Roth conversion: Threshold checklist

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Roth conversion: Threshold checklist

Post by VictoriaF » Wed Jul 29, 2015 10:38 am

2015 is the fist year when I don't have employment income, and I am now developing a plan for moving around my investments. I have a number of years before I reach the age of 70, when I will start receiving Social Security and will be subject to RMDs, if I still have any traditional IRA funds left.

My goal is to convert all my traditional tax-deferred funds into Roth before the age of 70 and to remove unrealized capital gains from my taxable accounts, so that starting at the age of 70, I would have taxable income only from the Social Security, two pensions, and maturing I Bonds.

The sequence of the Roth conversions and of tax gain harvesting is very important. If I do it too fast, I'll pay taxes in the 28% bracket and may even trigger various high-income tax code thresholds. If I don't do it fast enough, I'll exceed Medicare Part B AGI thresholds, possibly getting several bands higher. Thus, I am planning stock sales and Roth conversions that would produce the lowest total tax.

I have created Excel models to try various scenarios. I like my own models better than external ones, because creating them and playing with them forces me to think. I simplify what I want to simplify and add details to what I consider critical. Sometimes, a new thought strikes me and I go back to change my models. It's both useful and fun.

I am working out various scenarios while considering various thresholds, i.e., income levels exceeding which creates step increases in taxes or premiums. The reason for this thread is to ensure that I am not missing any critical thresholds. Here is my current list of thresholds:

[5 August 2015 update: The initial list of the thresholds is replaced by an updated one based on the discussion that ensued.]

Are there other thresholds related to the tax code, Medicare, or Social Security that I am missing?

Victoria
Last edited by VictoriaF on Wed Aug 05, 2015 9:23 am, edited 1 time in total.
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

kaneohe
Posts: 5955
Joined: Mon Sep 22, 2008 12:38 pm

Re: Roth conversion: Threshold checklist

Post by kaneohe » Wed Jul 29, 2015 11:54 am

How about this one: http://fairmark.com/medicare-tax-on-investments/
200K threshold (for singles), 3.8% on net investment income (or amount above AGI threshold if less).

User avatar
ObliviousInvestor
Posts: 3587
Joined: Tue Mar 17, 2009 9:32 am
Contact:

Re: Roth conversion: Threshold checklist

Post by ObliviousInvestor » Wed Jul 29, 2015 12:05 pm

One step I would take is check your prior tax returns for any credits/deductions that you've taken in the past (and which -- income limits aside -- you would be able to continue taking), so that you can look into relevant thresholds for those.

Also, it will be important to remember that the income being measured is different for many of the thresholds. For example:

Taxable income for tax brackets,
"Combined income" for taxability of Social Security benefits,
AGI for personal exemption phaseout,
MAGI for Medicare IRMAA (definition here),
A different MAGI for the 3.8% net investment income tax.
Mike Piper, author/blogger

User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Re: Roth conversion: Threshold checklist

Post by VictoriaF » Wed Jul 29, 2015 12:24 pm

kaneohe wrote:How about this one: http://fairmark.com/medicare-tax-on-investments/
200K threshold (for singles), 3.8% on net investment income (or amount above AGI threshold if less).
This is great! "Great" in the sense that I was not aware of it, and it affects my planning.

I found more recent information from the IRS:
Find out if Net Investment Income Tax applies to you dated 13 April 2015
and
Questions and Answers for the Additional Medicare Tax dated 5 March 2015.

The Additional Medicare Tax does not apply in my case, because I don't have wage income, but I am referencing it for others who may be interested.

Thank you very much,
Victoria
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Re: Roth conversion: Threshold checklist

Post by VictoriaF » Wed Jul 29, 2015 12:38 pm

ObliviousInvestor wrote:One step I would take is check your prior tax returns for any credits/deductions that you've taken in the past (and which -- income limits aside -- you would be able to continue taking), so that you can look into relevant thresholds for those.
Thank you, Mike,

I do my taxes using spreadsheets, and I use my 2014 calculations as the basis for the 2015 estimates. Thus, all my regular credits and deductions are accounted for.
ObliviousInvestor wrote:Also, it will be important to remember that the income being measured is different for many of the thresholds. For example:

Taxable income for tax brackets,
"Combined income" for taxability of Social Security benefits,
AGI for personal exemption phaseout,
MAGI for Medicare IRMAA (definition here),
A different MAGI for the 3.8% net investment income tax.
It's a good point, and I have incorporated different brackets as appropriate.

The thing that surprised me was that as I was trying various amounts of the capital gains income the result was essentially the same. The regular income would be taxed at 25% or 28%, and the capital gains income would be taxed at 15%. I was even considering getting ALL my unrealized gains in one year, but due to the Net Investment Income Tax referenced by kaneohe, I have to keep the AGI under $200k.

Victoria
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

trueblueky
Posts: 1623
Joined: Tue May 27, 2014 3:50 pm

Re: Roth conversion: Threshold checklist

Post by trueblueky » Sun Aug 02, 2015 5:32 pm

Have anyone calculated the time value of money on Roth conversions?

Say one converts $10,000 at age 60 from tIRA to Roth, paying 15% federal tax now to avoid 25% tax on RMD at age 70.5. So that's $1500 paid today.

The RMD is about 4% at first, so $400 that would have been taxable in the first year of RMD now isn't. The tax on that would have been $100. The same happens the next year and so on for 20 years or so. (Not exact numbers on the RMD -- I know the percentage rises a little each year). Eventually, you pay $2500 in tax if you don't convert, but it takes many years. Vs paying $1500 today. Has anyone worked that out?

Alternatively, if one withdraws more than the RMD each year, from necessity perhaps, the $10,000 can be thought of as the last $10,000 in the tIRA, so it might not have been withdrawn and taxed for many years.

retiredjg
Posts: 38461
Joined: Thu Jan 10, 2008 12:56 pm

Re: Roth conversion: Threshold checklist

Post by retiredjg » Sun Aug 02, 2015 6:55 pm

VictoriaF wrote:the reason I want to get rid of the RMDs and unrealized gains is that I want to avoid or minimize the 46.25% bracket for the singles
With 2 pensions, I'm not sure you can avoid the 46.25% bracket. The way I see it, the 46.25% bracket is like a donut. You go into it and you go out of it back into your "regular" bracket for the rest of the income. Maybe I'm remembering it wrong and need to check it again.

randomguy
Posts: 8402
Joined: Wed Sep 17, 2014 9:00 am

Re: Roth conversion: Threshold checklist

Post by randomguy » Sun Aug 02, 2015 7:52 pm

trueblueky wrote:Have anyone calculated the time value of money on Roth conversions?

