Advice on conversions

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Flyin55
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Advice on conversions

Post by Flyin55 »

Please help me understand the conversion thought process.

I find myself, unfortunately, in the position where my tax bracket will change from MFJ to S in the next 6 mos to 5 years. I am 58 and have over $2 million+ in tax deferred IRAs/401ks. I am working, make $130k and put $26k in pre tax 401k -no employer match, and $14k Roth. I am thinking of retiring at 62.

I feel I need to get things in order. I’d like to convert as much as possible for as many years as I can. I just have a few questions since unfortunately I had never heard of converting until the last few months. Since then, I’ve tried to absorb as much as possible.

1. Should I stop contributing to my pretax 401k since I will just have to convert it? Or should I contribute, lower my AGI which gives me more room to convert. Or just contribute to Roth401k instead of pretax 401k? Sorry, my head spins thinking of this.

2. Should I convert up to the top of the 24% tax bracket? If I should, I would need to give back my Roth 2021 contribution. Is that ok?

3. Do I have 5 years of conversions before I need to worry about my income for SS Medical benefits, assuming I am still MFJ at that time?

Thanks for your help! I’ve tried to research a lot in he last 3 months, but I always seem to have the same questions.

I also realize that our tax bracket is very low compared to when I was single and contributing in the 80s/90s, and lower than it (probably) will be when I am single I the future.

Thank you for your help!
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David Jay
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Re: Advice on conversions

Post by David Jay »

For someone who will be living on perhaps 90K (130K minus retirement contributions) and may be facing filing single, I would definitely recommend conversions to fill the entire 22% tax bracket. I would like to see you enter retirement with something under $1M in tax-deferred.

I would want to run the numbers further before suggesting conversions in the 24% tax bracket. But remember that in 2026 the 22% bracket is scheduled to revert to 25% and the 24% bracket is scheduled to revert to the 28% tax bracket. So whatever you decide to do, a big chunk of it needs to be done in 2021-2025.
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tibbitts
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Re: Advice on conversions

Post by tibbitts »

Flyin55 wrote: Sun May 02, 2021 10:20 pm Please help me understand the conversion thought process.
Mainly the process is that you'll never know what's optimal to do until it's too late. You just have to guess. I'd probably convert to the top of 24% now, but it depends partly on what other sources of income you anticipate having. Then you can determine how much deferred you want to end up with when filing single and work backwards from there.
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FiveK
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Re: Advice on conversions

Post by FiveK »

Whether to contribute to traditional or Roth now, or whether to do a Roth IRA conversion now or later, boils down to your marginal tax rate now vs. what you expect it to be later.

To your questions:
1. Usually it doesn't make sense to convert while working, due to the relatively high marginal tax rate it would cost. But usually is not always - have you compared your current marginal tax rate to your expected future marginal tax rate?

2. Same question about comparing marginal rates now to expected ones later. Note that Roth conversions do not count toward your MAGI for Roth IRA purposes, so you may not need to give back your Roth 2021 contribution.

3. Yes. Your income the year you turn 63 is used to calculate any IRMAA effects for the year you turn 65, etc. How significant that may be depends on your birth month. Someone born in January gets hit much harder than someone born in December for "the year they turn 65."
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celia
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Re: Advice on conversions

Post by celia »

This is a tough problem since you have some unknowns, both in your personal life, but also taxes laws could easily change. But based on the questions you've asked, I can tell you already know more than you realize.

The first thing I suggest is to not stress out over this since you will still have 10 years between ages 62 and 72 to do Roth conversions. You might also consider working less for a year or two if you want to enjoy the time you have together while taking less in wages and filling the space with Roth conversions instead. Then think of this as a math problem that will be there whether you are working full-time or not. And if you have not addressed estate planning, you probably want to take care of that too.

As far as Roth conversions, we find it best to "level" our Taxable Income on the tax return over all the years (starting now) instead of having a few low tax years followed by higher tax years after you are 72 and taking SS and RMDs. Since the "Taxable Income" is a dollar value on your tax return, when thinking of some years filing as MFJ and some years as Single, we should think of that as a tax bracket instead. (Your Taxable Income is calculated by subtracting the Standard Deduction or Itemized Deductions from your Adjusted Gross Income, before you look in any tables to see your tax bracket. Currently the Standard Deduction is $12,550 for Single or twice that for MFJ.)

Looking at the 2021 tax brackets for MFJ and Singles in this chart, we can see that the top of the 22% tax bracket is a Taxable Income of $86,375 for Singles or $172,750 for MFJ. Seeing the Single rate, you are around that amount without doing an Roth conversion, I would guess. So we already know that when you are Single you need to convert probably to near the top of the 24% tax bracket (Taxable Income of $165K, including Roth conversions). The equivalent of that for MFJ, is $329K in Taxable Income. While you are working, your wages will be the same whether Single or MFJ, so that shows you have MORE than twice the Roth conversion room when you convert while MFJ compared to Single. (Look at your last tax return on line 15 to find your current Taxable Income, as a baseline.)

To help you plan this and keep track of several scenarios, I suggest creating a spreadsheet like the one shown in the middle of this post. That spreadsheet was intentionally left for the OP to finish. Column A represents the lines on the 1040 that apply to your income sources. You can build a pre-2026 column for doing Roth conversions while MFJ and one for Filing Single, and re-use those columns for multiple years, as your situation changes.

Tax software is your friend here, so run each year's numbers through the tax software to confirm your tax amount and tax bracket.


Now, here are some suggestions for the "mechanics" of Roth conversions:

* The Roth IRA should contain only stock funds, especially any that are expected to grow the fastest, so convert those first. Change your tax-deferred accounts to hold your bonds funds to help slow down it's growth. In fact, you need to be aware that the tax-deferred accounts will continue to grow as long as the growth is more than the withdrawals each year. So be more aggressive in the early years, to make a significant dent here.

* You likely won't be able to convert everything, but if you can convert $1M, I would consider that a good goal. Then when you are over 70.5, you can start doing Qualified Charitable Distributions which won't be taxed.

* Start off each year with knowing how much you plan to convert that year. Then look to take advantage of "down" markets by converting more when the share prices are "down". When share prices are down, you can convert more shares for the same tax hit. I was very lucky in 2008 while the market was crashing. (Back then you could "un-do" Roth conversions, but you can no longer do that.) I converted a significant part of my tax-deferred assets when share prices were half their previous high. Even though I bumped up into a higher tax bracket for some of the conversions, it was still the same result as if I had paid "half price" on the conversion taxes, when the shares later rebounded to their previous value!

This takes advanced planning in that you should write down your Roth conversion plan and account for this possibility beforehand. Deciding to convert when you feel the financial world is collapsing all around you will be difficult to do. One way to do this is to convert 15% of your yearly amount each quarter, ending up with converting the rest in early December if there wasn't a downturn. But if the market goes down 20%, then do an extra 15% conversion. If it goes down 30%, do another 15%, and finish up your yearly quota immediately if it goes down 40%. I don't consider this "market timing" because you had already decided how much you were going to convert that year and just changed the timing for that year.


