Optimizing Taxes for future retirement with Roth Conversion

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Topic Author
Ccthealias
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Optimizing Taxes for future retirement with Roth Conversion

Post by Ccthealias »

I have been reading a lot on Boglehead and am trying to figure out how to optimize my investment for Tax Savings. I realized that if no changes are made, I might have a huge tax bill in the future. I would love some input as to other considerations

Tax Bracket- 24%, Unlikely to move up
State NJ bracket- 6.37% of the excess over $150,000
Kids- 7 and 9


Self- age 43
retirement- traditional 401k 1.2MM (1MM is in former employer's plan)
Roth IRA- just started backdoor for Tax year 23 and 24- 14K
Starting 2024- Max out Roth 401K, 3% employee match
Income- 220K
Job security- Low. If I get laid off, I might not be able to get a similar paying job and I have zero desire to commute or any ambitions :-P

Husband- Age 48
retirement- traditional 401k 810K (current employer
Roth IRA- 20K
Starting 2024- Max out Roth 401K, 5% employee match
Income -100K
Job security - high, Plan on retiring at 62 and get pension ~3,600 a month
Post retirement, eligible to continue employer’s health insurance covering the family

Non Retirement
- %00K in across taxable brokerage, HYSA, CD
- 100K across 2 custodian accounts brokerage
- 200K in 529 Plan


Real estate
-Primary house- 28 more years at 2.85% interest, $6,500 a month
-Rental- 2 more years at 3.5%, Rent currently covers mortgage and due to depreciation, has been reporting as loss for taxes. (10 more years of depreciation, will need to figure out what to do with this house later)

Current expense is about 160K a year, most of it coming from Mortgage, Downsizing and using equity from the current house will significantly reduce expenses. I think we should have more than enough to have left over $$ to pass on to our kids so I am taking that into considerations as I tweak my plan.


Retirement- Start converting Roth until we reach the top of the 24% bracket. I was thinking of rolling former employer 401K into traditional IRA than slowly to Roth each year. This would give me most fleixlbity in case I need to withdraw before 59 and more investment options. However they don’t allow partial rollover so once I move the $1MM into IRA, I can no longer do Backdoor IRA. Would it make sense contribute to 401K pretax and just convert more to Roth IRA to maximize flexibility?

529 - Based on current investment I should be able to cover public in state but might fall short if one or both goes to private. I could either then use $ from Custodian or from retirement (for the 2nd kid who might not have enough) Alternatively I can try to “overfund” and worse case scenario have money for Roth IRA conversion or grandkids

Side note- Already working on optimizing investment mix for tax efficiency across Custodian, retirement and taxable. (very neat trick I learn here)
livesoft
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by livesoft »

When I was your age there was no such thing as a Roth IRA. Then when Roth IRAs appeared people with moderate incomes could not contribute nor could they convert traditional IRAs to Roth IRAs.

Anyways, the above didn't stop families from saving lots of money and retiring early. Then Roth conversions while in much lower tax brackets became a thing. So rather than trying to do Roth conversions at 24% and more, why not wait until you have more clarity of being in the 0% or 10% or 15% tax brackets or whatever the future holds?
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Ccthealias
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by Ccthealias »

livesoft wrote: Mon Feb 05, 2024 2:05 pm When I was your age there was no such thing as a Roth IRA. Then when Roth IRAs appeared people with moderate incomes could not contribute nor could they convert traditional IRAs to Roth IRAs.

