ 40%), and I would like to really avoid that, so I am planning on sticking around until early 2023 at least. While still working going forward I will contribute 100% Roth, no traditional.

My Goal: My Goal is/was to contribute to Roth 457 / Convert existing Traditional 457 money to the top of the 22%-now / 25%-then tax bracket each year before RMDs kick in. However I do want to leave a large enough pile of traditional as money in traditional can come out tax free when there are years with high medical expenses. But I also want to keep the amount low enough so my RMDs don't kick in higher taxes.

My Plan: My job has a "DROP" retirement option, and I plan on entering "DROP" as soon as possible near the end of 2022, and then quit once I have maxed out Roth 457 contributions for 2023. At that time I should be ~60.5 years old. I will then commence Roth conversions the next year until I have RMDs at age 72 (I will have no room to convert in my first retirement year in the 22% bracket due to pension & earnings). (Also to note: I can do Roth conversions in-plan without rolling money out of the account. I did a small in-plan rollover this year, but the plan allows for this to be done only two times a year.)

My Problem: My traditional 457 account balance is currently at $610k ($860k total - $250k Roth). Assuming no unknown changes to the tax laws, my ultimate goal was to keep my Federal tax rates below 24%/28% if possible forever, as well as keeping myself in the lowest IRMAA bracket. Sounds nice, but this bull market is killing this plan (but in a good way) as the traditional total keeps growing.

My estimate for my planned-for income in retirement uses the top of the current 22% tax bracket ($98,000) or preferably a little less to make sure the first IRMAA cliff isn't crossed (Currently at $87,000 MAGI). I am also planning on holding off Social Security benefits until 70, and as I am already past the second bend point for SSI Income, I am figuring I should have a little over $3,000 of SS income per month, or $30,600 of SS income (85%) that will be taxed each year when I start taking it at 70. Also I am currently getting around $4,800 in dividends this year, so I will estimate $5,000 going forward.

This gives me the following timeline for known taxable income
Ages 61-67: Pension of $65,000 + $5,000 dividends = $70,000
Ages 68-70: Pension of $44,000 + $5,000 dividends = $49,000
Ages 71+: Pension of $44,000 + SS Income $30,600 (taxable) + $5,000 dividends = $79,600

This leaves the amount available for conversion in the 22%/25% bracket to be:
Ages 61-67: ~$28,000
Ages 68-70: ~$49,000
Age 71: ~$18,400

To keep my RMDs from forcing me into IRMAA penalty rates, I need at age 72 a starting balance of $460k or less in my traditional 457 plan ($460k * 4% = $18,400/year RMD). And of course this amount will most likely increase as the RMD percentages and 457 traditional account balance still grows for many years in the future.

With my account at $610k right now, and figuring an average 5% real growth yearly, I will be well above $700k when I turn 72 unless I do major Roth conversions.

Currently I am at the top of the 22% bracket, and if I assume in-plan roll overs each year to the top of the 22% bracket, I will still be pushed above the 22% bracket at 72 y.o.
If I do an extra $75k of Roth conversions in my two years before I am 63 my taxes at 72 will be at the top of the 22% bracket. Which is where I am at today. And of course future years will go higher anyway.

=============================================
My questions:
Question #1: I currently plan on doing these extra $150k of conversions after I retire (age 62 & 63) which I should be able to pay the taxes for from my savings & other taxable investments. However, in my case I can also do conversions before then (via in-plan conversions while working). Is there any reason to do the conversions this year or my last two future work years instead of waiting until 2024 when I turn 62?

Question #2: The above figures assume an average 5% growth of the account. Given the growth of my account in the past decade (10+% y.o.y.) I am thinking the assumption of 5% growth is too low, especially as this plan gives me no margin for error considering the IRMAA cliff. Also, tax rates are supposed to go up in the year I turn 64, so I am considering more conversions above what I already described. Is this a prudent strategy? (I am thinking I will convert an extra $25k for the next three years (beyond the $150k already mentioned) to bring the traditional down to a manageable level) I should be able to use some of the incoming pension income to pay for the taxes as needed.

========================================
Extra items in case there are questions:
========================================
Yes, our 457 plan allows for withdrawals from whichever bucket of money you indicate, but if I were to leave Roth money in the 457 it would count towards my RMDs. So I plan on leaving Roth money in until a few years before RMDs start, and then rolling over only the Roth portion of the account to the Roth IRA I currently have setup. I like the 457 fund expenses, so I want to keep the money there until needed to be pulled out.