Flyin55 wrote: Sun May 02, 2021 10:20 pm 1. Should I stop contributing to my pretax 401k since I will just have to convert it? Or should I contribute, lower my AGI which gives me more room to convert. Or just contribute to Roth401k instead of pretax 401k? Sorry, my head spins thinking of this.
Think of these options as canceling each other out. If you put one dollar in and take one out, you end up with the same amount in tax-deferred. That doesn't help bring down the balance, does it? The first thing I would do is to stop tax-deferring so much. You will probably need more money in Taxable accounts anyways to pay the Roth conversion taxes.
2. Should I convert up to the top of the 24% tax bracket? If I should, I would need to give back my Roth 2021 contribution. Is that ok?
You first need to confirm what the tax bill would be and if you would be able to cover it. If you are no longer able to contribute to the Roth IRA due to income limits, you will have to ask for a "Removal of an Excess Contribution", so the 1099-R tax form is coded correctly at the end of the year. If you don't do that, you will still have made an excess contribution and followed it by an early withdrawal, that would hit you with a 10% early withdrawal penalty.
3. Do I have 5 years of conversions before I need to worry about my income for SS Medical benefits, assuming I am still MFJ at that time?
The Roth conversion you do in the year you turn 63 will determine if you will pay a higher Medicare premium in the year you turn 65. But depending on the month you were born, you may only have to pay it for a few months.
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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Flyin55
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Re: Advice on conversions

Post by Flyin55 »

David Jay wrote: Sun May 02, 2021 10:54 pm For someone who will be living on perhaps 90K (130K minus retirement contributions) and may be facing filing single, I would definitely recommend conversions to fill the entire 22% tax bracket. I would like to see you enter retirement with something under $1M in tax-deferred.

I would want to run the numbers further before suggesting conversions in the 24% tax bracket. But remember that in 2026 the 22% bracket is scheduled to revert to 25% and the 24% bracket is scheduled to revert to the 28% tax bracket. So whatever you decide to do, a big chunk of it needs to be done in 2021-2025.
Thanks for the quick reply. I think we probably live on about 70k, since we have been paying about $20-25k/yr towards tuition for the last 10+ years. The house still has a mortgage of about $125k. I would like to have the house paid for just for peace of mind, but am unsure if I will stay in this house, so I don’t know if that’s a necessity. I will get SS survivor benefit of $25-30k, and will get SS at 70 of $40k. It sounds like I will need to do >$200k a year for as long as I can. Even if the tax rates don’t revert back, the marginal tax rates for single are scary. I will need to go into the 24% bracket for this. Would it ever be worth it to go to the 32%?
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jeffyscott
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Re: Advice on conversions

Post by jeffyscott »

Flyin55 wrote: Mon May 03, 2021 8:07 amI will get SS survivor benefit of $25-30k, and will get SS at 70 of $40k.
You will only get the higher benefit, not both.

I would first look at what your tax bracket would be at 72, when RMDs begin. With ~$2 million, initial RMD would be $74,000. At most 85% of SS is taxable, so total income for tax purposes would be about $108K and after the std deduction, taxable income would be about $95K. That puts you in the 24% bracket.

The first thing might be to convert enough so that you are below IRMAA with RMDs. That's $88,000, if you get tax-deferred balance down to about $1 million, then initial RMDs would be about $37K. That means you have about 14 years to convert about $1 million, so that would mean converting about $70K per year. But you would want to do less than that, once IRMAA is a factor. So a guess would be that it makes sense to do some conversions at 22%, but to limit them (when single) to an amount that keeps you below IRMAA.

I would certainly not rush to convert at rates higher than 22%. If you end up paying 24% instead of 22%, that is a pretty minor change.
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Flyin55
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Re: Advice on conversions

Post by Flyin55 »

tibbitts wrote: Sun May 02, 2021 11:30 pm
Flyin55 wrote: Sun May 02, 2021 10:20 pm Please help me understand the conversion thought process.
Mainly the process is that you'll never know what's optimal to do until it's too late. You just have to guess. I'd probably convert to the top of 24% now, but it depends partly on what other sources of income you anticipate having. Then you can determine how much deferred you want to end up with when filing single and work backwards from there.
Thanks tibbitts. I think this is exactly the problem, and I think that is why I am freaking out a bit. At first it was because I would be living on one SS vs. two, but then I realized that we probably have enough saved and my problem is going to be the single tax bracket. Well that and the reason for looking in to all of this in the first place. I have been going forward from where we are now, but I will try going backwards and see if that makes things clearer for me. Thanks for your help.
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Flyin55
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Re: Advice on conversions

Post by Flyin55 »

FiveK wrote: Mon May 03, 2021 1:28 am Whether to contribute to traditional or Roth now, or whether to do a Roth IRA conversion now or later, boils down to your marginal tax rate now vs. what you expect it to be later.

To your questions:
1. Usually it doesn't make sense to convert while working, due to the relatively high marginal tax rate it would cost. But usually is not always - have you compared your current marginal tax rate to your expected future marginal tax rate?

2. Same question about comparing marginal rates now to expected ones later. Note that Roth conversions do not count toward your MAGI for Roth IRA purposes, so you may not need to give back your Roth 2021 contribution.

3. Yes. Your income the year you turn 63 is used to calculate any IRMAA effects for the year you turn 65, etc. How significant that may be depends on your birth month. Someone born in January gets hit much harder than someone born in December for "the year they turn 65."
Thanks for your thoughts FiveK.
1.Right now I am just into the 22% marginal tax rate. If I continue working when in the single bracket, I will be at the very top of 22%, or the bottom of the 24%. That is my thought process in potentially going to the top of the 24% MFJ bracket. From what I've come to understand on SS, I should push off my SS to 70 and take survivor benefits from when I retire until 70.
2. Thanks. I've read a lot of posts, but I've never seen that stated. That is good news.
3. I will be hit hard. I did some numbers trying to stay under $88k, but I will need to research further to see the cost differences. I don't want to not be able to enjoy life just based on that constraint, but I suppose it will depend on how much I can convert in the next few years, my health, etc. Do most try to stay in the first tier?
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FiveK
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Re: Advice on conversions

Post by FiveK »

Flyin55 wrote: Mon May 03, 2021 10:01 am Do most try to stay in the first tier?
That really depends on one's specific projections for the future.

Note that if you can pay the conversion tax from cash on hand, you gain "some" percentage points in the marginal rate comparison. See when one uses taxable funds to pay the tax on a conversion and Break-even withdrawal rate for more on this.
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Re: Advice on conversions

Post by golfer292 »

celia wrote: Mon May 03, 2021 7:47 am This is a tough problem since you have some unknowns, both in your personal life, but also taxes laws could easily change. But based on the questions you've asked, I can tell you already know more than you realize.

The first thing I suggest is to not stress out over this since you will still have 10 years between ages 62 and 72 to do Roth conversions. You might also consider working less for a year or two if you want to enjoy the time you have together while taking less in wages and filling the space with Roth conversions instead. Then think of this as a math problem that will be there whether you are working full-time or not. And if you have not addressed estate planning, you probably want to take care of that too.

