Understanding whether Roth conversion is worthwhile and phasing

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Topic Author
TheDogFather
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Joined: Sun Jul 14, 2019 11:02 am

Understanding whether Roth conversion is worthwhile and phasing

Post by TheDogFather »

Background:
  • Currently $1.2M in tax-advantaged 401k/IRA accounts. 100% in total bond funds because of a sizeable stock holding in taxable brokerage accounts.
  • We have larger taxable account balances providing dividends that along with pensions will cover most of our expenses in retirement.
  • I am still working but thinking of retiring by 60 so I would have 12 years from when I retire to when RMDs are required, and 10 years before SS at age 70. During those 10 or 12 years I could draw down some of the retirement account balance for additional living expenses and/or perform Roth conversions during those years when my total earnings and top tax rate will very likely be lower than when employed.
  • Assuming I take SS at 70, at that point the RMDs on top of pensions, SS and dividends would be much in excess of what we need for our living expenses.
  • I have adequate funds in my taxable account to pay for any taxes on any Roth conversions.
  • Married filing jointly, My spouse is already mostly retired from paid work.

Given this situation, does it make sense to 'use up' most or all of the tax-advantaged retirement accounts before SS & RMDs through a combination of withdrawals and Roth conversions? i.e. subtract the portion I want to use for living expenses before SS kicks in at 70, and divide the remaining balance into 10 annual conversions?

Does it make sense to continue contributing to 401k until I retire (employer matching aside) so that taxable income at higher rates is reduced now, and potentially convert/withdraw at lower rates in the period between retirement and SS?

Any family legacy will mostly be from the taxable accounts.
pwrdwnsys
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Location: Ohio

Re: Understanding whether Roth conversion is worthwhile and phasing

Post by pwrdwnsys »

TheDogFather wrote: Tue Jun 08, 2021 10:23 am Does it make sense to continue contributing to 401k until I retire (employer matching aside) so that taxable income at higher rates is reduced now, and potentially convert/withdraw at lower rates in the period between retirement and SS?
I don't have anything to add about Roth conversions beyond what can be found in the Wiki article
https://www.bogleheads.org/wiki/Roth_IRA_conversion

but if your 401k has a match I wouldn't pass up that free money. Does your 401k plan have a Roth option?
123
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Re: Understanding whether Roth conversion is worthwhile and phasing

Post by 123 »

Roth conversions can be useful ways to reduce future RMDs. Any money you take out of a Traditional IRA prior to RMD time should remain in a Roth account for continued tax-free growth. It makes no sense to actually spend-down money from a Traditional IRA if it could continue to live in a Roth account, unless you have no alternative.
The closest helping hand is at the end of your own arm.
Topic Author
TheDogFather
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Re: Understanding whether Roth conversion is worthwhile and phasing

Post by TheDogFather »

123 wrote: Tue Jun 08, 2021 10:45 am Any money you take out of a Traditional IRA prior to RMD time should remain in a Roth account for continued tax-free growth. It makes no sense to actually spend-down money from a Traditional IRA if it could continue to live in a Roth account, unless you have no alternative.
Given that we are talking about bond funds (so that I can maintain my overall desired allocation), I'm trying to understand the rationale for converting traditional IRA money into Roth IRA money assuming I don't pay extra taxes by converting too much in a particular year.

And prompted by our reply, once I no longer have the option to contribute to a 401k, and provided income thresholds allow me to contribute to the Roth IRA, would it make sense to reinvest dividends from taxable into a Roth IRA?
delamer
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Re: Understanding whether Roth conversion is worthwhile and phasing

Post by delamer »

TheDogFather wrote: Tue Jun 08, 2021 11:27 am
123 wrote: Tue Jun 08, 2021 10:45 am Any money you take out of a Traditional IRA prior to RMD time should remain in a Roth account for continued tax-free growth. It makes no sense to actually spend-down money from a Traditional IRA if it could continue to live in a Roth account, unless you have no alternative.
Given that we are talking about bond funds (so that I can maintain my overall desired allocation), I'm trying to understand the rationale for converting traditional IRA money into Roth IRA money assuming I don't pay extra taxes by converting too much in a particular year.

