Are Roth conversions a no-brainer for me?

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catdude
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Are Roth conversions a no-brainer for me?

Post by catdude » Thu Aug 16, 2018 12:50 am

Hi Bogleheads -

So lately I've been stewing & fretting over Roth conversions... I'm in the 12% fed bracket, and the difference between my taxable income and the top of that 12% bracket is about $12,000. So I could convert $12K, and pay the 12% fed tax + 9% state tax (which I hate... grrr…). I've got the $$$ in cash to pay the taxes, but like I say, I hate paying taxes....

The question, of course, is what happens when I start RMD's at age 70.5... I'm not sure that I'll necessarily be pushed into a higher tax bracket. I'm 63 now and in three years I'll start collecting social security. My current pension income is about $36K, but my pension is "integrated" with social security -- that is, to the extent that I get SS benefits, my pension will be reduced. My latest SS statement (about two months ago) says I'll get $27,500 when I reach full retirement age in three years. Thus my pension income will drop to about $8,500 (ignoring inflation for the time being).

So, when I hit age 70.5, my income will be... SS of $27,500; pension of $8,500; and RMD of about $25,000 (assuming I don't do any more Roth conversions). My understanding is that in certain circumstances the feds tax 50% of SS benefits (BTW, my state doesn't tax SS income). The question is, will I get pushed into a higher tax bracket at that age? If not, I don't think I want to do Roth conversions. What do y'all think?

Thanks in advance for your attention to this.
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FiveK
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Re: Are Roth conversions a no-brainer for me?

Post by FiveK » Thu Aug 16, 2018 2:26 am

catdude wrote:
Thu Aug 16, 2018 12:50 am
So, when I hit age 70.5, my income will be... SS of $27,500; pension of $8,500; and RMD of about $25,000 (assuming I don't do any more Roth conversions). My understanding is that in certain circumstances the feds tax 50% of SS benefits (BTW, my state doesn't tax SS income). The question is, will I get pushed into a higher tax bracket at that age?
Yes, your marginal tax rate (fed + state) will be ~31% at that point. If your RMD goes up to ~$26,650 that rate will be ~50%.

Put your numbers into the personal finance toolbox Excel spreadsheet if you'd like to see that in graphical form.

walkindude
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Re: Are Roth conversions a no-brainer for me?

Post by walkindude » Thu Aug 16, 2018 6:59 am

catdude wrote:
Thu Aug 16, 2018 12:50 am
My understanding is that in certain circumstances the feds tax 50% of SS benefits (BTW, my state doesn't tax SS income).
The Feds tax up to 85% of your SS, based on a formula which takes into account your non-SS income sources (pension, dividends/cap gains, RMDs) and 50% of your SS. PROBABLY another reason to lean toward Roth conversions. You really need to run your numbers through tax programs to find out.

MikeG62
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Re: Are Roth conversions a no-brainer for me?

Post by MikeG62 » Thu Aug 16, 2018 7:22 am

catdude wrote:
Thu Aug 16, 2018 12:50 am
Hi Bogleheads -

So lately I've been stewing & fretting over Roth conversions... I'm in the 12% fed bracket, and the difference between my taxable income and the top of that 12% bracket is about $12,000. So I could convert $12K, and pay the 12% fed tax + 9% state tax (which I hate... grrr…). I've got the $$$ in cash to pay the taxes, but like I say, I hate paying taxes....
It is stunning to me that your marginal state rate is 9% with your Federal marginal rate only being 12%. :shock:

Wow, I thought NJ income tax rates were bad.
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MrBeaver
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Re: Are Roth conversions a no-brainer for me?

Post by MrBeaver » Thu Aug 16, 2018 7:39 am

I echo what FiveK said about the personal finance toolbox. It will really help to visualize it.
catdude wrote:
Thu Aug 16, 2018 12:50 am
I'm 63 now and in three years I'll start collecting social security. My current pension income is about $36K, but my pension is "integrated" with social security -- that is, to the extent that I get SS benefits, my pension will be reduced. My latest SS statement (about two months ago) says I'll get $27,500 when I reach full retirement age in three years. Thus my pension income will drop to about $8,500 (ignoring inflation for the time being).
Does your pension continue through age 70 if you delay Social Security?