Anyways, the above didn't stop families from saving lots of money and retiring early. Then Roth conversions while in much lower tax brackets became a thing. So rather than trying to do Roth conversions at 24% and more, why not wait until you have more clarity of being in the 0% or 10% or 15% tax brackets or whatever the future holds?
That was my initial thought however tax rates are scheduled to go up in 2026 and so even I stop working, it would be in a higher bracket starting in 2026 even if my income drops. (25% tax bracket)
livesoft
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by livesoft »

If you stop working and your spouse makes $100K, then why would you be paying any federal income taxes?
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UNCHEEL
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by UNCHEEL »

You may not need to rush into anything in the short term, but a few things to keep in mind:

1) The general assumption is that you defer income in an IRA/401k because the tax rates will be lower when you withdraw. However, tax rates almost HAVE to go up, so the cost of converting later may go up than you see today. Also, your future taxable income might not go down as much as you think. Social Security, pensions, and RMD's add to income. And, if your nest egg grows, your investment income will grow with it.
2) If you/spouse pass away, any remaining balance that goes to you kids has to be cashed out within 10 years - taxable at their marginal rate (perhaps during their peak earning years, and maybe at higher rates than you would have paid).
3) IRMMA. If you wait and convert until you nearing (or after) Full Retirement age, the conversion will be part of your excess cost of Medicare.
4) Rules change. Hard to say what. Limits on contributions, limits on balances, taxes on deferred income balance, limitation on conversions, and (as mentioned above) tax increases?

I wasn't thinking about any of those things when I was your age. But, they're all real items today.
Topic Author
Ccthealias
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by Ccthealias »

UNCHEEL wrote: Mon Feb 05, 2024 3:40 pm You may not need to rush into anything in the short term, but a few things to keep in mind:

1) The general assumption is that you defer income in an IRA/401k because the tax rates will be lower when you withdraw. However, tax rates almost HAVE to go up, so the cost of converting later may go up than you see today. Also, your future taxable income might not go down as much as you think. Social Security, pensions, and RMD's add to income. And, if your nest egg grows, your investment income will grow with it.
2) If you/spouse pass away, any remaining balance that goes to you kids has to be cashed out within 10 years - taxable at their marginal rate (perhaps during their peak earning years, and maybe at higher rates than you would have paid).
3) IRMMA. If you wait and convert until you nearing (or after) Full Retirement age, the conversion will be part of your excess cost of Medicare.
4) Rules change. Hard to say what. Limits on contributions, limits on balances, taxes on deferred income balance, limitation on conversions, and (as mentioned above) tax increases?

I wasn't thinking about any of those things when I was your age. But, they're all real items today.
Yes! That’s exactly why I want to start planning. I watched an YouTube video from a financial advisor talking about taxes in retirement then realize I should switch to contributing to 401k after taxes
Topic Author
Ccthealias
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by Ccthealias »

livesoft wrote: Mon Feb 05, 2024 2:53 pm If you stop working and your spouse makes $100K, then why would you be paying any federal income taxes?
If I have time, I can use turbo tax to size how much I would have to pay in taxes with one income. Maybe with deduction I would hit a lower tax bracket but definitely not 0. Also I would have to sell some of my taxable investments to support expenses and some have 300% caps gain from investing in 2016..
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Wiggums
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by Wiggums »

Ccthealias wrote: Mon Feb 05, 2024 4:11 pm
livesoft wrote: Mon Feb 05, 2024 2:53 pm If you stop working and your spouse makes $100K, then why would you be paying any federal income taxes?
If I have time, I can use turbo tax to size how much I would have to pay in taxes with one income. Maybe with deduction I would hit a lower tax bracket but definitely not 0. Also I would have to sell some of my taxable investments to support expenses and some have 300% caps gain from investing in 2016..
This is a good idea. You have to be careful that you don’t hit the threshold to pay the 3.8% NIIT tax from conversions. You are already halfway to the 24% bracket between the pension and portfolio returns. Add social security later and you are almost there. So the question might be when do you want to pay the tax?

