Convert to Roth for lower taxes or keep it invested?

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JohnHace
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Convert to Roth for lower taxes or keep it invested?

Post by JohnHace » Sat Aug 01, 2020 12:48 pm

I'm 72, married and I own a small company. I love my work so no plan to sell the business or retire. I'm very healthy so I plan to work many more years. My income is ~$800K. No pension or annuity. $5.3M IRA. $4.0M taxable account with $2.4M gains. I fear taxes are going higher. I'm wondering if I should take action this year. Convert some, most or all of the IRA to Roth? I imagime the tax bill for total conversion will be over $2M. To pay that, I would sell most or all the stock in the taxable. The gains are all long-term but that could generate additional taxes of $.5M. It seems I would end up with $5M in Roth and $1.5M in taxable. My state income tax is 5.75%. I can't help but wonder if its better to pay $2.5M in taxes now for the lower rates or keep it invested and try to earn more than the future tax increases will take? Am I missing anything? I appreciate your help.

02nz
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Re: Convert to Roth for lower taxes or keep it invested?

Post by 02nz » Sat Aug 01, 2020 1:06 pm

Your high income means that the tax cost will be very high. If and when you do retire and income drops, the tax cost will be lower (even if tax rates go up to pre-TCJA rates) because you'll fill up the lower tax brackets first.

If there's any possibility of passing the taxable holdings on to heirs and/or charity, then I would not take the tax hit now, and hold out instead for a step-up in basis and/or donate appreciated shares.

drzzzzz
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Re: Convert to Roth for lower taxes or keep it invested?

Post by drzzzzz » Sat Aug 01, 2020 1:17 pm

You are certainly in an enviable situation. Does you income include the RMD from your IRA which I quickly calculate is likely more than $200,000 a year and will increase each year. You are likely always going to be in a high tax bracket based upon your income and retirement savings and unless you are planning to gift much of your IRA in the future I would consider doing some ROTH conversions now. I would also consider what happens should you die and if the IRA assets are left to children, for example, since they will be required to spend down the IRA over 10 years and it could vastly impact their tax brackets as well.

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FiveK
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Re: Convert to Roth for lower taxes or keep it invested?

Post by FiveK » Sat Aug 01, 2020 1:39 pm

Roth conversion strategy is all about comparing marginal rates on conversions now vs. marginal rates on conversions (yours or heirs) later.

Your situation is somewhat complicated by taxes on capital gains that might not occur to your heirs. On the other hand, effectively moving money from taxable to Roth has a benefit, particularly for Very high earners.

See that link, and the rest of that wiki article, for details.

02nz
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Re: Convert to Roth for lower taxes or keep it invested?

Post by 02nz » Sat Aug 01, 2020 1:40 pm

drzzzzz wrote:
Sat Aug 01, 2020 1:17 pm
You are certainly in an enviable situation. Does you income include the RMD from your IRA which I quickly calculate is likely more than $200,000 a year and will increase each year. You are likely always going to be in a high tax bracket based upon your income and retirement savings and unless you are planning to gift much of your IRA in the future I would consider doing some ROTH conversions now. I would also consider what happens should you die and if the IRA assets are left to children, for example, since they will be required to spend down the IRA over 10 years and it could vastly impact their tax brackets as well.
200K of income means paying an average of around 15% federal income tax for a married couple. Roth conversions in the OP's current situation, however, mean 37% federal income tax.

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JohnHace
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Re: Convert to Roth for lower taxes or keep it invested?

Post by JohnHace » Sat Aug 01, 2020 1:55 pm

The income I mentioned was for 2019. My RMD for that year was $107K. I did a QCD of $67K to my church so only $40K went to taxable. It seemed like a good year this year to do a Roth since I believe we have no RMD this year.

Alan S.
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Re: Convert to Roth for lower taxes or keep it invested?

Post by Alan S. » Sat Aug 01, 2020 2:58 pm

JohnHace wrote:
Sat Aug 01, 2020 1:55 pm
The income I mentioned was for 2019. My RMD for that year was $107K. I did a QCD of $67K to my church so only $40K went to taxable. It seemed like a good year this year to do a Roth since I believe we have no RMD this year.
While your IRA probably grew plenty in 2019 to 5.3mm now, the 107k still seems quite low for your 2019 RMD. If you did a QCD in 2019, you had to have reached 70.5 in that year. Did you distribute the last 40k of your 2019 RMD (if that is the correct amount) in 2019 also? Are you sure the 107k figure was correct?

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JohnHace
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Re: Convert to Roth for lower taxes or keep it invested?

Post by JohnHace » Sat Aug 01, 2020 4:00 pm

Yes, $107K was correct. My IRA on 12/31/18 was $2.854M. 2019 was good ending at $3.68M. This year is smoking hot at $5.3M. I'm mostly in tech stocks, Tesla, Netflix, Amazon, Apple, etc.

123
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Re: Convert to Roth for lower taxes or keep it invested?

Post by 123 » Sat Aug 01, 2020 4:28 pm

JohnHace wrote:
Sat Aug 01, 2020 12:48 pm
...$5.3M IRA. $4.0M taxable account with $2.4M gains... Convert some, most or all of the IRA to Roth? I imagime the tax bill for total conversion will be over $2M. To pay that, I would sell most or all the stock in the taxable. The gains are all long-term but that could generate additional taxes of $.5M. It seems I would end up with $5M in Roth and $1.5M in taxable. My state income tax is 5.75%. I can't help but wonder if its better to pay $2.5M in taxes now for the lower rates or keep it invested and try to earn more than the future tax increases will take? Am I missing anything? I appreciate your help.
It doesn't really seem to make much sense to lose over half of your taxable account to pay the taxes on a Roth conversion, particularly if you plan to keep on working with your business with continuing taxes. Just consider yourself very fortunate and continue paying the taxes. Many people would be glad to be in your position.
The closest helping hand is at the end of your own arm.