As far as Roth conversions, we find it best to "level" our Taxable Income on the tax return over all the years (starting now) instead of having a few low tax years followed by higher tax years after you are 72 and taking SS and RMDs. Since the "Taxable Income" is a dollar value on your tax return, when thinking of some years filing as MFJ and some years as Single, we should think of that as a tax bracket instead. (Your Taxable Income is calculated by subtracting the Standard Deduction or Itemized Deductions from your Adjusted Gross Income, before you look in any tables to see your tax bracket. Currently the Standard Deduction is $12,550 for Single or twice that for MFJ.)

Looking at the 2021 tax brackets for MFJ and Singles in this chart, we can see that the top of the 22% tax bracket is a Taxable Income of $86,375 for Singles or $172,750 for MFJ. Seeing the Single rate, you are around that amount without doing an Roth conversion, I would guess. So we already know that when you are Single you need to convert probably to near the top of the 24% tax bracket (Taxable Income of $165K, including Roth conversions). The equivalent of that for MFJ, is $329K in Taxable Income. While you are working, your wages will be the same whether Single or MFJ, so that shows you have MORE than twice the Roth conversion room when you convert while MFJ compared to Single. (Look at your last tax return on line 15 to find your current Taxable Income, as a baseline.)

To help you plan this and keep track of several scenarios, I suggest creating a spreadsheet like the one shown in the middle of this post. That spreadsheet was intentionally left for the OP to finish. Column A represents the lines on the 1040 that apply to your income sources. You can build a pre-2026 column for doing Roth conversions while MFJ and one for Filing Single, and re-use those columns for multiple years, as your situation changes.

Tax software is your friend here, so run each year's numbers through the tax software to confirm your tax amount and tax bracket.


Now, here are some suggestions for the "mechanics" of Roth conversions:

* The Roth IRA should contain only stock funds, especially any that are expected to grow the fastest, so convert those first. Change your tax-deferred accounts to hold your bonds funds to help slow down it's growth. In fact, you need to be aware that the tax-deferred accounts will continue to grow as long as the growth is more than the withdrawals each year. So be more aggressive in the early years, to make a significant dent here.

* You likely won't be able to convert everything, but if you can convert $1M, I would consider that a good goal. Then when you are over 70.5, you can start doing Qualified Charitable Distributions which won't be taxed.

* Start off each year with knowing how much you plan to convert that year. Then look to take advantage of "down" markets by converting more when the share prices are "down". When share prices are down, you can convert more shares for the same tax hit. I was very lucky in 2008 while the market was crashing. (Back then you could "un-do" Roth conversions, but you can no longer do that.) I converted a significant part of my tax-deferred assets when share prices were half their previous high. Even though I bumped up into a higher tax bracket for some of the conversions, it was still the same result as if I had paid "half price" on the conversion taxes, when the shares later rebounded to their previous value!

This takes advanced planning in that you should write down your Roth conversion plan and account for this possibility beforehand. Deciding to convert when you feel the financial world is collapsing all around you will be difficult to do. One way to do this is to convert 15% of your yearly amount each quarter, ending up with converting the rest in early December if there wasn't a downturn. But if the market goes down 20%, then do an extra 15% conversion. If it goes down 30%, do another 15%, and finish up your yearly quota immediately if it goes down 40%. I don't consider this "market timing" because you had already decided how much you were going to convert that year and just changed the timing for that year.


Flyin55 wrote: Sun May 02, 2021 10:20 pm 1. Should I stop contributing to my pretax 401k since I will just have to convert it? Or should I contribute, lower my AGI which gives me more room to convert. Or just contribute to Roth401k instead of pretax 401k? Sorry, my head spins thinking of this.
Think of these options as canceling each other out. If you put one dollar in and take one out, you end up with the same amount in tax-deferred. That doesn't help bring down the balance, does it? The first thing I would do is to stop tax-deferring so much. You will probably need more money in Taxable accounts anyways to pay the Roth conversion taxes.
2. Should I convert up to the top of the 24% tax bracket? If I should, I would need to give back my Roth 2021 contribution. Is that ok?
You first need to confirm what the tax bill would be and if you would be able to cover it. If you are no longer able to contribute to the Roth IRA due to income limits, you will have to ask for a "Removal of an Excess Contribution", so the 1099-R tax form is coded correctly at the end of the year. If you don't do that, you will still have made an excess contribution and followed it by an early withdrawal, that would hit you with a 10% early withdrawal penalty.
3. Do I have 5 years of conversions before I need to worry about my income for SS Medical benefits, assuming I am still MFJ at that time?
The Roth conversion you do in the year you turn 63 will determine if you will pay a higher Medicare premium in the year you turn 65. But depending on the month you were born, you may only have to pay it for a few months.
Thanks to Celia for the clarity. Your post helps me understand the Roth conversion process and decisions I need to consider.
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Re: Advice on conversions

Post by tibbitts »

Flyin55 wrote: Mon May 03, 2021 9:35 am
tibbitts wrote: Sun May 02, 2021 11:30 pm
Flyin55 wrote: Sun May 02, 2021 10:20 pm Please help me understand the conversion thought process.
Mainly the process is that you'll never know what's optimal to do until it's too late. You just have to guess. I'd probably convert to the top of 24% now, but it depends partly on what other sources of income you anticipate having. Then you can determine how much deferred you want to end up with when filing single and work backwards from there.
Thanks tibbitts. I think this is exactly the problem, and I think that is why I am freaking out a bit. At first it was because I would be living on one SS vs. two, but then I realized that we probably have enough saved and my problem is going to be the single tax bracket. Well that and the reason for looking in to all of this in the first place. I have been going forward from where we are now, but I will try going backwards and see if that makes things clearer for me. Thanks for your help.
I think Bogleheads mostly ignore the both the impact and probability of filing status changes. Partly that's understandable because any changes you make to accommodate the possibility will be very non-optimal for the opposite outcome. You also have to consider the impact of state taxes, IRMAA, NIIT, ACA... anything where there are breakpoints based on any combination of income and filing status. For me in your situation I'd definitely be going to the top of federal 24% MFJ today but it does depend on what other income you have, your assumed rate of return going forward, whether state taxes are likely to change, etc. The worst-case (yet in a way not really bad vs. the running-out-of-money) scenario is reaching critical mass, where your deferred accounts grow despite conversions at any reasonable single filing rate. Sometimes you have to make uncomfortably large conversions up-front to reduce/eliminate the probability of that situation.
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Re: Advice on conversions

Post by jeffyscott »

Flyin55 wrote: Mon May 03, 2021 9:35 amAt first it was because I would be living on one SS vs. two, but then I realized that we probably have enough saved and my problem is going to be the single tax bracket. Well that and the reason for looking in to all of this in the first place.
It's a terrible reason to have to look into this, but I think you will have not have any financial issues aside from paying more in taxes.

Spending of $70,000 from $2 million is a 3.5% withdrawal rate. And it sounds like that $2 million+ does not include Roth balance? The house payment would go away at some point and then there is whatever the survivor SS benefit would be until your own benefit at 70 (didn't realize that this is not like the normal spousal benefit, where restricted application is no longer allowed, in my other post) . Effectively, I think you might average only about a 2% or even lower withdrawal rate?

