Roth conversions: how far should I go in 2017?

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Church Lady
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Roth conversions: how far should I go in 2017?

Post by Church Lady » Thu Dec 07, 2017 2:26 pm

I retired in early 2017. Wages and portfolio income put me in the 25%
tax bracket, so I did a partial Roth conversion for 2017 to the top of the 25% tax bracket. It seemed a no-brainer. Of course, I have already contributed the maximum to my Roth IRA for 2017.

Here is my problem. Between my tradional IRA (tIRA)
and t401K, I still have 43% of the goods in tax deferred assets, and only 9% of my portfolio is in Roth accounts. Projecting RMDs and tax brackets using 4% portfolio growth and 2% inflation, it looks like I'll spend my RMD years in the 28% bracket unless I pursue more Roth conversions.

If I convert to the top of the 25% bracket each year until RMD, I will be able to convert a little more than 40% of my tax deferred assets before RMDs begin. That's probably overstated because
- The 40% assumes no growth of the tax deferred portfolio from now to age 70 1/2.
- I have assumed no Social Security income until age 70. Due to family medical history and political uncertainty, I doubt I will wait until age 70 to claim.
- If I want to keep my income within Medicare tier 1 limits (about 88K last time I looked), the top of my
'space' is 88K, starting the year I turn 62. These leaves even less space for conversions. I realize Medicare income limits don't apply until I am age 62.


Separately,
- If I convert this year, I can deduct the state taxes from my 2017 federal tax return. If I convert in future years, I'll still owe state tax, but it's anyone's guess whether I'll be able to deduct that in future years. My state taxes have brackets that work like federal tax brackets. For me, the marginal rate is 7.2% on income up to 100,000.

Should I convert more aggressively? My situation:

Age: Speeding to 60, 59 1/2 is in the rear view mirror
Federal filing status: single
Federal tax bracket: 25%, but could be 28% -- see options later in this post.
State tax bracket: 7.2%, but could be higher -- see options later in this post
Pension: Pension alone puts me in 15% bracket. Portfolio income theoretically puts me into the 25%
bracket, but most of it is qdi/long term capital gain distributions which is taxed at a much lower rate under current law.
i-orp suggestion: it seems to be suggesting something like option (d), then converting in the 25% bracket
up to age 77. It also thinks the top of the 28% bracket is 210K, so I am leery of i-orp.
Portfolio : taxable/tax deferred/roth = 48%/44%/8%
Elephant in the room: certain legislation we're not supposed to discuss. If you feel compelled to
mention the elephant, please do so circumspectly so my thread isn't locked. Thanks!


These seem to be my options:
a) No more conversions ever. Deal with RMDs when I am 70 1/2.
Pros:
- Under current law, I'll pay uber low rates on portfolio income
for the next ten years, portfolio income being taxed some at 15%, but about 2/3 at 0% If the goal is to pay low
taxes, this is one way to that goal.
- Claim Social Security at will with somewhat less worry about it being taxed away. I can't avoid SS tax entirely because of
my pension and portfolio income. (I know about the 'hump').
- We can't know the future, so enjoy the low rates I have today. Don't pay taxes today gaming an unpredictable future.
Cons:
= My Roth assets are less than 9% of my portfolio. More Roth assets would give more tax planning flexibility in future
- As I said, I'll spend the RMD era in 28% bracket territory.
- Higher Medicare premiums in RMD years.
- We can't know the future, so there's nothing to say tax rates couldn't increase above 28%. State tax rates could
increase.

b) No more conversions in 2017. Convert to the top of 25% bracket, or Medicare tier 1 limit, each year until RMDs begin.
Pros:
- A little more Roth, a little less RMD
- Should taxes drop between now and RMD, I can take advantage.

Cons:
- As I said, under existing law, leaves 60% of tax deferred assets as tax deferred assets.
- Lose the 0% bracket on my portfolio income in future years. If the goal is to pay lower taxes, this is counter to that goal.
- Paying tax in 2018 I could be deferring to age 70 1/2, not to mention state tax.
- Again, gaming an unknowable future. Suppose Roth IRAs become taxable, or tax rates drop, or we move to national sales tax, or some other tax which negates the benefit of a Roth account?

