Convert to Roth or stay in tax deferred?

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Actmck3
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Convert to Roth or stay in tax deferred?

Post by Actmck3 »

Hi folks,
We are kind of new to this forum so pardon us if this question has been asked before or if we haven’t followed the proper format completely in submitting this.

All of our “retirement” savings are in an IRA tax deferred account.

My question is how do I determine whether or not it is in the best financial interest to begin to convert this money into a Roth IRA given that our intention is to leave as much as we can as legacy money for our two daughters. (25 and 16 years old)

I am almost 65, DW 61

We have approx 325K left in a mortgage with 25 years left at 4.25% but plan on selling house in 2 years once the 16 yo is at college. (25 yo is already on her own, gainfully employed) The house has a value of about 750K.

Our combo of pensions and SS provides us with more than we need for monthly expenses to live.

We are currently in the 22% tax bracket

IRA is 1.7m and is all tax deferred.

I was thinking that taxes in the future will increase and that using the window of years between now and when we will have to take RMD’s, so, we should start moving money into the Roth so that it can grow tax free with the ultimate goal of me and DW never withdrawing from it and passing it on to our daughters when we move on to the next life.

The hope is that it gets to grow at least 20 years tax free and then whenever they inherit it, they will have another 10 more years to let if grow if they’d like.

What considerations need to be made by us to determine if it is the best economic move for our family? Or should we just let it continue to grow in the tax deferred account and the girls will simply have to pay the taxes when they eventually inherit it?

Thank you all for your insight and advice in advance.
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Wiggums
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Re: Convert to Roth or stay in tax deferred?

Post by Wiggums »

You hit the two mail decision points:

1) RMDs: consider the impact of MFJ vs single tax payer when one of you passes.

2) The rules recently changed for RMDs and non-spouse Inheritance.

Both are good reasons to do Roth conversions. For planning purposes, I would assume that the tax rate will revert to the original higher rate in 2025. That the the default without any intervention.
"I started with nothing and I still have most of it left."
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Actmck3
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

Thanks Wiggums,

I guess I am wondering if there is some way to actually calculate with math the way to leave our daughters the most we can.

There’s probably more things to add to the equation as you mentioned relative to MFJ vs one of us filing singly. Also, just thinking that our daughters economic situation at the time of inheritance is a factor that we cannot determine with 100% certainty. They may be in a lower tax bracket than we are in now, or maybe not.

Just seems like if we pay the taxes now, in advance if you will, no matter what goes on with tax increases in the future, they will not be on the hook to pay any taxes on any of it.

Of course that is, unless Congress makes changes to the Roth.... :x
rlchambers
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Re: Convert to Roth or stay in tax deferred?

Post by rlchambers »

First if you are married and in the 22% tax bracket then you are making under $17150. If you would deduct the amount of your current income from this amount you will know the amount you could withdraw for the year without going in the higher bracket of 24%.

That would be the first step in determining what would be your next step.

Should you be single then that threshold is lowered to $85,525 before going to 24%.

On the good side you are 65 so you can spread your conversion for several years to keep under the 24%.

The last thing you would want to do is to convert your 1.7 million at one time that would give you a 37% tax rate.

You have until 72.5 when your RMD begins. The worst part of a conventional IRA is that the new rules have a dramatic affect on beneficiary IRA’s. There is a 10 year window that all funds must be liquidated except for spouse that are at least 10 years younger.

I would recommend that you find a trusted financial planner to help you make the right decision.
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celia
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Re: Convert to Roth or stay in tax deferred?

Post by celia »

Here are the first things to think about:
viewtopic.php?f=1&t=336886&p=5746261#p5746261

After pondering the above, you need to figure out HOW MUCH to convert each year. The method I suggest is to build a spreadsheet like the one shown in the middle of this post. That spreadsheet was intentionally left for that OP to finish. One thing I like about it, is my example showing that the tIRA decreases in value for a few years then goes back up to its initial value because the tIRA growth rate is more than the withdrawal rate. If you have other sources of income on your taxes, add more rows for those income sources.

