Roth Conversion: Does It Make Sense?

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iceport
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Roth Conversion: Does It Make Sense?

Post by iceport » Fri Mar 02, 2018 6:11 pm

Your help is requested in evaluating whether a Roth conversion makes sense for me. Some of the particulars are listed below.

— 56, single, retired
— low end of 22% federal tax bracket, 5% state (pension plus dividend income)
— tax rate on RMDs if/when needed is a tough one. The biggest wild card right now is whether we revert to 2017 rates in 2025 or not. The safest assumption is that RMDs will be taxed at a higher rate than 22%, though it's not clear.
— only 3 accounts so far: 43% taxable; 16% Roth IRA; and 41% trad. 457b (gov. w/fine investment options, low costs)
— plan to collect SS at 62 (i-ORP shows no difference between collecting at 62 vs. 67 for me)

There's a window of opportunity now, before SS and before any tax rate reversion, when a Roth conversion seems most attractive. But I'm still hesitant. In the absence of any clear indication *NOT* to convert, I'm inclined to convert, but only within the current 22% tax bracket.

I've run i-ORP, and was surprised to see that there was no appreciable difference between converting or not. And it only recommended conversions up to age 59, which I think is related to (wrongly) assumed early withdrawal penalties for normal withdrawals. (I couldn't find a way to eliminate early withdrawal penalties for the 457b.)

Do you have any recommendations? Additional considerations?

Your help would be greatly appreciated. Thank you!
"Discipline matters more than allocation.” ─William Bernstein

Dottie57
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Re: Roth Conversion: Does It Make Sense?

Post by Dottie57 » Fri Mar 02, 2018 6:28 pm

To me it would be nice to have a good stash of money that won't be taxed when withdrawn. If you want a trip or new car take the money out without considering taxes you would owe.

Rmd's also impact taxation of SS. So if RMD's are less, less SS raxation (up to a point).


I think converting would also make Tax time easier.

The Wizard
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Re: Roth Conversion: Does It Make Sense?

Post by The Wizard » Fri Mar 02, 2018 6:29 pm

Convert enough each year to get your AGI up close to, but not above what you expect it might be at age 70 and beyond, once RMDs kick in...
Attempted new signature...

retiredjg
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Re: Roth Conversion: Does It Make Sense?

Post by retiredjg » Fri Mar 02, 2018 6:48 pm

I think you might have a little to gain and nothing to lose if you convert during the next several years. This assumes you are not in any phase outs.

If taxes do not revert to the higher rates, you will have lost nothing because things will still be taxed at 22%. If they do revert to the higher rates, you will be a little bit "ahead".

I think I would stop at 62 or not take SS until later because the increased income from the conversion may make more of your SS taxable. However, if you are already past that point, it does not matter.

I don't know why I-orp suggests stopping at 59.


Be cautious when you get to age 63 though. A higher income at 63 can increase the cost of your Medicare Parts B and D at age 65. Look up IRMAA when you get closer to that time.
Last edited by retiredjg on Fri Mar 02, 2018 6:49 pm, edited 1 time in total.

lstone19
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Re: Roth Conversion: Does It Make Sense?

Post by lstone19 » Fri Mar 02, 2018 6:49 pm

Another factor to consider is state taxation. We currently live in Illinois which does not tax 1099-R income of any sort. It's extremely likely we will move after 65 (currently 61 and 60) and it could well be to a state that would tax 1099-R income (or Illinois may start taxing 1099-R income). Therefore, the more we convert now, the less that might have to be paid to a state later. Throw in uncertainty over future federal rates and we're converting to the top of 24% for the next two years after which we'll slow down due to the impact on Medicare premiums. Even with that, I expect there will still be some in tIRAs at 70-1/2 triggering RMDs.

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iceport
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Re: Roth Conversion: Does It Make Sense?

Post by iceport » Fri Mar 02, 2018 7:48 pm

Dottie57 wrote:
Fri Mar 02, 2018 6:28 pm
To me it would be nice to have a good stash of money that won't be taxed when withdrawn. If you want a trip or new car take the money out without considering taxes you would owe.

Rmd's also impact taxation of SS. So if RMD's are less, less SS raxation (up to a point).
Thanks Dottie. I agree completely.

The Wizard wrote:
Fri Mar 02, 2018 6:29 pm
Convert enough each year to get your AGI up close to, but not above what you expect it might be at age 70 and beyond, once RMDs kick in...
That's what I was thinking. In theory, I could take a chance on converting beyond the 22% bracket, but I can't bring myself to make that leap.

retiredjg wrote:
Fri Mar 02, 2018 6:48 pm
I think you might have a little to gain and nothing to lose if you convert during the next several years. This assumes you are not in any phase outs.

If taxes do not revert to the higher rates, you will have lost nothing because things will still be taxed at 22%. If they do revert to the higher rates, you will be a little bit "ahead".
I think you hit the nail on the head, retiredjg. I had that same thought after putting all the info together. Even if there's nothing gained, I'm fairly certain my tax rate will never be lower than it is right now.

lstone19 wrote:
Fri Mar 02, 2018 6:49 pm
Another factor to consider is state taxation.
That's a good point. Unfortunately, that introduces another unknown. Everything is fully taxed in my current state. Pension taxation in the most likely future state (MA) is a little bit complicated. I'll have to look into that one more.