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FiveK
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Re: Convert to Roth for lower taxes or keep it invested?

Post by FiveK » Sat Aug 01, 2020 7:33 pm

123 wrote:
Sat Aug 01, 2020 4:28 pm
JohnHace wrote:
Sat Aug 01, 2020 12:48 pm
...$5.3M IRA. $4.0M taxable account with $2.4M gains... Convert some, most or all of the IRA to Roth? I imagime the tax bill for total conversion will be over $2M. To pay that, I would sell most or all the stock in the taxable. The gains are all long-term but that could generate additional taxes of $.5M. It seems I would end up with $5M in Roth and $1.5M in taxable. My state income tax is 5.75%. I can't help but wonder if its better to pay $2.5M in taxes now for the lower rates or keep it invested and try to earn more than the future tax increases will take? Am I missing anything? I appreciate your help.
It doesn't really seem to make much sense to lose over half of your taxable account to pay the taxes on a Roth conversion, particularly if you plan to keep on working with your business with continuing taxes. Just consider yourself very fortunate and continue paying the taxes. Many people would be glad to be in your position.
Unless the plan is to leave all the traditional accounts to charity, taxes must be paid at some point. Depending on expected future marginal tax rates, it may make sense to convert now and "move" the tax amount from traditional to Roth. Or it may not. Only way for JohnHace to know (at least, make an educated guess) is for him to do the calculations for his specific situation.

the way
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Re: Convert to Roth for lower taxes or keep it invested?

Post by the way » Sat Aug 01, 2020 8:15 pm

Instead of selling in taxable, how about donating the highly appreciated stock, either directly or to a DAF. Given your list of stocks, maybe you have some 10 baggers, so a 1m donation with only 100k basis is possible. That saves you 180k LTCG + 34k NIIT. Then do a 1m Roth conversion, which is completely offset by the itemized deduction (you might have to play with these numbers a bit to avoid exceeding any limits).

This will be better than giving 100k QCD each year that you might otw do. It also has the benefit of lowering your estate.

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grabiner
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Re: Convert to Roth for lower taxes or keep it invested?

Post by grabiner » Sun Aug 02, 2020 9:46 am

Another possibility would be to plan to leave part of the traditional IRA to your heirs. If your heirs are in a lower tax bracket, they will pay less tax than you would.

If you are charitably inclined and don't need the money, you can reduce the tax on the IRA by making qualified charitable distributions. However, this is limited to $100K, and your RMDs may exceed that amount. (You can donate more than $100K to charity from an IRA, but the excess is reported as taxable income and then deductible only as an itemized deduction.)
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BolderBoy
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Re: Convert to Roth for lower taxes or keep it invested?

Post by BolderBoy » Sun Aug 02, 2020 10:04 am

JohnHace wrote:
Sat Aug 01, 2020 12:48 pm
Convert some, most or all of the IRA to Roth?
You are in an enviable position. Were it me, I'd probably start converting some of the tIRA to rIRA. The amount of the conversion would depend upon how much additional tax pain I'm willing to suffer each year (and how to pay for it). I make this suggest primarily for the benefit of your heirs.

Well done on a successful financial life.
"Never underestimate one's capacity to overestimate one's abilities" - The Dunning-Kruger Effect

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Watty
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Re: Convert to Roth for lower taxes or keep it invested?

Post by Watty » Sun Aug 02, 2020 10:42 am

JohnHace wrote:
Sat Aug 01, 2020 12:48 pm
I can't help but wonder if its better to pay $2.5M in taxes now for the lower rates or keep it invested and try to earn more than the future tax increases will take? Am I missing anything? I appreciate your help.
If you do sell it then under the current tax laws it will eventually go to your estate at a stepped up cost basis and the capital gains taxes would never need to be paid.

I would not sell it, but if you support a charity you may be able to give them shares of stocks instead of cash.

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celia
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Re: Convert to Roth for lower taxes or keep it invested?

Post by celia » Sun Aug 02, 2020 11:50 pm

JohnHace wrote:
Sat Aug 01, 2020 12:48 pm
My income is ~$800K.
How much of this income is available to pay taxes on the Roth conversion? I imagine $300K is needed for the taxes on the $800K (unless you tax-defer some of it which I don't recommend any more, as that is just making the "problem" worse). Maybe some of it goes back into the business and some is needed for living expenses. At a minimum, I would use the rest to pay taxes for a Roth conversion, trying to avoid selling taxable assets.
JohnHace wrote:
Sat Aug 01, 2020 4:00 pm
Yes, $107K was correct. My IRA on 12/31/18 was $2.854M. 2019 was good ending at $3.68M. This year is smoking hot at $5.3M. I'm mostly in tech stocks, Tesla, Netflix, Amazon, Apple, etc.
I often point out to people who want to convert that they should convert at least the amount of growth each year, else their tIRA will grow faster until the percentage withdrawn is more than the rate of growth. So, from this viewpoint, it looks like you should convert about $1M each year for a few years. Of course, those tech stocks would be the ideal candidates to go to Roth first.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.

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