Edit to correct NIIT tax name (A 3.8 percent Net Investment Income Tax (NIIT) applies to individuals, estates, and trusts that have net investment income above applicable threshold amounts.)
Last edited by Wiggums on Mon Feb 05, 2024 4:56 pm, edited 3 times in total.
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Topic Author
Ccthealias
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by Ccthealias »

Wiggums wrote: Mon Feb 05, 2024 4:28 pm
Ccthealias wrote: Mon Feb 05, 2024 4:11 pm
livesoft wrote: Mon Feb 05, 2024 2:53 pm If you stop working and your spouse makes $100K, then why would you be paying any federal income taxes?
If I have time, I can use turbo tax to size how much I would have to pay in taxes with one income. Maybe with deduction I would hit a lower tax bracket but definitely not 0. Also I would have to sell some of my taxable investments to support expenses and some have 300% caps gain from investing in 2016..
You have to be careful that you don’t hit the threshold to pay the NII tax from conversions. You are already halfway to the 24% bracket between the pension and portfolio returns. Add social security later and you are almost there. So the question might be when do you want to pay the tax?
Do you mean the NIT 3.8%? If so, I am already hitting it unfortunately.
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Wiggums
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by Wiggums »

Yes, the 3.8 percent Net Investment Income Tax (NIIT) applies to individuals, estates, and trusts that have net investment income above applicable threshold amounts.

So I guess your homework is to determine if you can avoid any of these taxes later. With your spouse retiring at 62, you will run into the medicare premium brackets which will further limit the size of any conversions. It’s a catch-22 I know all too well.
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livesoft
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by livesoft »

Ccthealias wrote: Mon Feb 05, 2024 4:11 pm
livesoft wrote: Mon Feb 05, 2024 2:53 pm If you stop working and your spouse makes $100K, then why would you be paying any federal income taxes?
If I have time, I can use turbo tax to size how much I would have to pay in taxes with one income. Maybe with deduction I would hit a lower tax bracket but definitely not 0. Also I would have to sell some of my taxable investments to support expenses and some have 300% caps gain from investing in 2016..
You might even be in the 0% long-term capital gains tax bracket with such low income and those children.
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Topic Author
Ccthealias
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by Ccthealias »

livesoft wrote: Mon Feb 05, 2024 5:09 pm
Ccthealias wrote: Mon Feb 05, 2024 4:11 pm
livesoft wrote: Mon Feb 05, 2024 2:53 pm If you stop working and your spouse makes $100K, then why would you be paying any federal income taxes?
If I have time, I can use turbo tax to size how much I would have to pay in taxes with one income. Maybe with deduction I would hit a lower tax bracket but definitely not 0. Also I would have to sell some of my taxable investments to support expenses and some have 300% caps gain from investing in 2016..
You might even be in the 0% long-term capital gains tax bracket with such low income and those children.
But a Roth IRA conversion would be taxed as ordinary income. So converting a sizable amount would push me back up to a higher bracket caps gain bracket of 15% even through we have one earned income.
Topic Author
Ccthealias
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by Ccthealias »

Wiggums wrote: Mon Feb 05, 2024 4:28 pm
Ccthealias wrote: Mon Feb 05, 2024 4:11 pm
livesoft wrote: Mon Feb 05, 2024 2:53 pm If you stop working and your spouse makes $100K, then why would you be paying any federal income taxes?
If I have time, I can use turbo tax to size how much I would have to pay in taxes with one income. Maybe with deduction I would hit a lower tax bracket but definitely not 0. Also I would have to sell some of my taxable investments to support expenses and some have 300% caps gain from investing in 2016..
This is a good idea. You have to be careful that you don’t hit the threshold to pay the 3.8% NIIT tax from conversions. You are already halfway to the 24% bracket between the pension and portfolio returns. Add social security later and you are almost there. So the question might be when do you want to pay the tax?

Edit to correct NIIT tax name (A 3.8 percent Net Investment Income Tax (NIIT) applies to individuals, estates, and trusts that have net investment income above applicable threshold amounts.)
Does the Roth Conversion amount get tax at 3.8% in addition to the 24%. i though it just count as ordinary income pushing you to a higher tax bracket.
livesoft
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by livesoft »

Ccthealias wrote: Mon Feb 05, 2024 7:47 pmBut a Roth IRA conversion would be taxed as ordinary income. So converting a sizable amount would push me back up to a higher bracket caps gain bracket of 15% even through we have one earned income.
I guess your spouse will have to stop working then as well.
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FiveK
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by FiveK »

Ccthealias wrote: Mon Feb 05, 2024 7:54 pm Does the Roth Conversion amount get tax at 3.8% in addition to the 24%. i though it just count as ordinary income pushing you to a higher tax bracket.
No to the question and yes to your thought.

