Roth Conversion basics...

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RetiOpening
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Roth Conversion basics...

Post by RetiOpening »

I plan on doing a Roth conversion for the first time this year, and I was wondering about a thing or two. Basically, my wife was out of work for the majority of the year after the birth of a child, and I was underemployed for a good chunk of it as well. (Things have been tight!) Additionally, with the market being down, and with us both having recently landed decently paying jobs, my understanding is that this is an ideal time to do a Roth conversion.

1) As we're both currently salaried employees, I can predict within $100 or so our income for the rest of the year. Is there any reason not to do the Roth conversion right now?
2) I need some help with calculations. Basically, we're in the 12% tax bracket this year (and hopefully will never be so again). I don't want to convert anything that would get taxed at the 22% rate. I should be basing my calculations on Adjusted Gross Income right? I believe our AGI will end up being around $53,750 or so. What's the maximum I can convert at 12%? Is it simply a matter of taking the top end of the 12% bracket ($83,550) and subtracting my AGI, which gives me $29,800. Is this the conversion amount I'm looking for?

Thanks for any help you'd be kind enough to provide. Any other considerations I'm missing are, of course, welcome.
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retired@50
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Re: Roth Conversion basics...

Post by retired@50 »

I think the $83,550 number is taxable income (not AGI). See IRS Form 1040 - line 15.

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retiredjg
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Re: Roth Conversion basics...

Post by retiredjg »

If you have any income that is long term capital gains or qualified dividends, the number to stay under (after deductions) is $83,350. This is a little bit lower than the top of the 12% tax bracket.

Taxable income, not AGI, is what you want to keep an eye on.
ThankYouJack
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Re: Roth Conversion basics...

Post by ThankYouJack »

RetiOpening wrote: Tue Nov 22, 2022 6:09 pm I plan on doing a Roth conversion for the first time this year, and I was wondering about a thing or two. Basically, my wife was out of work for the majority of the year after the birth of a child, and I was underemployed for a good chunk of it as well. (Things have been tight!) Additionally, with the market being down, and with us both having recently landed decently paying jobs, my understanding is that this is an ideal time to do a Roth conversion.

1) As we're both currently salaried employees, I can predict within $100 or so our income for the rest of the year. Is there any reason not to do the Roth conversion right now?
2) I need some help with calculations. Basically, we're in the 12% tax bracket this year (and hopefully will never be so again). I don't want to convert anything that would get taxed at the 22% rate. I should be basing my calculations on Adjusted Gross Income right? I believe our AGI will end up being around $53,750 or so. What's the maximum I can convert at 12%? Is it simply a matter of taking the top end of the 12% bracket ($83,550) and subtracting my AGI, which gives me $29,800. Is this the conversion amount I'm looking for?

Thanks for any help you'd be kind enough to provide. Any other considerations I'm missing are, of course, welcome.
I don't see a reason to wait on the conversion if you feel like doing it now.

With the standard deduction, I think you'll be able to convert more than $29,800. You can use the Personal Finance Toolbox to get a closer amount - https://www.bogleheads.org/wiki/Tools_a ... ce_toolbox

One thing to consider is the taxes owed on the conversion -- you may also have an under payment penalty (including state if applicable). So I would increase withholding from your paychecks and if that doesn't cover it all, make an estimated tax payment before 1/16/23.
Last edited by ThankYouJack on Tue Nov 22, 2022 7:37 pm, edited 1 time in total.
lakpr
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Re: Roth Conversion basics...

Post by lakpr »

The $83,550 threshold for the top of the 12% tax bracket is for TAXABLE INCOME. You have to add the standard deduction to it, resulting in an adjusted gross income of $83,550 + $25,900 = $109,450. If your AGI ends up being $53,750, then you have room to do Roth conversion up to $109,450 - $53,750 = $55,700

At a 12% tax rate on this Roth conversion, you will have additional tax liability of $6,684. Make sure you send this additional tax liability to IRS before January 15, 2023 itself; or at least $5,684, to avoid underpayment penalties. (Or as @ThankYouJack said, try to withhold additional $5600 from your paychecks together, before December 31, 2022). Make sure you don't forget state taxes, if any ...
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Peter Foley
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Re: Roth Conversion basics...

