Roth Conversion and Strategy

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MrFlish
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Roth Conversion and Strategy

Postby 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

Postby 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

Postby 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

Postby 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

Postby 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

Postby 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

Postby 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

Postby 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

Postby 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

Postby 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

Postby 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

Postby 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

Postby 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

Postby 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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