Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
Chicago60
Posts: 516
Joined: Tue Jan 29, 2013 2:40 pm

Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by Chicago60 »

This post is more in the vain of a Public Service Announcement if you are converting a tIRA to a Roth and want to get close to the top of a marginal tax bracket, no matter what bracket that might be. I thought I knew what I was doing in late 2019, but realized when I did our taxes that I missed my calculations by a longshot.

I have done my own taxes by hand for 45 years. In 2019, I wanted to convert a sizeable amount of my tIRA to Roth to the top of the 24% bracket: $321,450 (married filing jointly for 2019). In the latter part of 2019, I figured out my likely total income, as best I could: the capital gains and qualified dividends I expected for the year (approximately $70,000) plus taxable interest and Schedule C income. I estimated my adjustments to income and knew we'd take the standard deduction. I came to a total and knew how much to convert to my Roth in order to get total income close to $321,450. I then converted in late 2019

Then......in 2020 I did our taxes for 2019. And realized I messed up. I have always known of course that CG and QD get preferential tax treatment. But, it never occurred to me that, when calculating the top of a marginal tax bracket, I needed to not look at my total income, but needed take out those CG and QD. What this means is that I left on the table approximately $70,000 of unused space at the top of the 24% tax bracket that I could have used to convert my tIRA to Roth. I have a sizeable tIRA and am aggressively converting for the next 10 years or so, depending on balances.

So, when you calculate the top of your marginal tax bracket for purposes of converting your tIRA, make sure to delete your CG and QD from that calculation.
kaneohe
Posts: 6786
Joined: Mon Sep 22, 2008 12:38 pm

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by kaneohe »

Your point is good for your situation. Not necessarily always true tho.......for folks converting to the top of the 12% bracket, if they do what you suggest, they will up the 12% bracket w/ ordinary income and push the QD/LTCG into the 22% bracket (for ordinary income)where they will be taxed at 15% instead of 12%. The net effect could be a marginal tax rate of 27% (12% from adding the ordinary income and 15% for displacing the QDIV/LTCG income into the higher bracket.

Perhaps it is best to use tax software or a tax calculator https://www.mortgagecalculator.org/calc ... ulator.php to check what happens when you make a change to verify your assumptions.
lazynovice
Posts: 3369
Joined: Mon Apr 16, 2012 10:48 pm
Location: Denver area. Former Texan.

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by lazynovice »

Thanks for the PSA. While leaving conversion space hurts, I think it is better than making the other mistake which is where I thought you were going with this post. I try to look on the bright side when I can.
BruinBones
Posts: 273
Joined: Sun Apr 22, 2018 5:39 pm

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by BruinBones »

Paying more taxes for every dollar over the next marginal tax bracket is a mess up.
Not fully filling the tax bracket is an oversight and lesson learned.
Thanks for the PSA, though.
02nz
Posts: 10508
Joined: Wed Feb 21, 2018 2:17 pm

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by 02nz »

Doing your taxes by hand can be valuable learning (at least once), but for estimating taxes for Roth conversions and the like, I think $50 on TurboTax is well spent. It usually becomes available around Thanksgiving, so it's useful for figuring out how much Roth conversion to do before the end of the year.
Vanguard Fan 1367
Posts: 2139
Joined: Wed Feb 08, 2017 2:09 pm

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by Vanguard Fan 1367 »

02nz wrote: Sat Jul 04, 2020 12:58 pm Doing your taxes by hand can be valuable learning (at least once), but for estimating taxes for Roth conversions and the like, I think $50 on TurboTax is well spent. It usually becomes available around Thanksgiving, so it's useful for figuring out how much Roth conversion to do before the end of the year.
Thanks for the hint. I will invest the cash into a Thanksgiving TurboTax purchase.
John Bogle: "It's amazing how difficult it is for a man to understand something if he's paid a small fortune not to understand it."
User avatar
FiveK
Posts: 15742
Joined: Sun Mar 16, 2014 2:43 pm

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by FiveK »

Chicago60 wrote: Sat Jul 04, 2020 12:30 pm So, when you calculate the top of your marginal tax bracket for purposes of converting your tIRA, make sure to delete your CG and QD from that calculation.
If you think a picture is worth more than some number of individual TurboTax, etc., calculations, and have a little Excel knowledge, consider using something like the personal finance toolbox.

E.g., for a couple each age 65+, with
- $5K interest/ordinary dividends/etc.,
- $70K LTCG, and
- $50K Schedule C net profit from a "specified service business"

the marginal rates for various amounts of Roth conversions in 2019 (federal tax plus IRMAA tiers) were
Image

As one can see, for most amounts the actual marginal tax rate is not the same as the nominal tax bracket.
Topic Author
Chicago60
Posts: 516
Joined: Tue Jan 29, 2013 2:40 pm

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by Chicago60 »

kaneohe wrote: Sat Jul 04, 2020 12:42 pm Not necessarily always true tho.......for folks converting to the top of the 12% bracket, if they do what you suggest, they will up the 12% bracket w/ ordinary income and push the QD/LTCG into the 22% bracket (for ordinary income)where they will be taxed at 15% instead of 12%.
Point well taken.
Topic Author
Chicago60
Posts: 516
Joined: Tue Jan 29, 2013 2:40 pm

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by Chicago60 »