Say one converts $10,000 at age 60 from tIRA to Roth, paying 15% federal tax now to avoid 25% tax on RMD at age 70.5. So that's $1500 paid today.

The RMD is about 4% at first, so $400 that would have been taxable in the first year of RMD now isn't. The tax on that would have been $100. The same happens the next year and so on for 20 years or so. (Not exact numbers on the RMD -- I know the percentage rises a little each year). Eventually, you pay $2500 in tax if you don't convert, but it takes many years. Vs paying $1500 today. Has anyone worked that out?

Alternatively, if one withdraws more than the RMD each year, from necessity perhaps, the $10,000 can be thought of as the last $10,000 in the tIRA, so it might not have been withdrawn and taxed for many years.
You are going to end up doing the pretty much same calculations as the ROTH versus traditional contribution. You end up having to guess a lot on future tax rates (both yours and your heirs) to go along with growth rates. Simple example. 10k that grows to 100k over 30 years (you convert it to a ROTH at 60 or wait til 90 to take it out)

ROTH:
10k->100k
1500 taxable->0k to pay taxes
At 90 you have 100k

IRA
10->100k ->85k after taxes
1500 taxable ->15k->15 after taxes if your in the 15% bracket

at 90 you have 100k. Obviously paying taxes along the way on taxable acount makes the ROTH a bit of a winner. The RMD of having 100k might bump you up a tax bracket. And the ability to avoid taxes another 30+ years if you leave the ROTH to a kid is also worth a lot. Now if taxes drop in the future, the ira is a win. They go up the ROTH is a win.

One thing to think about is if it is worthwhile to avoid the medicare part B premiums. If you have to pay 20k in tax to avoid 5k in premiums, that might not be a win. Obviously you need to run your numbers.

Similiary going all the way into the 28% bracket can be a win. Imagine it was something like 2013 and compare the ROTH account values up to 28% at the start of 2013 and paying up to 25% over 2013,2014, and parts 2015.

User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Re: Roth conversion: Threshold checklist

Post by VictoriaF » Sun Aug 02, 2015 8:03 pm

trueblueky wrote:Have anyone calculated the time value of money on Roth conversions?

Say one converts $10,000 at age 60 from tIRA to Roth, paying 15% federal tax now to avoid 25% tax on RMD at age 70.5. So that's $1500 paid today.

The RMD is about 4% at first, so $400 that would have been taxable in the first year of RMD now isn't. The tax on that would have been $100. The same happens the next year and so on for 20 years or so. (Not exact numbers on the RMD -- I know the percentage rises a little each year). Eventually, you pay $2500 in tax if you don't convert, but it takes many years. Vs paying $1500 today. Has anyone worked that out?
Interesting comments. Lifecycle planning tools such as i-ORP and ESPlanner account for the time value of money, and in order to do so they ask about your future interest rate projections and anticipated rates of return. I have done a rough i-ORP run and then switched to my own spreadsheet.

One flaw in your calculation is that you assume that RMDs will remain at 4% for 20 years.
trueblueky wrote:Alternatively, if one withdraws more than the RMD each year, from necessity perhaps, the $10,000 can be thought of as the last $10,000 in the tIRA, so it might not have been withdrawn and taxed for many years.
If one needs money after the age of 70 he can withdraw from Roth. He will have paid 15% to convert to Roth but will be saving 25% from not having to withdraw from a tIRA.

Victoria
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

User avatar
pezblanco
Posts: 614
Joined: Thu Sep 12, 2013 8:02 pm

Re: Roth conversion: Threshold checklist

Post by pezblanco » Sun Aug 02, 2015 8:17 pm

I started this year doing conversions ... I decided to convert as much as possible with clicking over into the next tax bracket. I'm not going to be able to convert everything ... and I'm not sure that I should. We have no knowledge of future tax rules and rates. For example, there has been talk of forcing RMD's on Roth accounts: whether that occurs is anyone's guess.

The one thing that I think is a no-brainer to do, is do a "horse race" every year with 3 or 4 times the amount of money that you want to convert. I.e. create 3 or 4 different converted Roths's and see at the end of the year which wins .... If you have a big gainer, this can create a substantial tax saving ... then you recharacterize the "loser" Roths and do the same thing again the following year.

User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Re: Roth conversion: Threshold checklist

Post by VictoriaF » Sun Aug 02, 2015 8:19 pm

retiredjg wrote:
VictoriaF wrote:the reason I want to get rid of the RMDs and unrealized gains is that I want to avoid or minimize the 46.25% bracket for the singles
With 2 pensions, I'm not sure you can avoid the 46.25% bracket. The way I see it, the 46.25% bracket is like a donut. You go into it and you go out of it back into your "regular" bracket for the rest of the income. Maybe I'm remembering it wrong and need to check it again.
Based on my calculations, I will be inside the donut hole. Every dollar of income I remove is a dollar that would be taxed at 46.25%. But let's assume that instead of removing future income, I left it in place and exited the hole on the other side at 25%. A future change in taxation could put me back into the hole.

In general, I prefer to have fewer assets that are cleaner. You, Grabiner and a few other Bogleheads understand that $100 in Roth is better than $120 in t-IRA taxable at 25%. But the majority of people consider the latter 20% greater.

Roth conversions will also reduce my future state income tax in Virginia.

Victoria
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

User avatar
Epsilon Delta
Posts: 8090
Joined: Thu Apr 28, 2011 7:00 pm

Re: Roth conversion: Threshold checklist

Post by Epsilon Delta » Sun Aug 02, 2015 9:23 pm

VictoriaF wrote:
retiredjg wrote:
VictoriaF wrote:the reason I want to get rid of the RMDs and unrealized gains is that I want to avoid or minimize the 46.25% bracket for the singles
With 2 pensions, I'm not sure you can avoid the 46.25% bracket. The way I see it, the 46.25% bracket is like a donut. You go into it and you go out of it back into your "regular" bracket for the rest of the income. Maybe I'm remembering it wrong and need to check it again.
Based on my calculations, I will be inside the donut hole. Every dollar of income I remove is a dollar that would be taxed at 46.25%. But let's assume that instead of removing future income, I left it in place and exited the hole on the other side at 25%. A future change in taxation could put me back into the hole.
It may make sense to do some conversions after you are 70. On your facts, any conversions after you are taking SS will be partially taxed at 46.25% and partially at 25%. If your pensions and SS put you near the top of the donut hole then only a small amount of the conversion will be taxed at 46.25% and the blended rate could be less than 28%. OTOH if your at the bottom of the donut hole converting at 28% is probably better. You'd also need to take some small RMDs if you do some of the conversions after age 70.