Thanks to all of you for taking the time to review and comment. As much as I've toughened up to market risks, any significant financial decision still requires a certain amount of confidence. It helps to have more eyes checking for blind spots. The level and volume of help on this forum is nothing short of amazing.
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iceport
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Re: Roth Conversion: Does It Make Sense?

Post by iceport » Fri Mar 02, 2018 8:07 pm

A couple of follow-up questions:

1) Mechanics.

Direct 457b -> Roth IRA conversion *OR* rollover to a new tIRA at Vanguard first, and then convert at the same custodian?

Is there any advantage one way or the other? I have no tIRA now, so it would be a "clean" new one, but why bother? The 457b account is 100% tax-deferred.

2) Paying taxes.

I have the option of bumping up the pension W-4 withholding to cover the tax costs for the conversion. Otherwise, I'd need to pay estimated taxes — something I've never done and would rather avoid. Is there any downside to using W-4 withholding instead of paying estimated taxes?
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retiredjg
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Re: Roth Conversion: Does It Make Sense?

Post by retiredjg » Sat Mar 03, 2018 7:24 am

iceport wrote:
Fri Mar 02, 2018 8:07 pm
A couple of follow-up questions:

1) Mechanics.

Direct 457b -> Roth IRA conversion *OR* rollover to a new tIRA at Vanguard first, and then convert at the same custodian?

Is there any advantage one way or the other? I have no tIRA now, so it would be a "clean" new one, but why bother? The 457b account is 100% tax-deferred.
Since you are so young, you might want to keep the 457b because of your ability to take money any time you want for any reason - without a penalty. On the other hand, with a large taxable account, you already have a nice buffer of money available without penalty, so maybe it does not matter.

If you like the plan and it is flexible about withdrawals, why not keep it and give it a try for a year or so? Or even easier, roll part out to tIRA (where you have your Roth IRA) and make your conversions from that IRA. That would be only one transfer from custodian to custodian. After that, the Roth conversions could be done with a few mouse clicks each year.


2) Paying taxes.

I have the option of bumping up the pension W-4 withholding to cover the tax costs for the conversion. Otherwise, I'd need to pay estimated taxes — something I've never done and would rather avoid. Is there any downside to using W-4 withholding instead of paying estimated taxes?
I think bumping up withholding from the pension is a good idea if you have a definite idea of how much you are going to convert and what the tax will be. While figuring that out, stay within the safe harbor rules - I'm not real familiar with this, but I believe if you withhold at least as much as you paid in taxes the previous year, you are not penalized for under-withholding.

https://www.irs.gov/taxtopics/tc306

lstone19
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Re: Roth Conversion: Does It Make Sense?

Post by lstone19 » Sat Mar 03, 2018 8:24 am

iceport wrote:
Fri Mar 02, 2018 8:07 pm
I have the option of bumping up the pension W-4 withholding to cover the tax costs for the conversion. Otherwise, I'd need to pay estimated taxes — something I've never done and would rather avoid. Is there any downside to using W-4 withholding instead of paying estimated taxes?
There really is no need to "avoid" making estimated payments as it can be quite simple. All the paperwork that seems daunting is for your records and there is no need to actually do any of it. The only thing you actually send to the IRS is payment vouchers and they are simply name, SS#, address, and amount of the payment (or pay on-line through EFTPS).

For us, we just want to make sure we hit the 100% (110% for high-income taxpayers) of last year's tax safe-harbor amount. For example, if last year's tax was $20,000, then $5,000 is due by 4/15, a total of $10,000 by 6/15, $15,000 by 9/15, and the full $20,000 by 1/15 of the next year. As 4/15 approaches, get YTD withholding from paystubs, subtract it from $5,000 and send in the difference. As 6/15 approaches, again get YTD withholding from paystubs, subtract it plus the 4/15 estimated payment from $10,000 and send in the difference. Repeat at 9/15 and 1/15. There's no requirement that the estimated payments be equal - you can even skip one if appropriate. Of course, this can be mixed with increased withholding.
Last edited by lstone19 on Sat Mar 03, 2018 8:55 am, edited 1 time in total.

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Re: Roth Conversion: Does It Make Sense?

Post by cherijoh » Sat Mar 03, 2018 8:49 am

retiredjg wrote:
Sat Mar 03, 2018 7:24 am
I think bumping up withholding from the pension is a good idea if you have a definite idea of how much you are going to convert and what the tax will be. While figuring that out, stay within the safe harbor rules - I'm not real familiar with this, but I believe if you withhold at least as much as you paid in taxes the previous year, you are not penalized for under-withholding.

https://www.irs.gov/taxtopics/tc306
At a certain level of income the safe harbor goes from 100% of last years income to 110%. I think the point at which it switches is $150K AGI.

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Re: Roth Conversion: Does It Make Sense?

Post by iceport » Sat Mar 03, 2018 9:14 am

retiredjg wrote:
Sat Mar 03, 2018 7:24 am
Or even easier, roll part out to tIRA (where you have your Roth IRA) and make your conversions from that IRA. That would be only one transfer from custodian to custodian. After that, the Roth conversions could be done with a few mouse clicks each year.
I like this idea — a lot. It wasn't clear in my post, but I never intended a full rollover because I have a decent stable value fund that I want to keep using. (It's paying 2.84 this quarter, and rising.)