FiveK wrote: Sat Jul 04, 2020 3:26 pm If you think a picture is worth more than some number of individual TurboTax, etc., calculations, and have a little Excel knowledge, consider using something like the personal finance toolbox.
I tend to work better with numbers, but your picture summarizes the representation very well. I will try the toolkit, but my experience with Excel is sorely lacking. I am some years away from IRMAA/social security, but I can try to work with the rest of the calculator, though I think my mistake late last year will have me better focused for the end of 2020 to reach the top of the 24% bracket. I have a large tIRA balance that I want to work through. I will have to pay NIIT again, but I rather convert as much as I can without pushing into 32%.
Topic Author
Chicago60
Posts: 516
Joined: Tue Jan 29, 2013 2:40 pm

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by Chicago60 »

BruinBones wrote: Sat Jul 04, 2020 12:50 pm Paying more taxes for every dollar over the next marginal tax bracket is a mess up.
I agree that paying 8 points in taxes more than I would have wanted would have been worse, but leaving so much available for conversion was just a stupid mistake. I had never previously concerned myself with my marginal tax bracket, because I was simply accumulating as much income as I could, and paying whatever taxes were required without "manufacturing" an income bracket by manipulating what income I wanted to source.
User avatar
FiveK
Posts: 15742
Joined: Sun Mar 16, 2014 2:43 pm

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by FiveK »

Chicago60 wrote: Sat Jul 04, 2020 5:20 pm I am some years away from IRMAA/social security....
Not too many, based on you having done 45 years of returns by hand and your age 63 return being the first one that affects IRMAA tiers. ;)

Reading the first ~25 rows of the Instructions tab is probably a good place to start with that spreadsheet.
Topic Author
Chicago60
Posts: 516
Joined: Tue Jan 29, 2013 2:40 pm

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by Chicago60 »

FiveK wrote: Sat Jul 04, 2020 5:34 pm
Chicago60 wrote: Sat Jul 04, 2020 5:20 pm I am some years away from IRMAA/social security....
Not too many, based on you having done 45 years of returns by hand and your age 63 return being the first one that affects IRMAA tiers. ;)

Reading the first ~25 rows of the Instructions tab is probably a good place to start with that spreadsheet.
"Some", but "not too many" are both accurate. Thanks for the suggestion on the Instructions Tab. I may come back to you with questions.....if you are so inclined.
User avatar
FiveK
Posts: 15742
Joined: Sun Mar 16, 2014 2:43 pm

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by FiveK »

Chicago60 wrote: Sat Jul 04, 2020 6:07 pm "Some", but "not too many" are both accurate. Thanks for the suggestion on the Instructions Tab. I may come back to you with questions.....if you are so inclined.
Sure. I've used it enough that I could probably answer many questions. The thread where it is hosted is the best place for intricately detailed questions.
User avatar
Electron
Posts: 2658
Joined: Sat Mar 10, 2007 7:46 pm

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by Electron »

kaneohe wrote: Sat Jul 04, 2020 12:42 pm The net effect could be a marginal tax rate of 27% (12% from adding the ordinary income and 15% for displacing the QDIV/LTCG income into the higher bracket.
I totally agree when the 0% bracket for Capital Gains and Qualified Dividends is involved. That is why I did not do any Roth Conversions after retiring.

At the time any additional ordinary income resulted in a marginal tax rate of 25% in the 10% bracket and 30% in the 15% bracket. In checking one particular year (2014) I would also have triggered the AMT at a certain point. The marginal tax rate for ordinary income then jumped to 47.5%! :happy

The calculation for the AMT case was 26% AMT bracket + 26%/4 AMT exemption phaseout + 15% (loss of 0% bracket) = 47.5%.
Enjoying the Outdoors
LookinAround
Posts: 902
Joined: Tue Mar 27, 2018 5:41 am

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by LookinAround »

Chicago60 wrote: Sat Jul 04, 2020 12:30 pm <snip>So, when you calculate the top of your marginal tax bracket for purposes of converting your tIRA, make sure to delete your CG and QD from that calculation.
OMG. Thanks for the heads up. It made me realize I've made that same dumb mistake too! :oops:

p.s. You think it's something regional? I just noticed your username and I'm in Chicago too! :sharebeer
Topic Author
Chicago60
Posts: 516
Joined: Tue Jan 29, 2013 2:40 pm

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by Chicago60 »

LookinAround wrote: Fri Jul 10, 2020 8:45 am p.s. You think it's something regional? I just noticed your username and I'm in Chicago too! :sharebeer
Regional? I'd like to think Chicagoans are pretty astute with finances and numbers, but I suppose that somewhat ignorant would likely not know any better, so it is possible.
LookinAround
Posts: 902
Joined: Tue Mar 27, 2018 5:41 am

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by LookinAround »

Chicago60 wrote: Fri Jul 10, 2020 9:19 am
LookinAround wrote: Fri Jul 10, 2020 8:45 am p.s. You think it's something regional? I just noticed your username and I'm in Chicago too! :sharebeer
Regional? I'd like to think Chicagoans are pretty astute with finances and numbers, but I suppose that somewhat ignorant would likely not know any better, so it is possible.
Nah, I was being facetious but that and sarcasm don't always come across when reading text! :D
Topic Author
Chicago60
Posts: 516
Joined: Tue Jan 29, 2013 2:40 pm

Re: Converting IRA to Roth IRA at top of my Marginal Rate? I messed up

Post by Chicago60 »

[quote=LookinAround post_id=5362193 time=1594393705 user_id=132754
I was being facetious
[/quote]

As was I.
Post Reply