Roth conversion strategy

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2cents2
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Roth conversion strategy

Post by 2cents2 » Thu Nov 01, 2018 11:47 am

My plan is to convert some of DH’s tIRA to rIRA (in kind) up to the top of our tax bracket.

I have adjusted tax withholding amounts to cover the tax bill for the conversion.

The only thing that my plan is a little hazy on is when is the best time to do the conversion since this can’t be undone.

I was feeling pretty confident about my plan early on in the year until DH received a bonus and I had to revise my calculations. I decided to wait until December when I might be a little more sure about dividends and any other surprises.

But, with the market being lower now I decided to convert about 1/2 the planned amount now and the remaining amount mid December.

Going forward in future years — I’m wondering if I should be converting 1/12 each month since I have no idea which direction the market might be going. What is the latest conventional wisdom on the timing of Roth conversions since they can’t be recharacterized anymore?

DSInvestor
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Re: Roth conversion strategy

Post by DSInvestor » Thu Nov 01, 2018 12:06 pm

Are you receiving any ACA premium tax subsidy? Be aware that the higher AGI with the Roth conversion could result in loss of the subsidy if your AGI exceeds certain limits. Run your numbers very carefully. If you have taxable accounts, watch out for year end dividend and/or capital gains distributions.
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sawdust60
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Re: Roth conversion strategy

Post by sawdust60 » Thu Nov 01, 2018 12:17 pm

2cents2 wrote:
Thu Nov 01, 2018 11:47 am
My plan is to convert some of DH’s tIRA to rIRA (in kind) up to the top of our tax bracket.

...
.
Also watch the IRMAA penalty brackets at age 63 and higher. $1 higher can trigger a $1200 increased medicare premium, and you won't see it for two years when you get the bill from medicare.

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2cents2
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Re: Roth conversion strategy

Post by 2cents2 » Thu Nov 01, 2018 12:21 pm

No ACA subsidy, so no worries there.

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2cents2
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Re: Roth conversion strategy

Post by 2cents2 » Thu Nov 01, 2018 12:40 pm

sawdust60 wrote:
Thu Nov 01, 2018 12:17 pm
2cents2 wrote:
Thu Nov 01, 2018 11:47 am
My plan is to convert some of DH’s tIRA to rIRA (in kind) up to the top of our tax bracket.

...
.
Also watch the IRMAA penalty brackets at age 63 and higher. $1 higher can trigger a $1200 increased medicare premium, and you won't see it for two years when you get the bill from medicare.
Yes, I have considered IRMAA (and NIIT) in my calculations.
Once a conversion amount has been determined— what is the best strategy for the timing of the conversion?

DSInvestor
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Re: Roth conversion strategy

Post by DSInvestor » Thu Nov 01, 2018 12:55 pm

2cents2 wrote:
Thu Nov 01, 2018 12:40 pm
Once a conversion amount has been determined— what is the best strategy for the timing of the conversion?
Given that you have constraints on the Roth conversion to stay in your tax bracket, you cannot really know the amount of conversion until you know exactly how much other income you have for the year. If you have a taxable account with holdings that may make dividend and/or capital gains distributions, you may have to wait until late december to get the numbers. If your taxable holdings are tax efficient, these distributions are likely to be small. If you hold something tax inefficient like Vanguard PRIMECAP, you could be looking at dividend and capital gains distributions exceeding $10K if the holding is relatively large (200+K).

I suggest waiting until the last week of december to finalize the conversion amount and then convert. You should have access to tax software for 2018 by that time which should give you a much better picture of your tax situation.
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sawdust60
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Re: Roth conversion strategy

Post by sawdust60 » Thu Nov 01, 2018 1:05 pm

Another place where the tax rate tables do not reflect marginal rates is when you potentially could have a zero tax rate on qualified dividends and long term capital gains.
-- good example at the bottom of this page (but uses old tax rate table)
https://www.bogleheads.org/wiki/Marginal_tax_rate

And there are likely to be other items where additional income reduces a deduction or tax credit, and yields a higher marginal rate. You may want to do a pro-forma tax return or consult with a tax professional.