Hopefully the spreadsheet will help keep your analysis organized so you can try out different options. Be sure to run each year’s incomes through tax software to see what the tax hit will be for each year (including state).
GrowthSeeker
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Re: Convert to Roth or stay in tax deferred?

Post by GrowthSeeker »

Yes it can be calculated, but the calculations can become rather complicated.
To a first approximation, if you expect your future tax bracket will be higher (with SS + RMD + investment income) than your current bracket (including the effect of Roth conversions) then it's usually a good idea to do the Roth conversion. But not only that; if the future bracket is close; maybe 1 or 2 percentage points lower than your current bracket, then it still may be advantageous to do the conversion.

Complications (in the calculations) arise from the effects of IRMAA on Medicare premiums and the NIIT (net investment income tax) if your investment income is high enough.
And of course the future tax rates are unknown.

Since it's January, you have all year to decide what to do for 2021. I'm not doing any political predicting here, but historically, I believe it was 1993 the political party in power changed and there was a tax increase.

There is an online tool called i-ORP which may help.
The spreadsheet Retiree Portfolio Model is more comprehensive.
They both have some learning curve.

Most people who undergo this computational journey end up deciding to convert up to the top of some tax bracket or up to some level where IRMAA or NIIT kicks in.
{edit: another concept is "leveling your income" which I think means during the years when taxable income is low such as after retirement but before SS and RMDs begin, to do some Roth conversions during those years which would otherwise have low income with the goal of bringing the income up to what it will be years later}

You can add even one more layer of complexity if you want to (I did, but I'm not sure what percent of people who look at this question do). And that is to consider that a dollar in Roth is worth $1. but a dollar in an IRA or 401k is worth less. Less because at some point, someone is going to pay some tax when that dollar moves from a tax deferred account to a taxable account. It might be you taking an RMD, or it might be your heirs. So depending on what that tax rate is, a dollar in IRA might be worth $0.80.

My comments above assume the money to pay the tax on the Roth conversion comes out of a taxable account. If additional money has to be taken out of the IRA to pay the tax on the Roth conversion it shifts the decision pretty far in the direction of not doing the conversion.
Just because you're paranoid doesn't mean they're NOT out to get you.
Rajsx
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Re: Convert to Roth or stay in tax deferred?

Post by Rajsx »

Thanks for discussing a topic I am also struggling with.
Alan S.
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Re: Convert to Roth or stay in tax deferred?

Post by Alan S. »

Another major factor in the conversion decision is how much you intend to leave to charity, since the bulk of that would presumably be coming first from your TIRA. Also consider your mortality outlook.

As for major pending tax law changes, we must ignore them here, but that does not mean that YOU should ignore them in your decision making.
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Actmck3
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

rlchambers wrote: Mon Jan 25, 2021 1:05 pm First if you are married and in the 22% tax bracket then you are making under $17150. If you would deduct the amount of your current income from this amount you will know the amount you could withdraw for the year without going in the higher bracket of 24%.

That would be the first step in determining what would be your next step.

Should you be single then that threshold is lowered to $85,525 before going to 24%.

On the good side you are 65 so you can spread your conversion for several years to keep under the 24%.

The last thing you would want to do is to convert your 1.7 million at one time that would give you a 37% tax rate.

You have until 72.5 when your RMD begins. The worst part of a conventional IRA is that the new rules have a dramatic affect on beneficiary IRA’s. There is a 10 year window that all funds must be liquidated except for spouse that are at least 10 years younger.

I would recommend that you find a trusted financial planner to help you make the right decision.