I'll also say that you haven't mentioned state taxes or local taxes. I don't know Virginia taxes, but in NY there are definitely things that would make a difference. Look for things like AGI thresholds for property tax exclusions, progressive tax rates and exclusions for various types of income, which may include IRA withdrawals/conversions.

hale2
Posts: 226
Joined: Sat Feb 15, 2014 5:54 pm

Re: Roth conversion: Threshold checklist

Post by hale2 » Mon Aug 03, 2015 3:44 pm

Victoria,

Are you converting funds from your TSP? If so, how are you doing this over time? From what I understand you can only pull funds from the TSP once before you have to start taking regular payments.

I was thinking about moving some or all of my TSP to a TIRA so I can do small conversions annually, but am reluctant since that would result in losing access to the low TSP expense ratios as well as the G Fund.

User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Re: Roth conversion: Threshold checklist

Post by VictoriaF » Mon Aug 03, 2015 3:54 pm

hale2 wrote:Victoria,

Are you converting funds from your TSP? If so, how are you doing this over time? From what I understand you can only pull funds from the TSP once before you have to start taking regular payments.

I was thinking about moving some or all of my TSP to a TIRA so I can do small conversions annually, but am reluctant since that would result in losing access to the low TSP expense ratios as well as the G Fund.
Hi hale2,

I am encouraged by the recent news that the TSP Board is planning to allow multiple withdrawals. In 2015, I will roll-over from the TSP to Vanguard the amount that I want to convert to Roth in 2015, 2016, and 2017. I hope that by 2018 multiple withdrawals will be in place, and I will be able to roll over to Vanguard my planned annual amounts.

If at any time, starting in 2018, the TSP Board allows in-plan conversions, I will stop rolling over to Vanguard and will do the conversions within the TSP.

Victoria
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

Lynette
Posts: 1889
Joined: Sun Jul 27, 2014 9:47 am

Re: Roth conversion: Threshold checklist

Post by Lynette » Mon Aug 03, 2015 4:06 pm

I know that Bogleheads don't believe in market timing but it would help those of us considering Roth conversions if there was a correction in the market.

hale2
Posts: 226
Joined: Sat Feb 15, 2014 5:54 pm

Re: Roth conversion: Threshold checklist

Post by hale2 » Mon Aug 03, 2015 4:08 pm

Victoria,

Great idea. I plan to retire from govt in either 2016 or 2017, so when I hit that point I'll follow your plan and roll over the appropriate amount from the TSP so I can do my planned conversions over time.

Thanks

User avatar
Electron
Posts: 1919
Joined: Sat Mar 10, 2007 8:46 pm

Re: Roth conversion: Threshold checklist

Post by Electron » Mon Aug 03, 2015 4:15 pm

VictoriaF wrote:My goal is to convert all my traditional tax-deferred funds into Roth before the age of 70 and to remove unrealized capital gains from my taxable accounts, so that starting at the age of 70, I would have taxable income only from the Social Security, two pensions, and maturing I Bonds.
My impression was that unrealized long term capital gains may not be a problem if the investment can be held long term. One example would be unrealized capital gains in a Total Stock Market Index fund. An exception might be taking advantage of the 0% bracket for capital gains if space is available in the 15% bracket. However, in that case you might reduce the size of potential Roth Conversions. Capital gains and qualified dividends generally see favorable tax rates in retirement.
Electron

User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Re: Roth conversion: Threshold checklist

Post by VictoriaF » Mon Aug 03, 2015 4:16 pm

Lynette wrote:I know that Bogleheads don't believe in market timing but it would help those of us considering Roth conversions if there was a correction in the market.
At one of the Bogleheads conferences, Rick Ferri said that asset planning is easy, tax planning is difficult.

The flip side is that tax timing is easier than market timing. Using the thresholds I mentioned in this thread, i.e., the interest income tax, the Medicare Part B premium bands, and the change of the marginal rate from 25% to 28%, I have planned my Roth conversions and capital gains harvesting for many years ahead.

If I convert from a stock fund in a traditional account to a similar stock fund in a Roth account, I will retain the status quo. Selling stocks is a bit more tricky, but in a taxable account the tax law is my friend. If I move stocks from fund-A to fund-B and consecutively fund-B loses money, I will use its losses to offset the gains when selling other funds.

The current low-interest-rate environment is encouraging for Roth conversions. I will be paying taxes with the money that otherwise would earn little in money markets or CDs.

Victoria
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

retiredjg
Posts: 38461
Joined: Thu Jan 10, 2008 12:56 pm

Re: Roth conversion: Threshold checklist

Post by retiredjg » Mon Aug 03, 2015 4:20 pm

hale2 wrote:Great idea. I plan to retire from govt in either 2016 or 2017, so when I hit that point I'll follow your plan and roll over the appropriate amount from the TSP so I can do my planned conversions over time.
I took my one time withdrawal and just put a chunk in a tIRA. The rest is sitting in the TSP just cooking along in F Fund and G Fund and I haven't messed with it in years.

As for the tIRA, I have not been converting much to Roth yet, but I'm giving it strong consideration for this year and the next several years before RMDs start. I think that several years into RMDs, I'll be pushed into the 28% bracket if I don't start converting some now at 25% so converting at 25% seems reasonable to me.

User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Re: Roth conversion: Threshold checklist

Post by VictoriaF » Mon Aug 03, 2015 4:21 pm

Electron wrote:
VictoriaF wrote:My goal is to convert all my traditional tax-deferred funds into Roth before the age of 70 and to remove unrealized capital gains from my taxable accounts, so that starting at the age of 70, I would have taxable income only from the Social Security, two pensions, and maturing I Bonds.
My impression was that unrealized long term capital gains may not be a problem if the investment can be held long term. One example would be unrealized capital gains in a Total Stock Market Index fund. An exception might be taking advantage of the 0% bracket for capital gains if space is available in the 15% bracket. However, in that case you might reduce the size of potential Roth Conversions. Capital gains and qualified dividends generally see favorable tax rates in retirement.
I have pension income that puts me into the 25% bracket.

If I don't sell my taxable stocks now, I will have to sell them in a few years to pay taxes for the Roth conversions. At that time, the capital gains income would push me into a higher band for the Medicare Part B premiums. Medicare looks at the AGI rather than the nature of the gains.

