Should I Do Some Roth Conversions?

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BigFoot48
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Should I Do Some Roth Conversions?

Post by BigFoot48 » Wed May 23, 2012 4:06 pm

After many years of being satisfied with telling myself that I'd rather pay taxes in the future than now, I have decided to take a serious look at converting a portion of my TIRA into a Roth.

My question is, based on the data presented below, is there a significant benefit of any type to doing a conversion for a retiree in my situation? I will sincerely appreciate everyone's advice.

Background
We're retired and get our living expenses from an IRA, and SS which started at 62. I could do conversions for the next eight years until MRD kicks in, and stay within the 15% tax bracket. I expect to stay within this bracket, although my wife may inherit an IRA that could produce more MRD and push us higher (not included in the model yet).

We have no human heirs that might benefit from a Roth, and expect to have six-figure funds remaining when we pass.

Considerations:
Having a Roth would be useful if a large expenditure was required, say a car or RV, and there were insufficient funds in one's taxable account, and one wanted to avoid larger taxable IRA withdrawals.

It would be nice to have Roth earnings growing tax free for 30 or 40 years, but alas any conversions I make now will likely have a likely tax-free growth-life of only 10-20 years.

Moving TIRA funds to a Roth will reduce the MRD, thereby also reducing the amount of SS income that are taxable, while allowing me to supplement IRA withdrawals with Roth withdrawals without impacting SS taxes.

Models Note: I have made the model I created available to all. Enjoy!: http://www.bogleheads.org/forum/viewtop ... 5#p1405885
To start the process, I prepared a model that looks at an sample portfolio balance, annual earning, income sources, and the Federal only Married-Joint Return taxes. A second, approximately identical section, has an annual Roth conversion amount until MRD starts. The purpose of this model was to determine the impact, as best a simple one could, on my income, taxes and investment balances from doing a conversion.

I modeled out to age 95, although only a portion is shown here. Calculation of taxable SS is not shown but is included. No annual adjustment of the tax bracket was done. I believe the model to be correct, but there may be flaws.

As expected, total income and taxes are about the same in both cases. Ending portfolio values are about the same. The major difference is in the present value of the tax payments, as paying taxes on the Roth amounts will be a significant near-term hit. So this tells me this is not so much an economic decision, pending tax law changes.

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Last edited by BigFoot48 on Sat Oct 06, 2012 4:00 pm, edited 1 time in total.
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Re: Should I Do Some Roth Conversions?

Post by grabiner » Wed May 23, 2012 6:12 pm

BigFoot48 wrote:BackgroundWe're retired and get our living expenses from an IRA, and SS which started at 62. I could do conversions for the next eight years until MRD kicks in, and stay within the 15% tax bracket.
Check your marginal tax rate. Are you in the phase-in range for Social Security taxation? If so, your marginal tax rate is 27.75%. (However, if 85% of your Social Security is already being taxed, your marginal tax rate goes back down to 15%.)

A better idea might be to rescind your SS application for benefits and re-file when you turn 70. You would then need to withdraw more from the IRA, but you would be able to convert at 15% without causing non-existent SS to be taxed. Then, once you turn 70, you would have much less in the IRA and be taking smaller RMDs, so less of your SS would be taxed.
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Re: Should I Do Some Roth Conversions?

Post by BigFoot48 » Wed May 23, 2012 6:34 pm

My current marginal rate is near 0%, as I'm only withdrawing enough from the IRA to pay minimal Federal taxes. This currently provides adequate income to meet living expenses. Pulling out another $35k to fund a Roth would certainly put the SS benefits at the 85% level, as my model shows, which would mean about $3,500 in additional taxes. ($28k x .85 x .15)

I was unaware that SS benefits could be rescinded and restarted later, but would it be at the higher age-70 rate, or some other? I will have to add that idea to my model. Thanks.

[Edit]Oh, that rescind! Unfortunately we're beyond 12 months of benefits, and there's no rescind. When I originally decided to start at 62 I had the rescind-repay-reapply as a backup Plan B, but a few months later they pulled that rug out and I decided to stick with it.
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Re: Should I Do Some Roth Conversions?

Post by House Blend » Wed May 23, 2012 9:12 pm

You should include Arizona state income tax in your model.

Some states have special tax breaks for qualified IRA withdrawals/conversions.

