Convert to Roth or stay in tax deferred?

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Sahara
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Re: Convert to Roth or stay in tax deferred?

Post by Sahara »

I caught the primary goal, but missed the pensions! Thank you, now I understand.
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Actmck3
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

IRMAA is already knocking on my door
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Actmck3
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

David Jay wrote: Sun Apr 18, 2021 5:59 pm
Actmck3 wrote: Sun Apr 18, 2021 4:55 pmOne other thing related to “running the numbers” is that I do not have outside money to pay the taxes. Lange rec’d to use a HELOC to pay those taxes on the conversion money rather than having to dip deeper into the traditional IRA to pay the taxes. He said that otherwise, I’d need to take out 133K to get 100K into the Roth.

So, if I don’t have any money outside the IRA to pay any conversions, does it change any of your thoughts regarding the plan you have laid out?
I had already realized that this was the case, based on your numbers. Of course, if you have cash to pay the taxes it increases the amount that ends up in the Roth, but here is another perspective:

That tIRA money is going to get taxed when it is withdrawn. If you withdraw the money anytime after 2026 you will pay 25% federal income tax (plus any state tax) until RMDs get large or one spouse passes. At that point your marginal tax rate goes way up. If you leave it to your daughters, they will have to take it all out within 10 years and that will bump up their tax rates, very likely above 25%.

So any money you can take out at a tax rate less than 25% is a “win”. It is even better that you can use a conversion instead of a simple withdrawal so the withdrawn money (after paying taxes) continues to grow tax-free and your daughters get to take it out tax free. It takes a multi-generational understanding of taxes to understand why you need to take out everything you can at 22% and 24% in the next 5 years.

Are you on Medicare (or will your spouse be on Medicare?) or do you have another insurance plan? The only reason not to make conversions to the top of the 24% tax bracket is the IRMAA penalty, so this is an important question. That is the last remaining piece of the puzzle.
David,
IRMAA is already set to collect. See above reply
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David Jay
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Re: Convert to Roth or stay in tax deferred?

Post by David Jay »

At this point, your willingness to take short term pain for long term gain seems like the biggest decision. IRMAA has a 2-year look-back, and since you are already paying the higher premium I would certainly convert all the way to the top of the 24% tax bracket in 2021. This is over a $200,000 conversion, and it only costs one additional year of IRMAA penalty (because the first year of the lookback is already high).

If you are willing to "suffer" a little longer, do the same (top of 24% tax bracket) in 2022. Then stop the conversions and in 2 years your IRMAA penalty will drop, and your spouse will be subject to a much smaller IRMAA penalty when she files at age 65.

At this point you have taken almost a quarter of your tIRA out of the future RMD pool. Then you can look at smaller tIRA conversions for the remaining years until age 72. Each year you will need to balance the IRMAA charge with the potential cost of future RMDs.
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
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Actmck3
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

David Jay wrote: Mon Apr 19, 2021 12:33 pm At this point, your willingness to take short term pain for long term gain seems like the biggest decision. IRMAA has a 2-year look-back, and since you are already paying the higher premium I would certainly convert all the way to the top of the 24% tax bracket in 2021. This is over a $200,000 conversion, and it only costs one additional year of IRMAA penalty (because the first year of the lookback is already high).

If you are willing to "suffer" a little longer, do the same (top of 24% tax bracket) in 2022. Then stop the conversions and in 2 years your IRMAA penalty will drop, and your spouse will be subject to a much smaller IRMAA penalty when she files at age 65.

At this point you have taken almost a quarter of your tIRA out of the future RMD pool. Then you can look at smaller tIRA conversions for the remaining years until age 72. Each year you will need to balance the IRMAA charge with the potential cost of future RMDs.
Looks like ill need to take the pain now for a better tomorrow. What were your thoughts on using a HELOC to pay the taxes rather than having to withdraw more from the traditional IRA during the conversion?
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celia
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Re: Convert to Roth or stay in tax deferred?

Post by celia »

Actmck3 wrote: Mon Apr 19, 2021 9:14 pm What were your thoughts on using a HELOC to pay the taxes rather than having to withdraw more from the traditional IRA during the conversion?
I stopped following this thread since my last post, but how would you pay off the HELOC if all you have is the tax-deferred money? Seems like you would need to pay off the principal and interest (from the tax-deferred account) which would be more than paying the taxes, ie, HELOC principal (from the tax-deferred account).

And if the whole point here is to bring down the value of the tax-deferred account, why wouldn't you pay taxes from tax-deferred? Did you forget what I posted here?
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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David Jay
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Re: Convert to Roth or stay in tax deferred?

