Can a Roth conversion be reasonable at a 35% tax rate ?

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
Post Reply
Topic Author
Roncole
Posts: 7
Joined: Sun Sep 09, 2018 1:59 pm

Can a Roth conversion be reasonable at a 35% tax rate ?

Post by Roncole »

I believe the the stock market will recover and tax rates will go up. Would a Roth conversion be reasonable this year, and future years, at a 35% tax rate mainly due to large RMDs ?
User avatar
retiredjg
Posts: 50324
Joined: Thu Jan 10, 2008 11:56 am

Re: Can a Roth conversion be reasonable at a 35% tax rate ?

Post by retiredjg »

Roncole wrote: Sun Dec 04, 2022 3:44 pm I believe the the stock market will recover and tax rates will go up. Would a Roth conversion be reasonable this year, and future years, at a 35% tax rate mainly due to large RMDs ?
I don't think there is enough information to have much of an opinion.

But...if your tax rate is now 35% and will always be 35% until rates change, Roth conversions might be something to consider.
Raycpact
Posts: 168
Joined: Thu Jun 24, 2021 9:00 pm

Re: Can a Roth conversion be reasonable at a 35% tax rate ?

Post by Raycpact »

What is your beneficiary',s tax rate?
JoinToday
Posts: 1095
Joined: Sat Mar 10, 2007 8:59 pm

Re: Can a Roth conversion be reasonable at a 35% tax rate ?

Post by JoinToday »

Roncole wrote: Sun Dec 04, 2022 3:44 pm I believe the the stock market will recover and tax rates will go up. Would a Roth conversion be reasonable this year, and future years, at a 35% tax rate mainly due to large RMDs ?
I agree with you about the stock market and interest rates. But the decision mostly rests upon current marginal tax rates vs future marginal tax rates.

Part of the decision to do Roth conversions is influenced by where the money for taxes comes from. If you are paying taxes for the Roth conversion from your after tax account, this will reduce future tax drag, tilting the decision more in favor of doing larger conversions.

If you don't/won't need the money for living expenses, that tilts the reason in favor of doing Roth conversions. RMDs that end up in your after tax account suffer from tax drag for maybe 10-15-20 years depending on how long you (& spouse?) live after RMDs start. A Roth conversion will avoid the tax drag; plus an additional 10 years of tax drag where the money can sit in a your heir's Roth. [The entire IRA will not suffer from that tax drag, just the RMDs that aren't spent, for the duration they sit in an after tax account]

If you plan to leave IRAs in trust for your kids, marginal tax rates quickly rise to the top of the tax brackets. This is a pretty compelling reason to do larger Roth conversions.
I wish I had learned about index funds 25 years ago
Carl53
Posts: 2394
Joined: Sun Mar 07, 2010 7:26 pm

Re: Can a Roth conversion be reasonable at a 35% tax rate ?

Post by Carl53 »

With a tax rate of 35% now and presumably in retirement since you are asking is it worth it to do now, I'd say maybe. Will the tax rate go even higher in 2026?
What if we have another market slide of 25% are you good with paying 35% tax now and then having less than one-half of what you started with? .75 X .65 = .49
You are asking like you expect an significant market jump, say 25% up. If you know this, then I suppose doing it looks better. 1.25 X .65 =.81

Do you ever make charitable donations? Once you are 70.5 you can get 100% deductions for QCDs (up to 100k). If you normally donate 10k/yr but do so with after tax dollars, you can do so from your TIRA and save you the 35% tax on 10k you would ultimately pay on the RMD.
Topic Author
Roncole
Posts: 7
Joined: Sun Sep 09, 2018 1:59 pm

Re: Can a Roth conversion be reasonable at a 35% tax rate ?

Post by Roncole »

Thank you very much to each of you for your thoughtful insights !
This was my first post on the Forum and I look forward to using it regularly.

My wife and I are healthy so far, at 72. Watching a 2022 Roth conversion grow tax free, hopefully for 10-20 yrs, would be enjoyable... before another 10 years with our beneficiaries. Their current tax rate, around 24%, will likely go up, as JoinToday points out, when they take distributions.

Not sure what I'll do. But, at least, I've learned it's not a stupid idea !
User avatar
Watty
Posts: 26576
Joined: Wed Oct 10, 2007 3:55 pm

Re: Can a Roth conversion be reasonable at a 35% tax rate ?