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Re: Should I Do Some Roth Conversions?

Post by BigFoot48 » Wed May 23, 2012 9:37 pm

Good idea, and easy now that I'm over the hump on the bulk of the model. I'll investigate the AZ provisions on conversions. Generally AZ taxes run less than 2% of AGI.

[EDIT] AZ reduces Fed AGI by any taxable SS income included in it in determining AZ AGI. In reviewing the instructions, I could find no provision for special treatment of IRA withdrawals (except for prior to 1975) or Roth conversions.
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Re: Should I Do Some Roth Conversions?

Post by DickBenson » Thu May 24, 2012 2:14 am

Some things to consider.

1. A surviving spouse will have the changes in tax bracket come twice as fast as you are experiencing now,.... filing jointly. You might run some models for this contingency.

2. Tax regulations are subject to change. Suspect that rates are probably going to increase in the future.

3. That inherited IRA, rather than an inherited Roth, could put you in higher brackets.

4. After 70, you will be moving more funds out of your IRA than apparently you will need for expenses. If these funds are invested there will be more tax to be paid on the income generated. If in Roth no withdrawal needed and when withdrawn not taxable.

Dick

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Re: Should I Do Some Roth Conversions?

Post by Carl53 » Thu May 24, 2012 5:42 am

BigFoot48 wrote:
I modeled out to age 95, although only a portion is shown here. Calculation of taxable SS is not shown but is included. No annual adjustment of the tax bracket was done. I believe the model to be correct, but there may be flaws.
I see that you escalate the SS payment 3%, presumably for inflation. I did that also in my spreadsheet. You might also include inflation escalation factors for the tax table bracket break points, standard deductions, and exemptions. You also ought to include the bump up in standard deduction at age 65. Since the points that SS becomes taxable are not indexed for inflation how inflation plays with these other factors can impact greatly how the RMDs get taxed. Remember that SS begins to be taxed once your non SS income including RMDs and other tax exempt income plus one-half of your SS exceed $32000 (for joint filers). Taxation begins on 50% of the SS effectively making your nonSS income tax rate 150% of the nominal value. If you are in the 10% bracket, you are really in the 15% bracket until all of your SS income is taxed. Once one-half of your SS plus RMDs and other tax exempt income plus one-half of your SS exceed $44000 you find that you now have 85% of the SS being taxed effectively raising your nominal tax bracket to 18.5%. This occurs until every last dollar of the first 85% of your SS is taxed. Then your effective tax rate can drop back to the 10% assuming you have some space in that bracket left.

The $32000 and $44000 are NOT indexed for inflation! According to your spreadsheet even this year some of your SS is taxable (almost impossible to not be). By the time your RMDs kick in, those alone will put you in the 15% (really 27.75%) bracket based on your numbers and I estimate about 60% of your SS will be taxed. The saving grace is that with several tax factors being inflation indexed, your overall taxes will be substantially less.

Should you convert and how much? I cannot say, but hone your spreadsheet and keep analyzing.

+1 to Dick Benson's comments, particularly the first one. The taxable SS numbers drop to 25000 and 34000 for singles.

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Re: Should I Do Some Roth Conversions?

Post by dickenjb » Thu May 24, 2012 7:30 am

Try i-ORP and see what it says.

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Re: Should I Do Some Roth Conversions?

Post by BigFoot48 » Thu May 24, 2012 8:10 am

DickBenson wrote:1. A surviving spouse will have the changes in tax bracket
2. Tax regulations are subject to change. Suspect that rates are probably going to increase in the future.
3. That inherited IRA, rather than an inherited Roth, could put you in higher brackets.
4. After 70, you will be moving more funds out of your IRA than apparently you will need for expenses.
Excellent points to consider.
1. I had the surviving spouse "eventuality" modeled when I looked at starting SS, and need to get it in this model too. I've just seen, while doing the widowed MIL's return, what a significant impact going from joint to single can be.
2. I've been assuming the 15% will likely not change and thinking I would be safe within its loving arms, but the 25% rate likely will change somewhat and after refining the model as being recommended, I now expect I will be into that bracket more significantly, so I'm beginning to take this eventuality more seriously.
3. The wife's inheritance will nearly double our assets, and needs to be in the model for sure, and will probably be the deciding factor.
4. I have ignored income vs. expenses but our relatively low living expenses will mean taxable funds will be building up and generating taxable income. Again, not yet in the model but need to be added.