The GF has a TSP that is well over $1Mil and 99% traditional, so I can't plan on marrying her to get more conversion space. While we don't plan on marrying, if we did my situation would only get worse, not better, with regard to this issue.

My state tax rate is 5.75%, and I do not know if I will move to another state in the future, so I am not including state taxes in this analysis. (though moving to a no income tax state is a possibility)

My work has health insurance I can get once I retire. There will be a subsidy, but staying on the HDHP after retirement will cost about $500/month. So I will not be looking to get onto any ACA or similar health plan, but will have access to one so my income level is not an issue for HI.

[Spirit Rider]

TMI, I don't have time to read and digest the whole post. So just a FYI.

Prior to the SECURE ACT, 457b plans were unique in that in-service withdrawals/rollovers were not allowed until age 70 1/2. The SECURE ACT reduced that age to 59 1/2, but only if plan has adopted that change and many have not. Similarly, while a 457b plan can support in-plan Roth Rollovers (IRRs) many have not.

Bottom Line: You will not be able to do in-service withdrawals/rollovers prior to age 59 1/2. You will only be able to do them after age 59 1/2 if your plan has been amended to accept that change in the law. That would include any IRRs even if your plan supports them. Check with your 457b plan administrator.

[PhrugalPhan]

Prior to the SECURE ACT, 457b plans were unique in that in-service withdrawals/rollovers were not allowed until age 70 1/2. The SECURE ACT reduced that age to 59 1/2, but only if plan has adopted that change and many have not. Similarly, while a 457b plan can support in-plan Roth Rollovers (IRRs) many have not.

Bottom Line: You will not be able to do in-service withdrawals/rollovers prior to age 59 1/2. You will only be able to do them after age 59 1/2 if your plan has been amended to accept that change in the law. That would include any IRRs even if your plan supports them. Check with your 457b plan administrator.

Thanks for the response. Not sure what to say other than I was allowed by the administrator to do an in-plan rollover already. And I was 57.5 y.o. at the time. Perhaps the administrator didn't know the rules yet?

[retire2022]

My questions:
Question #1: I currently plan on doing these extra $150k of conversions after I retire (age 62 & 63) which I should be able to pay the taxes for from my savings & other taxable investments. However, in my case I can also do conversions before then (via in-plan conversions while working). Is there any reason to do the conversions this year or my last two future work years instead of waiting until 2024 when I turn 62?

Question #2: The above figures assume an average 5% growth of the account. Given the growth of my account in the past decade (10+% y.o.y.) I am thinking the assumption of 5% growth is too low, especially as this plan gives me no margin for error considering the IRMAA cliff. Also, tax rates are supposed to go up in the year I turn 64, so I am considering more conversions above what I already described. Is this a prudent strategy? (I am thinking I will convert an extra $25k for the next three years (beyond the $150k already mentioned) to bring the traditional down to a manageable level) I should be able to use some of the incoming pension income to pay for the taxes as needed.

========================================
Extra items in case there are questions:
========================================
Yes, our 457 plan allows for withdrawals from whichever bucket of money you indicate, but if I were to leave Roth money in the 457 it would count towards my RMDs. So I plan on leaving Roth money in until a few years before RMDs start, and then rolling over only the Roth portion of the account to the Roth IRA I currently have setup. I like the 457 fund expenses, so I want to keep the money there until needed to be pulled out.

The GF has a TSP that is well over $1Mil and 99% traditional, so I can't plan on marrying her to get more conversion space. While we don't plan on marrying, if we did my situation would only get worse, not better, with regard to this issue.

My state tax rate is 5.75%, and I do not know if I will move to another state in the future, so I am not including state taxes in this analysis. (though moving to a no income tax state is a possibility)

My work has health insurance I can get once I retire. There will be a subsidy, but staying on the HDHP after retirement will cost about $500/month. So I will not be looking to get onto any ACA or similar health plan, but will have access to one so my income level is not an issue for HI.

OP

I am 60 single male, in VHOL and 24% bracket.

I did not have cash on hand to pay for my pretax 457 to be converted to Roth 457, currently my balance sits at 1.4 million, the time to have done an in service Roth Conversion was March 23, 2020, when the market had -30% pullback.