I only recently learned that direct conversions into a Roth IRA were possible, and thought that might be a nice way to avoid opening up a fourth type of account. But I stress about the coordination between the two custodians, so the idea of doing it once for several years' worth of conversions is very appealing. Funds could even be rolled back in the other direction from the tIRA, according to Prudential.
retiredjg wrote:
Sat Mar 03, 2018 7:24 am
I think bumping up withholding from the pension is a good idea if you have a definite idea of how much you are going to convert and what the tax will be. While figuring that out, stay within the safe harbor rules - I'm not real familiar with this, but I believe if you withhold at least as much as you paid in taxes the previous year, you are not penalized for under-withholding.

https://www.irs.gov/taxtopics/tc306
I should be able to get real close with the withholding. I just sent in a new state W-4 to the pension payer, so I can just send in a revised state and new federal W-4. If I send it soon, it should take effect for the end of April payment. And I have no problem erring on the side of too much withholding.

Thank you, retiredjg.
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iceport
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Re: Roth Conversion: Does It Make Sense?

Post by iceport » Sat Mar 03, 2018 9:32 am

lstone19 wrote:
Sat Mar 03, 2018 8:24 am
iceport wrote:
Fri Mar 02, 2018 8:07 pm
I have the option of bumping up the pension W-4 withholding to cover the tax costs for the conversion. Otherwise, I'd need to pay estimated taxes — something I've never done and would rather avoid. Is there any downside to using W-4 withholding instead of paying estimated taxes?
There really is no need to "avoid" making estimated payments as it can be quite simple. All the paperwork that seems daunting is for your records and there is no need to actually do any of it. The only thing you actually send to the IRS is payment vouchers and they are simply name, SS#, address, and amount of the payment (or pay on-line through EFTPS).

For us, we just want to make sure we hit the 100% (110% for high-income taxpayers) of last year's tax safe-harbor amount. For example, if last year's tax was $20,000, then $5,000 is due by 4/15, a total of $10,000 by 6/15, $15,000 by 9/15, and the full $20,000 by 1/15 of the next year. As 4/15 approaches, get YTD withholding from paystubs, subtract it from $5,000 and send in the difference. As 6/15 approaches, again get YTD withholding from paystubs, subtract it plus the 4/15 estimated payment from $10,000 and send in the difference. Repeat at 9/15 and 1/15. There's no requirement that the estimated payments be equal - you can even skip one if appropriate. Of course, this can be mixed with increased withholding.
lstone19,

Was that to cover a rollover, or just income spread throughout the year?

I did some searching here before I posted, and there was talk about the need for a Form 2210 Sched. AI, to notify the IRS of the timing of the Roth conversion, and then send in a single payment? Something about keeping the estimated tax payments in the same quarter as the conversion? It gets fuzzy. :?

Alternatively, if the IRS just gets a 1099-R at tax time, and enough taxes had been paid to cover it throughout the year, they just assume everything was distributed throughout the year, or they don't care...(?)

I'm definitely leaning towards staying with the familiar, which is a couple of simple W-4s sent in to my payer, with whom I have already established a line of communication. A scanned W-4 sent via email worked last time.

Thanks for the encouragement, but the estimated tax process related to rollovers is still a little unclear.
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Re: Roth Conversion: Does It Make Sense?

Post by lstone19 » Sat Mar 03, 2018 2:43 pm

Form 2210AI is essentially a last resort way of avoiding the penalty. There is no need to fill one out, even if your income wasn't evenly distributed through the year, unless it's the only way to avoid or reduce a penalty.

The IRS will assume that all income was evenly distributed through the year and that all withholding was also evenly distributed through the year. Estimated payments are considered made on the actual date (which they know). So the first thing is to see if you meet any of the safe harbor tests: paid 100% (110%) of previous year's tax, paid 90% of current year's tax, or owe less than $1,000 after withholding amounts. The IRS knows how much was withheld and the dates of estimated payments so if you meet any of those, the IRS knows you're exempt from a penalty automatically and you don't even file 2210.

If that doesn't avoid a penalty, the next easiest is to have withholding considered by actual date rather than assumed evenly distributed. This could be useful if you have a large first quarter bonus and 40% of your withholding for the year occurred in the first quarter. You show the actual amounts by quarter (which for IRS purposes are the periods ending 4/15, 6/15, 9/15, and 12/31) and keep paystubs or equivalent as proof (no need to send). If there's an excess in one quarter, it carries through to the next (essentially, each quarter is checked with YTD numbers).

Only if none of these have worked would you get to doing annualized income (actual date of income). And with proper planning, that should only happen if you have large late in the year unexpected income (e.g. lottery winnings). And then yes, it can be complicated.

For us, we're doing conversions spread across the year plus I have self-employment income. But it really doesn't matter. We could have done all the planned conversion on Jan 2 and the IRS will still assume the income was spread across the year. The IRS is not going to come to us and say "you did the conversion in January; why didn't you make a big estimated payment that month". Income can be annualized or assumed evenly distributed - whichever is more advantageous for you. Withholding can be by actual date or assumed evenly distributed - whichever is more advantageous for you. Estimate payments are just payments - you do not include anything about why you're sending it or what specific income it's for as in the end, it's all just one big pool of money.

Back to my original example, if last year's tax was $20,000 and I had no withholding this year, I could simply make $5,000 estimated payments on 4/15, 6/15, 9/15, and 1/15 and I would have met my payment obligation. The IRS, seeing the estimated payments on those dates, would automatically see that I met the safe-harbor test with no 2210 involved. Send any balance on next year's 4/15 and I'm done.