Depending on health care cost prior to 65, I would think you could even afford to retire now, if you wanted to.
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WoodSpinner
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Re: Advice on conversions

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celia wrote: Mon May 03, 2021 7:47 am
As far as Roth conversions, we find it best to "level" our Taxable Income on the tax return over all the years (starting now) instead of having a few low tax years followed by higher tax years after you are 72 and taking SS and RMDs. Since the "Taxable Income" is a dollar value on your tax return, when thinking of some years filing as MFJ and some years as Single, we should think of that as a tax bracket instead. (Your Taxable Income is calculated by subtracting the Standard Deduction or Itemized Deductions from your Adjusted Gross Income, before you look in any tables to see your tax bracket. Currently the Standard Deduction is $12,550 for Single or twice that for MFJ.)
Celia,

First let me thank you again for your advice on Conversions when I started my Retirement planning in earnest in 2017. It’s now a significant part of my Retirement Financial plan and the conversion taxes are my largest expense.

I have struggled with using a Taxable Income leveling approach for my planning since our combined SS benefits will be significant plus my state, CA, has significant state taxes but doesn’t tax SS income. What I see is that even though my taxable Income may be leveled, my projected Effective Tax Rate is significantly different.

In addition I had 4 years of conversions that could be done (59-62) where I didn’t need to worry about IRMAA costs plus I have minimal assets in Taxable and any NIIT costs are very minor. We are also likely to be in the 24% bracket throughout Retirement due to Pensions, SS, RMDs and Conversions.

This has led me to shift my approach about from your recommendation:
- I have been focusing on balancing the average effective tax (Fed, State, IRMAA, NIIT) across rough 10 year periods, 59-70, 71-80, 81-90.
- Ramped up conversion amounts from 59-62 to the top of the 24% bracket
- Conversions from 63-70 will be to the top of the IRMAA 3rd-tier bracket (well below the top of the 24% bracket)..
- This will end up converting about 50% of my current TIRA balance and the remainder will be used for Medical expenses, QCDs and beneficiaries.
- I am very charitably inclined and plan to ramp up QCDs if needed to help balance taxes once I am over 70 1/2

As you suggested, the plan is revisited yearly (in December) and a Roth Conversion goal for the following year is developed based on the latest market conditions, life circumstances and plans.

Wondering if I am missing something in my shift from balancing Taxable Income towards balance Effective Taxes over a range of years? Your insights are much appreciated.

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celia
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Re: Advice on conversions

Post by celia »

jeffyscott wrote: Mon May 03, 2021 8:50 am I would first look at what your tax bracket would be at 72, when RMDs begin. With ~$2 million, initial RMD would be $74,000. At most 85% of SS is taxable, so total income for tax purposes would be about $108K and after the std deduction, taxable income would be about $95K. That puts you in the 24% bracket.
This statement falls into a very common trap of forgetting that the tax-deferred amount will continue to grow between now and age 72 (and even afterwards!). The current $2M could easily double if Roth conversions are not done aggressively. Then the RMD at age 72 would be about 4% of $4M, which is $160,000. That, by itself, puts a Single filer into the top of the 24% tax bracket (at today's historically low tax brackets).

OP, Notice that the bottom of my sample spreadsheet has a simple running estimate of the value remaining in Taxable, Tax-deferred, and Roth each year.

jeffyscott wrote: Mon May 03, 2021 12:10 pm Spending of $70,000 from $2 million is a 3.5% withdrawal rate. And it sounds like that $2 million+ does not include Roth balance? The house payment would go away at some point and then there is whatever the survivor SS benefit would be until your own benefit at 70 (didn't realize that this is not like the normal spousal benefit, where restricted application is no longer allowed, in my other post) . Effectively, I think you might average only about a 2% or even lower withdrawal rate?
This would be ok for capturing living expenses but won't do anything to bring down the value of the tax-deferred accounts since they are likely growing at more than 3.5% a year.
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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jeffyscott
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Re: Advice on conversions

Post by jeffyscott »

celia wrote: Mon May 03, 2021 1:07 pm
jeffyscott wrote: Mon May 03, 2021 8:50 am I would first look at what your tax bracket would be at 72, when RMDs begin. With ~$2 million, initial RMD would be $74,000. At most 85% of SS is taxable, so total income for tax purposes would be about $108K and after the std deduction, taxable income would be about $95K. That puts you in the 24% bracket.
This statement falls into a very common trap of forgetting that the tax-deferred amount will continue to grow between now and age 72 (and even afterwards!). The current $2M could easily double if Roth conversions are not done aggressively. Then the RMD at age 72 would be about 4% of $4M, which is $160,000. That, by itself, puts a Single filer into the top of the 24% tax bracket (at today's historically low tax brackets).
Actually it assumes the account grows at the rate of inflation, since tax brackets are indexed. Doubling in 14 years, would require a return over 5% and since tax rates are indexed, for your scenario to be accurate this would have to be 5% real. I would not consider 5% real to be something that will be "easily" achieved, when starting from the current high stock and bond prices.

The intent was certainly not to suggest no conversions, but to get an initial idea of what might make sense. Without knowing the asset allocation of the current and future tax-deferred account, the expected return is unknown. I don't expect my own tax-deferred account to grow at more than about 0% real, since it is about 90% bonds.
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Re: Advice on conversions

Post by celia »

OP, If you do not yet have a Roth IRA, you should open one asap to start the 5-year clock. You can possibly contribute $7,000 for 2020 before May 17 and that would make the clock start at January 1, 2020! This would ensure you could withdraw from the Roth tax-free starting in 2025 and you would also be over 59.5 then, so no early withdrawal penalties would apply should you need to withdraw the Roth conversions too.
Flyin55 wrote: Mon May 03, 2021 8:07 am I think we probably live on about 70k, since we have been paying about $20-25k/yr towards tuition for the last 10+ years.
I assume part of the tax-deferred accounts are IRAs in your spouse's name. The tuition implies that there are also children here. You should consider disclaiming part of your spouse's IRAs when the time comes in favor of your kids. This will lower your tax-deferred balance AND save you from paying some taxes using your Taxable money instead.

To have this be an option, you should be listed as the only primary beneficiary and the kids as secondary on the IRAs. You can decide on the disclaimed amount later on, but it shouldn't take long to make sure the beneficiaries are listed correctly. An alternate option is having you listed as primary per stirpes. While at it, check that ALL accounts that either of you own have the correct beneficiaries listed.
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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Re: Advice on conversions

Post by Flyin55 »

celia wrote: Mon May 03, 2021 7:47 am This is a tough problem since you have some unknowns, both in your personal life, but also taxes laws could easily change. But based on the questions you've asked, I can tell you already know more than you realize.

The first thing I suggest is to not stress out over this since you will still have 10 years between ages 62 and 72 to do Roth conversions. You might also consider working less for a year or two if you want to enjoy the time you have together while taking less in wages and filling the space with Roth conversions instead. Then think of this as a math problem that will be there whether you are working full-time or not. And if you have not addressed estate planning, you probably want to take care of that too.

As far as Roth conversions, we find it best to "level" our Taxable Income on the tax return over all the years (starting now) instead of having a few low tax years followed by higher tax years after you are 72 and taking SS and RMDs. Since the "Taxable Income" is a dollar value on your tax return, when thinking of some years filing as MFJ and some years as Single, we should think of that as a tax bracket instead. (Your Taxable Income is calculated by subtracting the Standard Deduction or Itemized Deductions from your Adjusted Gross Income, before you look in any tables to see your tax bracket. Currently the Standard Deduction is $12,550 for Single or twice that for MFJ.)