Thanks Rich.
No doubt, we will not move it all at once. Thinking of keeping amount just short of the tax bracket above 24%.
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Actmck3
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

celia wrote: Mon Jan 25, 2021 1:41 pm Here are the first things to think about:
viewtopic.php?f=1&t=336886&p=5746261#p5746261

After pondering the above, you need to figure out HOW MUCH to convert each year. The method I suggest is to build a spreadsheet like the one shown in the middle of this post. That spreadsheet was intentionally left for that OP to finish. One thing I like about it, is my example showing that the tIRA decreases in value for a few years then goes back up to its initial value because the tIRA growth rate is more than the withdrawal rate. If you have other sources of income on your taxes, add more rows for those income sources.

Hopefully the spreadsheet will help keep your analysis organized so you can try out different options. Be sure to run each year’s incomes through tax software to see what the tax hit will be for each year (including state).
Thank you Celia,
Really great points about the earnings per year on the tax deferred. I will also use the spreadsheet for organization.
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Actmck3
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

GrowthSeeker wrote: Mon Jan 25, 2021 2:24 pm Yes it can be calculated, but the calculations can become rather complicated.
To a first approximation, if you expect your future tax bracket will be higher (with SS + RMD + investment income) than your current bracket (including the effect of Roth conversions) then it's usually a good idea to do the Roth conversion. But not only that; if the future bracket is close; maybe 1 or 2 percentage points lower than your current bracket, then it still may be advantageous to do the conversion.

Complications (in the calculations) arise from the effects of IRMAA on Medicare premiums and the NIIT (net investment income tax) if your investment income is high enough.
And of course the future tax rates are unknown.

Since it's January, you have all year to decide what to do for 2021. I'm not doing any political predicting here, but historically, I believe it was 1993 the political party in power changed and there was a tax increase.

There is an online tool called i-ORP which may help.
The spreadsheet Retiree Portfolio Model is more comprehensive.
They both have some learning curve.

Most people who undergo this computational journey end up deciding to convert up to the top of some tax bracket or up to some level where IRMAA or NIIT kicks in.
{edit: another concept is "leveling your income" which I think means during the years when taxable income is low such as after retirement but before SS and RMDs begin, to do some Roth conversions during those years which would otherwise have low income with the goal of bringing the income up to what it will be years later}

You can add even one more layer of complexity if you want to (I did, but I'm not sure what percent of people who look at this question do). And that is to consider that a dollar in Roth is worth $1. but a dollar in an IRA or 401k is worth less. Less because at some point, someone is going to pay some tax when that dollar moves from a tax deferred account to a taxable account. It might be you taking an RMD, or it might be your heirs. So depending on what that tax rate is, a dollar in IRA might be worth $0.80.

My comments above assume the money to pay the tax on the Roth conversion comes out of a taxable account. If additional money has to be taken out of the IRA to pay the tax on the Roth conversion it shifts the decision pretty far in the direction of not doing the conversion.

Thank you Growthseeker,
Relative to the payment using Roth money for taxes, why does it shift the decision so much?
tibbitts
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Re: Convert to Roth or stay in tax deferred?

Post by tibbitts »

Actmck3 wrote: Mon Jan 25, 2021 12:18 pm What considerations need to be made by us to determine if it is the best economic move for our family? Or should we just let it continue to grow in the tax deferred account and the girls will simply have to pay the taxes when they eventually inherit it?
There is no way to know what path will be more beneficial - there are too many unknown variables involved. When in doubt, about half deferred and half exempt (Roth) isn't a bad compromise. This isn't a question you can answer with calculations.

For myself I made relatively large conversions this year and will continue to make smaller conversions until RMDs in about ten years. Most calculators favored making even larger conversions than I did, well into the 42% combined bracket, even though I've never been at more than the mid-20s in my life. Be careful if you use any calculator. They are extremely useful and powerful, but very minor changes in assumptions you enter can have dramatic effects on recommendations. Basically you can trust them if you very strongly believe that your assumptions will work out exactly as you expect. But when your run many projections with different assumptions you sometimes find that the downside of being wrong about certain assumptions sometimes outweighs the optimization you get if everything works out exactly the way you expect.