Victoria
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

jane1
Posts: 739
Joined: Mon Dec 26, 2011 2:00 am

Re: Roth conversion: Threshold checklist

Post by jane1 » Mon Aug 03, 2015 5:03 pm

Lynette wrote:I know that Bogleheads don't believe in market timing but it would help those of us considering Roth conversions if there was a correction in the market.
Yes. We did a bunch of Roth conversions in 2009-10. Waiting for another correction!
Retirement articles typically show the pitfalls of market drops soon after retirement (fixed withdrawal from a reduced portfolio). But new retirees can take advantage of such market drops for Roth conversion and end up ahead.

User avatar
Electron
Posts: 1919
Joined: Sat Mar 10, 2007 8:46 pm

Re: Roth conversion: Threshold checklist

Post by Electron » Mon Aug 03, 2015 5:25 pm

VictoriaF wrote:I have pension income that puts me into the 25% bracket. If I don't sell my taxable stocks now, I will have to sell them in a few years to pay taxes for the Roth conversions. At that time, the capital gains income would push me into a higher band for the Medicare Part B premiums. Medicare looks at the AGI rather than the nature of the gains.
Thanks for the clarification. I know all about Medicare Premium surcharges and am quite sure I could have made better choices in previous years. In addition, I have been impacted by a few holdings in high turnover actively managed funds that have significant tax penalty. I'm working to eliminate those funds which in some circumstances can help trigger the AMT.

One interesting question is whether it is best to minimize taxes and surcharges or optimize longer term investment returns and after-tax net worth. I suspect it is the latter which could add complication to your models.
Electron

User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Re: Roth conversion: Threshold checklist

Post by VictoriaF » Mon Aug 03, 2015 5:35 pm

Electron wrote:One interesting question is whether it is best to minimize taxes and surcharges or optimize longer term investment returns and after-tax net worth. I suspect it is the latter which could add complication to your models.
The problem with the future longer-term investment returns is that no one knows what they will be. I can model my taxes and Medicare Part B premium and find the minimum total cost over a number of years. But I can't predict the future market performance.

My goal is to cover my basic needs with the Social Security and two pensions. By the age of 70, I will also have substantial Roth assets. These assets will provide a resource for discretionary spending that I will be able to use without being concerned about paying taxes on the withdrawals. I will be more interested in preserving this capital than maximizing its expected growth.

Victoria
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

User avatar
Electron
Posts: 1919
Joined: Sat Mar 10, 2007 8:46 pm

Re: Roth conversion: Threshold checklist

Post by Electron » Tue Aug 04, 2015 12:40 pm

VictoriaF wrote:Are there other thresholds related to the tax code, Medicare, or Social Security that I am missing?
There is no clear threshold, but be aware that capital gains can help trigger the AMT in conjunction with other items such as any state income tax deduction. The additional income contributes to the phaseout of the AMT exemption.

I wish I had the simplified sources of income that you described. That would reduce my effort considerably at tax time. It looks as though you will have only ordinary income along with tax free income from Roth IRAs. That would be an interesting change for me as I now avoid ordinary income as much as possible and emphasize tax exempt income and qualified dividends.

In regards to future investment returns, simplified models such as those presented by John Bogle might be worth considering. Bond returns for the next decade might project to be around 2% based on current yield, while stock returns could be in the area of 5%. The stock return is based on the current dividend yield in the broad stock market plus estimated earnings growth and plus or minus any change in PE ratio.

I assume your Roth Conversions can be completed at a marginal tax rate less than the tax rate that otherwise would apply to T-IRA withdrawals and RMDs in retirement.

Here is an excellent discussion on the taxation of Social Security. If you are impacted by the 46.25% marginal rate it might only apply to a modest portion of income. There is an interesting comment about accelerating income and getting to the point where your tax rate drops back to 25%.

https://www.kitces.com/blog/the-taxatio ... -increase/
Electron

User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Re: Roth conversion: Threshold checklist

Post by VictoriaF » Tue Aug 04, 2015 1:16 pm

Electron wrote:
VictoriaF wrote:Are there other thresholds related to the tax code, Medicare, or Social Security that I am missing?
There is no clear threshold, but be aware that capital gains can help trigger the AMT in conjunction with other items such as any state income tax deduction. The additional income contributes to the phaseout of the AMT exemption.

I wish I had the simplified sources of income that you described. That would reduce my effort considerably at tax time. It looks as though you will have only ordinary income along with tax free income from Roth IRAs. That would be an interesting change for me as I now avoid ordinary income as much as possible and emphasize tax exempt income and qualified dividends.

In regards to future investment returns, simplified models such as those presented by John Bogle might be worth considering. Bond returns for the next decade might project to be around 2% based on current yield, while stock returns could be in the area of 5%. The stock return is based on the current dividend yield in the broad stock market plus estimated earnings growth and plus or minus any change in PE ratio.

I assume your Roth Conversions can be completed at a marginal tax rate less than the tax rate that otherwise would apply to T-IRA withdrawals and RMDs in retirement.

Here is an excellent discussion on the taxation of Social Security. If you are impacted by the 46.25% marginal rate it might only apply to a modest portion of income. There is an interesting comment about accelerating income and getting to the point where your tax rate drops back to 25%.

https://www.kitces.com/blog/the-taxatio ... -increase/
Hi electron,

Thank you for the Kitces' article. Its examples with calculations are similar to those in the Bogleheads Wiki and its recommendations are consistent with what I am doing, i.e., accelerating taxable income while I can.

If I were receiving Social Security today, I would be inside the donut hole, and every $100 of taxable income saved would remove $46 of taxes. Thus, based on today's situation, my strategy is correct. However, I am planning for many years ahead, and the longer the planning frame, the less accurate models become. My eventual Social Security and one of my pensions will be rising with the increases in the cost of living, whereas it's not known whether the Social Security taxation bands and Medicare Part B income bands would be adjusted and, if yes, by how much. My default assumption is that I will remain in the marginal 46% bracket. If my assumption turns out to be wrong, and I find myself on the high side of the donut in the 25% bracket, I will not regret the decisions I am making today based on the information available to me today.

Modeling of the future returns is also uncertain. I have attended numerous Jack's presentations at Bogleheads conferences but I am also a strong believer in Black Swans. The markets may not return what is prudent for them to return for a variety of reasons that we can't foresee today. Thus, I invest conservatively, because I have enough and don't need to take risks.