Looking at the 2021 tax brackets for MFJ and Singles in this chart, we can see that the top of the 22% tax bracket is a Taxable Income of $86,375 for Singles or $172,750 for MFJ. Seeing the Single rate, you are around that amount without doing an Roth conversion, I would guess. So we already know that when you are Single you need to convert probably to near the top of the 24% tax bracket (Taxable Income of $165K, including Roth conversions). The equivalent of that for MFJ, is $329K in Taxable Income. While you are working, your wages will be the same whether Single or MFJ, so that shows you have MORE than twice the Roth conversion room when you convert while MFJ compared to Single. (Look at your last tax return on line 15 to find your current Taxable Income, as a baseline.)

To help you plan this and keep track of several scenarios, I suggest creating a spreadsheet like the one shown in the middle of this post. That spreadsheet was intentionally left for the OP to finish. Column A represents the lines on the 1040 that apply to your income sources. You can build a pre-2026 column for doing Roth conversions while MFJ and one for Filing Single, and re-use those columns for multiple years, as your situation changes.

Tax software is your friend here, so run each year's numbers through the tax software to confirm your tax amount and tax bracket.


Now, here are some suggestions for the "mechanics" of Roth conversions:

* The Roth IRA should contain only stock funds, especially any that are expected to grow the fastest, so convert those first. Change your tax-deferred accounts to hold your bonds funds to help slow down it's growth. In fact, you need to be aware that the tax-deferred accounts will continue to grow as long as the growth is more than the withdrawals each year. So be more aggressive in the early years, to make a significant dent here.

* You likely won't be able to convert everything, but if you can convert $1M, I would consider that a good goal. Then when you are over 70.5, you can start doing Qualified Charitable Distributions which won't be taxed.

* Start off each year with knowing how much you plan to convert that year. Then look to take advantage of "down" markets by converting more when the share prices are "down". When share prices are down, you can convert more shares for the same tax hit. I was very lucky in 2008 while the market was crashing. (Back then you could "un-do" Roth conversions, but you can no longer do that.) I converted a significant part of my tax-deferred assets when share prices were half their previous high. Even though I bumped up into a higher tax bracket for some of the conversions, it was still the same result as if I had paid "half price" on the conversion taxes, when the shares later rebounded to their previous value!

This takes advanced planning in that you should write down your Roth conversion plan and account for this possibility beforehand. Deciding to convert when you feel the financial world is collapsing all around you will be difficult to do. One way to do this is to convert 15% of your yearly amount each quarter, ending up with converting the rest in early December if there wasn't a downturn. But if the market goes down 20%, then do an extra 15% conversion. If it goes down 30%, do another 15%, and finish up your yearly quota immediately if it goes down 40%. I don't consider this "market timing" because you had already decided how much you were going to convert that year and just changed the timing for that year.


Flyin55 wrote: Sun May 02, 2021 10:20 pm 1. Should I stop contributing to my pretax 401k since I will just have to convert it? Or should I contribute, lower my AGI which gives me more room to convert. Or just contribute to Roth401k instead of pretax 401k? Sorry, my head spins thinking of this.
Think of these options as canceling each other out. If you put one dollar in and take one out, you end up with the same amount in tax-deferred. That doesn't help bring down the balance, does it? The first thing I would do is to stop tax-deferring so much. You will probably need more money in Taxable accounts anyways to pay the Roth conversion taxes.
2. Should I convert up to the top of the 24% tax bracket? If I should, I would need to give back my Roth 2021 contribution. Is that ok?
You first need to confirm what the tax bill would be and if you would be able to cover it. If you are no longer able to contribute to the Roth IRA due to income limits, you will have to ask for a "Removal of an Excess Contribution", so the 1099-R tax form is coded correctly at the end of the year. If you don't do that, you will still have made an excess contribution and followed it by an early withdrawal, that would hit you with a 10% early withdrawal penalty.
3. Do I have 5 years of conversions before I need to worry about my income for SS Medical benefits, assuming I am still MFJ at that time?
The Roth conversion you do in the year you turn 63 will determine if you will pay a higher Medicare premium in the year you turn 65. But depending on the month you were born, you may only have to pay it for a few months.
Thanks so much for your help Celia, I had written you a response, but then as happens whenever I am reading posts, something occurs to me (this time it was does my state tax SS) and closed the wrong tab, deleting my post. I think I need to learn to hit the save draft button.

If I know anything about conversions it's from reading and rereading your posts, so thanks so much for your help and knowledge. I am of the opinion that taxes will increase, so I need to do as much as possible as soon as I can. I am lucky in that I am working from home, and my schedule is flexible, so I don't need to take time off yet. It may come to the point where I need to, so I will hold off and be thankful for working from home and for good insurance.

Thanks for the combined tax chart. That really helped cement the differences. I actually started using a variation of your spreadsheet, and have also done worst case scenarios. I think I first had to get it in my mind that with our portfolio, if the stock market dropped 50%, I would be fine. And I will. I think your idea of 2 spreadsheets is probably the best way to go.

I tried to use turbo tax. I think something was funky because of the covid bill that allowed people to take money out free of penalty. I think I am going to try changing my age in it. Can you tell me how a conversion looks on a 1099R? Which codes are in line 7? If it matters, this year I am 58. Next year I will pass the 59.5 milestone.

The 15% rate of conversion seems like a good plan. I was wondering how people capitalized on a down market without waiting until December and then the market could be up. I will implement this. That way I will pay taxes as I go to stay on top of things. If something unexpected comes up, and with the last year we have all had, who knows at this point, I can go from there.

I have to wrap my head around not contributing to the 401k. Crazy, right? But I think it's just been so ingrained in me. But you are right, the extra money in taxable accounts isn't a bad idea.

It sounds like, according to FiveK, that I shouldn't need to pull back my Roth contributions since conversions don't count toward MAGI for Roth. That's good news, although I could always pull them to pay for taxes, but I think we have the money to cover taxes.

Thanks again for your help.
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Re: Advice on conversions

Post by FiveK »

Flyin55 wrote: Mon May 03, 2021 2:53 pm I tried to use turbo tax. I think something was funky because of the covid bill that allowed people to take money out free of penalty. I think I am going to try changing my age in it.
If you don't mind Excel, you could try the personal finance toolbox for a 2021 marginal tax rate estimate on whatever range of Roth conversions you wish to see.
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Re: Advice on conversions

Post by Flyin55 »

celia wrote: Mon May 03, 2021 2:06 pm OP, If you do not yet have a Roth IRA, you should open one asap to start the 5-year clock. You can possibly contribute $7,000 for 2020 before May 17 and that would make the clock start at January 1, 2020! This would ensure you could withdraw from the Roth tax-free starting in 2025 and you would also be over 59.5 then, so no early withdrawal penalties would apply should you need to withdraw the Roth conversions too.
Flyin55 wrote: Mon May 03, 2021 8:07 am I think we probably live on about 70k, since we have been paying about $20-25k/yr towards tuition for the last 10+ years.
I assume part of the tax-deferred accounts are IRAs in your spouse's name. The tuition implies that there are also children here. You should consider disclaiming part of your spouse's IRAs when the time comes in favor of your kids. This will lower your tax-deferred balance AND save you from paying some taxes using your Taxable money instead.