Removing (c) because I have learned Roth conversions do not affect Roth contributions as noted later in this thread
c) In 2017, convert up to Roth contribution income phase-out, which begins at 118K of income. Re-evaluate next year.
Pros:
- Same as b), except more assets move from tax deferred to Roth accounts
- Retain 2017 Roth IRA contribution
- No worries about Medicare income limits at my age
- Deduct state tax in 2017, who knows about future years? At this income, state tax bracket is 7.25%. State tax is up to 7.8K for any single filer, but actually a little less due to other deductions and exemptions. It's probably about 7.5K 7500*.28 = 2123. So, the deduction is worth about 2.1K to me.

Cons:
- Still leaves $$$ in tax deferred accounts
- Paying 28% tax I could be deferring to age 70 1/2, as well as 7.5K state tax.
= Gaming an unknowable future, a little more so than option b).


d) In 2017, convert to top of 28% bracket which is 191,650. Presumably do the same each year until I reach age 62. Re-evaluate at age 62 (Medicare income look back age).
Pros:
- Serious movement of tax deferred assets to Roth assets!
- No worries about Medicare income limits until I reach age 62
- Deduct more state tax in 2017 than (c). At this level, state marginal tax rate is 7 1/2%. I figure a deduction of about 3.7K.
Cons:
- Serious tax bills! I'd probably have to sell some mutual funds in taxable accounts in later years to pay the tax bill -- selling my tax advantaged investments so I can pay ordinary income rates on my tax deferred investments.. hmmm.
= Paying 28% tax I could be deferring to age 70 1/2, as well as state tax I could be deferring.
- Lose my 2017 Roth contribution. I guess I can recharacterise he contribution into a new tIRA in 2018 .. leaving me another tIRA to convert. Hmmn...
- Seriously gaming an unknowable future, more so than option c).

e) In 2017, go for it! Convert all tax deferred assets to Roth!
Pros:
- Same as (d), plus it's done and forgotten about
- Talk about deducting state taxes from my federal return!
Cons:
- All of d), plus ..
- At this income level, I'd lose my personal exemption
- At this income level, my federal marginal rate is 39.6% and my state bracket is 8%. This far exceeds my projected
28% federal bracket and my state bracket in retirement.

This is absurd. I only mention this one for completeness
Last edited by Church Lady on Sat Dec 09, 2017 5:31 pm, edited 1 time in total.
He that loveth silver shall not be satisfied with silver; nor he that loveth abundance with increase: this is also vanity. Ecclesiastes 1:8

cas
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Re: Roth conversions: how far should I go in 2017?

Post by cas » Thu Dec 07, 2017 3:30 pm

Church Lady wrote:
Thu Dec 07, 2017 2:26 pm

c) In 2017, convert up to Roth contribution income phase-out, which begins at 118K of income. Re-evaluate next year.

d) In 2017, convert to top of 28% bracket which is 191,650.

Cons:
- Lose my 2017 Roth contribution. I guess I can recharacterise he contribution into a new tIRA in 2018 .. leaving me another tIRA to convert. Hmmn...
I'm not sure this helps your overall quandry any, but... Roth conversions don't affect your eligibility to make Roth contributions. (Assuming I'm understanding things correctly. This was new knowledge for me within the last year, and I keep poking at it a bit, not quite trusting it.)

(bold added by me)
To calculate your modified AGI [for Roth IRA contribution purposes], you would first subtract any amounts you converted or rolled over from a qualified retirement plan to a Roth IRA. Then you’d add back deductions for contributions you made to a traditional IRA plus any deductions for interest on student loans and for tuition and fees. You would also add back exclusions of qualified bond interest (shown on Form 8815) and of employer-provided adoption benefits. For the full list of deductions and exclusions, see IRS Publication 590, Individual Retirement Arrangements.
Source: "How to Calculate Your Modified AGI: There's an extra step when it comes to determining eligibility for a Roth IRA." (https://www.kiplinger.com/article/taxes ... d-agi.html)

And, indeed, if I go to the Roth IRA section of IRS Publication 590-A, the first 3 lines of the worksheet on page 42 (which calculates MAGI for Roth contribution purposes) does indeed seem to have me subtract out any Roth conversion amounts from my AGI. ( https://www.irs.gov/pub/irs-pdf/p590a.pdf )

Church Lady
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Re: Roth conversions: how far should I go in 2017?