If I end up paying more taxes than I am estimating now, I will be content with that. I am more driven by the pleasure of building a model and trying not to miss important factors than by the actual tax savings. Your suggestion about the AMT is useful; I will check it out for this and next year's taxes.

Thank you,

Victoria
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

retiredjg
Posts: 38461
Joined: Thu Jan 10, 2008 12:56 pm

Re: Roth conversion: Threshold checklist

Post by retiredjg » Tue Aug 04, 2015 2:45 pm

I have mixed feelings about this 46.25% marginal tax. It seems so unfair. But on the other hand, some of my SS is not even getting taxed at all so I've decided not to worry about it too much. Not much I can do about it anyway.

By the way, thanks for bringing up the point about the Medicare Part B bands. I was not fully aware of that and probably would have converted up to the top of the 25% bracket - triggering the increased Part B premiums.

User avatar
Electron
Posts: 1919
Joined: Sat Mar 10, 2007 8:46 pm

Re: Roth conversion: Threshold checklist

Post by Electron » Tue Aug 04, 2015 3:02 pm

The Medicare Part B bands (IRMAA) will apparently see an adjustment in 2018.

https://coastal.tax/be-prepared-for-hig ... -premiums/

I think the change only affects those in the 50% and 65% tiers. Read the paragraph below the chart.
Last edited by Electron on Tue Aug 04, 2015 3:06 pm, edited 1 time in total.
Electron

TheGipper
Posts: 278
Joined: Fri Jun 26, 2015 9:52 am

Re: Roth conversion: Threshold checklist

Post by TheGipper » Tue Aug 04, 2015 3:05 pm

VictoriaF, really enjoyed this thread and love the idea. Not too adept at Excel though, any chance you might be willing to share your Excel model with the Boglehead community?

User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Re: Roth conversion: Threshold checklist

Post by VictoriaF » Tue Aug 04, 2015 3:14 pm

TheGipper wrote:VictoriaF, really enjoyed this thread and love the idea. Not too adept at Excel though, any chance you might be willing to share your Excel model with the Boglehead community?

TheGipper,

Sorry, I can't. My spreadsheet is based on the personal data and generalizing it would be a completely new effort. If you are not interested in building your own spreadsheet, you can do modeling with the i-ORP tool. It's more sophisticated and more precise than my model.

Victoria
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

User avatar
BigFoot48
Posts: 2738
Joined: Tue Feb 20, 2007 10:47 am
Location: Arizona

Re: Roth conversion: Threshold checklist

Post by BigFoot48 » Tue Aug 04, 2015 3:35 pm

TheGipper wrote:VictoriaF, really enjoyed this thread and love the idea. Not too adept at Excel though, any chance you might be willing to share your Excel model with the Boglehead community?
Although certainly not to the detailed quality of Victoria's in the tax area, try mine to get a general overview of the conversion process and impact on taxes, RMD and one's portfolio. (James at i-ORP liked it enough to be a link to it on his site.) Retiree Portfolio Model
Retired | Two-time in top-10 in Bogleheads S&P500 contest; 13-time loser

trueblueky
Posts: 1623
Joined: Tue May 27, 2014 3:50 pm

Re: Roth conversion: Threshold checklist

Post by trueblueky » Tue Aug 04, 2015 5:19 pm

VictoriaF wrote:
hale2 wrote:Victoria,

Are you converting funds from your TSP? If so, how are you doing this over time? From what I understand you can only pull funds from the TSP once before you have to start taking regular payments.

I was thinking about moving some or all of my TSP to a TIRA so I can do small conversions annually, but am reluctant since that would result in losing access to the low TSP expense ratios as well as the G Fund.
Hi hale2,

I am encouraged by the recent news that the TSP Board is planning to allow multiple withdrawals. In 2015, I will roll-over from the TSP to Vanguard the amount that I want to convert to Roth in 2015, 2016, and 2017. I hope that by 2018 multiple withdrawals will be in place, and I will be able to roll over to Vanguard my planned annual amounts.

If at any time, starting in 2018, the TSP Board allows in-plan conversions, I will stop rolling over to Vanguard and will do the conversions within the TSP.

Victoria
You could set up monthly transfers from TSP to tIARA and then convert it to Roth IRA. That avoids having to transfer a lot out of TSP at once.

Beth*
Posts: 734
Joined: Wed Apr 30, 2014 9:57 am

Re: Roth conversion: Threshold checklist

Post by Beth* » Tue Aug 04, 2015 5:28 pm

VictoriaF wrote:Are there other thresholds related to the tax code, Medicare, or Social Security that I am missing?

Victoria
Do you live in a state with a state tax? If so, have you considered the effects of various scenarios on your state tax rate?

Have you considered whether some of your strategies could make you subject to the AMT?

User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Re: Roth conversion: Threshold checklist

Post by VictoriaF » Tue Aug 04, 2015 7:14 pm

trueblueky wrote:
VictoriaF wrote:
hale2 wrote:Victoria,

Are you converting funds from your TSP? If so, how are you doing this over time? From what I understand you can only pull funds from the TSP once before you have to start taking regular payments.

I was thinking about moving some or all of my TSP to a TIRA so I can do small conversions annually, but am reluctant since that would result in losing access to the low TSP expense ratios as well as the G Fund.
Hi hale2,

I am encouraged by the recent news that the TSP Board is planning to allow multiple withdrawals. In 2015, I will roll-over from the TSP to Vanguard the amount that I want to convert to Roth in 2015, 2016, and 2017. I hope that by 2018 multiple withdrawals will be in place, and I will be able to roll over to Vanguard my planned annual amounts.

If at any time, starting in 2018, the TSP Board allows in-plan conversions, I will stop rolling over to Vanguard and will do the conversions within the TSP.

Victoria
You could set up monthly transfers from TSP to tIARA and then convert it to Roth IRA. That avoids having to transfer a lot out of TSP at once.
In 2015, I will take a partial distribution from the TSP to cover 3 years of Roth conversions (2015-2017). In 2017, even if flexible distributions are in place, in-plan conversions are not likely, and thus my 2017 Roth conversion will be in Vanguard in any case. In 2018, if flexible distributions are not yet allowed, I will start monthly transfers.

Victoria
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Re: Roth conversion: Threshold checklist

Post by VictoriaF » Tue Aug 04, 2015 7:20 pm

Beth* wrote:
VictoriaF wrote:Are there other thresholds related to the tax code, Medicare, or Social Security that I am missing?