Thanks Dick, excellent ideas for improving the model and I'll be doing these next. Stay tuned.
Last edited by BigFoot48 on Thu May 24, 2012 8:42 am, edited 3 times in total.
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Re: Should I Do Some Roth Conversions?

Post by kaneohe » Thu May 24, 2012 8:19 am

DickBenson wrote:Some things to consider.

1. A surviving spouse will have the changes in tax bracket come twice as fast as you are experiencing now,.... filing jointly. You might run some models for this contingency.
3. That inherited IRA, rather than an inherited Roth, could put you in higher brackets

Dick
!) excellent point that I suspect is not considered often enough by others (including me)
3) Wouldn't an inherited Roth do the same thing? I thought you had to take RMDs from inherited Roths too.

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Re: Should I Do Some Roth Conversions?

Post by BigFoot48 » Thu May 24, 2012 8:27 am

Carl53 wrote:You might also include inflation escalation factors for the tax table bracket break points, standard deductions, and exemptions. You also ought to include the bump up in standard deduction at age 65.
The $32000 and $44000 are NOT indexed for inflation!
I estimate about 60% of your SS will be taxed.
The taxable SS numbers drop to 25000 and 34000 for singles.
I had hoped to keep the model simple but think you make a good point and the tax bracket inflation factors need to be in it, along with the age 65 SD bump.
I had not thought about it, but the fact the $32k/$44k factors are not indexed for inflation is a big deal over a 30 year retirement period.
In my current model, the "Don't Convert" section has SS becoming forever 85% taxable at age 72 when the RMD starts. Prior to 72 it's 7-8% taxable in every year. In the "Convert" section SS becomes 85% taxable in the first conversion year (2012) and then forever. While we're now wed to taking SS, others might want to consider this in their SS start date decision.

Thanks for the good ideas. Looks like I'll be busy with Excel today.
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Re: Should I Do Some Roth Conversions?

Post by Epsilon Delta » Thu May 24, 2012 8:57 am

kaneohe wrote:
DickBenson wrote:Some things to consider.

3. That inherited IRA, rather than an inherited Roth, could put you in higher brackets

Dick
3) Wouldn't an inherited Roth do the same thing? I thought you had to take RMDs from inherited Roths too.
A spouse can treat an inherited Roth as their own and there will be no RMDs. A non-spouse will have RMDs, but the Roth withdrawals will almost certainly be qualified so they will be tax free and not affect the tax brackets under current law.

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Re: Should I Do Some Roth Conversions?

Post by BigFoot48 » Thu May 24, 2012 9:02 am

dickenjb wrote:Try i-ORP and see what it says.
I've run it from time to time and find its charts interesting, but find its seemingly automatic creation of a Roth contributions when none are input somewhat puzzling. I (modestly) think my model will better!
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Re: Should I Do Some Roth Conversions?

Post by Carl53 » Fri May 25, 2012 10:41 am

[quote="BigFoot48"
In my current model, the "Don't Convert" section has SS becoming forever 85% taxable at age 72 when the RMD starts.
You might want to check the 72 starting age as it should be the year in which you reach 70.5. I noticed this on your spreadsheet originally but forgot to mention it.

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Re: Should I Do Some Roth Conversions?

Post by BigFoot48 » Fri May 25, 2012 10:53 am

Carl53 wrote:[quote="BigFoot48"
In my current model, the "Don't Convert" section has SS becoming forever 85% taxable at age 72 when the RMD starts.
You might want to check the 72 starting age as it should be the year in which you reach 70.5. I noticed this on your spreadsheet originally but forgot to mention it.
Thank you. I found the rule to be "a bit" confusing, but think 72 is correct. Here's how it's worded, and I was born in July. I would like to know if 72 (before April) is indeed correct.
An account owner must take the first RMD for the year in which he or she turns 70 ½. However, the first RMD payment can be delayed until April 1st of the year following the year in which he or she turns 70 ½.
http://www.irs.gov/retirement/article/0 ... ,00.html#3
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Re: Should I Do Some Roth Conversions?

Post by Alan S. » Fri May 25, 2012 10:59 am

You should build in 2-3% escalation on your std deduction and exemptions. You may also have overlooked the age 65 increased std deduction. Even for 2012, for a couple age 65 and up the total of the two is 21,800.