If so, the no brainer to me is to delay Social Security until age 70, especially if the pension is not indexed for inflation. Doing so would keep your current pension + SS income at 35k, and then bump it up to ~37k at age 70. And if the pension is not inflation indexed, it will mean higher real SS+pension income beyond that.

If it were me, I’d do what I could to defer as much as possible now (HSA contribution with a HDHP, for instance), then use the personal finance toolbox to figure out whether the top of the 12% bracket or the top of the 22% bracket is better for conversions. If you have any qualified dividends (guessing you do since you have cash to pay conversion taxes), then I would not go just a little above the 12% bracket. I’d go all the way to the 22% bracket top with conversions (assuming 22+state rate now is lower than anticipated federal + state rate during RMDs) because of the small marginal rate hump as your dividends get taxed at 15% instead of 0%.

But put your numbers into the toolbox and see what it looks like.

danaht
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Re: Are Roth conversions a no-brainer for me?

Post by danaht » Thu Aug 16, 2018 7:41 am

If it wasn't for the state taxes - I would say it probably does make sense to convert at 12%. But even with the state taxes it might make sense.
I reside in a no income tax state (TX) - and may retire in a high income tax state (CA). Because I'll probably be in a higher tax situation later - I am converting as much as I can now - within the 24% federal bracket. For me it no longer makes sense to convert in the 32% bracket - so I plan stop my conversions after I exceed the 24% bracket.

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Re: Are Roth conversions a no-brainer for me?

Post by bsteiner » Thu Aug 16, 2018 7:51 am

See my article on Roth conversions under the Tax Cuts and Jobs Act in the June 2018 issue of Trusts & Estates: https://www.kkwc.com/wp-content/uploads ... ations.pdf.

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susa
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Re: Are Roth conversions a no-brainer for me?

Post by susa » Thu Aug 16, 2018 8:14 am

bsteiner wrote: See my article on Roth conversions under the Tax Cuts and Jobs Act in the June 2018 issue of Trusts & Estates: https://www.kkwc.com/wp-content/uploads ... ations.pdf.
Thank you for the link. Does this mean that a Roth IRA beneficiary in a non-trust situation (ie. child) would end up with
more taxes than if the distributions came from a traditional IRA ? Perhaps in error thinking that it was better to leave Roth IRA's to children than traditional IRA's.

In the article, you mention in part
There are no required minimum distributions (RMDs) from a Roth IRA
during the IRA owner’s life time or the lifetime of the IRA owner’s spouse
if he’s the beneficiary.
If the IRA owner leaves the IRA to his beneficiaries in trust rather
than outright, the trust tax rates won’t apply to distributions from
the Roth IRA that are accumulated in the trust.

MikeG62
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Re: Are Roth conversions a no-brainer for me?

Post by MikeG62 » Thu Aug 16, 2018 8:41 am

bsteiner wrote:
Thu Aug 16, 2018 7:51 am
See my article on Roth conversions under the Tax Cuts and Jobs Act in the June 2018 issue of Trusts & Estates: https://www.kkwc.com/wp-content/uploads ... ations.pdf.
Great article Bruce. Thanks for posting.
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JW-Retired
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Re: Are Roth conversions a no-brainer for me?

Post by JW-Retired » Thu Aug 16, 2018 9:10 am

catdude wrote:
Thu Aug 16, 2018 12:50 am
So, when I hit age 70.5, my income will be... SS of $27,500; pension of $8,500; and RMD of about $25,000 (assuming I don't do any more Roth conversions). My understanding is that in certain circumstances the feds tax 50% of SS benefits (BTW, my state doesn't tax SS income). The question is, will I get pushed into a higher tax bracket at that age? If not, I don't think I want to do Roth conversions. What do y'all think?
Sounds like you live in California, as I do. The only thing they don't tax is SS benefits, which is enough to keep me here. :D

You just need to make your tax deferred account RMD smaller in favor of growing your SS bigger. Don't take SS at age 66!.......... and probably you don't need Roth conversions! Just live on the pension + whatever tax deferred account large withdrawals you need to live on until age 70. Then start your much bigger SS payments then.

If your SS is bigger and your RMD is smaller your Fed + state tax rate should be much smaller.
JW
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Earl Lemongrab
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Re: Are Roth conversions a no-brainer for me?

