Roth Conversion and Strategy

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MrFlish
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Roth Conversion and Strategy

Post by MrFlish » Sun Mar 19, 2017 6:58 am

Is there an ideal percentage that one should have when holding a Roth and a tax deferred IRA? We are looking at converting some or all of our tax deferred IRA's to Roth's. What are there tactical advantages to having one or both?

The conversion would take place post retirement with the primary goal being to provide income control once the RMD's hit.


Thanks in advance for the insight...
Last edited by MrFlish on Sun Mar 19, 2017 7:19 am, edited 1 time in total.

livesoft
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Re: Roth Conversion and Strategy

Post by livesoft » Sun Mar 19, 2017 7:03 am

One tactical advantage to having 4 or more accounts (one can have multiple Roths and multiple tIRAs) is that many places give a limited number of free commissions per account per month. So more accounts mean more free commissions.

Another tactical advantage of having multiple Roth accounts for conversions is described in the links found in this thread:
viewtopic.php?t=162635
A Roth conversion can be recharacterized if the Roth conversion loses too much money in the first year. That can save on taxes.

Another tactical advantage is that recharacterization can be done to exquisitely control one's tax bracket of the previous tax year, but before April tax filing time if one's taxable income exceeds a bracket limit, an IRMAA cutoff, or ACA subsidy cutoff, other tax cliff. In such cases, one can just recharacterize the exact amount needed to get to the lower taxable income or adjusted gross income needed on their tax return.
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MrFlish
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Re: Roth Conversion and Strategy

Post by MrFlish » Sun Mar 19, 2017 7:23 am

Thanks for the info...Will have to get smarter recharacterization as I didn't think we'd need that given the conversions would be done post retirement.

shanghaista
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Re: Roth Conversion and Strategy

Post by shanghaista » Sun Mar 19, 2017 10:20 am

"Is there an ideal percentage that one should have when holding a Roth and a tax deferred IRA? We are looking at converting some or all of our tax deferred IRA's to Roth's. What are there tactical advantages to having one or both?"

There is no "ideal percentage" that fits everyone, it's all a unique case basis.

The basic consideration is your tax rate - is it likely higher in your current year or future years?
You don't want to be paying a 25% tax rate on the conversion in the present if you'll have so little taxable income later that you'll only be in the 10-15% bucket. Or pay 28% now only to qualify for 25% later, ect.

Generally, the idea is that the Roth is flexible - you can withdraw it anything you want without taxes. But this should be done mostly to SUPPLEMENT your income (and have income that won't hit your tax return). If you're able to, you usually want to fill up your entire 15% bracket in retirement (RMDs included) so don't over-convert to Roth to the point where you have so little taxable IRA/401k where you can't fully take advantage of spreading out your taxes over the years.

There are multiple variables - IRA/401k RMDs, Social Security benefits taxability thresholds, Medicare eligibility, ect. So be sure to either really think this through and do the calculations or consult a financially savvy friend or professional for advice.

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AndrewXnn
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Re: Roth Conversion and Strategy

Post by AndrewXnn » Sun Mar 19, 2017 12:47 pm

To convert or not convert and how much to convert is a function of your current and future tax rates as well as the amount in IRAs.

At age 70.5, you must start RMDs from all of your IRAs. Initially, these are 3.6% of the value of the IRAs, but gradually increase over time. Also, once you start collecting social security that will push up your income tax rate.

Conversion works best for people who are retired and have taxable accounts that they can live off. This allows them to report no income unless they have a pension or SS. You can then convert however much from the IRAs into a Roth so long as it does not increase your marginal income tax rate above that which it is projected to be at age 70.5.

For most people, if you can keep your marginal tax rate below 15%, then it probably makes sense to convert.
What makes it even more complicated is that the value of your IRA's will change over time as well.

jebmke
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Re: Roth Conversion and Strategy

Post by jebmke » Sun Mar 19, 2017 12:59 pm

MrFlish wrote:Thanks for the info...Will have to get smarter recharacterization as I didn't think we'd need that given the conversions would be done post retirement.

