Finding The "Sweet Spot" on a Roth Conversion

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LifeIsGood
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Finding The "Sweet Spot" on a Roth Conversion

Post by LifeIsGood » Mon Mar 13, 2017 6:43 am

I'm finishing up my tax return and running some "what ifs" to determine how much of my tIRA->Roth conversion should be re-characterized to stay in the 15% bracket. The full $30K conversion would appear to represent an 11.17% tax rate (3352/30000) Here's what I've got:

Image

Any insight would be appreciated.

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by cresive » Mon Mar 13, 2017 6:51 am

I love your exercise, but you need to provide a bit more information. You present a case where you pay between 0.4-11% tax. Based upon that information, I would say your "sweet spot" is the $10,000 mark, as your taxes are the least percentage of your conversion. If you want to stay below 15%, all of your numbers are below that, so you can go with the $30,000 conversion rate. Am I missing something? I am not in the window to where I can convert tIRA to Roth IRA, so I would love to follow your thread.

Ben

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by TOJ » Mon Mar 13, 2017 7:00 am

This doesn't have to be a trial and error exercise.

Load up a spreadsheet with all your income and exemptions/deductions. That'll show you your taxable income.

Then, subtract your taxable income from the top of the 15% bracket to determine how much you can convert. Or, how much you need to re-characterize.

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by cherijoh » Mon Mar 13, 2017 7:17 am

LifeIsGood wrote:I'm finishing up my tax return and running some "what ifs" to determine how much of my tIRA->Roth conversion should be re-characterized to stay in the 15% bracket. The full $30K conversion would appear to represent an 11.17% tax rate (3352/30000) Here's what I've got:

Image

Any insight would be appreciated.
There are easier ways to determine this, but you didn't provide enough detail to do so. Given the info you provided, you need to look at the marginal differences:
($804 -$41)/($15,000 - $10,000) = 15.26% <--- $5k more conversion costs you $763 more in taxes or ~15%
($1572 - $804)/$5000 = 15.36%
($2340 - $1572)/ $5000 = 15.36%
($3352 - $2340)/$5000 = 20.24% <--- you cross over the 15% to 25% marginal tax bracket somewhere between $25K and $30K conversions

My best guess is ~$27.5K.

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by randomguy » Mon Mar 13, 2017 7:20 am

cresive wrote:I love your exercise, but you need to provide a bit more information. You present a case where you pay between 0.4-11% tax. Based upon that information, I would say your "sweet spot" is the $10,000 mark, as your taxes are the least percentage of your conversion. If you want to stay below 15%, all of your numbers are below that, so you can go with the $30,000 conversion rate. Am I missing something? I am not in the window to where I can convert tIRA to Roth IRA, so I would love to follow your thread.

Ben
Going 10k would be the short term optimization. What is the difference in say 20 years between taking out 10k and 30k? Maybe it is an additional 30k of an RMD which is then taxed at 30% between higher income tax rate and SS taxation. Obviously that is a much, much harder problem to solve.

You would have to think about you whole situation (age, amount of assets, future earning potential and chance of doing future ROTH conversions, potential tax changes with things like marriage, pensions+SS,...) and make a bunch of guesses. It seems likely to me that at least filling up the 10% bracket makes sense. After that might require some thought.

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by Silk McCue » Mon Mar 13, 2017 7:41 am

Cherijoh got it right. I was just about to post the same incremental analysis. Assuming that you want to fill the 15% bracket 10k is the wrong answer and somewhere between 25k and 30k is the right answer and possibly $27,376 based upon your figures and my calculations. Use your tax software to show you the exact headroom to the top of the 15% bracket.

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by Spirit Rider » Mon Mar 13, 2017 8:04 am

Remember you can recharacterize any amount you convert back to a Traditional IRA after the end of the year, but before your tax filing deadline. However, your conversions must occur before the end of the year.

If there is any variability in your taxable income, you can convert a comfortable margin. Then after you have completed a proforma return. You can recharacterize the exact amount to get you the top of the bracket.

Some will strive for simplicity at all cost. They will just convert their best estimate and not sweat whether they missed some of the 15% bracket or overshot into the 25% bracket. After all, if you have a good estimate it will probably be small dollars either way.

Others will view it as a challenge to be met and strive to not miss out on any chance to utilize the entire 15% bracket while not crossing into the 25% bracket.

To each their own. Just letting you know the option exists.