You might also find that if you do conversions after taking SS benefits, you may save tax dollars by converting more when you convert, but skip alternate years. The reason for that is the 27.75% marginal rate when SS is being dragged in up to 85% is higher than the 25% bracket. So you might convert to the top of the 25% bracket every second or third year and avoid the 27.75% marginal rate in the other years. Of course, once RMDs reach a certain amount you would no longer avoid the 27.75% rate as the RMD has exactly the same tax impact as a Roth conversion. You might model that out, as it all depends on the mix and amount of the various types of taxable income you have.

The SS taxation thresholds have never been adjusted for inflation and likely never will be, since the tax dollars generated by SS taxation are (supposed to be) allocated to the SS account and that account will be shrinking from now on. In a couple decades, anyone who has a pension or even modest retirement savings distributions will have 85% SS inclusion due to the lack of inflation adjustment.

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Re: Should I Do Some Roth Conversions?

Post by Carl53 » Fri May 25, 2012 11:27 am

BigFoot48 wrote:
Carl53 wrote:[quote="BigFoot48"
In my current model, the "Don't Convert" section has SS becoming forever 85% taxable at age 72 when the RMD starts.
You might want to check the 72 starting age as it should be the year in which you reach 70.5. I noticed this on your spreadsheet originally but forgot to mention it.
Thank you. I found the rule to be "a bit" confusing, but think 72 is correct. Here's how it's worded, and I was born in July. I would like to know if 72 (before April) is indeed correct.
An account owner must take the first RMD for the year in which he or she turns 70 ½. However, the first RMD payment can be delayed until April 1st of the year following the year in which he or she turns 70 ½.
http://www.irs.gov/retirement/article/0 ... ,00.html#3

Ok, July birthday, following January 70.5, first RMD delayed til following April. You will then need to make two RMDs for that first year, the one delayed and the one for that year. Your choice as to whether double up that first time, or one per year. Note the last sentence from the following excerpt from the IRS FAQ page on RMDs.

"When is the deadline for receiving a RMD from an IRA?

An account owner must take the first RMD for the year in which he or she turns 70 ½. However, the first RMD payment can be delayed until April 1st of the year following the year in which he or she turns 70 ½. For all subsequent years, including the year in which the first RMD was paid by April 1st, the account owner must take the RMD by December 31st of the year."

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Re: Should I Do Some Roth Conversions?

Post by BigFoot48 » Fri May 25, 2012 11:45 am

Alan S. wrote:You should build in 2-3% escalation on your std deduction and exemptions. You may also have overlooked the age 65 increased std deduction. Even for 2012, for a couple age 65 and up the total of the two is 21,800.

You might also find that if you do conversions after taking SS benefits, you may save tax dollars by converting more when you convert, but skip alternate years. .
Yesterday I modified the model to include the important yearly tax bracket, deduction and exemption increases, along with the age-65 bump. I looked at the increases in the last 10 years and used a fixed amount yearly increase rather than a percentage for no good reason other than to keep the amounts more "rounded off".

I will add the alternating year idea as an alternative case. That's one I hadn't heard of before, and as we are now taking SS benefits it might be beneficial. However I have only 8 years until MRD kicks in so if I do this I would want to maximize the conversions while staying within the 15% bracket if possible.
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Re: Should I Do Some Roth Conversions?

Post by BigFoot48 » Fri May 25, 2012 11:48 am

Carl53 wrote:Note the last sentence from the following excerpt from the IRS FAQ page on RMDs.
Got it finally. Thanks. 71 it is then as delaying for four months is not that significant, especially in a model.
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Re: Should I Do Some Roth Conversions?

Post by Carl53 » Fri May 25, 2012 12:02 pm

The benefit of loading up on conversions once your SS becomes fully taxable since how you may drop back down to the 15% or lower bracket for a number of 1000s of dollars can be seen on the four graphs in the following post.
http://www.bogleheads.org/forum/viewtop ... =1&t=70229

At 30K current SS, you will be between the yellow and green lines. Note how their relative marginal rates are different between now (2010) and the inflated to 2X 2034 chart.

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Re: Should I Do Some Roth Conversions?