Post by Watty »

Some things to keep in mind.

1) If you someday go into a nursing home you may have large itemized tax deductions and be in a lower tax bracket.

2) If you sell $10K(or whatever) of an investment out of taxable account to pay for the Roth conversion then you may also need to pay capital gains taxes on that sale. When you add in that tax you could be in a higher than 35% effective tax bracket fo the Roth conversion.

3) You could leave that $10K invested in a taxable account and your heirs would get it at a stepped up cost basis under the current tax laws. Your heirs might get the Roth tax free but they would also miss out on getting that investment at a stepped up cost basis tax free.

4) If you have more money than you need then spending that $10K(or whatever) for the Roth conversion is for the benefit of your heirs then you might consider giving them that money now instead of decades from now. There is a reasonable chance that at least one of you will live to be 95 or even older and by the time the heirs inherit it they may not need it or they may be too old to enjoy it. If you live to be 95+ then you could even outlive your expected heirs.

5) There is no telling what the tax laws will be 20 years from now. It may be likely that your heirs would get the Roth tax free but a lot can change and it might be subject to something like a special Roth estate tax.

It would take some real special situation, like estate tax planning, to make doing Roth conversions in such a high tax bracket reasonable. I would never do something like that without advice from tax or estate planning professional.
GAAP
Posts: 1918
Joined: Fri Apr 08, 2016 12:41 pm

Re: Can a Roth conversion be reasonable at a 35% tax rate ?

Post by GAAP »

Barring unusual events, it is likely that one of you will outlive the other. The survivor will be paying taxes as a single person, meaning that more income becomes subject to higher taxes sooner. The single 37% bracket starts at about 25% of the bottom of the married bracket. Roth conversions reduce the amount of any RMD required, potentially decreasing the amount of taxes paid.

If you live in a state with an estate tax, Roth conversions can reduce the amount of taxes due at death, leaving more for the heirs. The same obviously applies for the federal estate tax if your assets are large enough. Not all state estate taxes are indexed for inflation, increasing the likelihood of a larger tax bill.

If your heirs live in a state with an inheritance tax, reducing the size of the estate should reduce the amount of the inheritance tax due. Roth conversions can also help here.

As the law is currently written, you could easily be in a 39% tax bracket when those brackets revert in 2026.

RMDs will continue to take larger and larger parts of your IRAs, potentially forcing taxable income that you don't actually need.

If you are certain that your income will remain in the 35% bracket with or without bracket reversion. then you are still likely to come out ahead with Roth conversions to the upper limit of that bracket. If there is any chance of getting into a higher bracket, then they make even more sense. IRMAA additional premiums could potentially be affected by the choice to convert to somewhere in the 37% bracket, depending upon how far up you go.
“Adapt what is useful, reject what is useless, and add what is specifically your own.” ― Bruce Lee
Dantes
Posts: 394
Joined: Wed Feb 25, 2015 5:38 pm

Re: Can a Roth conversion be reasonable at a 35% tax rate ?

Post by Dantes »

There are other reasons for Roth Conversions than tax-rate-now vs. tax-rate-later. A driver for me was wanting more money to be available for spending without tax consequences; almost all of our savings had been in tax-deferred accounts. We have yet to actually spend any of it, but its there.
User avatar
FiveK
Posts: 13667
Joined: Sun Mar 16, 2014 2:43 pm

Re: Can a Roth conversion be reasonable at a 35% tax rate ?

Post by FiveK »

Dantes wrote: Mon Dec 05, 2022 4:20 pm There are other reasons for Roth Conversions than tax-rate-now vs. tax-rate-later. A driver for me was wanting more money to be available for spending without tax consequences....
How does following the tax-rate-now vs. tax-rate-later strategy conflict with wanting more spendable money after taxes are considered?
GAAP
Posts: 1918
Joined: Fri Apr 08, 2016 12:41 pm

Re: Can a Roth conversion be reasonable at a 35% tax rate ?