You just never know. I had to do one this year (for 2016) but it was a self-inflicted wound. I had enough info to do the original conversion correctly in December but got sloppy and overshot. I was able to re-characterize last month -- it only took a couple days via VG (paper form).
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Sheepdog
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Re: Roth Conversion and Strategy

Post by Sheepdog » Sun Mar 19, 2017 1:15 pm

AndrewXnn wrote:
Conversion works best for people who are retired and have taxable accounts that they can live off. This allows them to report no income unless they have a pension or SS. You can then convert however much from the IRAs into a Roth so long as it does not increase your marginal income tax rate above that which it is projected to be at age 70.5.

For most people, if you can keep your marginal tax rate below 15%, then it probably makes sense to convert.
What makes it even more complicated is that the value of your IRA's will change over time as well.

That fits my experience. At retirement (age 65), I lived off of SS and taxable investments until I reached 70.5 years old while converting 4.5% each year of our IRAs to Roths in the first 5 years for a total of about 22%. The tax owed was not over bearing. Since then I have occasionally converted more, according to our tax situation, even last year when I was 83. And, I expect to do so again this year.
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Prudence
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Re: Roth Conversion and Strategy

Post by Prudence » Sun Mar 19, 2017 1:39 pm

AndrewXnn wrote:To convert or not convert and how much to convert is a function of your current and future tax rates as well as the amount in IRAs.

At age 70.5, you must start RMDs from all of your IRAs. Initially, these are 3.6% of the value of the IRAs, but gradually increase over time. Also, once you start collecting social security that will push up your income tax rate.

Conversion works best for people who are retired and have taxable accounts that they can live off. This allows them to report no income unless they have a pension or SS. You can then convert however much from the IRAs into a Roth so long as it does not increase your marginal income tax rate above that which it is projected to be at age 70.5.

For most people, if you can keep your marginal tax rate below 15%, then it probably makes sense to convert.
What makes it even more complicated is that the value of your IRA's will change over time as well.


I am 70 and just completed my first RMDs in February. I have traditional IRAs and a 401k containing fully taxable funds. I have a pension and social security and other savings so I think it may be good to do some Roth conversions. I have read a number of threads on this. The best strategy for me may be to do start doing yearly conversions with the goal of not exceeding the 25% incremental tax rate in 2017 and in future years. This may not be feasible at this point e.g. a Roth conversion in 2017 when added to my RMD in 2017 may put me over the 25% rate in the 2017 tax year. So, I need to run the numbers and see what works. Am I on the right track?

MrFlish
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Re: Roth Conversion and Strategy

Post by MrFlish » Sun Mar 19, 2017 6:31 pm

Thanks to everyone for all the great points to consider...

I think it's pretty much a given that some conversion is in our future. The bulk of our savings (other than cash) sits in our tax deferred 401's/IRA's and we've got about 3 years to go before we're both going to retire. When they fully come on line, our pensions/social security should cover ~60-70% of our projected expenses. Presently we'll have around 12 years to get our ROTH conversion act together before RMD's kick in so we've got some calculating and planning to do for sure.

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Peter Foley
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Re: Roth Conversion and Strategy

Post by Peter Foley » Sun Mar 19, 2017 9:57 pm

As previously mentioned, I don't think there is an ideal percentage. A good guideline would be to try to stay in the 15% tax bracket or lower throughout one's retirement.

I like to think in terms of a constant level of spendable income (income after taxes).

Swelfie
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Re: Roth Conversion and Strategy

Post by Swelfie » Sun Mar 19, 2017 11:42 pm

MrFlish wrote:Thanks to everyone for all the great points to consider...

I think it's pretty much a given that some conversion is in our future. The bulk of our savings (other than cash) sits in our tax deferred 401's/IRA's and we've got about 3 years to go before we're both going to retire. When they fully come on line, our pensions/social security should cover ~60-70% of our projected expenses. Presently we'll have around 12 years to get our ROTH conversion act together before RMD's kick in so we've got some calculating and planning to do for sure.