Post by Peter Foley »

The "Numbers Unlimited" document is a good reference for this sort of thing. It shows marginal tax rates, taxes on capital gains, social security taxation, RMDs, etc.
Charon
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Re: Roth Conversion basics...

Post by Charon »

This sounds like a great year for you to Roth convert, given your low income relative to other years. We're doing something similar this year, also being (unexpectedly and unfortunately) in the 12% bracket. As others have said, the key considerations are your taxable income and how you'll pay taxes on the conversions.

That said, I just want to clarify that down markets are not special for Roth conversions. Do it when it makes sense tax-wise, and don't worry about the market.

math version of the explanation: viewtopic.php?p=6668687&sid=d19f4cdf3d9 ... 6#p6668687

words version: viewtopic.php?p=6668684&sid=c40318e137c ... 3#p6668684
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David Jay
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Re: Roth Conversion basics...

Post by David Jay »

As others have said, filling the 12% tax bracket is a great use of this low-income year. Additionally, the 12% tax bracket is scheduled to expire in 2025 so I say get it while the getting is good.
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RetiOpening
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Re: Roth Conversion basics...

Post by RetiOpening »

Thanks to all of you that took the time to reply. A few quick hitters:
  • Yes, I was mixing up AGI and taxable income. ::forehead slap::
  • On a related note, I was not taking into account the standard deduction.
  • It does sound like I could convert up to 55k and still stay within the 12%.
  • Thank you for the note about paying additional tax liability by Jan. 15. As you may have gathered, I wouldn't have thought of that on my own.
  • Speaking of things that I wasn't aware of, the irrelevance of it being a down market year was fascinating to read and think about. That does kind of make sense now that it is explained to me in that way. The funny thing is, I feel that it was in one of those Morningstar articles (by Christine Benz no less?) that the seed was planted in my head, this idea that a silver lining of a down market is how advantageous Roth conversions can be. Unless I read it wrong. Either way, this must be a common misconception. But as you suggest, after reading some of your comments and before I got the chance to respond, I did find myself wondering all night how I was going to pony up the $6800 in additional tax liability to pay for this conversion. Yep, that sum is equivalent to a full year of Roth contributions. The fact is I'm not sure I can afford that in the short term, as tempting as it is to do such a sizable conversion.
Topic Author
RetiOpening
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Re: Roth Conversion basics...

Post by RetiOpening »

Peter Foley wrote: Tue Nov 22, 2022 8:35 pm The "Numbers Unlimited" document is a good reference for this sort of thing. It shows marginal tax rates, taxes on capital gains, social security taxation, RMDs, etc.
I may have missed it, but where is this document of which you speak?
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RetiOpening
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Re: Roth Conversion basics...

Post by RetiOpening »

Charon wrote: Tue Nov 22, 2022 9:54 pm This sounds like a great year for you to Roth convert, given your low income relative to other years. We're doing something similar this year, also being (unexpectedly and unfortunately) in the 12% bracket. As others have said, the key considerations are your taxable income and how you'll pay taxes on the conversions.

That said, I just want to clarify that down markets are not special for Roth conversions. Do it when it makes sense tax-wise, and don't worry about the market.

math version of the explanation: viewtopic.php?p=6668687&sid=d19f4cdf3d9 ... 6#p6668687

words version: viewtopic.php?p=6668684&sid=c40318e137c ... 3#p6668684
I know that comparison is the path to unhappiness, but it's comforting to hear I'm not the only one in the 12%. I often get the impression that the vast majority of people on this forum are totally loaded. I mean, obviously, there's a selection bias at work here, so it kind of makes sense that people have money. Bogleheads, by definition, are savers, compounders, accumulators, etc. But still. :sharebeer
lakpr
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Re: Roth Conversion basics...

