I've been mulling over Roth conversions and tax management strategies. All the tax planning software I've heard of ignores state tax in the calculations. Maryland offers residents 65 years old or older some interesting tax breaks that I hesitate to ignore.
Here are the tax breaks I am aware of that affect tax planning and Roth conversions.
A) Seniors get to add 1000 to the personal exemption of 3200. The 3200 exemption
phases out as federal income exceeds 100 000, but the 1000 is not affected by income.
B) Social Security income (SS) is not taxed. Nor is Railroad Retirement income (RR). Of course, SS/RR is federally taxable, which affects (C).
C) Pension exclusion. To the extent (39,500 - federally taxed SS) exceeds zero, senior singles can deduct the smaller of that amount, or "retirement income", from state income.
Qualifying retirement income includes defined benefit and defined contribution pension plans, 401(a) plans, 401(k) plans, 403(b) plans, and 457(b) plans. N.B. income from a traditional IRA, a Roth IRA, a simplified employee plan (SEP), a Keogh Plan does not qualify for the pension exclusion.
The amount 39,500 is "indexed to the maximum annual benefit payable under the Social Security Act". I haven't found more detail than that, but the clear implication is this amount will increase over time as SS payouts increase.
D) You can claim a 1000 senior tax credit if your Federal AGI < 100,000. There's no phase out; one penny over, and no senior tax credit for you!
The amount of the senior tax credit can be reduced if the State doesn't meet its revenue targets in a given year.
Implications of these tax breaks:
(1) You could look at (A) and (D) and decide the thing to do is to manipulate your federal AGI below 100 000. That way, you get the senior tax credit and the full 4200 exemption for your state tax return.
(2) Looking at (C), you could say the thing to do is delay claiming SS (or RR) to maximize your pension exclusion. You could also say DO NOT Roth convert all your t401k (or other qualifying accounts) so as to always get a pension exclusion from state income. Nor should you roll all your t401k over to a tIRA.
(3) Again looking at C, you could say delaying SS/RR and Roth converting
(39,500 - pension) each year is a no brainer, as it would be free of state tax.
(4) You could look at (D) and say the thing to do is load up on Muni bonds in your taxable account because that income doesn't increase federal AGI, thereby helping you qualify for the tax credit.
5) You could look at D and say the thing to do is take the senior tax credit while you can before the legislature takes it away. I have no idea how likely this is.
Implications (2) and (3) are straightforward and easy to implement. Implication (4) is easy to do because your total income, federal or state, does not affect your ability to take this deduction. No rocket science needed.
But but but ...
Implication (1) is not easy, at least for me. The bulk of my income is investment income. Pension, Roth conversions, and income from individual stocks I can predict to the dime, but my mutual fund income seems random. It would be very easy to unintentionally go over 100,000. I'd have to sell off mutual funds (oops, additional income!) or forego Roth conversions (is this wise?) to increase my chances of qualifying for the credit.
(6) You could therefore say ignore the senior tax credit when planning a Roth conversion. Convert to top of IRMAA tier, to top of 22% bracket, or 24% bracket, or whatever.
q1) Are implications 1-5 true? Am I missing something here?
q2) Which is better: the 1000 tax credit today, or a Roth conversion and lower RMDs in future? How would you model this mathematically?
q3) Is there software that takes Md taxes and IRMAA tiers into account so I can compare Roth conversions and lower RMDs to the senior tax credit?
Thanks!