To have this be an option, you should be listed as the only primary beneficiary and the kids as secondary on the IRAs. You can decide on the disclaimed amount later on, but it shouldn't take long to make sure the beneficiaries are listed correctly. An alternate option is having you listed as primary per stirpes. While at it, check that ALL accounts that either of you own have the correct beneficiaries listed.
Thanks for thinking of this. We opened our first Roth in 2019 at Vanguard. I believe that one is in my name, so I will probably start the conversion with my IRAs. Although this brings up a different issue. Most of my money is at Fidelity, but my Roth at Fidelity wasn't opened until the following year (2020), and 2020 is when he opened one at Vanguard. So am I a year behind, or is it any Roth? Originally, we were going to transfer my retirement accounts to Vanguard. Then we had a few times where we couldn't get through to Vanguard online, so we decided it was best to keep mine at Fidelity.

We each have over a million in our tax deferred accounts. That's very interesting. So if I am listed as the beneficiary, for the full amount, I could disclaim just a part of that amount? Or does it need to be in a separate IRA? How would I disclaim some of it? That's a very good idea.
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Re: Advice on conversions

Post by celia »

jeffyscott wrote: Mon May 03, 2021 1:33 pm
celia wrote: Mon May 03, 2021 1:07 pm
jeffyscott wrote: Mon May 03, 2021 8:50 am I would first look at what your tax bracket would be at 72, when RMDs begin. With ~$2 million, initial RMD would be $74,000. At most 85% of SS is taxable, so total income for tax purposes would be about $108K and after the std deduction, taxable income would be about $95K. That puts you in the 24% bracket.
This statement falls into a very common trap of forgetting that the tax-deferred amount will continue to grow between now and age 72 (and even afterwards!). The current $2M could easily double if Roth conversions are not done aggressively. Then the RMD at age 72 would be about 4% of $4M, which is $160,000. That, by itself, puts a Single filer into the top of the 24% tax bracket (at today's historically low tax brackets).
Actually it assumes the account grows at the rate of inflation, since tax brackets are indexed. Doubling in 14 years, would require a return over 5% and since tax rates are indexed, for your scenario to be accurate this would have to be 5% real. I would not consider 5% real to be something that will be "easily" achieved, when starting from the current high stock and bond prices.

The intent was certainly not to suggest no conversions, but to get an initial idea of what might make sense. Without knowing the asset allocation of the current and future tax-deferred account, the expected return is unknown. I don't expect my own tax-deferred account to grow at more than about 0% real, since it is about 90% bonds.
JeffyScott, I guess our assumptions are clearly different. OP may be between us or skewed more towards the faster growth side due to having tax-deferred accounts so large at this age. Or maybe they are super-savers, maxing out all the retirement accounts they can.

But our role now, is to help OP look forward on what to do about potential Roth conversions. To that end, I would even suggest a growth rate of 7% would be quite possible, and plan for that. (That means the accounts are growing $140K each year.) If that rate continued for 10.2 years (according to the Rule of 72), the account would double to $4M. Then there are still 4 years left for it to get half-way to the next doubling. So the tax-deferred accounts could even be $6M at age 72 if no Roth conversions were to be done.

JeffyScott, I acknowledge you are working inflation into your version, while I am trying to show the OP the possibilities so they are motivated to head this off early by doing large conversions while still married. The value of the taxes will look scary :o and many people would back off on being so aggressive, but then they would regret it, if they were only converting an amount equal to the yearly growth. That, by itself, does not make a dent in the current tax-deferred accounts. To that, I would remind them that when they were tax-deferring, they were agreeing to pay the taxes later. The account was never all "theirs". It also belonged to Uncle Sam and the state as the taxes were, in effect, still in the account. They have been investing for not only themselves all these years, but for the government too. When the value of their tax-deferred accounts went up, the government's share also went up. And when the value of the accounts went down, the government's share also went down. But the fact still remains that every withdrawal, whether to taxable or to Roth will need to be taxed. If a QCD is taken out for charity, that is like the government is also donating to your chosen charity too.

So OP should just look at the taxes in comparison to the amount converted. Yes 24% of a large number is more than 22% or 24% of a smaller number, but if Roth conversions ARE NOT DONE, the taxes will be more later on and in a higher tax bracket (because I'm looking at the top of the 24% bracket based on just Roth conversions)!
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Re: Advice on conversions

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Flyin55 wrote: Mon May 03, 2021 2:53 pmCan you tell me how a conversion looks on a 1099R? Which codes are in line 7? If it matters, this year I am 58. Next year I will pass the 59.5 milestone.
It's code 2, until you are over 59.5, then it's code 7.
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Re: Advice on conversions

Post by jeffyscott »

celia wrote: Mon May 03, 2021 3:49 pmSo OP should just look at the taxes in comparison to the amount converted. Yes 24% of a large number is more than 22% or 24% of a smaller number, but if Roth conversions ARE NOT DONE, the taxes will be more later on and in a higher tax bracket (because I'm looking at the top of the 24% bracket based on just Roth conversions)!
Doing 24% vs. 22% is a small difference and erring one way or the other is no big deal. And if one believes that 22% is going back to 25%, that makes it an even easier decision. The OP had suggested maybe converting into the 32% bracket just prior to my post, I didn't think that was likely to make sense and part of my purpose was to demonstrate that.

For myself, I would tend to err toward under-converting, by using modest return expectations (and then make those modest returns more likely by stuffing the stocks into the Roth). If the returns end up being much higher, the problem would be one of paying more taxes but only due to having far more money than expected. OTOH, if you plan conversions based on very high returns and instead get very poor returns, then you will have overpaid taxes, while also having less money.
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Re: Advice on conversions

Post by jeffyscott »

Flyin55 wrote: Mon May 03, 2021 3:45 pm
celia wrote: Mon May 03, 2021 2:06 pm OP, If you do not yet have a Roth IRA, you should open one asap to start the 5-year clock. You can possibly contribute $7,000 for 2020 before May 17 and that would make the clock start at January 1, 2020! This would ensure you could withdraw from the Roth tax-free starting in 2025 and you would also be over 59.5 then, so no early withdrawal penalties would apply should you need to withdraw the Roth conversions too.
Flyin55 wrote: Mon May 03, 2021 8:07 am I think we probably live on about 70k, since we have been paying about $20-25k/yr towards tuition for the last 10+ years.
I assume part of the tax-deferred accounts are IRAs in your spouse's name. The tuition implies that there are also children here. You should consider disclaiming part of your spouse's IRAs when the time comes in favor of your kids. This will lower your tax-deferred balance AND save you from paying some taxes using your Taxable money instead.

To have this be an option, you should be listed as the only primary beneficiary and the kids as secondary on the IRAs. You can decide on the disclaimed amount later on, but it shouldn't take long to make sure the beneficiaries are listed correctly. An alternate option is having you listed as primary per stirpes. While at it, check that ALL accounts that either of you own have the correct beneficiaries listed.
Thanks for thinking of this. We opened our first Roth in 2019 at Vanguard. I believe that one is in my name, so I will probably start the conversion with my IRAs. Although this brings up a different issue. Most of my money is at Fidelity, but my Roth at Fidelity wasn't opened until the following year (2020), and 2020 is when he opened one at Vanguard. So am I a year behind, or is it any Roth? Originally, we were going to transfer my retirement accounts to Vanguard. Then we had a few times where we couldn't get through to Vanguard online, so we decided it was best to keep mine at Fidelity.

