Roth conversion & state income taxes

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
User avatar
catdude
Posts: 1533
Joined: Mon Jul 16, 2007 8:11 pm
Location: Central Oregon

Roth conversion & state income taxes

Post by catdude » Sat Aug 13, 2016 2:49 am

Hi Bogleheads -

I'm having trouble pulling the trigger on a Roth conversion for this year. I've got about $10K in "space" between my projected taxable income and the top of the 15% federal bracket. If all I had to deal with was federal taxes, I think I would quickly do it, but I've also got state income taxes to contend with. Oregon has a 9% income tax -- it really boils my [butt]... So I'm looking at a combined tax rate of 24%. The idea of paying an extra $2400 in taxes is painful to me. But I've got the $$$ sitting in cash, I just don't want to pay it.

I suppose it's always possible that I might move to a low-tax state within the next few years. Not likely, since I've got family here in Oregon, but it's possible. Maybe a move across the river to Washington, which doesn't have an income tax. If I was certain that I'd be doing that sort of thing, then skipping Roth conversions would be a pretty good idea.

Is a Roth conversion a no-brainer for someone in my situation?
catdude | | The only thing between North Dakota and the North Pole is a barbed-wire fence.

trasmuss
Posts: 230
Joined: Sun Oct 26, 2008 7:10 am

Re: Roth conversion & state income taxes

Post by trasmuss » Sat Aug 13, 2016 3:40 am

I live in Minnesota so I face the same situation with state taxes. In Minnesota property tax refunds are also affected so I also lost money there as my income went up with Roth conversions.

The first year I retired I bit the bullet and converted up to the 25% bracket. I did a smaller chunk the second year. Last year I didn't convert anything even though I could have.

From a purely logical standpoint you should likely convert up to the 25% bracket if like me you will go from the 15% to the 25% when RMD's start at age 70. You're going to pay it sooner or later unless you hold out hope of moving to Vancouver. Oregon is about as likely as Minnesota to reduce state income taxes. So "pay me now or pay me more later". I have elected to wait for further punishment until age 70 (since I'm 66 I may still change my mind from year to year). Each year you will face the same decision until your income moves up to the 25% bracket.

curmudgeon
Posts: 1583
Joined: Thu Jun 20, 2013 11:00 pm

Re: Roth conversion & state income taxes

Post by curmudgeon » Sat Aug 13, 2016 11:23 am

It might be worth combining your conversions with a "bunching" strategy for deductions. If the state tax rate is fairly level across a wide range of income, you might try to pull some property tax payments ahead, maybe a DAF donation as well, combined with the higher estimated state tax payments, to do a larger conversion in one year and then skip the next. You would want to spend some time with taxcaster (or last years tax software) and do some analysis to see if this would actually give a net benefit.

User avatar
SpringMan
Posts: 5357
Joined: Wed Mar 21, 2007 11:32 am
Location: Michigan

Re: Roth conversion & state income taxes

Post by SpringMan » Sat Aug 13, 2016 11:36 am

Depending on the size of your tax deferred accounts, your tax bracket my rise once RMDs kick in at age 70.5. So unless you plan to move out of Oregon to a more tax friendly state, it may make sense to convert to a Roth at 15% federal, 9% Oregon than at a higher federal rate later on. I converted some to a Roth for similar reasons though Michigan income tax is not quite as burdensome at 4.25%. The lion's share of our investments are in tax deferred accounts so our RMDs will be significant.
Best Wishes, SpringMan

User avatar
jimb_fromATL
Posts: 2275
Joined: Sun Nov 10, 2013 12:00 pm
Location: Atlanta area & Piedmont Triad NC and Interstate 85 in between.

Re: Roth conversion & state income taxes

Post by jimb_fromATL » Sat Aug 13, 2016 11:44 am

Are you expecting your federal tax to go over 15% in retirement?

It would take a lot of number crunching and crystal ball rubbing to make a guess unless you're sure a lot of your federal taxes are going to be taxed at 25% in the future because of higher RMDs. I sort of doubt that $10K per year is likely to make much difference unless you're very young now and anticpate several years of conversions before RMD time. If you're receiving social security, the steps for taxes on that would also be a factor to consider.

You don't mention your age, but remember that the standard deduction, personal exemptions, and steps between tax brackets go up with inflation. Plus you get a little better standard deduction after age 65.

