Converting trad IRA to Roth IRA

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Topic Author
fishhead442
Posts: 3
Joined: Wed Mar 25, 2020 1:27 pm

Converting trad IRA to Roth IRA

Post by fishhead442 »

I retired fall of last year. My wife and I are living off non-retirement savings and meager SS/pension (SS/pen is $2.5K/month). I would like to convert to Roth to avoid taxes and RMDs later. Wife is 62, I am 57. Trads are over $1M. Considering a conversion schedule/method to follow for a number of years. Also, when within the year to convert (will I need to pay estimated taxes?) I would like to avoid paying too much taxes, triggering higher Medicare Part B in a few years, anything else I might have missed. Health care is covered by a retiree group and HCTC, but that may go away - so next year might have to consider Obamacare too (do Roth conversions count toward Obamacare income limits?).

Should I just consider up to the:
Top of the 12% tax bracket ($77K - $30K)= $47K conversion?
Top of the 22% tax bracket ($165K - $30K)=$135K conversion?

The tax payment will come from my savings, would I get a penalty if I don't pay anything until next April?

Any thoughts?
MJS
Posts: 577
Joined: Sat Aug 05, 2017 10:55 pm

Re: Converting trad IRA to Roth IRA

Post by MJS »

IRAs are Individual accounts, and RMDs will be calculated individually even if you file jointly. So, to give good answers, we need to know how much of your $1 million is hers and how much is yours.* If her IRA is $30,000 out of the $1M, that's a very different calculation from one where $30,000 is yours! Also, can you provide a guesstimate for your income in 2031 when she turns 72?**

(Advice based on partial information is not really good advice.) This year, while your wife is under 63 years old, convert your wife's T-IRA or 401s to the top of the MFJ 22% bracket (unless adding her RMD to your income in 2031 will keep you in the 12/15% bracket ... tax rates are scheduled to go back the old system in 2026.**) Next year, she will be vulnerable to the IRMAA (Medicare) cliff. So, in 2021, keep your joint income under the guesstimated 2023 IRMAA level** ... maybe $175k?

* The RMD on $1M will be very roughly $4k/month at age 72, but $5.5k/month at age 80.
https://www.schwab.com/ira/understand-i ... lators/rmd

** A large part of Roth conversion choices is based on having a well functioning crystal ball.
rkhusky
Posts: 10169
Joined: Thu Aug 18, 2011 8:09 pm

Re: Converting trad IRA to Roth IRA

Post by rkhusky »

How much do you expect your annual expenses to be?

There is no sense worrying about RMD’s if you will need them for spending anyway.

Converting to at least the top of the 12% bracket seems like a no-brainer, but if you are already collecting SS, more care needs to be taken. What is your current SS amount?

Top of the 12% bracket is north of $100K. You forgot about the standard deduction.
Topic Author
fishhead442
Posts: 3
Joined: Wed Mar 25, 2020 1:27 pm

Re: Converting trad IRA to Roth IRA

Post by fishhead442 »

Thanks for the reminder on the standard deduction. Hope it stays. Est expenses are 60K/yr.
Topic Author
fishhead442
Posts: 3
Joined: Wed Mar 25, 2020 1:27 pm

Re: Converting trad IRA to Roth IRA

Post by fishhead442 »

Thanks MJS on the thoughts, Wife's Trad is 150K, My Trad is 1.3M. I expect income to double when I turn 62, so 60K at that point.
chemocean
Posts: 253
Joined: Mon Dec 19, 2016 9:45 pm

Re: Converting trad IRA to Roth IRA

Post by chemocean »

Couple of consideration:
The 2017 tax rates expire in 2026, so 12% goes to %15% and 22% goes to 25% without any legislative action.
This would suggest advantages to convert before 2026.

Do you expect to pass any traditional IRA to beneficiaries? If so, is their tax bracket likely to be 15% or 25%, without any legislative action, when they receive it. Is they are likely to be in the 15%, why would you pay 22-25% in the near future to save them 15% down the road.