Post by Church Lady » Thu Dec 07, 2017 5:00 pm

Cas,
I totally did not realize that. Thanks!
He that loveth silver shall not be satisfied with silver; nor he that loveth abundance with increase: this is also vanity. Ecclesiastes 1:8

1year23
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Re: Roth conversions: how far should I go in 2017?

Post by 1year23 » Thu Dec 07, 2017 7:26 pm

Did I miss something? Why do you care about Medicare at age 62? Isn't 65 the age you are eligible?

Church Lady
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Re: Roth conversions: how far should I go in 2017?

Post by Church Lady » Thu Dec 07, 2017 7:49 pm

1year23,
Medicare premiums are based on your annual income. To determine your income at age 65, they look at your tax returns for prior ages 64 and 63. Before reading cas' post, I would have said Roth conversions artificially inflate your income. Now I'm not sure.
He that loveth silver shall not be satisfied with silver; nor he that loveth abundance with increase: this is also vanity. Ecclesiastes 1:8

scifilover
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Re: Roth conversions: how far should I go in 2017?

Post by scifilover » Fri Dec 08, 2017 7:36 am

Those of us fortunate enough to have substantial tax-deferred assets all face the same conundrum. That is, even if you work at doing conversions very hard, market growth is liable to push you into a higher bracket once SS and RMD's begin.
Things I have tried include keeping Roth 100% equity and having more fixed income in the TIRA, this for the purpose of making Roth grow faster than TIRA. Another option once you are in RMD time is to do QCD to reduce the RMD.
And, just a reminder that if you could find a poor but nice person you could get hitched (with a pre-nup) and get a lot more room to deal with things.

Can you defer your pension? Some give the option to defer for a few years and collect more later. This would let you substitute early withdrawals from tax-deferred instead for pension income or give more room for conversions.

Roth conversions definitely affect SS premiums.

cas
Posts: 344
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Re: Roth conversions: how far should I go in 2017?

Post by cas » Fri Dec 08, 2017 8:19 am

Church Lady wrote:
Thu Dec 07, 2017 7:49 pm
1year23,
Medicare premiums are based on your annual income. To determine your income at age 65, they look at your tax returns for prior ages 64 and 63. Before reading cas' post, I would have said Roth conversions artificially inflate your income. Now I'm not sure.
To make things even more confusing than they already are, there are lots of different "modified" AGIs.

The MAGI relevant to Roth contributions has you subtract out Roth conversion amounts. You also don't have to include tax-exempt interest in the MAGI.

The MAGI relevent to IRMAA (Income Related Medicare Adjustment Amount, which is a surcharge to Medicare B and D premiums) does not have you subtract out Roth conversion amounts. And you do have to add tax-exempt interest to your Line 38 AGI:
To determine if you’ll pay higher premiums, Social Security uses the most recent federal tax return the IRS provides to us. . . . Your MAGI is your total adjusted gross income and tax-exempt interest income.

Source: "2017 Medicare Premiums: Rules For Higher-Income Beneficiaries" p. 2 https://www.ssa.gov/pubs/EN-05-10536.pdf (unfortunately the equivalent pamphlet for 2018 doesn't seem to be out yet.)

The 2 year delay for determining IRMAA surcharges seems odd on the surface of things, but it has to do with what SS knows when.

Suppose SS wants to notify someone (usually in late November/early December 2017) what their IRMAA surcharge will be starting in January 2018.
The most recent tax return SS can get from the IRS was due (nominally) April 2017 or (with extension) October 2017.
And that tax return is for income earned in 2016.

So that's why they are using 2016 income (filed as late as October 2017) to notify (in December 2017) what premiums will be starting in January 2018.

Church Lady
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Re: Roth conversions: how far should I go in 2017?

Post by Church Lady » Fri Dec 08, 2017 8:31 am

scifilover wrote:
Fri Dec 08, 2017 7:36 am
And, just a reminder that if you could find a poor but nice person you could get hitched (with a pre-nup) and get a lot more room to deal with things.