We each have over a million in our tax deferred accounts. That's very interesting. So if I am listed as the beneficiary, for the full amount, I could disclaim just a part of that amount? Or does it need to be in a separate IRA? How would I disclaim some of it? That's a very good idea.
Any Roth starts the 5 year clock for all your Roth IRA accounts.
https://fairmark.com/retirement/roth-ac ... roth-iras/
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Re: Advice on conversions

Post by celia »

Flyin55 wrote: Mon May 03, 2021 3:45 pm We each have over a million in our tax deferred accounts. . . So if I am listed as the beneficiary, for the full amount, I could disclaim just a part of that amount? Or does it need to be in a separate IRA? How would I disclaim some of it? That's a very good idea.
First, I know nothing about disclaiming on 401Ks, but they can be rolled over to IRAs if you don't want them dispersed over time (like an annuity). Once you are over 59.5 or you have left employment, they can be rolled over to an IRA. So my comments refer to IRA beneficiaries.

You can disclaim a whole account or part of one. And you can do something different on each account. If there are multiple people listed as primary beneficiary and one disclaims, the disclaimed money goes to the other primary beneficiaries, just as if the disclaiming person had died before the account owner. But if there is only one person as primary, their disclaimed assets go to the contingent beneficiaries. They cannot choose who gets the money. There is also a time limit to disclaiming, probably less than a year. But IRAs and retirement accounts are usually re-titled and split soon after death so the new owners can take RMDs/withdrawals.

The disclaimer has to be done before you take the assets in your own name/own IRA. I believe you just write a statement to the custodian (or trustee, in the case of trust assets) to the effect that you disclaim a fixed dollar amount (or percentage) of what you are inheriting from that account. Date and sign the statement. Check with the custodian as you are changing title on the account, as they might want your statement notarized, too.

Added Correction: After googling about disclaiming, I found that the disclaimer must be done within 9 months. The IRS has some requirements that a disclaimer should meet and states can add other requirements, such as having it notarized or witnessed.
https://smartasset.com/financial-adviso ... nheritance
Last edited by celia on Wed May 05, 2021 12:04 am, edited 1 time in total.
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Re: Advice on conversions

Post by Flyin55 »

FiveK wrote: Mon May 03, 2021 10:48 am
Flyin55 wrote: Mon May 03, 2021 10:01 am Do most try to stay in the first tier?
That really depends on one's specific projections for the future.

Note that if you can pay the conversion tax from cash on hand, you gain "some" percentage points in the marginal rate comparison. See when one uses taxable funds to pay the tax on a conversion and Break-even withdrawal rate for more on this.
Yes, at least for this year we will pay it out of our taxable funds. Next year I will have access to the retirement accounts penalty free, so I may do 50/50. We will see. We basically received a raise by no longer needing to pay for tuition or other kids related items, and we usually take a couple big trips each year and those are out too. Thanks for the links and help.
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Re: Advice on conversions

Post by Flyin55 »

jeffyscott wrote: Mon May 03, 2021 12:10 pm
Flyin55 wrote: Mon May 03, 2021 9:35 amAt first it was because I would be living on one SS vs. two, but then I realized that we probably have enough saved and my problem is going to be the single tax bracket. Well that and the reason for looking in to all of this in the first place.
It's a terrible reason to have to look into this, but I think you will have not have any financial issues aside from paying more in taxes.

Spending of $70,000 from $2 million is a 3.5% withdrawal rate. And it sounds like that $2 million+ does not include Roth balance? The house payment would go away at some point and then there is whatever the survivor SS benefit would be until your own benefit at 70 (didn't realize that this is not like the normal spousal benefit, where restricted application is no longer allowed, in my other post) . Effectively, I think you might average only about a 2% or even lower withdrawal rate?

Depending on health care cost prior to 65, I would think you could even afford to retire now, if you wanted to.
Thanks for taking the time to calculate that. That initially was my concern. We had originally figured that we could live on SS if we both took it at 70. So our money would just need to cover us from when we retired until then. If I look at every retirement account we are probably at close to $2.2, including only $35k in Roth. I am working towards 60/40, as I sold a bunch of stocks to move more towards index funds, and still have a bunch of cash sitting in the retirement accounts. You mentioned in another post that you are 90% in bonds in your IRA. Can I ask what type of bonds? I am completely clueless other than a few college finance and accounting classes 40 years ago. Also health insurance is the big unknown as far as retiring. Is figuring that out as simple as going to the government healthcare website?
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Re: Advice on conversions

Post by jeffyscott »

Flyin55 wrote: Mon May 03, 2021 5:15 pm
jeffyscott wrote: Mon May 03, 2021 12:10 pm
Flyin55 wrote: Mon May 03, 2021 9:35 amAt first it was because I would be living on one SS vs. two, but then I realized that we probably have enough saved and my problem is going to be the single tax bracket. Well that and the reason for looking in to all of this in the first place.
It's a terrible reason to have to look into this, but I think you will have not have any financial issues aside from paying more in taxes.

Spending of $70,000 from $2 million is a 3.5% withdrawal rate. And it sounds like that $2 million+ does not include Roth balance? The house payment would go away at some point and then there is whatever the survivor SS benefit would be until your own benefit at 70 (didn't realize that this is not like the normal spousal benefit, where restricted application is no longer allowed, in my other post) . Effectively, I think you might average only about a 2% or even lower withdrawal rate?

Depending on health care cost prior to 65, I would think you could even afford to retire now, if you wanted to.
Thanks for taking the time to calculate that. That initially was my concern. We had originally figured that we could live on SS if we both took it at 70. So our money would just need to cover us from when we retired until then. If I look at every retirement account we are probably at close to $2.2, including only $35k in Roth. I am working towards 60/40, as I sold a bunch of stocks to move more towards index funds, and still have a bunch of cash sitting in the retirement accounts. You mentioned in another post that you are 90% in bonds in your IRA. Can I ask what type of bonds? I am completely clueless other than a few college finance and accounting classes 40 years ago. Also health insurance is the big unknown as far as retiring. Is figuring that out as simple as going to the government healthcare website?
Sure, I would look at healthcare.gov or your state's site if they have one. One complication would be the elimination of the income limit for subsidies is only for 2021 and 2022, so you would want to look at the unsubsidized cost in case that is not extended. And you would also want to look at what the cost will be at age 64 to see how much it might increase by then. Some employers allow retirees to continue to buy coverage, so that could be another thing to look at for costs. I am lucky enough to have that option available.

We do currently have 85-90% bonds/fixed income in our tax deferred accounts. In contrast, our Roth accounts are about 80% equities. I have been doing conversions to the top of the 12% tax bracket each year, since retiring a few years ago. Our total portfolio is a bit smaller than yours, but only about 50% is in tax deferred accounts with most of the rest in Roth (very small amounts in HSA and taxable) and we also have pension income.