There is a lot to consider. It depends on whether you are retiring early or not also and whether you can or need to withdraw from that tax deferred space and don't want that penalty.

Here's my plan as an outline to get you started:

I'll be retiring early, so I'll roll over into Roth what I think I will need in 5 years and live on taxable, HSA, old Roth rollovers (backdoors) and Roth contributions I have from when I was young and poor for those first 5 years. I do the rollover and then see how much is left in my 15% tax bracket, because that's 0% cap gains tax space. I'll try to space out my taxable selling under that limit, drawing off Roth and hsa if I run out of room. If I don't run out of room, say I've got $10k left before I hit the 25% bracket, I'll sell enough to incur that 10k gain at the end of the year and immediately buy it all back. That will set my cost basis higher for future years, since I have now paid the taxes on that $10k gain, it was just that I was in the 0% bucket. Once you are 60 it becomes simpler since you don't have to think 5 years ahead and get your tax brackets so close, you just do it for the current year.

Google "Roth ladder" and "tax gain harvesting" for more info.

Now to make this more complicated, I'll probably do 2 or 3 rollovers, all for what I need in 5 years, and only keep one and "undo" the others by recharacterizing. Say I need $30k in 5 years. I'll roll 30k of bonds into one Roth IRA, and 30k of stocks into the other both in January. When December rolls around, if they both went down then I'll recharacterize both and do a final one. Otherwise I'll keep the one that went up the most. This puts more into the Roth with the same taxes since the IRS is kind enough to give us a Mulligan option.

Now, if you have a whole lot in traditional, make sure to look at RMDs and space out your rollovers even if you don't need the money. Better to pay the 25% tax bracket then the higher ones if you are forced to withdraw large amounts later in life.
Last edited by Swelfie on Tue Mar 21, 2017 9:19 pm, edited 1 time in total.

MrFlish
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Re: Roth Conversion and Strategy

Post by MrFlish » Mon Mar 20, 2017 8:27 am

Peter Foley wrote:As previously mentioned, I don't think there is an ideal percentage. A good guideline would be to try to stay in the 15% tax bracket or lower throughout one's retirement.

I like to think in terms of a constant level of spendable income (income after taxes).



I agree, this is what we're hoping to be able to do.

MrFlish
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Re: Roth Conversion and Strategy

Post by MrFlish » Mon Mar 20, 2017 8:37 am

Now, if you have a whole lot in traditional, make sure to look at RMDs and space out your rollovers even if you don't need the money. Better to pay the 25% tax bracket then the higher ones if you are forced to withdraw large amounts later in life.[/quote]


This is where I'm looking to get smarter and build some efficiencies in the overall portfolio ...large traditional IRA's, covert/spread Roth's over the next ten years so we've got some flexibility when we get to the RMD.

No one said fun was gonna be easy....but it's better than the alternative for sure.

The Wizard
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Re: Roth Conversion and Strategy

Post by The Wizard » Mon Mar 20, 2017 8:53 am

Peter Foley wrote:As previously mentioned, I don't think there is an ideal percentage. A good guideline would be to try to stay in the 15% tax bracket or lower throughout one's retirement.

I like to think in terms of a constant level of spendable income (income after taxes).

The 15% bracket simply isn't possible for some folks with too much in tax deferred.

And rather than spendable income, I prefer to focus on achieving a constant to slightly increasing level of TAXABLE income each year in retirement, through your early 70s at least.
This scheme requires one to project their future SS and RMD income and then adjust Roth conversions to lessen the jump in AGI at age 70.5...
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southport
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Re: Roth Conversion and Strategy

Post by southport » Fri Sep 22, 2017 7:51 am

Converting a traditional IRA to fill to the top of the 15% bracket is terrific, of course, if you're going to save 25% later.

But we don't hear much about filling up the 25% bracket, in order to avoid taking distributions while in the 28% bracket. That 3% difference only applies, of course, to those dollars that make it into the higher bracket. So if that's $10,000, the additional tax for being in the 28% bracket is $300 - $2800 instead of $2500.