That all said, I noticed this year, because TurboTax (desktop) had all my income before entering estimated payments, at an intermediate point it was including a 2210 and 2210AI in my return. It seemed to be defaulting to 2210AI before checking easier exemptions. Bad on TT, particularly since I had to manually delete the 2210AI (although maybe it eventually would have deleted it). As I said, 2210AI should be a last resort at avoiding or reducing a penalty. TT will ask about actual dates of withholding to see if that eliminates or reduces a penalty.

2210 is not actually that complicated a form as most of the lines are calculations. The only things you really need to know is the previous year's tax, dates and amounts of estimated payments, and dates and amounts of actual withholding if you go that direction.

That all said, I understand the ease of increasing withholding. But you have to get that right or you still could be in an underpayment situation if you don't check that the increased withholding will actually get you to where you need to be. I have a spreadsheet - YTD numbers get entered off paystubs, it has last year's 100%(110%) number, and estimated payments get entered as well, and it tells me how much I need to pay at the next date to meet the 100%(110%) safe harbor test. Just before 4/15, I'll set up that payment on EFTPS and I'm done. Repeat two months later for 6/15 and then again for 9/15 and 1/15.

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Re: Roth Conversion: Does It Make Sense?

Post by iceport » Sat Mar 03, 2018 3:45 pm

Wow, that was a mouthful! Thanks for trying to educate me on this, lstone19. This is all totally new to me, and I'm struggling to catch up...

I just retired last year, so this year's withholding will be a small fraction of last year's. If I do, say, a $35k conversion this year, the federal tax associated with that is $7,700. So there's no way I'll meet the safe harbor tests unless I do something — with either a W-4 or estimated payments.

So this caught my attention:
lstone19 wrote:
Sat Mar 03, 2018 2:43 pm
Estimate payments are just payments - you do not include anything about why you're sending it or what specific income it's for as in the end, it's all just one big pool of money.
Okay, this might seem naive, but it makes sense intuitively: Say I convert $35k in March 2018, and will owe $7,700 in the 22% bracket for that distribution.

Option 1:

Can I just send in a single check for $7,700 with Payment Voucher 1 in April 2018 and call it a day, never send another one? That would cover the rollover, and the withholding will cover all other income for the year. The IRS will have all the cash they need by the end of the year. Is that an option?

Option 2: I had a large lump sum payment when I stopped working last year, and they withheld way too much. I didn't stress about it because I knew I'd get it back about now. Well, the refund I'm due this year will just about cover the tax on the Roth conversion. Can I just have the IRS apply that refund to my "account" towards my 2018 estimated tax, and then never bother with any other paperwork? As with Option 1, they'd have all the cash they'll be looking for by the end of the year.
Last edited by iceport on Sat Mar 03, 2018 3:57 pm, edited 1 time in total.
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Re: Roth Conversion: Does It Make Sense?

Post by retired early&luv it » Sat Mar 03, 2018 3:54 pm

Most years since I retired, I converted some of my Rollover IRA to the Roth. That IRA started out as a 457 plan that I converted to the Rollover IRA after I retired. I moved the 457 to the Rollover IRA so that it would be easier to do a bit of a conversion each year. Can do that on-line at Vanguard quite easily.

Each year I estimated my tax rates using Turbo Tax Taxcaster (free) by entering my data and doing "what ifs" for various conversion strategies. I finished my conversion in December last year, I have now converted all of it. Thus, I will not have any RMDs.

I am 64, have not started taking social security yet, in part I did not want the social security income to increase my taxable income before I finished my conversions. I accelerated my conversion last year because it looks like in future years I will be in a 32 percent bracket, I want to get that down to the 24 percent bracket.

I also was trying to keep my income lower after I was old enough for the income to impact my medicare premiums, that is one reason I converted it faster than was otherwise really necessary.

A side note on Taxcaster, I found the Android App version worked better for me the past few years than the online version on my lap top.

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Re: Roth Conversion: Does It Make Sense?

Post by iceport » Sat Mar 03, 2018 4:03 pm

retired early&luv it wrote:
Sat Mar 03, 2018 3:54 pm
Most years since I retired, I converted some of my Rollover IRA to the Roth. That IRA started out as a 457 plan that I converted to the Rollover IRA after I retired. I moved the 457 to the Rollover IRA so that it would be easier to do a bit of a conversion each year. Can do that on-line at Vanguard quite easily.

Each year I estimated my tax rates using Turbo Tax Taxcaster (free) by entering my data and doing "what ifs" for various conversion strategies. I finished my conversion in December last year, I have now converted all of it. Thus, I will not have any RMDs.

I am 64, have not started taking social security yet, in part I did not want the social security income to increase my taxable income before I finished my conversions. I accelerated my conversion last year because it looks like in future years I will be in a 32 percent bracket, I want to get that down to the 24 percent bracket.

I also was trying to keep my income lower after I was old enough for the income to impact my medicare premiums, that is one reason I converted it faster than was otherwise really necessary.

A side note on Taxcaster, I found the Android App version worked better for me the past few years than the online version on my lap top.
Thanks, retired early! Sounds like I'll be following in your footsteps. It's all starting to make sense.

The most complicated part now is how to pay the $^#^@& tax! If I may ask, what method did you use to cover the expected tax?
"Discipline matters more than allocation.” ─William Bernstein

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Re: Roth Conversion: Does It Make Sense?