For bonds/fixed income, most here use bond index fund, treasuries, and/or CDs. I don't know that doing anything more complicated adds much value, but do it anyway :) . In part because we have a low stock allocation of about 40%, I put some in riskier bond categories. We have about 20% of portfolio in CDs, TIPS, I and EE bonds (mostly CDs), about 20% in low cost managed intermediate term bond funds (substituting for bond index, as I prefer to minimize the treasury component with the CDs substituting for that), and about 20% in some riskier bond funds (things like emerging market bonds, floating rate, high yield). Many would say we should just put a bit more in stocks and get rid of the risky bonds.
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Re: Advice on conversions

Post by Imadeit »

Another thing to consider while you have time is to verify your house is titled properly. I went through the same as you and luckily my house was titled as Community Property with Right of survivorship. Or you have a living Trust that indicates the house will transfer to you. This allows you to obtain an appraisal a short time after you become single and provides for a Stepped up cost basis. I’m not a tax professional but I know this saved me from paying more taxes Upon selling. You may want to consult with an estate lawyer.
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Re: Advice on conversions

Post by Fat Tails »

celia wrote: Mon May 03, 2021 3:49 pm
jeffyscott wrote: Mon May 03, 2021 1:33 pm
celia wrote: Mon May 03, 2021 1:07 pm
jeffyscott wrote: Mon May 03, 2021 8:50 am I would first look at what your tax bracket would be at 72, when RMDs begin. With ~$2 million, initial RMD would be $74,000. At most 85% of SS is taxable, so total income for tax purposes would be about $108K and after the std deduction, taxable income would be about $95K. That puts you in the 24% bracket.
This statement falls into a very common trap of forgetting that the tax-deferred amount will continue to grow between now and age 72 (and even afterwards!). The current $2M could easily double if Roth conversions are not done aggressively. Then the RMD at age 72 would be about 4% of $4M, which is $160,000. That, by itself, puts a Single filer into the top of the 24% tax bracket (at today's historically low tax brackets).
Actually it assumes the account grows at the rate of inflation, since tax brackets are indexed. Doubling in 14 years, would require a return over 5% and since tax rates are indexed, for your scenario to be accurate this would have to be 5% real. I would not consider 5% real to be something that will be "easily" achieved, when starting from the current high stock and bond prices.

The intent was certainly not to suggest no conversions, but to get an initial idea of what might make sense. Without knowing the asset allocation of the current and future tax-deferred account, the expected return is unknown. I don't expect my own tax-deferred account to grow at more than about 0% real, since it is about 90% bonds.
JeffyScott, I guess our assumptions are clearly different. OP may be between us or skewed more towards the faster growth side due to having tax-deferred accounts so large at this age. Or maybe they are super-savers, maxing out all the retirement accounts they can.

But our role now, is to help OP look forward on what to do about potential Roth conversions. To that end, I would even suggest a growth rate of 7% would be quite possible, and plan for that. (That means the accounts are growing $140K each year.) If that rate continued for 10.2 years (according to the Rule of 72), the account would double to $4M. Then there are still 4 years left for it to get half-way to the next doubling. So the tax-deferred accounts could even be $6M at age 72 if no Roth conversions were to be done.

JeffyScott, I acknowledge you are working inflation into your version, while I am trying to show the OP the possibilities so they are motivated to head this off early by doing large conversions while still married. The value of the taxes will look scary :o and many people would back off on being so aggressive, but then they would regret it, if they were only converting an amount equal to the yearly growth. That, by itself, does not make a dent in the current tax-deferred accounts. To that, I would remind them that when they were tax-deferring, they were agreeing to pay the taxes later. The account was never all "theirs". It also belonged to Uncle Sam and the state as the taxes were, in effect, still in the account. They have been investing for not only themselves all these years, but for the government too. When the value of their tax-deferred accounts went up, the government's share also went up. And when the value of the accounts went down, the government's share also went down. But the fact still remains that every withdrawal, whether to taxable or to Roth will need to be taxed. If a QCD is taken out for charity, that is like the government is also donating to your chosen charity too.

So OP should just look at the taxes in comparison to the amount converted. Yes 24% of a large number is more than 22% or 24% of a smaller number, but if Roth conversions ARE NOT DONE, the taxes will be more later on and in a higher tax bracket (because I'm looking at the top of the 24% bracket based on just Roth conversions)!
+1, Celia has good advice in all her posts in this thread. If I were you I’d do conversions to the top of the 24% bracket this year at least and you can reassess next year. I imagine that you will need to convert to the top of the 24% bracket every year to make a dent in those large IRA balances. If you use that spreadsheet Celia references you will see that earlier conversions are more valuable that later due to the future growth of the money in the traditional IRAs. Once you change to filing single your ability to convert large sums at lower tax brackets goes away, so do it while you can. And really, the difference between 22% and 24% is negligible, so there is no need to worry over it. Stop the 401(k) contributions. Open a Roth ASAP if you dont have one, and convert ASAP. It is better to pay the taxes on the conversion from taxable money if you can. Invest the higher growth assets (stocks) in the Roth and your lower growth assets (bonds, cash) in the Traditional.

I wish you the very best.
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Re: Advice on conversions

Post by jeffyscott »

Fat Tails wrote: Tue May 04, 2021 12:25 amIf I were you I’d do conversions to the top of the 24% bracket this year at least and you can reassess next year. I imagine that you will need to convert to the top of the 24% bracket every year to make a dent in those large IRA balances. If you use that spreadsheet Celia references you will see that earlier conversions are more valuable that later due to the future growth of the money in the traditional IRAs. Once you change to filing single your ability to convert large sums at lower tax brackets goes away, so do it while you can. And really, the difference between 22% and 24% is negligible, so there is no need to worry over it. Stop the 401(k) contributions. Open a Roth ASAP if you dont have one, and convert ASAP. It is better to pay the taxes on the conversion from taxable money if you can. Invest the higher growth assets (stocks) in the Roth and your lower growth assets (bonds, cash) in the Traditional.

I wish you the very best.
That is a key point, that this will be something to take a look at each year. With the portfolio info, that it is 60/40 and nearly all in tax deferred, that means there is about $1.3 million in stocks that can be converted to Roth. This balance can be reduced by maybe about $200K per year via converting to the top of the 24% bracket while MFJ . The balance could also change drastically via market action, of course. That's kind of a catch-22, if stocks go up a lot, you may want to convert as much as possible to get balance down, but if stocks go down a lot, you would benefit from converting at the low prices.

On the other end, getting the TIRA balance down to about $1 million at age 72, would put total income under IRMAA based on $40K SS and about the same amount as initial RMD. And if that $1 million level has been reached, the TIRA will likely be all or nearly all in bonds and so will not grow too much.

The second tier of IRMAA is at $111K, with $40K SS that means RMDs could be about $70K and would mean balance could be about $1.9 million. Barring unexpectedly large returns, that should be easily achievable. So when it gets to the point where filing as single and conversions will affect IRMAA (age 63?), that may become a reasonable target for income (of course, to be reassessed when you actually get there). Income at that time will be $25-30K from SS, so that still leaves room to convert $80-85K per year or so (I'm not sure if MAGI used for IRMAA includes 100% of SS or only the taxable portion :?: ).
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