OffGridder
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Re: Roth conversion strategy

Post by OffGridder » Thu Nov 01, 2018 2:28 pm

In December, I estimate my total income from all sources and any deductions for the following year. I then enter those numbers in TaxCaster to determine how much headspace I will have for Roth conversions. I then convert 75% of that amount in January and top it off in December when I know my final income and deduction numbers.
"Goodness is the only investment that never fails." | H.D. Thoreau

Chip
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Re: Roth conversion strategy

Post by Chip » Fri Nov 02, 2018 5:13 am

OffGridder wrote:
Thu Nov 01, 2018 2:28 pm
In December, I estimate my total income from all sources and any deductions for the following year. I then enter those numbers in TaxCaster to determine how much headspace I will have for Roth conversions. I then convert 75% of that amount in January and top it off in December when I know my final income and deduction numbers.
I do this as well, now that recharacterizations are no longer an option. This seems similar to a lump sum vs. DCA decision. Since the market long term trend has been up it makes sense to convert as much as possible as early as possible.

It would seem to me that the conversion amount to "reserve" for December would be situation specific -- some are able to forecast income more easily than others.

GrowthSeeker
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Re: Roth conversion strategy

Post by GrowthSeeker » Fri Nov 02, 2018 6:59 am

DSInvestor wrote:
Thu Nov 01, 2018 12:55 pm

If your taxable holdings are tax efficient, these distributions are likely to be small. If you hold something tax inefficient like Vanguard PRIMECAP, you could be looking at dividend and capital gains distributions exceeding $10K if the holding is relatively large (200+K).
When I look up PRIMECAP, Vanguard lists it as being 100% QDI for dividend and net short-term capital gains distributions.
And the SEC 30 day yield is 1.17% for PRIMECAP Fund Investor Shares and 1.25% for the PRIMECAP Core Fund.

So I don't understand in what way that fund is tax-inefficient. Can you explain? Thanks.

Qualified dividend income—2017 year-end figures:
https://advisors.vanguard.com/VGApp/iip ... endfigures
Just because you're paranoid doesn't mean they're NOT out to get you.

Greenman72
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Re: Roth conversion strategy

Post by Greenman72 » Fri Nov 02, 2018 7:36 am

2cents2 wrote:
Thu Nov 01, 2018 11:47 am
I’m wondering if I should be converting 1/12 each month since I have no idea which direction the market might be going.
As I’ve said before—if you don’t know what the market is going to do, then any type of market-timing strategy is just as likely to work for you as it is against you.

Personally, two things that are often touted, but I rarely actually use in real life are TLH and the Roth Conversion. I would only ever recommend a Roth Conversion if we knew the client was in one of the two lowest brackets. And even then, estimating income that precisely is really hard to do—even in December.

diy60
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Re: Roth conversion strategy

Post by diy60 » Fri Nov 02, 2018 7:45 am

This was my first year for aggressive Roth conversions. Prior to this year I had planned to do the horse race strategy, but that went away last year with the tax law changes. So I decided to to 50% in the first week of January, 25% mid year, and the remaining near year-end when I have a clear picture of my final taxes. No magic in my strategy, in fact it's not really a strategy at all, just gets me into a routine for the next 6 years of conversions. Good luck.

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jeffyscott
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Re: Roth conversion strategy

Post by jeffyscott » Fri Nov 02, 2018 8:14 am

sawdust60 wrote:
Thu Nov 01, 2018 1:05 pm
Another place where the tax rate tables do not reflect marginal rates is when you potentially could have a zero tax rate on qualified dividends and long term capital gains.
-- good example at the bottom of this page (but uses old tax rate table)
https://www.bogleheads.org/wiki/Marginal_tax_rate

And there are likely to be other items where additional income reduces a deduction or tax credit, and yields a higher marginal rate. You may want to do a pro-forma tax return or consult with a tax professional.
In the the wiki text* related to that, the income level is given as X. This X is about $77,000 taxable income for a joint return, correct? (The 0% cap gain and QDI bracket goes up to $77,200, but the 12% bracket goes to $77,400)