Post by JBTX » Sat Mar 03, 2018 4:06 pm

iceport wrote:
Sat Mar 03, 2018 3:45 pm
Wow, that was a mouthful! Thanks for trying to educate me on this, lstone19. This is all totally new to me, and I'm struggling to catch up...

I just retired last year, so this year's withholding will be a small fraction of last year's. If I do, say, a $35k conversion this year, the federal tax associated with that is $7,700. So there's no way I'll meet the safe harbor tests unless I do something — with either a W-4 or estimated payments.

So this caught my attention:
lstone19 wrote:
Sat Mar 03, 2018 2:43 pm
Estimate payments are just payments - you do not include anything about why you're sending it or what specific income it's for as in the end, it's all just one big pool of money.
Okay, this might seem naive, but it makes sense intuitively: Say I convert $35k in March 2018, and will owe $7,700 in the 22% bracket for that distribution.

Option 1:

Can I just send in a single check for $7,700 with Payment Voucher 1 in April 2018 and call it a day, never send another one? That would cover the rollover, and the withholding will cover all other income for the year. The IRS will have all the cash they need by the end of the year. Is that an option?

Option 2: I had a large lump sum payment when I stopped working last year, and they withheld way too much. I didn't stress about it because I knew I'd get it back about now. Well, the refund I'm due this year will just about cover the tax on the Roth conversion. Can I just have the IRS apply that refund to my "account" towards my 2018 estimated tax, and then never bother with any other paperwork? As with Option 1, they'd have all the cash they'll be looking for by the end of the year.
As to your timing question just doing one payment at the beginning of year should be fine, provided it is enough. The opposite, if you had the income and did the payment at the end of the year, may require marginally more work, as the irs by default assumes revenue is recognized evenly throughout the year and if you paid all of your taxes at the end of the year you could run into penalties. However you can fill
Out additional form to show the actual timing of your tax payments. Most tax software will easily help you with this.

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Re: Roth Conversion: Does It Make Sense?

Post by iceport » Sat Mar 03, 2018 4:15 pm

JBTX wrote:
Sat Mar 03, 2018 4:06 pm
As to your timing question just doing one payment at the beginning of year should be fine, provided it is enough. The opposite, if you had the income and did the payment at the end of the year, may require marginally more work, as the irs by default assumes revenue is recognized evenly throughout the year and if you paid all of your taxes at the end of the year you could run into penalties. However you can fill
Out additional form to show the actual timing of your tax payments. Most tax software will easily help you with this.
Thanks, JBTX. From what you say, the timing of the payment does matter.

The more I think about this, the more I like the idea of using the W-4 route. That lets me pocket this year's refund and earn a little interest as the withholding slowly pays the tax liability. I should be able to spread the tax out over the last 9 months, April thru December.
"Discipline matters more than allocation.” ─William Bernstein

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Re: Roth Conversion: Does It Make Sense?

Post by JBTX » Sat Mar 03, 2018 4:19 pm

iceport wrote:
Sat Mar 03, 2018 4:15 pm
JBTX wrote:
Sat Mar 03, 2018 4:06 pm
As to your timing question just doing one payment at the beginning of year should be fine, provided it is enough. The opposite, if you had the income and did the payment at the end of the year, may require marginally more work, as the irs by default assumes revenue is recognized evenly throughout the year and if you paid all of your taxes at the end of the year you could run into penalties. However you can fill
Out additional form to show the actual timing of your tax payments. Most tax software will easily help you with this.
Thanks, JBTX. From what you say, the timing of the payment does matter.

The more I think about this, the more I like the idea of using the W-4 route. That lets me pocket this year's refund and earn a little interest as the withholding slowly pays the tax liability. I should be able to spread the tax out over the last 9 months, April thru December.
The timing doesn't matter if you made the payment at the beginning of the year. It would matter if you made it at the end of the year.
Last edited by JBTX on Sat Mar 03, 2018 4:25 pm, edited 1 time in total.

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Re: Roth Conversion: Does It Make Sense?

Post by JBTX » Sat Mar 03, 2018 4:24 pm

As to your OP question, it seems like the chances that your income tax rate will eventually go up are greater than it going down. You are already at 22% with no income from work.

1. As you indicate, in 2026 tax rates are scheduled to go up. Maybe they will maybe they won’t, but the odds of them going up seem higher than them going down.

2. Once you start pulling social security that has an impact. I don’t know if you are married and don’t know how much your SS payout will be but the odds are high that the SS impact will drive your marginal rate even higher. If you wish to divulge that info i can plug it into my version of “The Hump”

Seems to me doing conversations at 22% probably makes sense for you.

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Re: Roth Conversion: Does It Make Sense?

Post by iceport » Sat Mar 03, 2018 5:26 pm

JBTX wrote:
Sat Mar 03, 2018 4:24 pm
As to your OP question, it seems like the chances that your income tax rate will eventually go up are greater than it going down. You are already at 22% with no income from work.

1. As you indicate, in 2026 tax rates are scheduled to go up. Maybe they will maybe they won’t, but the odds of them going up seem higher than them going down.

2. Once you start pulling social security that has an impact. I don’t know if you are married and don’t know how much your SS payout will be but the odds are high that the SS impact will drive your marginal rate even higher. If you wish to divulge that info i can plug it into my version of “The Hump”

Seems to me doing conversations at 22% probably makes sense for you.
Thanks. I appreciate your thoughts.