:D :D :D
Can you defer your pension? Some give the option to defer for a few years and collect more later. This would let you substitute early withdrawals from tax-deferred instead for pension income or give more room for conversions.
I asked Bogleheads about a year ago what to do about the pension. Consensus was the deferral option was 'actuarially unfair'. It turns out that by starting at retirement, I got an early retirement kicker from Megacorp (you can't buy even a Megacorp-subsidized annuity that pays as well as the pension). Megacorp wants early retirements :D Now that I've made my pension choice, it's cast in stone and I can't change it. But I see where you're coming from.

Roth conversions definitely affect SS premiums.
Did you mean Medicare premiums? I appreciate the confirmation!
He that loveth silver shall not be satisfied with silver; nor he that loveth abundance with increase: this is also vanity. Ecclesiastes 1:8

JW-Retired
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Re: Roth conversions: how far should I go in 2017?

Post by JW-Retired » Fri Dec 08, 2017 8:37 am

Church Lady wrote:
Thu Dec 07, 2017 2:26 pm
If I convert to the top of the 25% bracket each year until RMD, I will be able to convert a little more than 40% of my tax deferred assets before RMDs begin. That's probably overstated because
- The 40% assumes no growth of the tax deferred portfolio from now to age 70 1/2.
- I have assumed no Social Security income until age 70. Due to family medical history and political uncertainty, I doubt I will wait until age 70 to claim.
- If I want to keep my income within Medicare tier 1 limits (about 88K last time I looked), the top of my
'space' is 88K, starting the year I turn 62. These leaves even less space for conversions. I realize Medicare income limits don't apply until I am age 62.
Converting 40% of your tax deferred assets looks like a worthy goal from here, but you sure shouldn't be taking any SS until you are all done with Roth conversions. Wait until 70 for SS. The doctors say family history doesn't mean very much and IMO politics means even less.

I can definitly attest that it is sure nice to have maxed out that much less taxed SS income. (i.e., no state tax and at least a bracket or so less federal tax)
JW
Retired at Last

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BigFoot48
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Re: Roth conversions: how far should I go in 2017?

Post by BigFoot48 » Fri Dec 08, 2017 9:23 am

Church Lady wrote:
Thu Dec 07, 2017 2:26 pm
Here is my problem. Between my tradional IRA (tIRA)
and t401K, I still have 43% of the goods in tax deferred assets, and only 9% of my portfolio is in Roth accounts. Projecting RMDs and tax brackets using 4% portfolio growth and 2% inflation, it looks like I'll spend my RMD years in the 28% bracket unless I pursue more Roth conversions.
You might try running your situation through the Retiree Portfolio Model which has a more precise tax calculation than ORP and see if it helps in your decision. Retiree Portfolio Model
Retired | Two-time in top-10 in Bogleheads S&P500 contest; 12-time loser

iflyjetzzz
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Re: Roth conversions: how far should I go in 2017?

Post by iflyjetzzz » Fri Dec 08, 2017 10:39 am

Church Lady, my wife and I are in similar circumstances. We had a short dip in taxable income after we retired from the military and I used that time to convert most of our TIRAs and 401ks to Roths.

Due to current salaries plus two military pensions, we are currently subject to Pease and PEP surtaxes. For that reason, we are maxing out our pretax 401k contributions and converting our TIRA contributions (which are not tax deductible) to Roth IRAs. This will leave us with substantial taxable 401k money when we retire. I will retire before my wife.

Currently, my 'plan' is to retire at 65 and defer SS for me until 70. During that time, we plan on converting as much taxable 401k money to Roth as we can to stay just below $320K (based on today's medicare part B brackets) MAGI. I will do this past age 70 1/2 (until all funds have been converted to Roth for both of us), as one can convert to Roth regardless of age.

One further consideration for us is that we will likely never withdraw any Roth money during our lives due to 2 military pensions + 2 social security checks are more than we spend annually. We are doing the Roth conversions for heirs, not for us. We will place our Roths (all of our assets) in trusts so that only RMDs can be made on them after our deaths ... that prevents heirs from blowing our Roths and allows the money to grow tax free well past our deaths.

That was long winded. My advice to you is to convert as much retirement assets annually that you feel comfortable converting, keeping tax brackets and IRMAA in mind. Don't convert nothing and don't convert everything in one year; pick your personal sweet spot based on both tax rates and IRMAA.