And prompted by our reply, once I no longer have the option to contribute to a 401k, and provided income thresholds allow me to contribute to the Roth IRA, would it make sense to reinvest dividends from taxable into a Roth IRA?
You have to have earned income to contribute to a Roth so once you stop working, moving your dividends isn’t an option.

If you make significant charitable contributions, then familiarize yourself with QCDs: https://www.fidelity.com/learning-cente ... the-basics

Also, once you are on Medicare, a higher income (which includes Roth conversions) can subject you to IRMAA (higher Medicare Part B premiums).

And, more good news :?, you can get hit with the NIIT if your income is pushed over $250,000 (you may already be subject to that).

So lots of moving parts.

Roth conversions are a good idea, to a point. But given the vagaries of US tax law, it makes sense to have Traditional, Roth, and taxable accounts in retirement. Long-term planning is important, but so is flexibility.

Good luck.
One thing that humbles me deeply is to see that human genius has its limits while human stupidity does not. | | Alexandre Dumas, fils
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Johnsson
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Re: Understanding whether Roth conversion is worthwhile and phasing

Post by Johnsson »

Probably. Try using https://www.i-orp.com/Plans/extended.html.

Easy to use and trial many possibilities. It works to maximize spendable dollars and level out taxes.

To avoid bias, enter the same allocations for all 3 account types (even though your allocations are all different)

A dollar in a Roth is worth more than a dollar in the other accounts. I-orp'll likely spend down from taxable. If you convert the Roth should be all equity.
'In theory there is no difference between theory and practice. In practice there is.' Yogi Berra
sailaway
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Re: Understanding whether Roth conversion is worthwhile and phasing

Post by sailaway »

If you engage in charitable giving, you may want to leave money in the traditional IRA for QCDs. High medical expenses can be another way to reduce the tax burden, but harder to make part of a plan.
Exchme
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Re: Understanding whether Roth conversion is worthwhile and phasing

Post by Exchme »

Johnsson wrote: Tue Jun 08, 2021 11:59 am Probably. Try using https://www.i-orp.com/Plans/extended.html.

Easy to use and trial many possibilities. It works to maximize spendable dollars and level out taxes.

To avoid bias, enter the same allocations for all 3 account types (even though your allocations are all different)

A dollar in a Roth is worth more than a dollar in the other accounts. I-orp'll likely spend down from taxable. If you convert the Roth should be all equity.
If the OP wants a quick study with just a a basic look at taxes, I-orp is fine, but if he is more of a numbers guy that doesn't mind getting the data and sorting through more complex programs, then the Retiree Portfolio Model spreadsheet available free on this site. RPM has more tax fidelity and allows you to set a value for your heirs tax rate and how many years to give them to withdraw it. If you set the tax rate at what you think it appropriate for your heirs average marginal taxes on the RMDs they will have to take and set the number of years to 1, it will tell you the total impact to your heirs as well, that's often larger than the impact to you.

The best tax package I've seen is in Pralana Gold ($99/1st year, $49 updates, requires Excel). The Pralana Gold tax package even includes a way to enter existing LTCG, loss carryovers, non-deductible contributions to t-IRAs. It handles things like AMT, deduction phaseouts, (plus obvious stuff like state taxes, NIIT, IRMAA, etc.) P-G has a Roth optimizer that I think got lost in my case as DW has some non-deductible contributions but could be a time saver for others.

Agree that you have to be sure the programs are not just snooping to increase returns by increasing stock allocation as that effect would mix with the true benefit/costs of Roth conversions and mask or reverse the answer. Keeping allocations in all accounts constant is the easiest way and in most programs the only way to get a look at the effect of Roth conversions. But OP has done the optimal thing and put bonds in his t-IRA so it won't grow much and the constant allocation approach will tend to overshoot the amount of conversions to do.

If OP really wants to study it and is willing to do the work, he can use the feature in P-G to manually change allocations (4 changes allowed) in each type of account over time, while keeping the overall allocation (which the program reports) on target. This requires starting your accounts at a little lower stock allocation than their current value and then allowing the stock percentage to rise for a few years and then reallocating in each account to bring the overall back below target and repeat for the next time period.