If I hadn't been able pay the taxes out of taxable money, I'd have been much more conservative about converting than if I had to pay taxes with my conversions.
GrowthSeeker
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Re: Convert to Roth or stay in tax deferred?

Post by GrowthSeeker »

Actmck3 wrote: Mon Jan 25, 2021 4:06 pm
GrowthSeeker wrote: Mon Jan 25, 2021 2:24 pm My comments above assume the money to pay the tax on the Roth conversion comes out of a taxable account. If additional money has to be taken out of the IRA to pay the tax on the Roth conversion it shifts the decision pretty far in the direction of not doing the conversion.

Thank you Growthseeker,
Relative to the payment using Roth money for taxes, why does it shift the decision so much?
Good question.
To be honest, in all my modelling of it, I always assumed paying the taxes purely from taxable.
But I recall a Vanguard white paper "A BETR approach to Roth conversions" which I think discussed the subject of where tax payments were coming from. It's a pdf download
Just because you're paranoid doesn't mean they're NOT out to get you.
tibbitts
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Re: Convert to Roth or stay in tax deferred?

Post by tibbitts »

Actmck3 wrote: Mon Jan 25, 2021 4:06 pm Relative to the payment using Roth money for taxes, why does it shift the decision so much?
You're permanently losing tax-preferred space if you pay taxes from your conversion.
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Actmck3
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

tibbitts wrote: Mon Jan 25, 2021 9:19 pm
Actmck3 wrote: Mon Jan 25, 2021 4:06 pm Relative to the payment using Roth money for taxes, why does it shift the decision so much?
You're permanently losing tax-preferred space if you pay taxes from your conversion.
Thanks Tibbitts, I do realize that but I was also thinking that I am paying those taxes with money that grew from the tax deferred investment and was “house money” to use. So, in effect, I am getting to roll over all of my original money invested and use the money that I earned “tax free” for all of the years it has been invested. Does this thinking make sense?
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Actmck3
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

GrowthSeeker wrote: Mon Jan 25, 2021 4:26 pm
Actmck3 wrote: Mon Jan 25, 2021 4:06 pm
GrowthSeeker wrote: Mon Jan 25, 2021 2:24 pm My comments above assume the money to pay the tax on the Roth conversion comes out of a taxable account. If additional money has to be taken out of the IRA to pay the tax on the Roth conversion it shifts the decision pretty far in the direction of not doing the conversion.

Thank you Growthseeker,
Relative to the payment using Roth money for taxes, why does it shift the decision so much?
Good question.
To be honest, in all my modelling of it, I always assumed paying the taxes purely from taxable.
But I recall a Vanguard white paper "A BETR approach to Roth conversions" which I think discussed the subject of where tax payments were coming from. It's a pdf download
Thanks Growthseeker.
Ive taken a cursory look at the lwhite paper. I am going to need to spend some more time to process it so that I get a full understanding of what it is saying. Thanks for the link.
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celia
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Re: Convert to Roth or stay in tax deferred?

Post by celia »

GrowthSeeker wrote: Mon Jan 25, 2021 2:24 pm My comments above assume the money to pay the tax on the Roth conversion comes out of a taxable account. If additional money has to be taken out of the IRA to pay the tax on the Roth conversion it shifts the decision pretty far in the direction of not doing the conversion.
I disagree with this comment and that the decision is impacted that much. Yes, when you have the choice of paying the taxes from taxable or from the tIRA withdrawal, it is better to use taxable to pay the taxes for two reasons:
* It is preferred to let the Roth grow as much as it can.
* There is a 10% early withdrawal penalty (besides the regular tax) if the account owner is under 59.5 at time of withdrawal from tax-deferred.

But, some people over 59.5 withdraw to taxable to help pay living expenses, when needed, in retirement. I see taxes as one of your living expenses!