My latest statement says SS will be $32,300 annual at FRA (67), but that's high because it assumes I keep working, but I retired at 55. When I used the online calculator that specifically calculates the benefit at 62 with work ending at 55, based on my actual earnings history, the estimate is $22,250 annual.

The 22% bracket is actually fairly wide now...
"Discipline matters more than allocation.” ─William Bernstein

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Re: Roth Conversion: Does It Make Sense?

Post by lstone19 » Sat Mar 03, 2018 9:57 pm

iceport wrote:
Sat Mar 03, 2018 3:45 pm
Wow, that was a mouthful! Thanks for trying to educate me on this, lstone19. This is all totally new to me, and I'm struggling to catch up...

I just retired last year, so this year's withholding will be a small fraction of last year's. If I do, say, a $35k conversion this year, the federal tax associated with that is $7,700. So there's no way I'll meet the safe harbor tests unless I do something — with either a W-4 or estimated payments.

So this caught my attention:
lstone19 wrote:
Sat Mar 03, 2018 2:43 pm
Estimate payments are just payments - you do not include anything about why you're sending it or what specific income it's for as in the end, it's all just one big pool of money.
Okay, this might seem naive, but it makes sense intuitively: Say I convert $35k in March 2018, and will owe $7,700 in the 22% bracket for that distribution.

Option 1:

Can I just send in a single check for $7,700 with Payment Voucher 1 in April 2018 and call it a day, never send another one? That would cover the rollover, and the withholding will cover all other income for the year. The IRS will have all the cash they need by the end of the year. Is that an option?

Option 2: I had a large lump sum payment when I stopped working last year, and they withheld way too much. I didn't stress about it because I knew I'd get it back about now. Well, the refund I'm due this year will just about cover the tax on the Roth conversion. Can I just have the IRS apply that refund to my "account" towards my 2018 estimated tax, and then never bother with any other paperwork? As with Option 1, they'd have all the cash they'll be looking for by the end of the year.
Sorry, I’ve been out all day.

Re: Option 1. As others have already responded, yes, you can make one payment in April 2018 and not send anymore. The IRS will not write to you saying “you made an estimated payment on 4/15, where’s the 6/15 payment?”. As I said before, any excess in one quarter rolls forward automatically (as can be seen on Form 2210) to meet the next quarter’s requirement.

Re: Option 2. Yes, you can have a refund applied to the next year’s estimated tax. There’s a spot on Form 1040 to indicate how much of your refund you want applied to estimated (it does not have to be the whole thing). Any such amount will be considered as being a 4/15 estimated payment, even if you get an extension and don’t file until later in the year (which makes sense since the IRS had the money on 4/15).
Last edited by lstone19 on Sun Mar 04, 2018 7:52 am, edited 1 time in total.

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iceport
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Re: Roth Conversion: Does It Make Sense?

Post by iceport » Sun Mar 04, 2018 2:08 am

lstone19 wrote:
Sat Mar 03, 2018 9:57 pm
iceport wrote:
Sat Mar 03, 2018 3:45 pm
Wow, that was a mouthful! Thanks for trying to educate me on this, lstone19. This is all totally new to me, and I'm struggling to catch up...

I just retired last year, so this year's withholding will be a small fraction of last year's. If I do, say, a $35k conversion this year, the federal tax associated with that is $7,700. So there's no way I'll meet the safe harbor tests unless I do something — with either a W-4 or estimated payments.

So this caught my attention:
lstone19 wrote:
Sat Mar 03, 2018 2:43 pm
Estimate payments are just payments - you do not include anything about why you're sending it or what specific income it's for as in the end, it's all just one big pool of money.
Okay, this might seem naive, but it makes sense intuitively: Say I convert $35k in March 2018, and will owe $7,700 in the 22% bracket for that distribution.

Option 1:

Can I just send in a single check for $7,700 with Payment Voucher 1 in April 2018 and call it a day, never send another one? That would cover the rollover, and the withholding will cover all other income for the year. The IRS will have all the cash they need by the end of the year. Is that an option?

Option 2: I had a large lump sum payment when I stopped working last year, and they withheld way too much. I didn't stress about it because I knew I'd get it back about now. Well, the refund I'm due this year will just about cover the tax on the Roth conversion. Can I just have the IRS apply that refund to my "account" towards my 2018 estimated tax, and then never bother with any other paperwork? As with Option 1, they'd have all the cash they'll be looking for by the end of the year.
Sorry, I’ve been out all day.

Re: Option 1. As others have already responded, yes, you can make one payment in April 2018 and not send anymore. The IRS will not write to you saying “you made an estimated payment on 4/15, where’s the 6/15 payment?”. As I said before, any excess in one quarter rolls forward automatically (as can be seen on Form 2210) to meet the next quarter’s requirement.

Re: Option 2. Yes, you can have a refund applied to the next year’s estimated tax. There’s a spot on Form 1040 to indicate how much of your refund you want applied to estimated (it does not have to be the whole thing). Any such amount will be considered as being a 4/15 estimated payment, even if you get an extension and don’t file until later in the year (which makes sense the IRS had the money on 4/15).
Thank you! That helps.
"Discipline matters more than allocation.” ─William Bernstein

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Re: Roth Conversion: Does It Make Sense?