For the state, the 9% that you don't pay now should grow to enough to make up the extra 9% tax you'd pay on it later on withdrawals from a tax-deferred plan. If you won't be paying more than 15% federal tax in the future, I see no advantage in paying the state tax ahead of time.

jimb

User avatar
catdude
Posts: 1533
Joined: Mon Jul 16, 2007 8:11 pm
Location: Central Oregon

Re: Roth conversion & state income taxes

Post by catdude » Sat Aug 13, 2016 1:25 pm

Thanks y'all for your responses.

jimb - yes, I do expect that once I start taking RMD's I'll be in the 25% fed bracket. I just turned 61, so that's 9 - 10 years away. I'm on a fixed income; my pension income is quite predictable. The tax brackets will increase over time, but so will my pension, so my expectation is that for the next 10 years I'll have $10K space available each year for possible conversions. (Once I start taking social security, my pension will decrease by a comparable amount).

Currently the balance in my TIRA is about $415K. Let's say that in 10 years the balance is $525K (assuming no Roth conversions). Using the IRS tables for RMD's, I figure that I'll have to take out (very) roughly $20K per year. So yeah, my marginal rate at that time will likely be 25% federal...
catdude | | The only thing between North Dakota and the North Pole is a barbed-wire fence.

curmudgeon
Posts: 1583
Joined: Thu Jun 20, 2013 11:00 pm

Re: Roth conversion & state income taxes

Post by curmudgeon » Sat Aug 13, 2016 1:36 pm

So it's pay 24% now to (probably) save 34% later, with a whole lot of uncertainty about where the tax code will be in 10 years thrown in. Paying taxes earlier than you have to is no fun.

User avatar
jimb_fromATL
Posts: 2275
Joined: Sun Nov 10, 2013 12:00 pm
Location: Atlanta area & Piedmont Triad NC and Interstate 85 in between.

Re: Roth conversion & state income taxes

Post by jimb_fromATL » Sat Aug 13, 2016 3:37 pm

johnny wrote:Thanks y'all for your responses.

jimb - yes, I do expect that once I start taking RMD's I'll be in the 25% fed bracket. I just turned 61, so that's 9 - 10 years away. I'm on a fixed income; my pension income is quite predictable. The tax brackets will increase over time, but so will my pension, so my expectation is that for the next 10 years I'll have $10K space available each year for possible conversions. (Once I start taking social security, my pension will decrease by a comparable amount).

Currently the balance in my TIRA is about $415K. Let's say that in 10 years the balance is $525K (assuming no Roth conversions). Using the IRS tables for RMD's, I figure that I'll have to take out (very) roughly $20K per year. So yeah, my marginal rate at that time will likely be 25% federal...
Boy howdy it gets complicated in Oregon, and choosing Washington versus Oregon.

Looks like you get some kind of tax credit on your Oregon taxes for the federal taxes you pay. So the 25% bracket may not be quite as bad as it might sound at first. And If I understand it correctly OR doesn't have a sales tax, so that should offset quite a bit of the state income tax bite. On the other hand, WA doesn't have a state income tax, but sales taxes are relatively high.

Seems like if there's any remote chance at all that you might move to WA, it would not be a good idea to pay 9% OR taxes now on the off-chance that you might pay 10% more fed tax on some of your withdrawals if you stay ... especially depending on how much the tax credit in OR is for the federal taxes you pay.

Maybe another reason to convert to a Roth would be if you want to pay the taxes out of your income now so your heirs can get it tax free later.

(Incidentally, I find it somewhat amusing that Oregon's tax instruction booklet is Publication 17½.)

jimb

User avatar
catdude
Posts: 1533
Joined: Mon Jul 16, 2007 8:11 pm
Location: Central Oregon

Re: Roth conversion & state income taxes

Post by catdude » Sat Aug 13, 2016 8:25 pm

jimb_fromATL wrote:Boy howdy it gets complicated in Oregon, and choosing Washington versus Oregon.

Looks like you get some kind of tax credit on your Oregon taxes for the federal taxes you pay. So the 25% bracket may not be quite as bad as it might sound at first. And If I understand it correctly OR doesn't have a sales tax, so that should offset quite a bit of the state income tax bite. On the other hand, WA doesn't have a state income tax, but sales taxes are relatively high.

Seems like if there's any remote chance at all that you might move to WA, it would not be a good idea to pay 9% OR taxes now on the off-chance that you might pay 10% more fed tax on some of your withdrawals if you stay ... especially depending on how much the tax credit in OR is for the federal taxes you pay.

Maybe another reason to convert to a Roth would be if you want to pay the taxes out of your income now so your heirs can get it tax free later.

(Incidentally, I find it somewhat amusing that Oregon's tax instruction booklet is Publication 17½.)

jimb
Your post prompted me to dig out my 2015 tax returns. Federal tax liability is a "subtraction" from taxable income in calculating Oregon personal income taxes. So that reduces my state tax liability somewhat. Another subtraction is Social Security income, to the extent that it's taxed by the feds. Once I start taking SS, my state tax liability will be further reduced.