That is as close as I can find in the current crop of consumer tools to modeling what you really want to do. I haven't seen any other program allows that but it does take a lot of patience and fiddling. For my own case studies, the answer gave a broad, flat optimum amount of conversions. I could be a Texas sharpshooter and hit the barn almost anywhere and draw a bullseye around it and the answers were indistinguishable. P-G doesn't allow you to set you heir's tax rate on inherited IRA's but uses your average lifetime marginal tax rate on them to determine "effective $" in the estate.
Topic Author
TheDogFather
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Re: Understanding whether Roth conversion is worthwhile and phasing

Post by TheDogFather »

Thank you all for the feedback. Those are some very interesting resources I will explore.
retiredjg
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Re: Understanding whether Roth conversion is worthwhile and phasing

Post by retiredjg »

TheDogFather wrote: Tue Jun 08, 2021 10:23 am Currently $1.2M in tax-advantaged 401k/IRA accounts. 100% in total bond funds because of a sizeable stock holding in taxable brokerage accounts.
In my opinion, this is probably "enough" to have in tax-deferred accounts, especially with a pension. Whether saving more in tax-deferred accounts is a good idea depends on things we don't know yet.

I am still working but thinking of retiring by 60....
Ok. Is that 2 years from now or 20 years from now? :D

Assuming I take SS at 70, at that point the RMDs on top of pensions, SS and dividends would be much in excess of what we need for our living expenses.
About what do you think your living expenses might be when you retire?

Given this situation, does it make sense to 'use up' most or all of the tax-advantaged retirement accounts before SS & RMDs through a combination of withdrawals and Roth conversions?
Roth conversions are a good idea if they serve a purpose. The two that come to mind are keeping your RMDs from being burdensome and if you prefer to leave Roth IRAs to your heirs rather than traditional IRAs.

It is not necessary to get rid of all of it though. Leaving some in tIRA can have benefits (qualified charitable donations that reduce your RMDs and for paying large medical or long term care costs at some point).

Does it make sense to continue contributing to 401k until I retire (employer matching aside) so that taxable income at higher rates is reduced now, and potentially convert/withdraw at lower rates in the period between retirement and SS?
Can't guess without having some idea of your ages and what you current tax bracket is. And some idea about tax bracket in retirement.
retiredjg
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Re: Understanding whether Roth conversion is worthwhile and phasing

Post by retiredjg »

TheDogFather wrote: Tue Jun 08, 2021 11:27 am Given that we are talking about bond funds (so that I can maintain my overall desired allocation), I'm trying to understand the rationale for converting traditional IRA money into Roth IRA money assuming I don't pay extra taxes by converting too much in a particular year.
The two reasons to convert are to avoid burdensome RMDs (may not be a problem for you unless that tax-deferred account grows a great deal) and what your preference is for leaving money to heirs.

If your heirs are in higher tax brackets, having to drain a tIRA in 10 years could be burdensome for them. Some people want to eliminate that issue for their heirs. If your heirs will be a charity, you may not need to do Roth conversions at all.
And prompted by our reply, once I no longer have the option to contribute to a 401k, and provided income thresholds allow me to contribute to the Roth IRA, would it make sense to reinvest dividends from taxable into a Roth IRA?
Only if you are still earning income at a job. Contributing to IRA requires earned income (compensation).
Lee_WSP
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Re: Understanding whether Roth conversion is worthwhile and phasing

Post by Lee_WSP »

TheDogFather wrote: Tue Jun 08, 2021 11:27 am
123 wrote: Tue Jun 08, 2021 10:45 am Any money you take out of a Traditional IRA prior to RMD time should remain in a Roth account for continued tax-free growth. It makes no sense to actually spend-down money from a Traditional IRA if it could continue to live in a Roth account, unless you have no alternative.
1. Given that we are talking about bond funds (so that I can maintain my overall desired allocation), I'm trying to understand the rationale for converting traditional IRA money into Roth IRA money assuming I don't pay extra taxes by converting too much in a particular year.

2. And prompted by our reply, once I no longer have the option to contribute to a 401k, and provided income thresholds allow me to contribute to the Roth IRA, would it make sense to reinvest dividends from taxable into a Roth IRA?
1. Bond funds absolutely positively should reside in a tax advantaged account if possible. Dividend tax drag can add up. Plus it can push you into a higher bracket than you'd like.

2. Once you stop working, you can no longer contribute to a Roth. So you can't do that.
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