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by gkaplan » Mon Mar 13, 2017 9:50 am

Vanguard posted this video and transcript on its website today that you might find informative.


https://personal.vanguard.com/us/insigh ... -LIVE-Ex-1
Gordon

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by Peter Foley » Mon Mar 13, 2017 10:04 am

This would be a lot easier to do if you posted your marital status and your taxable income w/o any Roth conversion. Other factors are important as well.

Current marginal tax rate versus estimated tax rate in retirement. Estimated age of receipt of SS benefits. Estimated tax rate when RMD's start. When it comes to Roth conversions there are a lot of factors to consider.

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LifeIsGood
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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by LifeIsGood » Mon Mar 13, 2017 1:03 pm

Additional Info:

Status = MFJ
Taxable Income w/o Conversion: $41,737
Currently retired and drawing Soc. Sec. 70% taxable
RMD's start 4/2019
Est. RMD = $73,000

Thanks everyone for your input. Very helpful.

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by Wakefield1 » Mon Mar 13, 2017 3:30 pm

LifeIsGood wrote:Additional Info:

Status = MFJ
Taxable Income w/o Conversion: $41,737
Currently retired and drawing Soc. Sec. 70% taxable
RMD's start 4/2019
Est. RMD = $73,000

Thanks everyone for your input. Very helpful.
So looks tempting to do conversions for the two years left before RMDs start if they can be kept within the taxation bracket.

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by Alan S. » Mon Mar 13, 2017 3:35 pm

LifeIsGood wrote:Additional Info:

Status = MFJ
Taxable Income w/o Conversion: $41,737
Currently retired and drawing Soc. Sec. 70% taxable
RMD's start 4/2019
Est. RMD = $73,000

Thanks everyone for your input. Very helpful.
When you refer to RMDs starting in April, that suggests 4/1/2019 is your RBD.

Since your RMDs will need to start in 2018 to avoid having 150,000 in RMDs in 2019, 2017 is the last year you can convert a meaningful portion of your TIRA at a marginal rate that is less than your expected average marginal rate throughout retirement. As such, you will probably need to convert well beyond these small numbers. Even a conversion of 100k will only reduce your RMDs by 5% going forward. Taxable SS will go to 85% of gross, and you will generate IRMAA surcharges at some point.

You cannot convert anything in 2018 without first withdrawing your entire 2018 RMD. While there are scenarios to test out in 2018 for taking a portion of your 2018 first RMD and deferring the rest, those strategies must exclude any 2018 conversions.

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by Peter Foley » Mon Mar 13, 2017 4:19 pm

Just to clarify, is the RMD itself $73,000 or will the RMD raise your taxable income to $73,000?

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by Silk McCue » Mon Mar 13, 2017 5:48 pm

There may be something I just don't understand but I can't see how with $41,737 of taxable income how your first $10k of conversion could be taxed at $41. Using The standard deduction and personal exemptions available to you the first $10k would mostly be in the 15% bracket. If I am wrong, what is it that I have missed?

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by JW-Retired » Mon Mar 13, 2017 6:27 pm

LifeIsGood wrote:
Status = MFJ
Taxable Income w/o Conversion: $41,737
Currently retired and drawing Soc. Sec. 70% taxable
RMD's start 4/2019
Est. RMD = $73,000
This is not enough information. If you are getting SS plus other income then there are way more marginal tax rates than the ones without SS. It's highly dependent on the ratio of SS to your "other" income.

I think we would need your gross SS income and also the gross for the other types of income to make any sense of this.
JW
ps: see https://www.bogleheads.org/wiki/Social_ ... calculator
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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by FiveK » Mon Mar 13, 2017 7:32 pm

If you want a chart of your marginal rates for a wide range of tIRA withdrawals, see the Personal finance toolbox.

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by LifeIsGood » Tue Mar 14, 2017 6:50 am

Peter Foley wrote:Just to clarify, is the RMD itself $73,000 or will the RMD raise your taxable income to $73,000?
RMD is $73,000.
Taxable Interest = 2,336
Ord. Div. = 42,893
Qual Div = 35,765
Cap Gain = -3,000
Taxable SS 22,708
AGI = 64,937
Taxable Inc = 41,737

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by JW-Retired » Tue Mar 14, 2017 7:05 am

LifeIsGood wrote:
RMD is $73,000.
Taxable Interest = 2,336
Ord. Div. = 42,893
Qual Div = 35,765
Cap Gain = -3,000
Taxable SS 22,708
AGI = 64,937
Taxable Inc = 41,737
What is total gross SS income? Taxable SS is a wildly moving target that depends on your other income, which complicates things immensely.