If you can use Excel, you can see the marginal tax rates for different conversion amounts by using the personal finance toolbox. It should be accurate for federal taxes - don't know how well it does with NJ tax.
tj
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by tj »

Ccthealias wrote: Mon Feb 05, 2024 7:47 pm
livesoft wrote: Mon Feb 05, 2024 5:09 pm
Ccthealias wrote: Mon Feb 05, 2024 4:11 pm
livesoft wrote: Mon Feb 05, 2024 2:53 pm If you stop working and your spouse makes $100K, then why would you be paying any federal income taxes?
If I have time, I can use turbo tax to size how much I would have to pay in taxes with one income. Maybe with deduction I would hit a lower tax bracket but definitely not 0. Also I would have to sell some of my taxable investments to support expenses and some have 300% caps gain from investing in 2016..
You might even be in the 0% long-term capital gains tax bracket with such low income and those children.
But a Roth IRA conversion would be taxed as ordinary income. So converting a sizable amount would push me back up to a higher bracket caps gain bracket of 15% even through we have one earned income.

It would not make a whole lot of sense to do Roth conversions while earning a six figure salary.
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by tibbitts »

I must have missed something but it sounds like $2M in deferred for MFJ, and all future contributions going to Roth? With deferred (now, soon, eventually?) being mostly fixed income at maybe 1.5% real returns, is that a problem that you'd even want to address at this point?
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Re: Optimizing Taxes for future retirement with Roth Conversion

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Ccthealias
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by Ccthealias »

tibbitts wrote: Tue Feb 06, 2024 1:43 pm I must have missed something but it sounds like $2M in deferred for MFJ, and all future contributions going to Roth? With deferred (now, soon, eventually?) being mostly fixed income at maybe 1.5% real returns, is that a problem that you'd even want to address at this point?
What do you mean by fixed income? 2M retirement is in a mix of 75/25 stock, bond ratio. There might be some optimization opportunity to have no bonds in taxable shifting more to retirement but that's a separate question all together
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Re: Optimizing Taxes for future retirement with Roth Conversion

Post by tibbitts »

Ccthealias wrote: Sun Feb 11, 2024 8:39 am
tibbitts wrote: Tue Feb 06, 2024 1:43 pm I must have missed something but it sounds like $2M in deferred for MFJ, and all future contributions going to Roth? With deferred (now, soon, eventually?) being mostly fixed income at maybe 1.5% real returns, is that a problem that you'd even want to address at this point?
What do you mean by fixed income? 2M retirement is in a mix of 75/25 stock, bond ratio. There might be some optimization opportunity to have no bonds in taxable shifting more to retirement but that's a separate question all together
There is no "retirement" category that I'm aware of; there are only taxable, deferred, and Roth categories. Part of the benefit of a Roth conversion is that it may allow improving the placement of investments for tax purposes. For example when deferred was 80% of my investments, if I wanted any kind of reasonable asset allocation I had to have a high percentage of equity in deferred accounts. Now, after some "jumbo" conversions, the "risk" of good performance in deferred is mostly gone, due to deferred now containing a much higher percentage of fixed income. As it happened the "risk" didn't show up during the conversion years, but that's not something you know ahead of time. I'm not going to go back over the thread to see if you mean the OP is targeting 75/25 and that's why you referenced that, but that's not a particular common (or rare) allocation in retirement.

I'm sticking to my story that for someone finished with deferred contributions and at the ages discussed by the OP, $2M in deferred isn't necessarily a big problem, given that it's all in fixed income, which is probably going to return in the range of 1.5% real. Certainly it can wait for conversions if the OP believes there will be better opportunities later.
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