Post by GAAP »

FiveK wrote: Mon Dec 05, 2022 5:02 pm
Dantes wrote: Mon Dec 05, 2022 4:20 pm There are other reasons for Roth Conversions than tax-rate-now vs. tax-rate-later. A driver for me was wanting more money to be available for spending without tax consequences....
How does following the tax-rate-now vs. tax-rate-later strategy conflict with wanting more spendable money after taxes are considered?
It doesn't necessarily conflict, but it's another reason -- especially if you think you will have a large need at some point in the future. For example, you expect to need to re-roof your house in three years, with a cost that would shove you into the next tax bracket if taken from tax-deferred.
“Adapt what is useful, reject what is useless, and add what is specifically your own.” ― Bruce Lee
User avatar
FiveK
Posts: 13667
Joined: Sun Mar 16, 2014 2:43 pm

Re: Can a Roth conversion be reasonable at a 35% tax rate ?

Post by FiveK »

GAAP wrote: Mon Dec 05, 2022 5:05 pm
FiveK wrote: Mon Dec 05, 2022 5:02 pm
Dantes wrote: Mon Dec 05, 2022 4:20 pm There are other reasons for Roth Conversions than tax-rate-now vs. tax-rate-later. A driver for me was wanting more money to be available for spending without tax consequences....
How does following the tax-rate-now vs. tax-rate-later strategy conflict with wanting more spendable money after taxes are considered?
It doesn't necessarily conflict, but it's another reason -- especially if you think you will have a large need at some point in the future. For example, you expect to need to re-roof your house in three years, with a cost that would shove you into the next tax bracket if taken from tax-deferred.
Yes, that's a good use of tax-rate-now vs. tax-rate-later: take smaller conversions over several years "now" to avoid paying a higher rate on a larger withdrawal "later".
User avatar
busdriver
Posts: 226
Joined: Thu Apr 10, 2014 8:57 am
Location: Vancouver, WA

Re: Can a Roth conversion be reasonable at a 35% tax rate ?

Post by busdriver »

Roncole wrote: Sun Dec 04, 2022 3:44 pm I believe the the stock market will recover and tax rates will go up. Would a Roth conversion be reasonable this year, and future years, at a 35% tax rate mainly due to large RMDs ?
There are sites with software that might help with your decision, if you're up to doing some work.

In early 2018, prior to retirement, I subscribed to Income Strategy, https://incomestrategy.com, with the basic $20/mo. service and also had a few personal sessions to help with the learning curve and some complexities with investments, as I'm not very intuitive. I subscribed for over a year; however, within a month or two, I came up with my plan and could have saved some money by cancelling subscription earlier. The software comes up with several recommendations and allows for the user to custom tailor a plan to their liking.

Due to waiting until age 70 next year to start SS & pension in 2024 that have been increasing while I wait, the software's top recommended plan was for conversions to the top of the 35% bracket. Even with tax coming from IRA and heavy IRMAA charges it projected that we would be ahead at the end.

Assuming TCJA expires in 2025, and IRMAA brackets index up some each year, we should be in a far lower tax bracket for the majority of our retirement years starting in 2026 and not be subject to IRMAA in 2028.

Everyone's s circumstances and desires are different and without being able to work the numbers for different ideas, it's hard to come up with a plan that makes sense and one you can stomach. For $20, it might be worth trying out for a month.
WhiteMaxima
Posts: 2873
Joined: Thu May 19, 2016 5:04 pm

Re: Can a Roth conversion be reasonable at a 35% tax rate ?

Post by WhiteMaxima »

I will target 12%. next bracket is almost double.
User avatar
arcticpineapplecorp.
Posts: 12036
Joined: Tue Mar 06, 2012 8:22 pm

Re: Can a Roth conversion be reasonable at a 35% tax rate ?

Post by arcticpineapplecorp. »

Roncole wrote: Sun Dec 04, 2022 3:44 pm I believe the the stock market will recover and tax rates will go up. Would a Roth conversion be reasonable this year, and future years, at a 35% tax rate mainly due to large RMDs ?
Depends on the income between now and then.

35% for MFJ (assumed from another of your posts) right now is income:
Over $462,500 but not over $693,750

but when they revert to 2017 levels (in 2026) 35% for MFJ is income:
over $416,700 but not over $470,700

(this all excludes inflation which does change the amounts in each bracket and is unknown)

So if your income is above $470k now (but less than $693k) then you're taxed at 35%, but after 2025 would be taxed at 39.6% when brackets revert.
It's hard to accept the truth when the lies were exactly what you wanted to hear. Investing is simple, but not easy. Buy, hold & rebalance low cost index funds & manage taxable events. Asking Portfolio Questions | Wiki
Post Reply