CnC
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Re: Roth conversions: how far should I go in 2017?

Post by CnC » Fri Dec 08, 2017 10:50 am

Church lady,

I would like to say, hold off on taking SS at 62. I am usually pro early filing, but it sounds like you have more than enough assets that you don't 'need' social security.


Think about this.
Delay Social security to 64 and use the additional 2 years to convert as much to Roth as possible. It will lower RMD's bump up your social security and put more in your Roth.

Church Lady
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Re: Roth conversions: how far should I go in 2017?

Post by Church Lady » Fri Dec 08, 2017 2:30 pm

CnC, JW-retired, with respect to claiming social security. I hope to wait until FRA to claim. For me, that's almost 67 years old. At FRA, I can see where things stand and decide if I want to hold out longer.

There's a benefit to claiming at 65, though. Apparently, if you have Medicare premiums deducted from your Social Security, at least part of the premium is frozen. It'll go up for other people, but not for you. This aspect of Medicare/SS is not often discussed here. Of course, the law could change. I'll see where things stand at 65 to figure out what the trade-offs are.

My strategy is to evaluate 'political risk' continually once I attain age 62. That's a few years out, so I'll refrain from explicit examples of political risk.
He that loveth silver shall not be satisfied with silver; nor he that loveth abundance with increase: this is also vanity. Ecclesiastes 1:8

Church Lady
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Re: Roth conversions: how far should I go in 2017?

Post by Church Lady » Fri Dec 08, 2017 2:34 pm

cas wrote:
Fri Dec 08, 2017 8:19 am
Church Lady wrote:
Thu Dec 07, 2017 7:49 pm
1year23,
Medicare premiums are based on your annual income. To determine your income at age 65, they look at your tax returns for prior ages 64 and 63. Before reading cas' post, I would have said Roth conversions artificially inflate your income. Now I'm not sure.
To make things even more confusing than they already are, there are lots of different "modified" AGIs.

The MAGI relevant to Roth contributions has you subtract out Roth conversion amounts. You also don't have to include tax-exempt interest in the MAGI.

The MAGI relevent to IRMAA (Income Related Medicare Adjustment Amount, which is a surcharge to Medicare B and D premiums) does not have you subtract out Roth conversion amounts. And you do have to add tax-exempt interest to your Line 38 AGI:
To determine if you’ll pay higher premiums, Social Security uses the most recent federal tax return the IRS provides to us. . . . Your MAGI is your total adjusted gross income and tax-exempt interest income.

Source: "2017 Medicare Premiums: Rules For Higher-Income Beneficiaries" p. 2 https://www.ssa.gov/pubs/EN-05-10536.pdf (unfortunately the equivalent pamphlet for 2018 doesn't seem to be out yet.)

The 2 year delay for determining IRMAA surcharges seems odd on the surface of things, but it has to do with what SS knows when.

Suppose SS wants to notify someone (usually in late November/early December 2017) what their IRMAA surcharge will be starting in January 2018.
The most recent tax return SS can get from the IRS was due (nominally) April 2017 or (with extension) October 2017.
And that tax return is for income earned in 2016.

So that's why they are using 2016 income (filed as late as October 2017) to notify (in December 2017) what premiums will be starting in January 2018.
cas, that's very informative and useful! Thanks for clarifying this!
He that loveth silver shall not be satisfied with silver; nor he that loveth abundance with increase: this is also vanity. Ecclesiastes 1:8

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Artsdoctor
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Re: Roth conversions: how far should I go in 2017?

Post by Artsdoctor » Fri Dec 08, 2017 2:42 pm

^ You might find this helpful, pertaining to the "hold harmless" rule:

social-security-and-medicare-claiming-strategies-to-navigate-the-looming-52-medicare-part-b-premium-spike-due-to-hold-harmless

Church Lady
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Joined: Sat Jun 28, 2014 7:49 pm

Re: Roth conversions: how far should I go in 2017?

Post by Church Lady » Fri Dec 08, 2017 4:39 pm

Artsdoctor, very interesting and not well known, it would seem.
He that loveth silver shall not be satisfied with silver; nor he that loveth abundance with increase: this is also vanity. Ecclesiastes 1:8

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