Also, is there any muni-bond interest? That effects how much of SS is taxable too.
JW
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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by rustymutt » Tue Mar 14, 2017 7:55 am

TOJ wrote:This doesn't have to be a trial and error exercise.

Load up a spreadsheet with all your income and exemptions/deductions. That'll show you your taxable income.

Then, subtract your taxable income from the top of the 15% bracket to determine how much you can convert. Or, how much you need to re-characterize.
This is how I do it, and works out quite well. I second this method.
I'm amazed at the wealth of Knowledge others gather, and share over a lifetime of learning. The mind is truly unique. It's nice when we use it!

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by LifeIsGood » Tue Mar 14, 2017 8:15 am

JW-Retired wrote:
LifeIsGood wrote:
RMD is $73,000.
Taxable Interest = 2,336
Ord. Div. = 42,893
Qual Div = 35,765
Cap Gain = -3,000
Taxable SS 22,708
AGI = 64,937
Taxable Inc = 41,737
What is total gross SS income? Taxable SS is a wildly moving target that depends on your other income, which complicates things immensely.

Also, is there any muni-bond interest? That effects how much of SS is taxable too.
JW
Total SS Income = 32776
Tax Exempt Interest = 5,040

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by JW-Retired » Tue Mar 14, 2017 9:28 am

LifeIsGood wrote:
JW-Retired wrote:
LifeIsGood wrote:
RMD is $73,000.
Taxable Interest = 2,336
Ord. Div. = 42,893
Qual Div = 35,765
Cap Gain = -3,000
Taxable SS 22,708
AGI = 64,937
Taxable Inc = 41,737
What is total gross SS income? Taxable SS is a wildly moving target that depends on your other income, which complicates things immensely.

Also, is there any muni-bond interest? That effects how much of SS is taxable too.
JW
Total SS Income = 32776
Tax Exempt Interest = 5,040
OK I put the following into my favorite HR&Block on-line Tax calculator, but unfortunately I learned that it doesn't allow putting in any tax exempt interest income! :oops: Does anyone know of another calculator that does handle tax exempt income effects on SS taxation?

Anyway, for what it's worth, ignoring your tax exempt interest, a $10k Roth conversion would be taxed at 22.1%. That's much higher than you were getting.
RMD is $73,000. (not used)
Taxable Interest = 2,336
Ord. Div. = 42,893
Qual Div = 35,765
Cap Gain = -3,000
Gross SS 32776
Tax Exempt Interest = 5,040 (not used, H&R Blk calc doesn't allow it)
Roth Conversion amount = $0 or $10,000 gives:
AGI ....... = 60,653 or 79,153
Taxable Inc = 39,953 or 58,453
tax owed = $719 or $2926 ==> 22.1% tax on the $10,000 conversion

Notice how a $10k Roth conversion causes AGI and taxable income to go up by $18.5k. That's due to the phase-in of taxing SS.
JW

ps: https://www.hrblock.com/get-answers/tax ... e/aboutYou
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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by FiveK » Tue Mar 14, 2017 12:12 pm

LifeIsGood wrote: RMD is $73,000.
Taxable Interest = 2,336
Ord. Div. = 42,893
Qual Div = 35,765
Cap Gain = -3,000
Taxable SS 22,708
AGI = 64,937
Taxable Inc = 41,737

Total SS Income = 32776
Tax Exempt Interest = 5,040
The chart below is from the toolbox link mentioned previously, and includes the tax exempt interest in the SS calculation.
For $0 in tIRA withdrawals, it matches the $22,708 for taxable SS and the $41,737 for taxable income, and calculates a tax of $597.

Image

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by House Blend » Tue Mar 14, 2017 1:09 pm

^I think the most important bit of information is that, yes, the OP is inside the SS Tax Hump (before doing any Roth conversions), but not far from getting out beyond it.

In particular for MFJ with SS = $32,776, you are beyond the SS tax hump once your non-SS income totals more than $53,329. Of course this will creep up in the future as SS gets COLA'd.

And the OP isn't far from this already, currently with

$47,269 = $42893 - $3000 + $2336 + $5040 of non-SS income

So with RMDs on the order of $70K looming, there's no way they'll ever be inside the SS hump at age 70.5 and beyond, unless they do something insane, such as convert 90%+ of their tax-deferred assets to Roth in the next year or two.

As far as marginal tax rates go, we have no information about whether they itemize or take the standard deduction. If the latter, and both are over age 65, in 2017 it would be $15,200 ( + 2 x $4,050 exemptions). Continuing with the assumption of 0 Roth conversions, let's consider what would happen if they had to take a $73,000 RMD in this year, with the rest of the numbers as is:

I get AGI = $143,089 and Taxable Income = $119,789.