Post by BigFoot48 » Mon May 28, 2012 1:13 am

I've finished doing an Excel model to help evaluate the value of doing Roth conversions in retirement and prior to RMD starting. Using test data, it appears doing the conversions for seven years might add about 12% to investment balances by age 95, with little difference at age 83. Thus a benefit and probably a good idea if for no other reasons than to have a large amount of funds available with tax-free earnings should a need arise.

When I included a low estimate of an expected inheritance, the results changed significantly and there was no financial benefit to doing conversions, again assuming it was modeled correctly, something I am continuing to review and refine. At this point, I'm leaning toward not doing conversions as the funds we have available to pay the taxes would be significantly depleted.

If anyone would like a copy of the model I created, please send me a PM with your email address. While I couldn't help with any customization, and it's not warranted as being accurate or correct, it is generic enough for most retiree situations and largely self-explanatory. Plus you might find an "issue" that would be beneficial to fix or add!

Here's a comparison table showing some of the years of data in the model.
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Re: Should I Do Some Roth Conversions?

Post by DickBenson » Mon May 28, 2012 5:14 pm

I'll add just one more thing to consider. It is a long-shot, and could have sensitive family implications, but I think it would have a significant impact on your situation.

If your benefactor would change their traditional IRA to a Roth, it would prevent the inheritance from having a negative impact on your tax liabilities. Of course, they would either have to be generous, or be shown that this would not have a negative impact on their own portfolio (net worth).

The latter would be the case if they were in a 15% tax bracket and would always have to pay this rate upon withdrawing funds from their IRA. In such a situation they really "own" only 85% of the IRA and the government "owns" the other 15%. So converting $100,000 of an IRA using $15,000 of taxable savings leaves you with a "net worth" of $100,000 (the value of the Roth).... the same "net worth" you had before conversion ($85,000 of the IRA plus $15,000 in other savings).

This viewpoint of the share of one's IRA that the government "owns", based upon tax bracket, and how that share can change, may be helpful in getting a "feel" for the impact of various possible future events. Let me be the government and show how I can get a better slice of the pie,... i.e. increase ownership of our IRA using the 4 considerations I posted earlier.

1. Your now a single taxpayer, .... I own a bigger percentage of our IRA.

2. I need more money, so tax rates are going up ..... I own a bigger percentage of our IRA.

3. I used to own only 15% of that inherited IRA, but now since you have it I own 25% of it (and I'm going to start withdrawing some of it as soon as you receive it).

4. You have more income (pay at larger tax rate)..... I own a bigger percentage of our IRA.

Dick

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Re: Should I Do Some Roth Conversions?

Post by BigFoot48 » Mon May 28, 2012 6:15 pm

DickBenson wrote:I'll add just one more thing to consider. It is a long-shot, and could have sensitive family implications, but I think it would have a significant impact on your situation.

If your benefactor would change their traditional IRA to a Roth, it would prevent the inheritance from having a negative impact on your tax liabilities. Of course, they would either have to be generous, or be shown that this would not have a negative impact on their own portfolio (net worth).
Ah so, a very interesting and intriguing idea, but alas probably would be too little and too late in our situation, with a minimal amount of conversion possible for the years remaining. That said, I will take a look at the numbers, and taxes involved and see what the result would be under different time periods - the great unknown. Now that I have a working model, it's a trivial thing to do!

I think if I had human heirs, rather than just institutional heirs, that Roth conversion would be a high priority and greatly appreciated by said heirs someday.

Thanks for the idea!
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Re: Should I Do Some Roth Conversions?

Post by BigFoot48 » Sat Oct 06, 2012 5:01 pm

An update on my effort this year to finally either decide to do Roth conversions over the next 8 years until RMD starts, or decide not to. Over the past few months I have been working on my model, which I have also made available to anyone via this thread http://www.bogleheads.org/forum/viewtop ... 5#p1405885, and think it now has most of the factors needed to evaluate the financial outcomes of the various alternatives. (And I believe the model is mathematically, logically, and tax calculation correct, but this has not been confirmed by a peer review!)

The alternatives I've run today include maxing-out the 15% and 25% brackets with conversions, and doing the same assuming there is a 5% increase in all bracket rates in 2020. What I'm seeing is that there is no advantage in doing conversions by maximizing the 15% taxes, even if tax rates increase in the future, but maximizing the 25% bracket every other year, as Alan S. suggested in an earlier post, does offer a slight advantage if there is such a tax increase.