Victoria
Do you live in a state with a state tax? If so, have you considered the effects of various scenarios on your state tax rate?

Have you considered whether some of your strategies could make you subject to the AMT?
Yes to both. Virginia has income tax, and it taxes the pension income but not Social Security. After I finish Roth conversions I will qualify for the State's $12k deduction for those over the age of 65. I will check if my strategies affect the AMT.

Thank you,
Victoria
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

furwut
Posts: 1537
Joined: Tue Jun 05, 2012 8:54 pm

Re: Roth conversion: Threshold checklist

Post by furwut » Tue Aug 04, 2015 7:44 pm

The idea of a deferred annuity to delay RMD and provide longevity insurance has been rummaging around in my mind of late since I read Wade Pfau's latest on annuities enhancing portfolio sustainability.
The Treasury Department’s new rule would permit people to invest up to 25% of their IRA or 401(k) account balance (or $125,000, whichever is less) in these longevity annuities without having to take RMDs on that money. Because of this change, insurers are expected to extend the deferral age to 80 or 85.
Read more at http://www.kiplinger.com/article/retire ... yS5KEeJ.99

TheGipper
Posts: 278
Joined: Fri Jun 26, 2015 9:52 am

Re: Roth conversion: Threshold checklist

Post by TheGipper » Tue Aug 04, 2015 7:56 pm

Really like the I-Orp tool. It recommends I do Roth conversions of about almost 300k a year from age 62 when I hope to retire until age 70 when I plan to start taking RMDs an SS. It also recommends I continue to do much smaller Roth conversions into my mid 70s interesting. The Roth conversion amounts are sugnificantly affected by when I sell/downsize my primary home (plan to at age 58-62) if real estate market cooperates.

It is certainly not sophisticated enough to include all of Victoria's tax thresholds but large brute force conversions from retirement to and slightly into early RMD and SS years may still win out. Clearly it helps to have built up your taxable account or $ from home sale to get you through these years.

Projections seem a bit optimistic though, even when I put in expected average annual stock returns of 3% and 1.5% for bonds, just to see worst case scenario.

User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Re: Roth conversion: Threshold checklist

Post by VictoriaF » Tue Aug 04, 2015 8:06 pm

TheGipper wrote:Really like the I-Orp tool. It recommends I do Roth conversions of about almost 300k a year from age 62 when I hope to retire until age 70 when I plan to start taking RMDs an SS. It also recommends I continue to do much smaller Roth conversions into my mid 70s interesting. The Roth conversion amounts are sugnificantly affected by when I sell/downsize my primary home (plan to at age 58-62) if real estate market cooperates.
Have you considered retiring earlier? Run i-ORP on the assumption that you retire at the age of 58 and see what you get.

Victoria
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

BigJohn
Posts: 1801
Joined: Wed Apr 02, 2014 11:27 pm

Re: Roth conversion: Threshold checklist

Post by BigJohn » Tue Aug 04, 2015 8:48 pm

Victoria, thanks for this thread. As a fellow member of the retirement class of 2014 with many years until RMDs and SS I'm struggling with the same question. One thing I haven't seen mentioned here is an issue brought to my attention by Alan S in this thread http://www.bogleheads.org/forum/viewtop ... 9#p2463709. Until he mentioned it I had not given a lot of thought to the future tax bracket of my kids (or whoever might inherit the tIRA) as a variable in this decision.

FWIW, I started this journey convinced that I could come up with a spreadsheet model to help hone in on the best approach. The amazing amount of non-linearity and breakpoints in the tax code make this a daunting task but at least it's known and a model is feasible. The real conundrum for me has become a series of questions on what assumptions I would make even if I had the perfect model. Some examples ... What's my real return on the tIRA over the next 12 years, a big difference if I assume 2% vs 5% real. Kids tax bracket and when will they inherit (ie how long will I live)? What's going to happen to future tax rates?

I've just about reach the conclusion that a lot of work on a great model is not going to help much as the uncertainty on the inputs overwhelms the accuracy of the model details. I'd be interested in your or others perspectives on this issue as maybe I'm missing something and just need to keep plugging.

TheGipper
Posts: 278
Joined: Fri Jun 26, 2015 9:52 am

Re: Roth conversion: Threshold checklist

Post by TheGipper » Tue Aug 04, 2015 9:32 pm

In the end, I suspect it is better to err on the side of over converting tIRA to Roth (if unknowable assumptions prove false) even if it means a slight tax net negative, for the priceless benefit of leaving Roths vs inherited IRAs to ones kids.

bsteiner
Posts: 4409
Joined: Sat Oct 20, 2012 9:39 pm
Location: NYC/NJ/FL

Re: Roth conversion: Threshold checklist

Post by bsteiner » Tue Aug 04, 2015 9:34 pm

At a constant tax rate, the Roth conversion is a big winner, assuming you have other money with which to pay the tax on the conversion. By paying the tax out of other assets, you're effectively making an additional contribution to your IRA.

For example, assuming a constant 30% tax rate, suppose you have a $1 million traditional IRA and $300,000 in your taxable account. If you convert, you have a $1 million Roth IRA. Over some period of time, it grows to $2 million, all of which is yours.

If you didn't convert, your traditional IRA would grow to $2 million, or $1.4 million after taxes. However, your $300,000 of other assets won't grow to $600,000, since the income and gains on your taxable account will be taxable each year.

Other benefits of the Roth conversion are:

1. No required distributions after age 70 1/2.

2. There's an income tax deduction for the Federal, but not the state, estate tax. By converting, someone in a state with a state estate tax avoids this problem with respect to the state estate tax.

3. A Roth IRA is a more valuable asset for a GST exempt disposition.

4. Our clients leave their assets to their children in separate trusts for their benefit rather than outright. This keeps the children's inheritances out of their estates, and better protects their inheritances against their creditors and spouses. However, if a trust receives distributions from a traditional IRA, the trustees must choose between distributing the money to the beneficiaries, which gives up these protections, or retaining the money in the trust, where it will be taxable at 39.6%. A Roth conversion avoids this tradeoff.

5. The ability to recharacterize is a free option. To take it to the extreme, an IRA owner could set up separate IRAs for each mutual fund or security, convert them all, and recharacterize the ones that performed the worst, and repeat the process each year.

6. Since IRAs are better protected against creditors. by converting and paying the income tax out of other assets, you're better protected against creditors.

The countervailing factors are (i) converting a large IRA all at once will bunch the income (so some people spread the conversion out over a number of years), and (ii) if you have large medical expenses later on, you can use the medical expense deduction against IRA distributions or conversions (so some people keep some money in their traditional IRA).