We had a Boglehead a while back who was retiring and almost all of their portfolio was tax-deferred (a very large sum). Whether they withdrew for living expenses or did Roth conversions, it was irrelevant, as they needed to eat as well as pay taxes. The taxes are the same whether you withdraw to taxable or convert. The ONLY difference is that one withdrawal can continue to grow tax-free while one doesn’t. If the account owner hadn’t tax-deferred so much, s/he would be in the situation some people here would consider more ideal. So what’s the real difference between tax-deferring “too much” and paying taxes later to move some to taxable compared to tax-deferring a more moderate amount and having enough in taxable to pay future Roth conversion taxes?

I say there is no difference. Both parties ended up in the same place in early retirement but got there in different ways.

(I think some Bogleheads have been exposed to “pay the taxes from taxable” for so long that they can’t see the other option.)
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Re: Convert to Roth or stay in tax deferred?

Post by GrowthSeeker »

celia wrote: Mon Jan 25, 2021 11:48 pm
GrowthSeeker wrote: Mon Jan 25, 2021 2:24 pm My comments above assume the money to pay the tax on the Roth conversion comes out of a taxable account. If additional money has to be taken out of the IRA to pay the tax on the Roth conversion it shifts the decision pretty far in the direction of not doing the conversion.
I disagree with this comment and that the decision is impacted that much. Yes, when you have the choice of paying the taxes from taxable or from the tIRA withdrawal, it is better to use taxable to pay the taxes for two reasons:
* It is preferred to let the Roth grow as much as it can.
* There is a 10% early withdrawal penalty (besides the regular tax) if the account owner is under 59.5 at time of withdrawal from tax-deferred.

But, some people over 59.5 withdraw to taxable to help pay living expenses, when needed, in retirement. I see taxes as one of your living expenses!

We had a Boglehead a while back who was retiring and almost all of their portfolio was tax-deferred (a very large sum). Whether they withdrew for living expenses or did Roth conversions, it was irrelevant, as they needed to eat as well as pay taxes. The taxes are the same whether you withdraw to taxable or convert. The ONLY difference is that one withdrawal can continue to grow tax-free while one doesn’t. If the account owner hadn’t tax-deferred so much, s/he would be in the situation some people here would consider more ideal. So what’s the real difference between tax-deferring “too much” and paying taxes later to move some to taxable compared to tax-deferring a more moderate amount and having enough in taxable to pay future Roth conversion taxes?

I say there is no difference. Both parties ended up in the same place in early retirement but got there in different ways.

(I think some Bogleheads have been exposed to “pay the taxes from taxable” for so long that they can’t see the other option.)
celia makes a good point.
I probably should qualify my statement and retract the words "pretty far" - because I'm not really sure how large the effect is.
If you have the luxury of being able to choose whether to pay the tax out of Taxable vs out of Tax-deferred, I'm fairly certain the numbers work out better if you pay it out of Taxable - but I don't know how much better. Personally, I started retirement with 80% in Taxable and only 20% in tax deferred (and zero Roth). So I think of preserving my tax deferred space. But everyone's situation is different; all the more reason to make your own spreadsheet if possible.
Just because you're paranoid doesn't mean they're NOT out to get you.
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celia
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Re: Convert to Roth or stay in tax deferred?

Post by celia »

GrowthSeeker wrote: ...in the direction of not doing the conversion.
This phrase was the part that motivated me to respond. Not doing a Roth conversion because:
* I don’t have extra cash in taxable
* The analysis seems too hard to do
* I don’t understand how taxes are calculated
are not good reasons, in my opinion, to forego doing Roth conversions. Now, some people may not think about their RMDs years ahead of when they start, or inherit a large tax-deferred account. Some people never had much opportunity to contribute much to tax-deferred accounts, but those with over a million in tax-deferred at age 72, hopefully should have thought about it ahead of time.