Post by SGM » Sun Mar 04, 2018 5:02 am

I converted all of my tax deferred accounts to Roth accounts over a period of several years before starting delayed SS. I had slightly lower income due to cutting back work then retiring. RMDs at 70 1/2 would put me in a higher bracket even with the recent tax changes. I also have additional Medicare parts B and D costs.

It is very nice to have accounts that will not be taxed. My current taxable dividends are less than they would have been if I had not paid the taxes for conversions out of a taxable account.The advantage is small but will be much larger after age 70 1/2 when RMDs kick in.

Since most of our stressors are related to taxation and local government regulations any decrease in complexity is a very welcome thing. RMDs can be made automatic, but I think would be an expensive annoyance as we aged.

I also realized that there is no loss of purchasing power at the time of conversion when taxes were paid out of a taxable account. This also made the conversions more palatable. No loss of purchasing power is something most advisors reportedly do not understand.

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Re: Roth Conversion: Does It Make Sense?

Post by lstone19 » Sun Mar 04, 2018 8:10 am

All of this discussion had me double-checking my own assumptions. Both my wife and I are currently planning to wait until age 70 to draw SS and we expect near maximum SS benefits. Once RMDs are factored in, we are deep into 12% with SS taxation phasing in at 85% (a dollar of additional other income subjects another $0.85 of SS to taxation until you reach the maximum 85% of SS being taxed) so effectively a 22.2% marginal rate (and if any dollars end up taxed at 22% while phasing in SS taxation, that's an effective 40.7% marginal rate on those dollars). And by the time we reach maximum SS taxation, we'd be in 22%. And all this at today's rates - who knows what they'll be in 2028 when we're both 70-1/2. Throw in other uncertainty (including moving to a state that will tax some or all of this unlike our current state) and I think converting as much as possible, as we're doing, up to the top of 24% is not a bad decision.

Throw in Medicare premiums and that whole mess, having a good pool of Roth dollars before we reach 63 (two year lead time on income for Medicare premium purposes) gives us flexibility later on - even though we plan to leave Roth until last, it may make sense to draw some earlier while there are still tIRA funds in order to reduce that year's taxable income.

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Re: Roth Conversion: Does It Make Sense?

Post by iceport » Sun Mar 04, 2018 11:51 am

SGM wrote:
Sun Mar 04, 2018 5:02 am
I also realized that there is no loss of purchasing power at the time of conversion when taxes were paid out of a taxable account. This also made the conversions more palatable. No loss of purchasing power is something most advisors reportedly do not understand.
SMG, could you elaborate on that last point? I'm not sure I follow you.

Thanks!
"Discipline matters more than allocation.” ─William Bernstein

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Re: Roth Conversion: Does It Make Sense?

Post by iceport » Sun Mar 04, 2018 11:56 am

lstone19 wrote:
Sun Mar 04, 2018 8:10 am
All of this discussion had me double-checking my own assumptions. Both my wife and I are currently planning to wait until age 70 to draw SS and we expect near maximum SS benefits. Once RMDs are factored in, we are deep into 12% with SS taxation phasing in at 85% (a dollar of additional other income subjects another $0.85 of SS to taxation until you reach the maximum 85% of SS being taxed) so effectively a 22.2% marginal rate (and if any dollars end up taxed at 22% while phasing in SS taxation, that's an effective 40.7% marginal rate on those dollars). And by the time we reach maximum SS taxation, we'd be in 22%. And all this at today's rates - who knows what they'll be in 2028 when we're both 70-1/2. Throw in other uncertainty (including moving to a state that will tax some or all of this unlike our current state) and I think converting as much as possible, as we're doing, up to the top of 24% is not a bad decision.

Throw in Medicare premiums and that whole mess, having a good pool of Roth dollars before we reach 63 (two year lead time on income for Medicare premium purposes) gives us flexibility later on - even though we plan to leave Roth until last, it may make sense to draw some earlier while there are still tIRA funds in order to reduce that year's taxable income.
Sounds like in the end, your plan proved to be solid all along.

Your example got me curious to review the MFJ tax brackets, and it gave me bracket envy. :shock: Whatever marriage penalty there might have been earlier in life, it seems to go away for you in retirement. There's no way a retired married couple needs to spend twice as much as a single person to maintain the same lifestyle.
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Re: Roth Conversion: Does It Make Sense?

Post by SGM » Sun Mar 04, 2018 1:15 pm

iceport wrote:
Sun Mar 04, 2018 11:51 am
SGM wrote:
Sun Mar 04, 2018 5:02 am
I also realized that there is no loss of purchasing power at the time of conversion when taxes were paid out of a taxable account. This also made the conversions more palatable. No loss of purchasing power is something most advisors reportedly do not understand.
SMG, could you elaborate on that last point? I'm not sure I follow you.

Thanks!
Assume you are in the 25% tax bracket at the time of conversion. You have $100k in a traditional IRA and $25k in a taxable account. You can only purchase $75k from the IRA plus $25k from taxable (assume cash) for spending power of $100k immediately prior to conversion

At the time of conversion you convert all of the $100k in the traditonal IRA to a Roth IRA and you pay the $25k out of taxable cash. You are left with a Roth of $100k and $0.00 in taxable. You still have a purchasing power of $100k.

$100k in tIRA+ $25k in taxable is equivalent to $100k in a Roth and nothing in taxable in terms of what you can purchase with it on the day of conversion. There is no change in the amount of goods you can purchase despite the total being $25k less. This is what happens at the immediate moment when you convert and pay the taxes out of a taxable account.