You are using taxable income to calculate your conversion opportunities. Remember IRMMA is based on MAGI. The first premium threshold (cliff) is about $170,000. You need to use $170,000 MAGI to calculate the upper range of the current 22% to determine Roth conversion opportunity, if you want to avoid IRMMA premiums.

At 62, you say your taxable income goes to 60K. Much less opportunity in the 12% bracket.

Leave the $150K in your wife's traditional, especially if your charitably inclined. The only opportunity to withdrawal from traditional IRA for the joint charities with no taxes is from her traditional IRA during the five years before you reach 70.5.

If you are Excel savvy, create a "what-if" using your estimates of increase income at 62, SS benefits and RMDs.
At 72, the RMD is only 4%, so your RMD with no increase in value of your traditional IRA will be pushing near the first IRMMA threshold. As you age, the percentage goes up and you might be going into the tax bracket above the current 22%.

I am also lower income before RMDs, and am converting. My own spreadsheet simulation was revealed a number of subtle conditions. There are canned spreadsheets as well as some free and inexpensive programs out there. With your net worth, it might be useful to pay a professional to do the simulation, if you can get someone who charges by the hour.
rkhusky
Posts: 10169
Joined: Thu Aug 18, 2011 8:09 pm

Re: Converting trad IRA to Roth IRA

Post by rkhusky »

I find the heat maps on this wiki page to be useful in whatif's regarding SS: https://www.bogleheads.org/wiki/Taxatio ... y_benefits

You can see the marginal tax rate that you will pay for doing Roth conversions now, while you are taking SS, as well as later when RMD's kick in.

As an example, suppose you are getting $10K of pension and $20K of SS now, and then $20K of pension and $40K of SS when you turn 62 and after. If your portfolio balance is $1.5M at age 72, then the first-year RMD is about $55K.

$40K of SS and $75K of other income (pension + RMD) would put you just barely into the 22% tax bracket at age 72.

Between now and age 62, you are in the 0% tax bracket. You could Roth convert up to $14K and stay in the 0% bracket. Adding more would put you into a 15%, then 18.5%, then 22.2%, then 12% marginal tax rates. It appears from the chart that you could Roth convert $80K (resulting in $90K additional income) to reach the top of the 12% marginal tax rate. The average rate would be near 12%. It would seem useful in this example, with $20K SS, to convert enough such that the total other income is $90K.

At age 62, you will have $40K of SS, where you would want to again convert to the top of the 12% marginal rate, which is reached at an other income of $72K. Since you have $20K of pension in this example, you could Roth convert $52K. Your average tax rate on these conversions would be on the order of 18%, which isn't as good of a deal as the conversions between ages 57-62, but still less than 22%.

In total then, you would Roth convert 5 x $80K + 10 x $52K = $920K. This should substantially reduce your tIRA balances. Suppose your tIRA balances drop to $500K at age 72 through these Roth conversions, then your first-year RMD is about $20K. Your income would then be $40K from SS and $40K from pension + RMD, which would be in the 22.2% marginal rate, but your average rate on the RMD would be about 20%.

If you only Roth convert between now and 62, you would reduce your tIRA by $400K, perhaps down to $1M, which would give you an RMD of $35K. That would put you at the top of the 22.2% marginal tax rate, just shy of the 12% band, with $40K of SS and $55K of other income.

It is therefore a tossup on whether to Roth convert into the 22% tax bracket now. If tax rates do go up to 15%/25%, you may save a little by Roth converting more now in order to get the RMD into the 18.5% marginal rate, which would be about $32K other income or $12K from RMD + $20K pension. An RMD of $12k means a tIRA balance of $330K, meaning that you would need to Roth convert an extra $170K.

If you delay SS to age 70, you will get a larger SS check and you can do more Roth conversions. If you need more spending money, you could withdraw from the tIRA at age 59.5 and reduce Roth conversions slightly.
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