A good general rule is that it generally makes sense to convert to the extent you can do so at a tax bracket less than, equal to, or not too much higher than the tax rate that would otherwise apply to the distributions.

User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Re: Roth conversion: Threshold checklist

Post by VictoriaF » Tue Aug 04, 2015 9:51 pm

BigJohn wrote:Victoria, thanks for this thread. As a fellow member of the retirement class of 2014 with many years until RMDs and SS I'm struggling with the same question. One thing I haven't seen mentioned here is an issue brought to my attention by Alan S in this thread http://www.bogleheads.org/forum/viewtop ... 9#p2463709. Until he mentioned it I had not given a lot of thought to the future tax bracket of my kids (or whoever might inherit the tIRA) as a variable in this decision.
Hi BigJohn,

I have not been considering inheritance, because my planning horizon is 40 years, and by that time my estate will be diminished. If I die sooner than that, Roth conversions will be beneficial for my heir, because she is already in a high tax bracket.
BigJohn wrote:FWIW, I started this journey convinced that I could come up with a spreadsheet model to help hone in on the best approach. The amazing amount of non-linearity and breakpoints in the tax code make this a daunting task but at least it's known and a model is feasible. The real conundrum for me has become a series of questions on what assumptions I would make even if I had the perfect model. Some examples ... What's my real return on the tIRA over the next 12 years, a big difference if I assume 2% vs 5% real. Kids tax bracket and when will they inherit (ie how long will I live)? What's going to happen to future tax rates?

I've just about reach the conclusion that a lot of work on a great model is not going to help much as the uncertainty on the inputs overwhelms the accuracy of the model details. I'd be interested in your or others perspectives on this issue as maybe I'm missing something and just need to keep plugging.
I started my retirement modeling by using the i-ORP tool and quickly reached the same conclusion as you. There are too many assumptions, changes in which could significantly change the outcome of my modeling. There is too much data in the i-ORP output, and trying what-if scenarios is awkward.

Thus, I decided to build my own simple model that would help me to optimize the Roth conversion stage. My main premise is that I could not go wrong by converting all my traditional retirement accounts to Roth and eliminating RMDs by the age of 70, even if there were a slight advantage in stretching the conversions for a few more years.

I started my model by spreading Roth conversions across pre-age 70 years to see which combination would produce the lowest tax. Then I learned that Medicare Part B premiums are calculated based on the MAGI two years prior, and I extended my model to minimize a combination of the taxes and Medicare premiums. Then I learned about the Medicare tax on interest and dividends and modified my model so that not to trigger this tax. Later, I made some other tweaks.

Now I have a rough but useful tool that tells me how much I should convert to Roth every year and how much capital gains I should harvest every year. Even if it's not perfect, it's good enough. As I proceed with the conversions and as the market conditions change, I can easily adjust my tool and adjust the course.

Victoria
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

BigJohn
Posts: 1801
Joined: Wed Apr 02, 2014 11:27 pm

Re: Roth conversion: Threshold checklist

Post by BigJohn » Tue Aug 04, 2015 10:24 pm

Victoria,bsteiner and TheGipper, thanks for the responses, I've reached about the same conclusion which is to convert when the numbers are close to a toss-up.
VictoriaF wrote:My main premise is that I could not go wrong by converting all my traditional retirement accounts to Roth and eliminating RMDs by the age of 70, even if there were a slight advantage in stretching the conversions for a few more years.
Victoria,I was intrigued by this as your premise. I started with a clear desire to do significant conversions (at least 50%) but never thought about going to 100%. I'd be interested in your thought process behind this premise. It may be that our situations are different enough to not be apples-to-apples. One key difference I'd note is that I choose a lump sum rolled into a tIRA rather than a pension. One reason for this choice was to lower normal income in order to facilitate Roth conversions. As a result I've got 60 - 65% of my net worth in tIRA type assets so the marginal tax rate to convert 100% over the next 12 years is much higher than my current and likely future tax rate (baring any major change in the tax code). Are you able to get 100% conversions with only a modest increase in marginal tax rate?

TradingPlaces
Posts: 1245
Joined: Sun Nov 09, 2014 1:19 pm
Location: 30.286029, -97.530011

Re: Roth conversion: Threshold checklist

Post by TradingPlaces » Tue Aug 04, 2015 10:31 pm

What's the 46.25% donut hole bracket?

Nevermind, figured it out:

http://www.bogleheads.org/wiki/Taxation ... y_benefits

User avatar
celia
Posts: 9842
Joined: Sun Mar 09, 2008 6:32 am
Location: SoCal

Re: Roth conversion: Threshold checklist

Post by celia » Tue Aug 04, 2015 10:56 pm

Our plan for Roth conversions was based on aiming for a "level" taxable income from the year we retired until age 70, and allowed for tax brackets and standard deductions increasing slightly each year. In our case, we had known one-time chunks of taxable income in certain years. One of us could start the spousal SS at age 66. So we put the known incomes in a chart for each year and penciled in the low spots with more conversions.

After we started, we saw that we could fill up the 15% bracket and finish conversions a little early. It's a good thing we did, as we were scheduled to finish conversions this year, when DH inherited a traditional IRA that also has RMDs starting next year. That money can't be converted, but now we are adding it to the chart so we can start withdrawing more than the RMD while remaining in the same tax bracket, until age-70 SS starts for both of us.

Moral: Try to get ahead on your conversions (especially if the market drops significantly) to allow room for future unexpected taxable income.

Don't forget that at age 65, your standard deduction increases.
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.

User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Re: Roth conversion: Threshold checklist

Post by VictoriaF » Wed Aug 05, 2015 6:58 am

BigJohn wrote:Victoria,bsteiner and TheGipper, thanks for the responses, I've reached about the same conclusion which is to convert when the numbers are close to a toss-up.
VictoriaF wrote:My main premise is that I could not go wrong by converting all my traditional retirement accounts to Roth and eliminating RMDs by the age of 70, even if there were a slight advantage in stretching the conversions for a few more years.
Victoria,I was intrigued by this as your premise. I started with a clear desire to do significant conversions (at least 50%) but never thought about going to 100%. I'd be interested in your thought process behind this premise. It may be that our situations are different enough to not be apples-to-apples. One key difference I'd note is that I choose a lump sum rolled into a tIRA rather than a pension. One reason for this choice was to lower normal income in order to facilitate Roth conversions. As a result I've got 60 - 65% of my net worth in tIRA type assets so the marginal tax rate to convert 100% over the next 12 years is much higher than my current and likely future tax rate (baring any major change in the tax code). Are you able to get 100% conversions with only a modest increase in marginal tax rate?
BigJohn,

I started this planning process when my former employer Alcatel-Lucent (ALU) has offered a pension buyout. My initial preference was to keep the pension, because my personal planning horizon is longer than the theoretical life expectancy used in the lump sum calculations. If I die earlier than my plan, my estate will be larger.