Post by Earl Lemongrab » Thu Aug 16, 2018 12:52 pm

If you have significant stock holdings in taxable, your conversion rate might be higher than you think. I'm in that bracket in retirement, but my taxable qualified dividends "fill" the remaining space. Those are taxed at 0%. So if I converted a dollar of pretax to Roth, that would incur state and federal tax itself AND bump a dollar of dividends to the 15% bracket. Net tax 27% + state tax.
This week's fortune cookie: "Your financial life will be secure and beneficial." So I got that going for me, which is nice.

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catdude
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Re: Are Roth conversions a no-brainer for me?

Post by catdude » Thu Aug 16, 2018 3:15 pm

MrBeaver wrote:
Thu Aug 16, 2018 7:39 am
Does your pension continue through age 70 if you delay Social Security?

If so, the no brainer to me is to delay Social Security until age 70, especially if the pension is not indexed for inflation. Doing so would keep your current pension + SS income at 35k, and then bump it up to ~37k at age 70. And if the pension is not inflation indexed, it will mean higher real SS+pension income beyond that.
I doubt very much if my pension will continue if I delay SS. My understanding is that my ex-employer will contact me when I get to age 66, and tell me to start collecting SS. They probably can't force me to do it, but I would have to tap my portfolio for income between ages 66 and 70.
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catdude
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Re: Are Roth conversions a no-brainer for me?

Post by catdude » Thu Aug 16, 2018 3:16 pm

bsteiner wrote:
Thu Aug 16, 2018 7:51 am
See my article on Roth conversions under the Tax Cuts and Jobs Act in the June 2018 issue of Trusts & Estates: https://www.kkwc.com/wp-content/uploads ... ations.pdf.
Really a good article, thanks much for posting the link.
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catdude
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Re: Are Roth conversions a no-brainer for me?

Post by catdude » Thu Aug 16, 2018 3:22 pm

JW-Retired wrote:
Thu Aug 16, 2018 9:10 am
Sounds like you live in California, as I do. The only thing they don't tax is SS benefits, which is enough to keep me here. :D

You just need to make your tax deferred account RMD smaller in favor of growing your SS bigger. Don't take SS at age 66!.......... and probably you don't need Roth conversions! Just live on the pension + whatever tax deferred account large withdrawals you need to live on until age 70. Then start your much bigger SS payments then.

If your SS is bigger and your RMD is smaller your Fed + state tax rate should be much smaller.
JW
Well, the governor's name here is Brown, but no, I don't live in California -- I live in Oregon. There's no sales tax here, so to make up for that the state imposes a significant income tax.

As far as making large withdrawals from my tax-deferred account between ages 66 and 70, I suppose I'll have to jump off that bridge when I get to it... :)
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Peter Foley
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Re: Are Roth conversions a no-brainer for me?

Post by Peter Foley » Thu Aug 16, 2018 3:36 pm

I would be inclined to do Roth conversions to the top of the 12% bracket prior to taking SS benefits.

You don't mention what your annual living expenses are. My guess is that once you start taking SS benefits you will have some combination of ss benefits + pension + taxable account or deferred account withdrawals. The combination of the last two could push you into a higher marginal tax bracket. You probably have a short window for relatively low tax Roth conversions.

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FiveK
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Re: Are Roth conversions a no-brainer for me?

Post by FiveK » Thu Aug 16, 2018 10:53 pm

Peter Foley wrote:
Thu Aug 16, 2018 3:36 pm
I would be inclined to do Roth conversions to the top of the 12% bracket prior to taking SS benefits.
Perhaps even through the 22% fed bracket, given the expected age 70 marginal rates. Of course, that much conversion could reduce RMDs so much that age 70 marginal rates would drop, so a little iteration may be useful.

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catdude
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Re: Are Roth conversions a no-brainer for me?

Post by catdude » Thu Aug 16, 2018 11:49 pm

Hi, OP here again. My thanks to y'all for the feedback and advice, I'm much obliged. I've been doing a little math, and consulting the IRS RMD distribution table. The current balance in my traditional IRA is $432,000. I think what I'll try to do is draw that down via Roth conversions over the next 8 years to roughly $318,000. That $318K will generate an RMD of $12,000 at age 71. I'll be trying to hit a moving target, but as long as I stay flexible I think I'll be OK. That $12,000 RMD will keep me in the 12% fed bracket.