I also ran the cases assuming one of us departs the planet at age 80 (model goes through age 95) and the 25% conversion alternative is a bit more advantageous in this likely scenario.

So what I'm concluding here is that the decision is a toss-up - doing the conversions may or may not offer a slight financial advantage. However, not modeled is one situation that might arise of needing a large sum late in life, such as for buying into an extended care facility, or buying a second home or RV, and having Roth funds available to do so could possibly avoid large taxable IRA withdrawals.

Thanks again for all the advice which I'm reviewing along with other sources to see if I've missed something. I've also not included an inheritance that my DW will be receiving, which makes this decision much less important.

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Re: Should I Do Some Roth Conversions?

Post by BigFoot48 » Tue Oct 23, 2012 5:38 pm

Well, I have finally used my last Roth Conversion model (v5.1) to analyze our situation, and have concluded doing Roth conversions from age 64 to 70 would have little financial benefit, therefore I WILL NOT be doing them.

Summary of the four primary cases I ran:

1. Doing a conversion over seven years, maxing-out the 15% bracket every year, but doing nothing with the Roth money results in an ending account balance (age 90) 4.8% LOWER than not doing the conversion. Assuming a 5% tax increase in all brackets in 2020, doesn't help much, making the ending balance 3.7% LOWER than not doing the conversion.

2. If I assume a use for most of the Roth funds, say buying a second home at age 75, and funding that if there's no Roth by higher IRA withdraws from 71 to 75, the ending account balance is 1% higher if the Roth conversion takes place. If the tax increase happens, the Roth balance is 4.3% higher.

Here are some of the factors I have that others may not have.

1. I have a low taxable balance. To fund the Roth conversion taxes I must withdraw additional amounts from my IRA, increasing my near-term taxes.
2. I don't anticipate any need to withdraw Roth funds for any purpose, as my SS+RMD is more than adequate for our living needs.

So, some of the reasons I will not be doing any conversions:

1. The calculated financial benefit, assuming the model is calculating everything reasonable well, is very small.
2. I have no heirs, and thus no need to havi a Roth to benefit the estate.
3. I would prefer to not incur an additional $67,000 in tax expense over the next seven years for little or no future benefit.
4. My DW will receive a sizable inheritance, making any possible Roth benefit not critical to our living standards.

So, pending someone discovering an large calculating mistake in the model, I believe my study of doing conversions is over. I hope others using the model will discover a sizable benefit for doing a conversion, but it just not there for us.
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Re: Should I Do Some Roth Conversions?

Post by grabiner » Tue Oct 23, 2012 9:43 pm

BigFoot48 wrote:2. I have no heirs, and thus no need to havi a Roth to benefit the estate.
What will happen to your assets? If you leave them to charity, then you don't want the Roth, as a traditional IRA is just as good for a charity to receive.
4. My DW will receive a sizable inheritance, making any possible Roth benefit not critical to our living standards.
When she receives this inheritance, you might move into a higher tax bracket (because of the RMDs she must take on an inherited IRA, or the dividends and capital gains if she invests it in her taxable account). This argues for the Roth.
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Re: Should I Do Some Roth Conversions?

Post by BigFoot48 » Tue Oct 23, 2012 10:43 pm

The Nature Conservancy gets it all, although I've told my friend who will be executor that if he doesn't loot the estate on its way to the Conservancy that I will be very disappointed in him.

I didn't list it above, but my model provides for inheritance factors and including them results in the Roth conversion making the age account account balance 1.4% higher than the non-Roth case (2.4% with the tax increase), as compared to 1% higher in the non-inheritance cases. So, not a major impact if the model is counting correctly.
Retired | Two-time in top-10 in Bogleheads S&P500 contest; 13-time loser

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Re: Should I Do Some Roth Conversions?

Post by LadyGeek » Sat Apr 06, 2013 7:05 pm

(I'm posting in this old thread because it's referenced from Retiree Roth Conversion Decision Model)

The OP's spreadsheet is now in the wiki. See: Roth IRA conversion (Using a spreadsheet) and Tools and Calculators (Roth conversion calculators)

Comments / questions / suggestions on the wiki article are welcome.

Spreadsheet comments should be posted in the referenced thread: Retiree Roth Conversion Decision Model
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