I was prompted to consider the lump sum by bsteiner's comment in the Lucent offering pension buyout to retirees: what to do? thread. I was tempted by an opportunity to get rid of a nominal (non-inflation indexed) annuity and start Roth conversions immediately without touching my TSP funds.

To evaluate this opportunity, I used i-ORP to model two scenarios: with the ALU pension and with the lump sum. The output showed that with the pension my spending power is $2,000/year greater than with the lump sum. This $2k is in today's dollars, and the model increases it every year for my estimated inflation. The model's results have led me to two decisions:
1) to decline the lump sum offer
2) to start moving my traditional TSP funds to Vanguard and do the conversions there.

The second decision has prompted me to build a spreadsheet and start this thread.

John, while our situations may be quite different, and it's difficult to compare them without divulging private information, your reasons for choosing a lump sum are similar to mine when I was considering the ALU offer. Thus, I recommend that you also compare the two scenarios in i-ORP. Although long-term assumptions of interest rates, inflation and portfolio performance are highly speculative, they become apples-to-apples when comparing two courses of action.

Victoria
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

BigJohn
Posts: 1801
Joined: Wed Apr 02, 2014 11:27 pm

Re: Roth conversion: Threshold checklist

Post by BigJohn » Wed Aug 05, 2015 8:13 am

Thanks Victoria, helpful comments as always :beer

TheGipper
Posts: 278
Joined: Fri Jun 26, 2015 9:52 am

Re: Roth conversion: Threshold checklist

Post by TheGipper » Wed Aug 05, 2015 9:00 am

celia wrote:Our plan for Roth conversions was based on aiming for a "level" taxable income from the year we retired until age 70, and allowed for tax brackets and standard deductions increasing slightly each year. In our case, we had known one-time chunks of taxable income in certain years. One of us could start the spousal SS at age 66. So we put the known incomes in a chart for each year and penciled in the low spots with more conversions.

After we started, we saw that we could fill up the 15% bracket and finish conversions a little early. It's a good thing we did, as we were scheduled to finish conversions this year, when DH inherited a traditional IRA that also has RMDs starting next year. That money can't be converted, but now we are adding it to the chart so we can start withdrawing more than the RMD while remaining in the same tax bracket, until age-70 SS starts for both of us.

Moral: Try to get ahead on your conversions (especially if the market drops significantly) to allow room for future unexpected taxable income.

Don't forget that at age 65, your standard deduction increases.
This post is right on the money. An inherited IRA can through a monkey wrench in your plans, best to really accelerate those Roth conversions early after retirement and before SS/RMDs.

User avatar
Topic Author
VictoriaF
Posts: 18984
Joined: Tue Feb 27, 2007 7:27 am
Location: Black Swan Lake

Re: Roth conversion: Threshold checklist

Post by VictoriaF » Wed Aug 05, 2015 9:17 am

Based on the discussion, here is an updated list of the thresholds for a single person:

1. Roth conversions within 25% Federal tax bracket
- if not possible, minimize income subject to the 28% tax

2. MAGI less than $85k to have the lowest Medicare Part B premiums
- this considerations starts two years before one turns 65 years old
- if MAGI must exceed $85k, make it just under $107k, which is the next limit

3. AGI less than $258k to avoid Federal exemption phase-out
- this could happen even in the 25% or 28% bracket due to large long-term capital gains
- this consideration is for the years that don't count towards Medicare Part B premiums, i.e., more than 2 years prior to reaching the age of 65

4. Affordable Care Act related premiums
- not applicable to me, because I am covered by the FEHB

5. Taxation of the Social Security
- my main reference is the Bogleheads Wiki article Taxation of Social Security benefits
- the reason I want to get rid of the RMDs and unrealized capital gains is that I want to minimize my income in the marginal 46.25% bracket for the singles

6. Net Investment Income Tax
- starts at MAGI > $200k (single)
- see Questions and Answers on the Net Investment Income Tax (IRS, Last Reviewed or Updated: 13-Nov-2014)

7. Additional Medicare Tax
- not applicable to me, because I don't have employment income
- see Questions and Answers for the Additional Medicare Tax (IRS, Last Reviewed or Updated: 05-Mar-2015)

8. AMT
- may be triggered by the composition of the distributions

9. State income tax thresholds
- in my case, Virginia

Victoria
WINNER of the 2015 Boglehead Contest. | Every joke has a bit of a joke. ... The rest is the truth. (Marat F)

User avatar
House Blend
Posts: 4621
Joined: Fri May 04, 2007 1:02 pm

Re: Roth conversion: Threshold checklist

Post by House Blend » Wed Aug 05, 2015 10:52 am

VictoriaF wrote:1. Roth conversions within 25% Federal tax bracket
- if not possible, minimize income subject to the 28% tax
Every tax bracket boundary is a potential threshold.

And there are two sets of brackets, one for ordinary income, another for LTCG/QDI. The latter has rates of 0, 15%, and 20%.

Also worth noting that "Roth conversion within the 25% Federal bracket" is ambiguous.

Example: Your Taxable Income for 2015 is $90,750.
That's the top of the 25% bracket for Singles.
Included in that Taxable Income is $20,000 of LTCG/QDI.
Then you can raise your ordinary income another $20K to $110,750 before you start paying a 28% marginal rate on that income.

The top of the 15% bracket does not work this way, because it is also the top of a bracket for LTCG/QDI.

User avatar
celia
Posts: 9842
Joined: Sun Mar 09, 2008 6:32 am
Location: SoCal

Re: Roth conversion: Threshold checklist

Post by celia » Wed Aug 05, 2015 11:56 am

Just to add to my previous comment on trying to complete Roth conversions early, a married couple faces the risk that one of them could die before the conversions are complete. The survivor could likely be in a higher tax bracket when filing taxes as single.

Even when a spouse dies after RMDs have begun, the survivor may also be in a higher tax bracket as a single, but the RMDs need to continue if the survivor is over age 70.
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.

Post Reply