Post by lakpr »

RetiOpening wrote: Wed Nov 23, 2022 12:33 am I did find myself wondering all night how I was going to pony up the $6800 in additional tax liability to pay for this conversion. Yep, that sum is equivalent to a full year of Roth contributions. The fact is I'm not sure I can afford that in the short term, as tempting as it is to do such a sizable conversion.[/list]
If your combined salary is going to put you in a 22% tax bracket in 2023, I do urge you to borrow that $6800 from somewhere. HELOC, if you own a home? Car title loans? Open a new credit card that offers 0% interest rate for 18 months?

This would be a temporary squeeze with potential to pay off big in future years.
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retiredjg
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Re: Roth Conversion basics...

Post by retiredjg »

RetiOpening wrote: Wed Nov 23, 2022 12:33 am Thanks to all of you that took the time to reply. A few quick hitters:
  • Yes, I was mixing up AGI and taxable income. ::forehead slap::
  • On a related note, I was not taking into account the standard deduction.
  • It does sound like I could convert up to 55k and still stay within the 12%.
  • Thank you for the note about paying additional tax liability by Jan. 15. As you may have gathered, I wouldn't have thought of that on my own.
  • Speaking of things that I wasn't aware of, the irrelevance of it being a down market year was fascinating to read and think about. That does kind of make sense now that it is explained to me in that way. The funny thing is, I feel that it was in one of those Morningstar articles (by Christine Benz no less?) that the seed was planted in my head, this idea that a silver lining of a down market is how advantageous Roth conversions can be. Unless I read it wrong. Either way, this must be a common misconception. But as you suggest, after reading some of your comments and before I got the chance to respond, I did find myself wondering all night how I was going to pony up the $6800 in additional tax liability to pay for this conversion. Yep, that sum is equivalent to a full year of Roth contributions. The fact is I'm not sure I can afford that in the short term, as tempting as it is to do such a sizable conversion.
My thinking...a down market does not make a Roth conversion a good thing. This is because it is the tax rates that rules the conversion, not the market. But if a Roth conversion is a good idea for other reasons, doing the Roth conversion in a down market makes it even a better idea...icing on the cake...because you get to convert more shares for the same amount of tax. So both views are at least partially right.

I would not give up on your hope to take some advantage of the low income tax year. Maybe you can't convert as much as you would like, but you can surely convert some. And/or you might choose to put more into Roth IRA than traditional 401k (a little late for that plan, but maybe there is enough time for some shifting).
ThankYouJack
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Re: Roth Conversion basics...

Post by ThankYouJack »

RetiOpening wrote: Wed Nov 23, 2022 12:33 am But as you suggest, after reading some of your comments and before I got the chance to respond, I did find myself wondering all night how I was going to pony up the $6800 in additional tax liability to pay for this conversion. Yep, that sum is equivalent to a full year of Roth contributions. The fact is I'm not sure I can afford that in the short term, as tempting as it is to do such a sizable conversion.
Could you afford it (easily) by April 18, 2023? If so, it may be worth skipping the estimated tax payment and paying the underpayment penalty.
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Re: Roth Conversion basics...

Post by retired@50 »

retiredjg wrote: Wed Nov 23, 2022 8:22 am ... But if a Roth conversion is a good idea for other reasons, doing the Roth conversion in a down market makes it even a better idea...icing on the cake...because you get to convert more shares for the same amount of tax.
+1.
More shares, same tax hit. This allows the (presumed) share price recovery to occur in the Roth account, instead of in the traditional IRA.

Regards,
This is one person's opinion. Nothing more.
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Re: Roth Conversion basics...