As far as the TIRA drawdown goes, $432K - $318K = $114K or $14,250 a year over 8 years. Hopefully I'll have some growth in the TIRA over that time, so I'll probably have to convert more than $14,250 a year, but most of my IRA is in Vanguard Total Bond fund, so I don't expect it to go gangbusters...

Thoughts?
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Re: Are Roth conversions a no-brainer for me?

Post by emoore » Fri Aug 17, 2018 12:12 am

catdude wrote:
Thu Aug 16, 2018 11:49 pm
Hi, OP here again. My thanks to y'all for the feedback and advice, I'm much obliged. I've been doing a little math, and consulting the IRS RMD distribution table. The current balance in my traditional IRA is $432,000. I think what I'll try to do is draw that down via Roth conversions over the next 8 years to roughly $318,000. That $318K will generate an RMD of $12,000 at age 71. I'll be trying to hit a moving target, but as long as I stay flexible I think I'll be OK. That $12,000 RMD will keep me in the 12% fed bracket.

As far as the TIRA drawdown goes, $432K - $318K = $114K or $14,250 a year over 8 years. Hopefully I'll have some growth in the TIRA over that time, so I'll probably have to convert more than $14,250 a year, but most of my IRA is in Vanguard Total Bond fund, so I don't expect it to go gangbusters...

Thoughts?
What do you mean RMD from your Roth? I think Roth’s don’t have RMDs.

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catdude
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Re: Are Roth conversions a no-brainer for me?

Post by catdude » Fri Aug 17, 2018 12:17 am

Sorry if I wasn't clear. The RMD's will be taken from my Traditional IRA, not from my Roth IRA...
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FiveK
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Re: Are Roth conversions a no-brainer for me?

Post by FiveK » Fri Aug 17, 2018 1:45 am

catdude wrote:
Thu Aug 16, 2018 11:49 pm
That $12,000 RMD will keep me in the 12% fed bracket.
You'll be paying 15% or more on any RMD amounts above ~$4300. Have you been able to take a look at the spreadsheet suggested to see this in chart form?

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catdude
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Re: Are Roth conversions a no-brainer for me?

Post by catdude » Fri Aug 17, 2018 3:04 am

FiveK wrote:
Fri Aug 17, 2018 1:45 am
catdude wrote:
Thu Aug 16, 2018 11:49 pm
That $12,000 RMD will keep me in the 12% fed bracket.
You'll be paying 15% or more on any RMD amounts above ~$4300. Have you been able to take a look at the spreadsheet suggested to see this in chart form?
FiveK, thank you very much for reminding me about that spreadsheet. When I saw your initial message I took a quick look at the spreadsheet and made a mental note to go back to it. But I totally forgot about it. Again, thanks for the reminder.

Anyway, I've used it to play around with the numbers, and now I get it! :oops: I see that as my RMD's increase, the percentage of my social security benefits that are subject to tax also increases. For example, a $12K RMD results in federal taxes of $1,356; while a $15K RMD results in fed taxes of $2,022. The marginal rate of the increase from $1,356 to $2,022 is 22.2%. Meanwhile, the state of Oregon is taking its 9% chunk, so (in this example) my total marginal rate is 31.2%. Yikes!

The good news is that it looks like, overall, my taxes will go down quite a bit from what I'm paying now. But those marginal rates are pretty rough. I think I'm gonna have to go back to the drawing board...
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Re: Are Roth conversions a no-brainer for me?

Post by walkindude » Fri Aug 17, 2018 6:27 am

catdude wrote:
Fri Aug 17, 2018 3:04 am
Anyway, I've used it to play around with the numbers, and now I get it! :oops: I see that as my RMD's increase, the percentage of my social security benefits that are subject to tax also increases. For example, a $12K RMD results in federal taxes of $1,356; while a $15K RMD results in fed taxes of $2,022. The marginal rate of the increase from $1,356 to $2,022 is 22.2%. Meanwhile, the state of Oregon is taking its 9% chunk, so (in this example) my total marginal rate is 31.2%. Yikes!

The good news is that it looks like, overall, my taxes will go down quite a bit from what I'm paying now. But those marginal rates are pretty rough. I think I'm gonna have to go back to the drawing board...
I think you're looking at this in a much better way than when you started out - good job to stick with it and do the math!

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Re: Are Roth conversions a no-brainer for me?

Post by BigFoot48 » Wed Sep 19, 2018 9:01 am

You might find the Retiree Portfolio Model very useful in running your numbers.

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