*Another unusually high marginal rate is the result of the 0% tax rate on qualified dividends and capital gains at low incomes. There is a taxable-income level X which is the top of the 12% bracket. Ordinary taxable income up to X is taxed at a marginal rate of 12%, and ordinary income above X is taxed at a marginal rate of 22%. Qualified dividends and capital gains are then added to your ordinary taxable income; the amount which is still below X is taxed at 0%, and the amount above X is taxed at 15%. Thus, if your ordinary-taxable income is less than X but your total taxable income is more than X, your marginal tax rate is 27%. Every additional $1 of ordinary income is below X and thus taxed at 12%, but it also moves $1 of qualified dividends from below X to above X, and that $1 is now taxed at 15% rather than 0%.
Time is your friend; impulse is your enemy. - John C. Bogle

OffGridder
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Re: Roth conversion strategy

Post by OffGridder » Fri Nov 02, 2018 12:00 pm

Greenman72 wrote:
Fri Nov 02, 2018 7:36 am
2cents2 wrote:
Thu Nov 01, 2018 11:47 am
I’m wondering if I should be converting 1/12 each month since I have no idea which direction the market might be going.
As I’ve said before—if you don’t know what the market is going to do, then any type of market-timing strategy is just as likely to work for you as it is against you.

Personally, two things that are often touted, but I rarely actually use in real life are TLH and the Roth Conversion. I would only ever recommend a Roth Conversion if we knew the client was in one of the two lowest brackets. And even then, estimating income that precisely is really hard to do—even in December.
I don't try to be that precise. Just conservative enough not to over convert into the next tax bracket. No biggy to me if I leave $1-2K of conversions on the table at the end of the year.
"Goodness is the only investment that never fails." | H.D. Thoreau

Topic Author
2cents2
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Re: Roth conversion strategy

Post by 2cents2 » Fri Nov 02, 2018 2:26 pm

OffGridder wrote:
Fri Nov 02, 2018 12:00 pm
Greenman72 wrote:
Fri Nov 02, 2018 7:36 am
2cents2 wrote:
Thu Nov 01, 2018 11:47 am
I’m wondering if I should be converting 1/12 each month since I have no idea which direction the market might be going.
As I’ve said before—if you don’t know what the market is going to do, then any type of market-timing strategy is just as likely to work for you as it is against you.

Personally, two things that are often touted, but I rarely actually use in real life are TLH and the Roth Conversion. I would only ever recommend a Roth Conversion if we knew the client was in one of the two lowest brackets. And even then, estimating income that precisely is really hard to do—even in December.
I don't try to be that precise. Just conservative enough not to over convert into the next tax bracket. No biggy to me if I leave $1-2K of conversions on the table at the end of the year.
I am planning to leave a little space, too.
I have been tracking my tax liabilities on a spreadsheet for several years. I compare the results with TurboTax at tax time. It has made me pretty comfortable with my plan.

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Peter Foley
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Re: Roth conversion strategy

Post by Peter Foley » Fri Nov 02, 2018 3:21 pm

2cents2

You mentioned that you use Turbo tax. There is a form you can print out (or view) called the 2 year comparison. It is very helpful for future tax planning including Roth conversions.

In your case, if your income fluctuates I would be tempted to do at least a couple conversions during the year. One early on and another when you are more certain of your final numbers. I've done conversions for a numbers of years and have not been too concerned with converting a bit into the next tax bracket. (MAGI and Medicare B are important but I've been well below those numbers aiming for the top of the 15% bracket - now 12%.)

DSInvestor
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Re: Roth conversion strategy

Post by DSInvestor » Sat Nov 03, 2018 1:56 pm

GrowthSeeker wrote:
Fri Nov 02, 2018 6:59 am
DSInvestor wrote:
Thu Nov 01, 2018 12:55 pm

If your taxable holdings are tax efficient, these distributions are likely to be small. If you hold something tax inefficient like Vanguard PRIMECAP, you could be looking at dividend and capital gains distributions exceeding $10K if the holding is relatively large (200+K).
When I look up PRIMECAP, Vanguard lists it as being 100% QDI for dividend and net short-term capital gains distributions.
And the SEC 30 day yield is 1.17% for PRIMECAP Fund Investor Shares and 1.25% for the PRIMECAP Core Fund.

So I don't understand in what way that fund is tax-inefficient. Can you explain? Thanks.