On that day my pretax 457 balance was down to 989K, unless the market drops in the next two weeks, we are at the top of the market, I don't see how the numbers could work for a in service Roth conversion 457.

I am in a similar issue, but I will not let the tax tail wag my decisions.

If there is another crash 2021-2024, then you could do an in service plan conversion, another alternative is move a portion of assets out of equities and put them is a slower growth assets, stable value, or bonds until you are ready to convert them to in service Roth 457.

Yes 65 IRMAA rule will impact your medical expenses, will you have government post health plan? That will become secondary once you are retired.

Good luck.

[PhrugalPhan]

OP

I am 60 single male, in VHOL and 24% bracket.

I did not have cash on hand to pay for my pretax 457 to be converted to Roth 457, currently my balance sits at 1.4 million, the time to have done an in service Roth Conversion was March 23, 2020, when the market had -30% pullback.

On that day my pretax 457 balance was down to 989K, unless the market drops in the next two weeks, we are at the top of the market, I don't see how the numbers could work for a in service Roth conversion 457.

I am in a similar issue, but I will not let the tax tail wag my decisions.

If there is another crash 2021-2024, then you could do an in service plan conversion, another alternative is move a portion of assets out of equities and put them is a slower growth assets, stable value, or bonds until you are ready to convert them to in service Roth 457.

Yes 65 IRMAA rule will impact your medical expenses, will you have government post health plan? That will become secondary once you are retired.

Good luck.

I did my small ($2,000) test conversion the first week of April. I thought I would have more time to do another one and didn't need to rush into this. I whiffed on that. That amount is shown in a separate contribution "bucket" on the administrator website, and it is already at $2,900! I wish I did more then, but at least I did some, if not nearly enough.

As far as transitioning to slow growth assets, I figure my pension is my "bond" portion of my savings. With that I am putting in at over 90% stocks. Even if that causes tax issues, well so be it.

[retire2022]

I did my small ($2,000) test conversion the first week of April. I thought I would have more time to do another one and didn't need to rush into this. I whiffed on that. That amount is shown in a separate contribution "bucket" on the administrator website, and it is already at $2,900! I wish I did more then, but at least I did some, if not nearly enough.

As far as transitioning to slow growth assets, I figure my pension is my "bond" portion of my savings. With that I am putting in at over 90% stocks. Even if that causes tax issues, well so be it.

In 2013 my pretax 457 assets were 700K, just as you are, by 2016 I had hit 1 million in the account, so you are at the precipice of moving into where at 72 Required Minimum Distributions will put you in a higher bracket.

Here is an idea I have not explored, try Mega Backdoor Roth with your pretax 457

look at how is done:

https://www.madfientist.com/after-tax-contributions/

https://www.brandonrenfro.com/mega-backdoor-roth/

[czaj]

As far as #1, I think it's going to make sense for you to start converting this year or next if you're able. Based on my modeling:
• 2020-2025: you should perform Roth conversions such that your ordinary income fills up the 24% bracket. Perhaps just slightly into the 32% bracket in 2022 and 2023 when your have salary + pension (If I'm understanding correctly).
• 2026+: you should perform Roth conversions (or spend from Traditional) such that your MAGI is less than the first IRMAA bracket ($88k in 2021 dollars). This should keep you at that level once RMDs hit at 72. You may have some years where it might make sense to go up to the second IRMAA point within the 28% bracket, but that would be a good problem to have.

How does the "DROP" work? I did not incorporate the "DROP" option as I'm not familiar how this would affect your numbers. I could also give more specific recommendations if I had your SS PIA, and your month of birth (for mid-year changes, like your pension decrease and Social Security start date).

The above assumes a 5% real return that you specified and I projected out to age 100 using a mixed-integer linear programming model I've built that attempts to find your tax equilibrium. It takes into account all types of accounts, federal brackets, LTCG brackets, Social Security taxation, IRMAA, and ACA (not applicable in your case).

[PhrugalPhan]

As far as #1, I think it's going to make sense for you to start converting this year or next if you're able. Based on my modeling:
• 2020-2025: you should perform Roth conversions such that your ordinary income fills up the 24% bracket. Perhaps just slightly into the 32% bracket in 2022 and 2023 when your have salary + pension (If I'm understanding correctly).
• 2026+: you should perform Roth conversions (or spend from Traditional) such that your MAGI is less than the first IRMAA bracket ($88k in 2021 dollars). This should keep you at that level once RMDs hit at 72. You may have some years where it might make sense to go up to the second IRMAA point within the 28% bracket, but that would be a good problem to have.