For anyone reading this who did not follow the first link in my first post above, I encourage you to read it and do the simple calculations it suggests. I wrote this “Big Picture” post hoping it would motivate others to think about their accounts in a different way, even if they are several years away from retirement.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Actmck3
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

celia wrote: Tue Jan 26, 2021 3:05 am
GrowthSeeker wrote: ...in the direction of not doing the conversion.
This phrase was the part that motivated me to respond. Not doing a Roth conversion because:
* I don’t have extra cash in taxable
* The analysis seems too hard to do
* I don’t understand how taxes are calculated
are not good reasons, in my opinion, to forego doing Roth conversions. Now, some people may not think about their RMDs years ahead of when they start, or inherit a large tax-deferred account. Some people never had much opportunity to contribute much to tax-deferred accounts, but those with over a million in tax-deferred at age 72, hopefully should have thought about it ahead of time.

For anyone reading this who did not follow the first link in my first post above, I encourage you to read it and do the simple calculations it suggests. I wrote this “Big Picture” post hoping it would motivate others to think about their accounts in a different way, even if they are several years away from retirement.
Thank you again Celia. Being that I am close to 65 and everything is in tax deferred, I am going to take this window of opportunity before RMD’s kick in to try to move at least 100k per year for the next 7 years into Roth. That will move me close to a 50-50 split of tax deferred and tax free just as RMDs start.
I can then reevaluate depending on tax bracket numbers and adjust any further conversion considerations.

Much thanks to all for your input and advice
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Actmck3
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

Actmck3 wrote: Tue Jan 26, 2021 8:30 am
celia wrote: Tue Jan 26, 2021 3:05 am
GrowthSeeker wrote: ...in the direction of not doing the conversion.
This phrase was the part that motivated me to respond. Not doing a Roth conversion because:
* I don’t have extra cash in taxable
* The analysis seems too hard to do
* I don’t understand how taxes are calculated
are not good reasons, in my opinion, to forego doing Roth conversions. Now, some people may not think about their RMDs years ahead of when they start, or inherit a large tax-deferred account. Some people never had much opportunity to contribute much to tax-deferred accounts, but those with over a million in tax-deferred at age 72, hopefully should have thought about it ahead of time.

For anyone reading this who did not follow the first link in my first post above, I encourage you to read it and do the simple calculations it suggests. I wrote this “Big Picture” post hoping it would motivate others to think about their accounts in a different way, even if they are several years away from retirement.
Thank you again Celia. Being that I am close to 65 and everything is in tax deferred, I am going to take this window of opportunity before RMD’s kick in to try to move at least 100k per year for the next 7 years into Roth. That will move me close to a 50-50 split of tax deferred and tax free just as RMDs start.
I can then reevaluate depending on tax bracket numbers and adjust any further conversion considerations.

Much thanks to all for your input and advice

And one final question, Should I keep some cash in the tax deferred IRA, equivalent to a few years RMD, in case the stock market is coincidentally depressed during my RMD years? Or, would my bond money allocations be better suited to address that?
Last edited by Actmck3 on Tue Jan 26, 2021 9:31 pm, edited 1 time in total.
Pistachioicecream
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Re: Convert to Roth or stay in tax deferred?

Post by Pistachioicecream »

Bump!
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celia
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Re: Convert to Roth or stay in tax deferred?

Post by celia »

Actmck3 wrote: Tue Jan 26, 2021 8:38 am And one final question, Should I keep some cash in the tax deferred IRA, equivalent to a few years RMD, in case the stock market is coincidentally depressed during my RMD years? Or, would my bond money allocations be better suited to address that?
A slight detour is needed first, before I address the question.