Some think well I had $125k and now I have $100k. Yes this is true but the amount of goods you can buy is exactly the same when you convert. Going forward your $100k grows tax free.

I would not have made the conversions if I did not have the money in taxable to pay the taxes due. For a more extensive explanation see the Roth Revolution by James Lange.

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Re: Roth Conversion: Does It Make Sense?

Post by iceport » Sun Mar 04, 2018 2:13 pm

SGM wrote:
Sun Mar 04, 2018 1:15 pm
iceport wrote:
Sun Mar 04, 2018 11:51 am
SGM wrote:
Sun Mar 04, 2018 5:02 am
I also realized that there is no loss of purchasing power at the time of conversion when taxes were paid out of a taxable account. This also made the conversions more palatable. No loss of purchasing power is something most advisors reportedly do not understand.
SMG, could you elaborate on that last point? I'm not sure I follow you.

Thanks!
Assume you are in the 25% tax bracket at the time of conversion. You have $100k in a traditional IRA and $25k in a taxable account. You can only purchase $75k from the IRA plus $25k from taxable (assume cash) for spending power of $100k immediately prior to conversion

At the time of conversion you convert all of the $100k in the traditonal IRA to a Roth IRA and you pay the $25k out of taxable cash. You are left with a Roth of $100k and $0.00 in taxable. You still have a purchasing power of $100k.

$100k in tIRA+ $25k in taxable is equivalent to $100k in a Roth and nothing in taxable in terms of what you can purchase with it on the day of conversion. There is no change in the amount of goods you can purchase despite the total being $25k less. This is what happens at the immediate moment when you convert and pay the taxes out of a taxable account.

Some think well I had $125k and now I have $100k. Yes this is true but the amount of goods you can buy is exactly the same when you convert. Going forward your $100k grows tax free.

I would not have made the conversions if I did not have the money in taxable to pay the taxes due. For a more extensive explanation see the Roth Revolution by James Lange.
Thanks SGM. Of course, I agree with everything you say above.

I would just like to add one point of clarification. On the day of conversion, it doesn't matter if the tax payment comes from the taxable account or the Roth. The immediate spending power is the same either way. ($25k taxable + $75k Roth = 0 taxable + $100k Roth)

The big benefit of paying from taxable is the tax treatment moving forward. In essence, paying from taxable "converts" taxable space into tax-advantaged space. Would you agree?
"Discipline matters more than allocation.” ─William Bernstein

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Re: Roth Conversion: Does It Make Sense?

Post by SGM » Sun Mar 04, 2018 5:06 pm

Iceport,

I agree with you. There is an advantage for changing the taxable and the traditional into a never taxed Roth. There is a slight advantage in a little less dividend taxation by lowering the taxable account, by paying taxes. But the biggest advantage is after the RMDs come due. Large RMDs can increase your taxes and increase your Medicare payments. I expect the real benefit for me will be after age 70 1/2.

Paying the taxes out of the tIRA instead of taxable would diminish the opportunity to have a really large non-taxable account as you age and as it hopefully compounds.

Best of luck
SGM

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Re: Roth Conversion: Does It Make Sense?

Post by R. ANDERSON » Tue Mar 13, 2018 5:31 pm

In case you didn't know, if you tap the roth ira before five years is up, you will pay a 10% penalty :(

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iceport
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Re: Roth Conversion: Does It Make Sense?

Post by iceport » Thu Mar 15, 2018 1:13 pm

R. ANDERSON wrote:
Tue Mar 13, 2018 5:31 pm
In case you didn't know, if you tap the roth ira before five years is up, you will pay a 10% penalty :(
Yes and no... The Roth IRA is an old one, and there have been lots of regular contributions made over the last 20 years. My understanding is that those would be distributed before any conversion amounts. So there should be plenty of room for withdrawals before I start running into the conversion.

But thank you for the heads-up reminder. I just read up on that out of curiosity, even though I don't anticipate any withdrawals prior to 59.5.
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Re: Roth Conversion: Does It Make Sense?

Post by iceport » Thu Mar 15, 2018 1:35 pm

I just wanted to thank all of you for your help with this. It has been invaluable!

I started the partial rollover process on 3/5/2018, initiated a partial conversion on 3/12/2018, and all accounts were in-place and rebalanced by the close of business on 3/13/2018 — only 8 calendar days, or 6 business days.

Now the only funds owned in the 457b account are a stable value fund and a buffer allocated to a Vanguard total bond market fund.

I rolled over (pre-tax 457b ---> tIRA) just about how much I think I will ever be converting to the Roth IRA. I think I'll use state W-4 withholding to cover the state taxes, and estimated payments to cover the federal taxes. The federal taxes will be paid with a combination of a 2017 refund and first quarter 2018 estimated payment. I've got some reading of prior threads on the forum to figure out how I want to make — and monitor — payments to the IRS.

The process was not without a mishap, however. It ended up costing me about $400. Who knew the roughly $12,000 of US REITs sold on 3/5/2018 in the 457b would have risen 3.5% by the time they were re-purchased on 3/5/2018 in the Roth IRA. :annoyed I just never figured it was worth paying attention to the minor dollar amount. That cost really drove home the benefit of having the rollover tIRA at Vanguard, where future conversions and rebalancing can happen on the same day.

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