My considerations include future tax rates and the general direction of the market. Perhaps a better time to convert (if one converts at all) would be when the market takes a big drop, when more shares can be converted for a given dollar amount.

Phil DeMuth
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Re: Roth Conversion and Strategy

Post by Phil DeMuth » Sat Sep 23, 2017 12:44 pm

The following article by Sumutka and Coopersmith might be of interest:
http://www.iarfc.org/documents/issues/Vol16Issue1.pdf

Chip
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Re: Roth Conversion and Strategy

Post by Chip » Sat Sep 23, 2017 3:19 pm

Phil DeMuth wrote:
Sat Sep 23, 2017 12:44 pm
The following article by Sumutka and Coopersmith might be of interest:
http://www.iarfc.org/documents/issues/Vol16Issue1.pdf
Thanks for pointing out that article, Phil. It's an interesting approach, but I think it fails to take into account some important variables that we discuss here.

1. The authors make the point that rate of return differential between rIRA and tIRA assets creates a lot of the benefits of conversions in their example. However, they don't address the fact that after a few years of conversions lower returning assets will have to be held in the Roth in order to maintain a constant stock/bond allocation. So the ROR differential declines as conversions proceed.

2. There was no discussion of early death of one spouse and the resulting single filer tax rate that the survivor would face.

3. They didn't examine retirements starting before age 65 (giving more time for conversions before RMDs). Nor did they look at delaying social security until age 70, which would allow larger conversions within a given tax bracket.

It's not a bad start, but I think it's incomplete.

johnra
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Re: Roth Conversion and Strategy

Post by johnra » Sat Sep 23, 2017 5:56 pm

In tax-deferred space I am more conservative (50-60 stocks/REIT, rest bonds), and in Roth space I am all stocks (including a few risky tilts)

LeeMKE
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Re: Roth Conversion and Strategy

Post by LeeMKE » Sun Sep 24, 2017 9:46 pm

I use the Roth Conversion Strategy from I-ORP.com

This tool is designed to calculate how much and when you should convert to ROTH to optimize for future taxes. I'm a fan. Be sure to select the long form.
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smitcat
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Re: Roth Conversion and Strategy

Post by smitcat » Mon Sep 25, 2017 8:36 am

southport wrote:
Fri Sep 22, 2017 7:51 am
Converting a traditional IRA to fill to the top of the 15% bracket is terrific, of course, if you're going to save 25% later.

But we don't hear much about filling up the 25% bracket, in order to avoid taking distributions while in the 28% bracket. That 3% difference only applies, of course, to those dollars that make it into the higher bracket. So if that's $10,000, the additional tax for being in the 28% bracket is $300 - $2800 instead of $2500.

My considerations include future tax rates and the general direction of the market. Perhaps a better time to convert (if one converts at all) would be when the market takes a big drop, when more shares can be converted for a given dollar amount.
Of course if you are currently MFJ and have figured all of your future taxes at that rate you might miss a larger picture. When one spouse passes the tax rates become much more onerous and that si when a larger advantage of the Roth conversions may take place.
As LeeMKE posted - try the IORP which will allow you to quickly look at various future possibilities which can greatly affect your taxes in a big way.
FWIW - we will likely be converting well into the 25% area each year after consulting the IORP , RPM and then checking with tax software.

smitcat
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Re: Roth Conversion and Strategy

Post by smitcat » Mon Sep 25, 2017 8:40 am

LeeMKE wrote:
Sun Sep 24, 2017 9:46 pm
I use the Roth Conversion Strategy from I-ORP.com

This tool is designed to calculate how much and when you should convert to ROTH to optimize for future taxes. I'm a fan. Be sure to select the long form.
Agreed Lee - we have found the IORP tool indispensable to quickly look into potential future scenarios on income and taxes. Many folks find it too difficult to compare when to take SS< what happens if one spouse passes early , or anything else. IORP allows us to do that quickly and make direct comparisons which we then compare to the equally useful RPM tool. Once we are happy with a yearly plane we check it with tax software as a last confirmation. Repeat each year as the variables change.

southport
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Re: Roth Conversion and Strategy

Post by southport » Mon Sep 25, 2017 10:27 am

I just wonder if there's any scenario in which is it NOT advisable to convert to the top of one's bracket, assuming one always pays the taxes owed out of a separate (non-IRA funds) account.