Our Tax-efficient Fund Placement wiki page goes into lots of detail (maybe too much :confused ) about how to make your portfolio tax-efficient. It assumes you have some money in taxable, in tax-deferred, and in Roth. Basically, the recommendation is to keep the fastest-growing assets (stock funds) in Roth so you can maximize future tax-free growth. Keep bond funds in Tax-deferred as much as possible since the interest does not qualify for any tax advantages. Your Taxable account should hold the remainder of your stocks as well as International funds. These will generate dividends which have a preferential tax rate if the dividends are "qualified" as well as Long Term Capital Gains if the assets being sold had been held for more than a year. International funds that pay foreign taxes may also earn a Foreign Tax Credit for you, if held in Taxable.

When you withdraw from Tax-deferred, whether by using RMDs, extra withdrawals to Taxable, Roth conversions, or QCDs, you are usually concerned with withdrawing a certain dollar amount. It really doesn't matter if you withdraw cash, shares of a bond fund, or anything else. The tax will be based on the value withdrawn. And you probably want to consider what you want the "going-to" account to hold. If going to Taxable, you probably want money there to spend, else you will have to cash out bond shares there. If going to Roth (and there are no more stock fund in Tax-deferred), you probably want to transfer shares. I don't know if many people hold bonds directly in their Tax-deferred, but if you do, I'm not sure you can transfer part of the bond. You might have to transfer the whole bond. If you can transfer x% of the bond, I caution against doing that since you probably won't be able to sell the x% of a bond, should you need cash. (My DH inherited a tIRA that had a partial bond in it (after being split amongst several beneficiaries) and none of the heirs could sell their part. I was flabbergasted that the deceased's financial advisor didn't even suggest the bond be sold before the IRA was divided up.)

Regardless of the asset you transfer to taxable or Roth, the cash can be used to buy more bond shares or the bond shares can be sold for cash. So it really doesn't matter.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Actmck3
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

Thanks Celia.

😳 wow, that is lot of reading I will need to do to help me make smart tax moves.

But currently, I am all invested with only tax deferred money.

For tax purposes, My investment categories will start to change once I begin to move money from my tax deferred into tax free
( when I convert to Roth) and when I have to take RMD’s ( and then put those to work in taxable places)

That said, I appreciate you pointing out the need to have a tax strategy as part of the overall investment plan.

My question about cash or bond allocation was inquiring about having a plan to have money that could be used to draw down on during RMD times when the possibility exists that the market has significantly dropped and I rather not have to take a heavy loss by having to sell stocks for the RMD.
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Eagle33
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Re: Convert to Roth or stay in tax deferred?

Post by Eagle33 »

What is your current asset allocation (AA) across your total portfolio (all taxable/tax-deferred/tax-free) accounts w/money earmarked for retirement)? Does this match your desired (target) AA?

My own situation (about same ages) when I retired 2 years ago was a portfolio with a 10-to-1 ratio between our tax-deferred and tax-free accounts balance - no taxable account other than our emergency fund. Not a good ratio. Simplified accounts to a single fund in each account except for the largest that now has 3-funds. The large IRA is where we do our rebalancing, take our needed withdrawal for annual expenses and make conversions to my Roth IRA up to IRMAA threshold. We are holding off SS until the oldest reaches 70 so have max room for conversions. We are directing dividends to settlement account of large IRA and reinvesting dividends in all the other accounts. VTSAX in our Roth IRAs and VBTLX in spouses traditional IRA.
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celia
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Re: Convert to Roth or stay in tax deferred?

Post by celia »

Actmck3 wrote: Wed Jan 27, 2021 7:26 am My question about cash or bond allocation was inquiring about having a plan to have money that could be used to draw down on during RMD times when the possibility exists that the market has significantly dropped and I rather not have to take a heavy loss by having to sell stocks for the RMD.
Now I see the "problem" you meant. First, you don't have to sell anything, ever (unless you need/want cash). You can withdraw from tax-deferred in-kind (meaning you can withdraw mutual fund or ETF or individual stock shares without selling them and re-buying them in the next account)!