Post by tibbitts »

retired@50 wrote: Wed Nov 23, 2022 10:05 am
retiredjg wrote: Wed Nov 23, 2022 8:22 am ... But if a Roth conversion is a good idea for other reasons, doing the Roth conversion in a down market makes it even a better idea...icing on the cake...because you get to convert more shares for the same amount of tax.
+1.
More shares, same tax hit. This allows the (presumed) share price recovery to occur in the Roth account, instead of in the traditional IRA.

Regards,
I don't understand the "it doesn't matter" aspect even though I (re)read the links above. If we get a 90% drop I'm converting 90% of everything I've got regardless of resulting marginal bracket, even though my current plan is to convert only about a third of my existing deferred balance, ever (and to do that over time.) Well okay maybe it depends on what I perceive to be the reason for the 90% drop.
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Re: Roth Conversion basics...

Post by retired@50 »

tibbitts wrote: Wed Nov 23, 2022 10:47 am
retired@50 wrote: Wed Nov 23, 2022 10:05 am
retiredjg wrote: Wed Nov 23, 2022 8:22 am ... But if a Roth conversion is a good idea for other reasons, doing the Roth conversion in a down market makes it even a better idea...icing on the cake...because you get to convert more shares for the same amount of tax.
+1.
More shares, same tax hit. This allows the (presumed) share price recovery to occur in the Roth account, instead of in the traditional IRA.

Regards,
I don't understand the "it doesn't matter" aspect even though I (re)read the links above. If we get a 90% drop I'm converting 90% of everything I've got regardless of resulting marginal bracket, even though my current plan is to convert only about a third of my existing deferred balance, ever (and to do that over time.) Well okay maybe it depends on what I perceive to be the reason for the 90% drop.
Are you referring to the links by Charon?

Regards,
This is one person's opinion. Nothing more.
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retiredjg
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Re: Roth Conversion basics...

Post by retiredjg »

tibbitts wrote: Wed Nov 23, 2022 10:47 am
retired@50 wrote: Wed Nov 23, 2022 10:05 am
retiredjg wrote: Wed Nov 23, 2022 8:22 am ... But if a Roth conversion is a good idea for other reasons, doing the Roth conversion in a down market makes it even a better idea...icing on the cake...because you get to convert more shares for the same amount of tax.
+1.
More shares, same tax hit. This allows the (presumed) share price recovery to occur in the Roth account, instead of in the traditional IRA.

Regards,
I don't understand the "it doesn't matter" aspect even though I (re)read the links above. If we get a 90% drop I'm converting 90% of everything I've got regardless of resulting marginal bracket, even though my current plan is to convert only about a third of my existing deferred balance, ever (and to do that over time.) Well okay maybe it depends on what I perceive to be the reason for the 90% drop.
I think it would matter in a 90% drop.

In a run of the mill drop like we are in now, I would not convert unless it is already a good idea anyway (based on current and future rates). This is partly because at some later date, I likely would be in another run of the mill drop at a point when it actually is a good idea to do Roth conversions. That's the time to get the greatest benefit.

To me, a drop of 20% to 30% does not make a conversion at 37% a good idea if your comparison is 37% now vs 12% or 22% later. On the other hand, a drop of 50% could make a lot of sense if comparing 22% now to 15% later.

To me, a drop in the stock market does not alone make conversions good. Every situation requires its own analysis.
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retired@50
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Re: Roth Conversion basics...

Post by retired@50 »

retiredjg wrote: Wed Nov 23, 2022 11:15 am
tibbitts wrote: Wed Nov 23, 2022 10:47 am
retired@50 wrote: Wed Nov 23, 2022 10:05 am
retiredjg wrote: Wed Nov 23, 2022 8:22 am ... But if a Roth conversion is a good idea for other reasons, doing the Roth conversion in a down market makes it even a better idea...icing on the cake...because you get to convert more shares for the same amount of tax.
+1.
More shares, same tax hit. This allows the (presumed) share price recovery to occur in the Roth account, instead of in the traditional IRA.