You're right that Oregon doesn't have a sales tax. The state is highly dependent on the income tax, which makes things rough during recessionary times. There have been many attempts over the years to pass a sales tax, but it always gets voted down by the populace. People here won't stand for it. Currently there's a ballot measure up for a vote in November to significantly raise corporate taxes... we'll see how it does...
catdude | | The only thing between North Dakota and the North Pole is a barbed-wire fence.

bsteiner
Posts: 3432
Joined: Sat Oct 20, 2012 9:39 pm
Location: NYC/NJ/FL

Re: Roth conversion & state income taxes

Post by bsteiner » Sat Aug 13, 2016 8:52 pm

johnny wrote:I'm having trouble pulling the trigger on a Roth conversion for this year. I've got about $10K in "space" between my projected taxable income and the top of the 15% federal bracket. ... Oregon has a 9% income tax ... So I'm looking at a combined tax rate of 24%.
...
I do expect that once I start taking RMD's I'll be in the 25% fed bracket. ...
curmudgeon wrote:So it's pay 24% now to (probably) save 34% later ....
Converting at 15% Federal seems easy.

Given all of the other benefits of the Roth conversion (paying the tax on the conversion out of other money is essentially the same as adding additional money to your IRA, and there are no required distributions from a Roth after age 70 1/2), you might even convert through the 25% or 28% Federal bracket. However, since you're not yet fully comfortable with Roth conversions, you might start by converting up to the top of the 15% Federal bracket, and taking another look at it in a few years.

There's no way to predict future tax rates over a long period of time. If they go down, the benefit of the Roth conversion won't be as great. However, if they go up, the benefit of the Roth conversion will be greater.

daveydoo
Posts: 1564
Joined: Sun May 15, 2016 1:53 am

Re: Roth conversion & state income taxes

Post by daveydoo » Sat Aug 13, 2016 8:55 pm

johnny wrote: I suppose it's always possible that I might move to a low-tax state within the next few years. Not likely, since I've got family here in Oregon, but it's possible.
You will move across the river; everyone else does, and for exactly this reason. I'd venture that Roth conversions are relatively infrequent in OR. It's not just that OR state tax is high -- it's also very steeply graduated so that by the time you're earning a whopping $8400, you're nearly in the highest bracket (!). Would you rather be taxed 10% on your income in OR or 6.5% on your spending in WA? Since you're a BH, you will earn more than you spend. Retirees still come to OR from CA to flee the high taxes. CA may have a higher top marginal rate (13.3%) but the intermediate brackets are fairly broad so that at the more typical five- and low-six-figure incomes, OR is more expensive than even CA (excluding the CA sales tax, of course).
"I mean, it's one banana, Michael...what could it cost? Ten dollars?"

User avatar
grabiner
Advisory Board
Posts: 22531
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Roth conversion & state income taxes

Post by grabiner » Sat Aug 13, 2016 11:06 pm

jimb_fromATL wrote:Looks like you get some kind of tax credit on your Oregon taxes for the federal taxes you pay. So the 25% bracket may not be quite as bad as it might sound at first.
Oregon allows you to deduct up to $6250 of federal tax from OR state tax. If you pay less than that and are the 15% bracket, the federal tax is fully deductible, so your marginal state tax rate is 7.65% rather than 9%. But for most taxpayers for whom this is an issue, the $6250 maxes out and you save $563 in state tax at 9% but your marginal state tax rate doesn't change.
Wiki David Grabiner

User avatar
catdude
Posts: 1533
Joined: Mon Jul 16, 2007 8:11 pm
Location: Central Oregon

Re: Roth conversion & state income taxes

Post by catdude » Sun Aug 14, 2016 1:17 am

daveydoo wrote:You will move across the river; everyone else does, and for exactly this reason. I'd venture that Roth conversions are relatively infrequent in OR. It's not just that OR state tax is high -- it's also very steeply graduated so that by the time you're earning a whopping $8400, you're nearly in the highest bracket (!). Would you rather be taxed 10% on your income in OR or 6.5% on your spending in WA? Since you're a BH, you will earn more than you spend. Retirees still come to OR from CA to flee the high taxes. CA may have a higher top marginal rate (13.3%) but the intermediate brackets are fairly broad so that at the more typical five- and low-six-figure incomes, OR is more expensive than even CA (excluding the CA sales tax, of course).
I take it you live in Washington? If so I will look you up when I move there... :)
catdude | | The only thing between North Dakota and the North Pole is a barbed-wire fence.

Post Reply