Post by David Jay »

Actmck3 wrote: Mon Apr 19, 2021 9:14 pmLooks like ill need to take the pain now for a better tomorrow. What were your thoughts on using a HELOC to pay the taxes rather than having to withdraw more from the traditional IRA during the conversion?
I don’t see the advantage. I think you are going back to Lange’s advice to use taxable funds to pay taxes. His advice optimizes the amount that goes into the Roth. But that is not your situation. Your problem is a tIRA balance that will push you into higher and higher tax brackets, “eating up” your legacy. You need to take as much as possible out of the tIRA while staying in the 24% tax bracket.
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
hawkfan55
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Re: Convert to Roth or stay in tax deferred?

Post by hawkfan55 »

My comments above assume the money to pay the tax on the Roth conversion comes out of a taxable account. If additional money has to be taken out of the IRA to pay the tax on the Roth conversion it shifts the decision pretty far in the direction of not doing the conversion.
All of our retirement savings were and are in tax deferred (401k, 403B, IRA) and Roth IRAs. DW and I always tried to maximize our contributions to those accounts, the balance of our yearly income was used for living expenses. The only taxable investment we had was an emergency fund of about $30k.

We are both retired for 4 and 2 years. We've been converting tIRA to Roth IRA over the past 4 or so years up to the MFJ MAGI of $170-172k to avoid increased IRMAA premiums. Since all of our portfolio is in tax advantaged (tax deferred or tax free) accounts, we convert about 50-60k from our tax deferred IRA to Roth IRA each year and pay the taxes in mid-December each year by having taxes paid from my tax deferred IRA account. Since we have pensions totaling $56k, we have not started SS as of yet. DW will start SS this year at age 62 and I will start SS between 68-70 years old. Our combined SS payments will be approx $55-60k per year. We currently hold approx. $710k in Deferred IRA/403b with 100% in fixed income (1/2 Short term bonds and 1/2 Stable Value yielding about 3%). Our Roth IRAs total approx $700k with a 90/10 Stock/Stable Value AA. Our overall AA is 45/55 Stocks/Bonds. We utilize the Total US Stock Market and Total International Stock Market funds with an 80/20 US/Int'l allocation.

We spent the majority of our peak earnings years in the 25% tax bracket so we feel converting tax deferred IRAs/403b to Roth IRA at 22% is a bargain. We are trying to get as much deferred dollars into Roth before I start SS. We use I-ORP as a rough guide to determine estimated future tax brackets and our projected income and taxes.

If you have pensions, social security and significant deferred tax accounts, RMDs can push you into higher tax brackets than during working years. My DW is 4 years younger than me so holding off on taking SS is a benefit if I pass first as my DW would be in a higher marginal tax bracket if she has to file single.

Paying taxes out of our tax deferred accounts is not a problem at all. We've never paid taxes on these tax deferred accounts vs one who did previously pay taxes on after tax savings, and possibly the capital gains at 15-20%. We are happy that we contributed to Roth IRAs since their inception. Doing conversions from tIRAs to Roth IRAs using tax deferred funds to pay the taxes makes sense for us. Roth Accounts are the closest thing to an "Investing Free Lunch" as it gets!!!
Last edited by hawkfan55 on Fri Apr 23, 2021 2:56 am, edited 6 times in total.
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Topic Author
Actmck3
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

celia wrote: Tue Apr 20, 2021 4:04 am
Actmck3 wrote: Mon Apr 19, 2021 9:14 pm What were your thoughts on using a HELOC to pay the taxes rather than having to withdraw more from the traditional IRA during the conversion?
I stopped following this thread since my last post, but how would you pay off the HELOC if all you have is the tax-deferred money? Seems like you would need to pay off the principal and interest (from the tax-deferred account) which would be more than paying the taxes, ie, HELOC principal (from the tax-deferred account).

And if the whole point here is to bring down the value of the tax-deferred account, why wouldn't you pay taxes from tax-deferred? Did you forget what I posted here?
Umm, yes actually, I had lost sight of some of our conversations :( . That said, I just reread them and have once again been “re-enlightened” :happy
Thanks Celia, rereading it refreshed and reinforced my direction. :sharebeer
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Actmck3
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

David Jay wrote: Tue Apr 20, 2021 9:15 am
Actmck3 wrote: Mon Apr 19, 2021 9:14 pmLooks like ill need to take the pain now for a better tomorrow. What were your thoughts on using a HELOC to pay the taxes rather than having to withdraw more from the traditional IRA during the conversion?
I don’t see the advantage. I think you are going back to Lange’s advice to use taxable funds to pay taxes. His advice optimizes the amount that goes into the Roth. But that is not your situation. Your problem is a tIRA balance that will push you into higher and higher tax brackets, “eating up” your legacy. You need to take as much as possible out of the tIRA while staying in the 24% tax bracket.
Gotcha David. Big picture, long term.... thank you for staying with this. :sharebeer
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