If at best it's a break-even strategy, there are ancillary benefits - no RMDs required with the Roth while I'm living, and heirs can "stretch" the Roth IRA RMDs with no income tax liability. I have a hard time seeing a downside (apart from being dead).

smitcat
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Re: Roth Conversion and Strategy

Post by smitcat » Mon Sep 25, 2017 10:43 am

southport wrote:
Mon Sep 25, 2017 10:27 am
I just wonder if there's any scenario in which is it NOT advisable to convert to the top of one's bracket, assuming one always pays the taxes owed out of a separate (non-IRA funds) account.

If at best it's a break-even strategy, there are ancillary benefits - no RMDs required with the Roth while I'm living, and heirs can "stretch" the Roth IRA RMDs with no income tax liability. I have a hard time seeing a downside (apart from being dead).
I can think of a couple quickly....
- You could figure it wrong and pay more taxes than required.
- You could end up with larger healthcare bills that would be payable with the IRA funds

2015
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Re: Roth Conversion and Strategy

Post by 2015 » Mon Sep 25, 2017 11:31 am

The Wizard wrote:
Mon Mar 20, 2017 8:53 am
Peter Foley wrote:As previously mentioned, I don't think there is an ideal percentage. A good guideline would be to try to stay in the 15% tax bracket or lower throughout one's retirement.

I like to think in terms of a constant level of spendable income (income after taxes).
The 15% bracket simply isn't possible for some folks with too much in tax deferred.

And rather than spendable income, I prefer to focus on achieving a constant to slightly increasing level of TAXABLE income each year in retirement, through your early 70s at least.
This scheme requires one to project their future SS and RMD income and then adjust Roth conversions to lessen the jump in AGI at age 70.5...
This is my strategy, and I use tax software to project. Having 2/3 of PF in taxable facilitates my ability maximize conversions up to the 15% bracket.

Carl53
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Re: Roth Conversion and Strategy

Post by Carl53 » Mon Sep 25, 2017 11:47 am

In our 60s we have been converting to the top of the 15% bracket. TIRA annual gains have exceeded our plan and as such the pretax accounts have been increasing in value. The plan has been to continue to convert in our 70s as necessary to the top of whatever bracket we are in. That bracket is starting to look like the 25% bracket. Oh well, paying 25% now, when tax brackets might change is not immediately attractive but will continue to revisit this decision on a year by year basis.

The Wizard
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Re: Roth Conversion and Strategy

Post by The Wizard » Mon Sep 25, 2017 12:15 pm

Carl53 wrote:
Mon Sep 25, 2017 11:47 am
In our 60s we have been converting to the top of the 15% bracket. TIRA annual gains have exceeded our plan and as such the pretax accounts have been increasing in value. The plan has been to continue to convert in our 70s as necessary to the top of whatever bracket we are in. That bracket is starting to look like the 25% bracket. Oh well, paying 25% now, when tax brackets might change is not immediately attractive but will continue to revisit this decision on a year by year basis.
Roth converting to top of a tax bracket seems easy enough to do but is likely not optimal.
What is closer to optimal is converting enough each year in your 60s so that your AGI before and after age 70 is roughly the same.

There are at least two caveats to this approach:
1) if you are receiving SS benefits prior to age 70 and are in the hump zone with high marginal tax rate, you might want to modify your approach. Member vtmaps knows more about this than I do.

2) you need to be aware of Medicare IRMAA tiers. Nothing wrong with being in a higher IRMAA tier, I certainly am, but you don't want to be just over a tier boundary due to Roth conversions...
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