Thanks for the confirmation. I will only have salary + pension during 2023 as I will be able to start my pension around Christmas 2022, so I will leave it to start the beginning of 2023. As for my income it only fills up the 22% bracket, so the conversions will be costing me 24% (+ state taxes) through 2023. I can't see going into the 32% bracket at this point, though by then I may change my mind.

How does the "DROP" work? I did not incorporate the "DROP" option as I'm not familiar how this would affect your numbers.

DROP effectively allows you to start your pension before you leave your job (for up to 3 years). But you have to be pension eligible, which will only be at Christmas 2022 for me. So for long as I work in 2023, if I sign up for "DROP" I will get my pension for the whole year, my salary for as long as I work in the year, and my salary will no longer have a pension deduction (currently 5%). So for a full year of pension, 1/3 year of salary, and no pension contributions, I will gross about what I normally do in a year of normal salaried work. It only affects the calculations in that it explains why I won't have extra space to convert in 2023 even though I will retire early in the year.

[czaj]

DROP effectively allows you to start your pension before you leave your job (for up to 3 years). But you have to be pension eligible, which will only be at Christmas 2022 for me. So for long as I work in 2023, if I sign up for "DROP" I will get my pension for the whole year, my salary for as long as I work in the year, and my salary will no longer have a pension deduction (currently 5%). So for a full year of pension, 1/3 year of salary, and no pension contributions, I will gross about what I normally do in a year of normal salaried work. It only affects the calculations in that it explains why I won't have extra space to convert in 2023 even though I will retire early in the year.

Thanks for clarifying. Then yes, I agree that there is no need for going into the 32% bracket then. Updated recommendation:

• 2020-2025: Fill up 24% bracket, while also staying below 200k in MAGI to avoid paying NIIT
• 2026+: Keep your MAGI below $88K to avoid paying IRMAA. Between 2028 and 2031 (before SS starts), there may be a year or two with the opportunity to stay in the 15% bracket. But once SS starts with your pension, it looks like you'll be in the 25% bracket, so your main goal should be to avoid paying IRMAA.

[PhrugalPhan]

Prior to the SECURE ACT, 457b plans were unique in that in-service withdrawals/rollovers were not allowed until age 70 1/2. The SECURE ACT reduced that age to 59 1/2, but only if plan has adopted that change and many have not. Similarly, while a 457b plan can support in-plan Roth Rollovers (IRRs) many have not.

Bottom Line: You will not be able to do in-service withdrawals/rollovers prior to age 59 1/2. You will only be able to do them after age 59 1/2 if your plan has been amended to accept that change in the law. That would include any IRRs even if your plan supports them. Check with your 457b plan administrator.

Thanks for the response. Not sure what to say other than I was allowed by the administrator to do an in-plan rollover already. And I was 57.5 y.o. at the time. Perhaps the administrator didn't know the rules yet?

I figured I should follow up on this in case anyone reads this. After researching this more, when in-plan rollovers first became possible there was confusion if you were allowed to do an in-plan rollover before 59.5 y.o. It turns out there is no lower age limit. However, there is a 5 year rule that is *NOT* attached to your personal Roth IRA (if you have one). This is called a "special recapture rule" and requires that you keep the money in a separate bucket of money in your account and do not withdraw for 5 years (from the beginning of the year of the first rollover.) So in my case I will not have access to this money until Jan 1, 2025. So it turns out it was good that I did a small in-plan rollover. It started this 5 year clock so I don't have to worry about it when I get closer to retirement.

[Spirit Rider]

This is called a "special recapture rule" and requires that you keep the money in a separate bucket of money in your account and do not withdraw for 5 years (from the beginning of the year of the first rollover.

Depends what you mean by a "separate bucket of money". The only thing that is required is to document the date and amount of the rollover. There is absolutely no requirement to segregate this money in a separate account or fund. If you ever make a non-qualified withdrawal of some or all of this money. The IRA custodian will be able to calculate how much of the distribution is contributions and how much is earnings. You will have to provide the basis for the non-qualified distribution on Form 8606.