Qualified dividend income—2017 year-end figures:
https://advisors.vanguard.com/VGApp/iip ... endfigures
The link you provided does not include the large long term capital gain distributions that PRIMECAP has every year. Due to a system upgrade at Vanguard this weekend, I am not able to provide a link to Vanguard's distribution page for PRIMECAP. Here's a link to a morningstar page for PRIMECAP Admiral VPMAX that has a table for dividend and capital gain distributions for several years.
https://www.morningstar.com/funds/xnas/vpmax/quote.html

Code: Select all

Dividend and Capital Gains Distributions VPMAX

Distribution  Distribution   LT        ST         Return     Dividend Total
date          NAV            Cap Gain  Cap Gain   of Capital Income   Distribution
12/18/2017    134.48         5.8099    0.2359     0.0000     1.4439   7.4897
12/23/2016    110.28         3.9596    0.1285     0.0000     1.4910   5.5791
12/16/2015    104.81         4.9510    0.0000     0.0000     1.2360   6.1870
12/22/2014    108.14         5.8710    0.0420     0.0000     1.4030   7.3160
12/17/2013     92.47         3.8880    0.0210     0.0000     0.9830   4.8920
If you compare the same page or annual report/prospectus for a tax efficient fund like Vanguard Total Stock Index fund, you will see no ST or LT capital gains distributions.
https://www.morningstar.com/funds/xnas/vtsax/quote.html
Last edited by DSInvestor on Sun Nov 04, 2018 10:32 am, edited 2 times in total.
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heyyou
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Re: Roth conversion strategy

Post by heyyou » Sat Nov 03, 2018 2:44 pm

The info from several posters above is better than usual for many topics. Thank you to all for being so clear.

GrowthSeeker
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Re: Roth conversion strategy

Post by GrowthSeeker » Sun Nov 04, 2018 1:36 pm

DSInvestor wrote:
Sat Nov 03, 2018 1:56 pm
GrowthSeeker wrote:
Fri Nov 02, 2018 6:59 am

So I don't understand in what way that fund {edit: VPMAX} is tax-inefficient. Can you explain? Thanks.
The link you provided does not include the large long term capital gain distributions that PRIMECAP has every year.
Wow! Thank you. This was very helpful.
So in round numbers, although there is a (ballpark) 1.2% qualified dividend, there is also about another 4% of capital gain (only a small percent of which is short term). But if you were in a theoretical 25% tax bracket, the extra 4% of gain would cost you about 1% in taxes (assuming your income is over the threshold).
So instead of thinking about the expense ratio as 0.32%, which is what is reported; it is "kind of like" the expense is 1.32% where the extra percent is from the taxes you have to pay on the capital gains. (well, if held in a taxable account). So this actively managed fund would have to "beat the market" by on the order of 1.3% consistently to make it "better" than TSM.
https://www.morningstar.com/funds/xnas/vpmax/quote.html

And now I understand tax efficiency of a mutual fund better. Again, my thanks.
Just because you're paranoid doesn't mean they're NOT out to get you.

Topic Author
2cents2
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Re: Roth conversion strategy

Post by 2cents2 » Mon Nov 05, 2018 11:56 am

OffGridder wrote:
Thu Nov 01, 2018 2:28 pm
In December, I estimate my total income from all sources and any deductions for the following year. I then enter those numbers in TaxCaster to determine how much headspace I will have for Roth conversions. I then convert 75% of that amount in January and top it off in December when I know my final income and deduction numbers.
Chip wrote:
Fri Nov 02, 2018 5:13 am
I do this as well, now that recharacterizations are no longer an option. This seems similar to a lump sum vs. DCA decision. Since the market long term trend has been up it makes sense to convert as much as possible as early as possible.
It would seem to me that the conversion amount to "reserve" for December would be situation specific -- some are able to forecast income more easily than others.
diy60 wrote:
Fri Nov 02, 2018 7:45 am
This was my first year for aggressive Roth conversions. Prior to this year I had planned to do the horse race strategy, but that went away last year with the tax law changes. So I decided to to 50% in the first week of January, 25% mid year, and the remaining near year-end when I have a clear picture of my final taxes. No magic in my strategy, in fact it's not really a strategy at all, just gets me into a routine for the next 6 years of conversions. Good luck.
I appreciate your responses. I used to marvel at how forgiving conversions were before they changed the tax law. I like the idea of converting most early in the year, but saving a little bit of conversion space towards the end of year just in case there is some unplanned income source.

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