On paper, that's deep into the 25% bracket, and comfortably below the top. On the other hand, they also have reported $35,765 of Qualified Div Income. Subtract that off, and Taxable Income is $84,024. The good news is that's still about $8K into the 25% bracket, so they would not be in immediate danger of experiencing the 30% marginal rate, assuming your deductions plus exemptions are $23,200.

But it does add a bit of inducement: if you Roth-convert larger amounts, your future Federal marginal rate during RMDs could rise to 30%. And that's not a bad thing; it just has the potential to make conversions now even more advantageous.

The bottom line if it were me is that Roth converting now at marginal rates up to 25% are probably fine. I would not rely on being able to precisely game the 30% future rate--too many moving parts. (And this is all under the assumption that tax rates don't change. Also not accounted for: state taxes, and medicare premiums.)

If the numbers quoted are 2017 numbers, and the other assumptions are correct (e.g., standard deduction for two over age 65), that would mean Roth converting about $34,000 $29,000. Beyond that, you would be in the 30% marginal rate territory, in agreement with FiveK's chart.This is more than what FiveK's chart shows--I'm betting the reasons are that he used 2016 numbers and a below age 65 standard deduction.

Edited to correct a math error.

Edit #2: D'oh! I just reread the OP and realized that the numbers we are looking at are for 2016, and this is about recharacterization after the fact.

That doesn't change things a huge amount, except that the standard deduction is $100 lower, and the 25% bracket starts $600 lower. A Roth conversion of $28,411 puts you just below the start of the 30% marginal rate.
Last edited by House Blend on Tue Mar 14, 2017 3:38 pm, edited 1 time in total.

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by FiveK » Tue Mar 14, 2017 3:30 pm

Chart was based on 2016 rates for MFJ, standard deduction for both over 65, to match AGI = 64,937 and Taxable Inc = 41,737.

The marginal rates in the five horizontal sections are, from left to right:
1) combination of 10% bracket and still adding $0.85 of a SS dollar for every $1 of non-SS income: 18.5%
2) 10% bracket, no further SS income taxed: 10%
3) 15% bracket, no tax yet on qualified dividends: 15%
4) 15% bracket, $1 of qualified dividends now taxed for every $1 of ordinary income: 30%
5) 25% bracket, no further tax on qualified dividends: 25%

The marginal rate stays at 25% for a long stretch.

2017 numbers would be slightly different.

Silk McCue's question remains:
Silk McCue wrote:There may be something I just don't understand but I can't see how with $41,737 of taxable income how your first $10k of conversion could be taxed at $41. Using The standard deduction and personal exemptions available to you the first $10k would mostly be in the 15% bracket. If I am wrong, what is it that I have missed?

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by #Cruncher » Wed Mar 15, 2017 12:20 am

FiveK in [url=https://www.bogleheads.org/forum/viewtopic.php?p=3281156#p3281156]this post[/url] wrote:
LifeIsGood wrote:...
Taxable Interest = 2,336
Ord. Div. = 42,893 [7,128 not qualified]
Qual Div = 35,765
Cap Gain = -3,000
Taxable SS 22,708
AGI = 64,937
Taxable Inc = 41,737
Total SS Income = 32776
Tax Exempt Interest = 5,040
The chart below is from the toolbox link mentioned previously, and includes the tax exempt interest in the SS calculation.
For $0 in tIRA withdrawals, it matches the $22,708 for taxable SS and the $41,737 for taxable income, and calculates a tax of $597.
Image
Nice graph! My calculations produce the same $22,708 taxable SS, $41,737 taxable income, and $597 tax. [*]
FiveK in previous post wrote:1) combination of 10% bracket and still adding $0.85 of a SS dollar for every $1 of non-SS income: 18.5%
2) 10% bracket, no further SS income taxed: 10%
3) 15% bracket, no tax yet on qualified dividends: 15%
4) 15% bracket, $1 of qualified dividends now taxed for every $1 of ordinary income: 30%
5) 25% bracket, no further tax on qualified dividends: 25%
The marginal rate stays at 25% for a long stretch.
Here are the corresponding Roth conversion amounts. [*]

Code: Select all

         Range        Increment    Rate
    ----------------  ---------   -----
1)       0 -   6,061     6,061    18.5%
2)   6,061 -   7,426     1,365    10.0%
3)   7,426 -  28,411    20,985    15.0%
4)  28,411 -  64,176    35,765    30.0%
5)  64,176 - 140,776    76,600    25.0%
To summarize, the first $6,100 of conversion is taxed at 18.5%, the next $1,400 at 10%, the next $21,000 at 15%, the next $35,800 at 30%, and the next $76,600 at 25%. So I'd say the "sweet spot" shown here and in FiveK's graph is to convert $28,400. Any more would trigger a 30% marginal rate.