Regards,
I don't understand the "it doesn't matter" aspect even though I (re)read the links above. If we get a 90% drop I'm converting 90% of everything I've got regardless of resulting marginal bracket, even though my current plan is to convert only about a third of my existing deferred balance, ever (and to do that over time.) Well okay maybe it depends on what I perceive to be the reason for the 90% drop.
I think it would matter in a 90% drop.

In a run of the mill drop like we are in now, I would not convert unless it is already a good idea anyway (based on current and future rates). This is partly because at some later date, I likely would be in another run of the mill drop at a point when it actually is a good idea to do Roth conversions. That's the time to get the greatest benefit.

To me, a drop of 20% to 30% does not make a conversion at 37% a good idea if your comparison is 37% now vs 12% or 22% later. On the other hand, a drop of 50% could make a lot of sense if comparing 22% now to 15% later.

To me, a drop in the stock market does not alone make conversions good. Every situation requires its own analysis.
Once again, I agree with retiredjg.

The first order question is "Am I a good candidate to do a Roth IRA conversion?" ** If ** the answer is yes, then proceed to convert the asset that has fallen in value the most, to get the most shares converted for the desired size (dollar value) of conversion. I wouldn't inflate the size of the conversion just because the market is down. I tend to convert to (or near) the top of the relevant tax bracket.

Regards,
This is one person's opinion. Nothing more.
tibbitts
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Re: Roth Conversion basics...

Post by tibbitts »

retired@50 wrote: Wed Nov 23, 2022 11:27 am
retiredjg wrote: Wed Nov 23, 2022 11:15 am
tibbitts wrote: Wed Nov 23, 2022 10:47 am
retired@50 wrote: Wed Nov 23, 2022 10:05 am
retiredjg wrote: Wed Nov 23, 2022 8:22 am ... But if a Roth conversion is a good idea for other reasons, doing the Roth conversion in a down market makes it even a better idea...icing on the cake...because you get to convert more shares for the same amount of tax.
+1.
More shares, same tax hit. This allows the (presumed) share price recovery to occur in the Roth account, instead of in the traditional IRA.

Regards,
I don't understand the "it doesn't matter" aspect even though I (re)read the links above. If we get a 90% drop I'm converting 90% of everything I've got regardless of resulting marginal bracket, even though my current plan is to convert only about a third of my existing deferred balance, ever (and to do that over time.) Well okay maybe it depends on what I perceive to be the reason for the 90% drop.
I think it would matter in a 90% drop.

In a run of the mill drop like we are in now, I would not convert unless it is already a good idea anyway (based on current and future rates). This is partly because at some later date, I likely would be in another run of the mill drop at a point when it actually is a good idea to do Roth conversions. That's the time to get the greatest benefit.

To me, a drop of 20% to 30% does not make a conversion at 37% a good idea if your comparison is 37% now vs 12% or 22% later. On the other hand, a drop of 50% could make a lot of sense if comparing 22% now to 15% later.

To me, a drop in the stock market does not alone make conversions good. Every situation requires its own analysis.
Once again, I agree with retiredjg.

The first order question is "Am I a good candidate to do a Roth IRA conversion?" ** If ** the answer is yes, then proceed to convert the asset that has fallen in value the most, to get the most shares converted for the desired size (dollar value) of conversion. I wouldn't inflate the size of the conversion just because the market is down. I tend to convert to (or near) the top of the relevant tax bracket.

Regards,
You are already way beyond the point of deciding whether to do conversions; you know you want to do at least $1M in conversions over time based on your current balance, leaving you with say another $1M in deferred. Tomorrow the market says says the $1M is now $100k. I'm all in on the conversion; I'm not even looking at my marginal bracket or IRMAA or whatever the way I do now.
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Re: Roth Conversion basics...

Post by Lee_WSP »

tibbitts wrote: Wed Nov 23, 2022 10:47 am
retired@50 wrote: Wed Nov 23, 2022 10:05 am
retiredjg wrote: Wed Nov 23, 2022 8:22 am ... But if a Roth conversion is a good idea for other reasons, doing the Roth conversion in a down market makes it even a better idea...icing on the cake...because you get to convert more shares for the same amount of tax.
+1.
More shares, same tax hit. This allows the (presumed) share price recovery to occur in the Roth account, instead of in the traditional IRA.