* Here is the detail for a 2016 Joint return for two age 65+ taxpayers taking the standard deduction from the Compare sheet of my Marginal Tax Rates spreadsheet.

Code: Select all

Tax exempt interest                5,040   ----------------------------------------->
Taxable int + reg div - cap loss   6,464   ----------------------------------------->
Roth conversion                        0    6,061    7,426   28,411   64,176  140,776
LTCG & QDI                        35,765   ----------------------------------------->
Social Security Benefit           32,776   ----------------------------------------->
Deductions plus Exemptions        23,200   ----------------------------------------->

Code: Select all

Social Security 50% threshhold    32,000   ----------------------------------------->
Social Security 85% threshhold    44,000   ----------------------------------------->
Ord Income Tax Bracket 15%        18,550   ----------------------------------------->
Ord Income Tax Bracket 25%        75,300   ----------------------------------------->
Ord Income Tax Bracket 28%       151,900   ----------------------------------------->
LTCG & QDI Tax Bracket 15%        75,300   ----------------------------------------->

Code: Select all

SS Relevant Income                63,657   69,718   71,083   92,068  127,833  204,433
50% SS taxable                     6,000    6,000    6,000    6,000    6,000    6,000
85% SS taxable                    16,708   21,860   21,860   21,860   21,860   21,860
Total SS taxable                  22,708   27,860   27,860   27,860   27,860   27,860

Code: Select all

Adjusted gross income             64,937   76,150   77,515   98,500  134,265  210,865
Taxable Income                    41,737   52,950   54,315   75,300  111,065  187,665
LTCG & QDI Taxable                35,765   35,765   35,765   35,765   35,765   35,765
Ordinary Taxable                   5,972   17,185   18,550   39,535   75,300  151,900
Ordinary taxable @ 25%               -        -        -        -        -     76,600
Ordinary taxable @ 15%               -        -        -     20,985   56,750   56,750
Ordinary taxable @ 10%             5,972   17,185   18,550   18,550   18,550   18,550
LTCG & QDI taxable @ 15%             -        -        -        -     35,765   35,765
LTCG & QDI taxable @ 0%           35,765   35,765   35,765   35,765

Code: Select all

Ordinary tax @ 25%                   -        -        -        -        -     19,150
Ordinary tax @ 15%                   -        -        -      3,148    8,512    8,513
Ordinary tax @ 10%                   597    1,718    1,855    1,855    1,855    1,855
LTCG & QDI tax @ 15%                 -        -        -        -      5,365    5,365
Total tax                            597    1,718    1,855    5,003   15,732   34,882

Code: Select all

                                          1        2        3        4        5
                                       ------   ------   ------   ------   ------
Increased Roth conversion               6,061    1,365   20,985   35,765   76,600
Increased taxable SS                    5,151      -        -        -        -  
Increased tax                           1,121      137    3,148   10,729   19,150
Marginal SS taxable                    84.99%    0.00%    0.00%    0.00%    0.00%
Marginal tax rate                      18.50%   10.00%   15.00%   30.00%   25.00%

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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by The Wizard » Wed Mar 15, 2017 7:17 am

The SS taxation "hump" makes things tricky to compute and mandates use of tax software to figure the optimal Sweet Spot for the particular case in question.

While aiming to do Roth conversions to the top of the 15% bracket makes sense for some people, I think it makes even better sense to project your AGI (which obviously includes Roth conversions) up through your early 70s. Some people will see a step increase in their AGI when they start delayed SS and RMDs. Doing Roth conversions prior to age 70 can reduce the magnitude of that increase. This explains why I'm doing moderate Roth conversions for the next three years in the 28% marginal Federal tax bracket...
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Re: Finding The "Sweet Spot" on a Roth Conversion

Post by kaneohe » Wed Mar 15, 2017 8:56 am

rustymutt wrote:
TOJ wrote:This doesn't have to be a trial and error exercise.

Load up a spreadsheet with all your income and exemptions/deductions. That'll show you your taxable income.

Then, subtract your taxable income from the top of the 15% bracket to determine how much you can convert. Or, how much you need to re-characterize.
This is how I do it, and works out quite well. I second this method.
This is too simplistic when SS is involved since the taxable SS is a function of other income.

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