Regards,
I don't understand the "it doesn't matter" aspect even though I (re)read the links above. If we get a 90% drop I'm converting 90% of everything I've got regardless of resulting marginal bracket, even though my current plan is to convert only about a third of my existing deferred balance, ever (and to do that over time.) Well okay maybe it depends on what I perceive to be the reason for the 90% drop.
If you convert at 24% tax hit to “lock in the rate” for the same number of shares, but would have paid only 12% if you did nothing, you are worse off. If you would have paid the same rate, then you are no better or worse off.

The only thing that changes with such a massive drop are the projections.
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Re: Roth Conversion basics...

Post by tibbitts »

Lee_WSP wrote: Wed Nov 23, 2022 12:30 pm
tibbitts wrote: Wed Nov 23, 2022 10:47 am
retired@50 wrote: Wed Nov 23, 2022 10:05 am
retiredjg wrote: Wed Nov 23, 2022 8:22 am ... But if a Roth conversion is a good idea for other reasons, doing the Roth conversion in a down market makes it even a better idea...icing on the cake...because you get to convert more shares for the same amount of tax.
+1.
More shares, same tax hit. This allows the (presumed) share price recovery to occur in the Roth account, instead of in the traditional IRA.

Regards,
I don't understand the "it doesn't matter" aspect even though I (re)read the links above. If we get a 90% drop I'm converting 90% of everything I've got regardless of resulting marginal bracket, even though my current plan is to convert only about a third of my existing deferred balance, ever (and to do that over time.) Well okay maybe it depends on what I perceive to be the reason for the 90% drop.
If you convert at 24% tax hit to “lock in the rate” for the same number of shares, but would have paid only 12% if you did nothing, you are worse off. If you would have paid the same rate, then you are no better or worse off.

The only thing that changes with such a massive drop are the projections.
Admittedly you do have to make the assumption that asset prices will eventually recover, but Roth conversions are always about assumptions, and you're always rolling the dice when converting above 0%.
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Lee_WSP
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Re: Roth Conversion basics...

Post by Lee_WSP »

tibbitts wrote: Wed Nov 23, 2022 12:36 pm
Lee_WSP wrote: Wed Nov 23, 2022 12:30 pm
tibbitts wrote: Wed Nov 23, 2022 10:47 am
retired@50 wrote: Wed Nov 23, 2022 10:05 am
retiredjg wrote: Wed Nov 23, 2022 8:22 am ... But if a Roth conversion is a good idea for other reasons, doing the Roth conversion in a down market makes it even a better idea...icing on the cake...because you get to convert more shares for the same amount of tax.
+1.
More shares, same tax hit. This allows the (presumed) share price recovery to occur in the Roth account, instead of in the traditional IRA.

Regards,
I don't understand the "it doesn't matter" aspect even though I (re)read the links above. If we get a 90% drop I'm converting 90% of everything I've got regardless of resulting marginal bracket, even though my current plan is to convert only about a third of my existing deferred balance, ever (and to do that over time.) Well okay maybe it depends on what I perceive to be the reason for the 90% drop.
If you convert at 24% tax hit to “lock in the rate” for the same number of shares, but would have paid only 12% if you did nothing, you are worse off. If you would have paid the same rate, then you are no better or worse off.

The only thing that changes with such a massive drop are the projections.
Admittedly you do have to make the assumption that asset prices will eventually recover, but Roth conversions are always about assumptions, and you're always rolling the dice when converting above 0%.
It's a SORR bet IMO. It could very well turn out to be correct, but it could also very well turn out to have been wrong. I do think it's an asymmetric risk of being wrong though since the entire bet requires the assets to grow at an even faster rate than before because without the drop the assumption was no conversion.
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