This is advantageous especially in a "down" market. Say your shares are worth half of their previous price (like in 2008) and you want/need to withdraw $10K to either taxable or convert to Roth. Those shares that are now worth $10K were worth $20K last year. This is the best time to withdraw or convert, since you will only have to pay taxes on $10K. When the shares return to their previous value, it is like you paid half price for the conversion taxes. I like to say "taxes are on sale"!

In this situation, you would want to take advantage of the situation and withdraw and/or convert as much as you can afford tax-wise. I was able to do that in 2008, even though I was in my highest earning years before I retired and I would do it again!

If you want to plan for this, delay taking the RMD for as long as you can during the tax year and see how the markets move. Then if the markets don't look like they will go down much, withdraw or convert in November or early December. Don't wait until the last two weeks of December since the custodians are really busy then and if something goes wrong, you need time to fix it.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Re: Convert to Roth or stay in tax deferred?

Post by niagara_guy »

I converted some money to a Roth from a tira before I retired and in hindsight I think it was a mistake, because I am in a very low tax bracket now (waiting to take ss at 70). In 2020 I converted just enough to have to pay a small amount in fed taxes and will continue to do so. I use last year's tax software to model how much to convert each year.
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

celia wrote: Wed Jan 27, 2021 10:47 pm
Actmck3 wrote: Wed Jan 27, 2021 7:26 am My question about cash or bond allocation was inquiring about having a plan to have money that could be used to draw down on during RMD times when the possibility exists that the market has significantly dropped and I rather not have to take a heavy loss by having to sell stocks for the RMD.
Now I see the "problem" you meant. First, you don't have to sell anything, ever (unless you need/want cash). You can withdraw from tax-deferred in-kind (meaning you can withdraw mutual fund or ETF or individual stock shares without selling them and re-buying them in the next account)!

This is advantageous especially in a "down" market. Say your shares are worth half of their previous price (like in 2008) and you want/need to withdraw $10K to either taxable or convert to Roth. Those shares that are now worth $10K were worth $20K last year. This is the best time to withdraw or convert, since you will only have to pay taxes on $10K. When the shares return to their previous value, it is like you paid half price for the conversion taxes. I like to say "taxes are on sale"!

In this situation, you would want to take advantage of the situation and withdraw and/or convert as much as you can afford tax-wise. I was able to do that in 2008, even though I was in my highest earning years before I retired and I would do it again!

If you want to plan for this, delay taking the RMD for as long as you can during the tax year and see how the markets move. Then if the markets don't look like they will go down much, withdraw or convert in November or early December. Don't wait until the last two weeks of December since the custodians are really busy then and if something goes wrong, you need time to fix it.
While I hate to see any loss of value in my equities, you have just pointed out the “Silver lining” !
Brilliant time to move them from tax deferred into the Roth.
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Actmck3
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

celia wrote: Wed Jan 27, 2021 10:47 pm
Actmck3 wrote: Wed Jan 27, 2021 7:26 am My question about cash or bond allocation was inquiring about having a plan to have money that could be used to draw down on during RMD times when the possibility exists that the market has significantly dropped and I rather not have to take a heavy loss by having to sell stocks for the RMD.
Now I see the "problem" you meant. First, you don't have to sell anything, ever (unless you need/want cash). You can withdraw from tax-deferred in-kind (meaning you can withdraw mutual fund or ETF or individual stock shares without selling them and re-buying them in the next account)!

This is advantageous especially in a "down" market. Say your shares are worth half of their previous price (like in 2008) and you want/need to withdraw $10K to either taxable or convert to Roth. Those shares that are now worth $10K were worth $20K last year. This is the best time to withdraw or convert, since you will only have to pay taxes on $10K. When the shares return to their previous value, it is like you paid half price for the conversion taxes. I like to say "taxes are on sale"!

In this situation, you would want to take advantage of the situation and withdraw and/or convert as much as you can afford tax-wise. I was able to do that in 2008, even though I was in my highest earning years before I retired and I would do it again!

If you want to plan for this, delay taking the RMD for as long as you can during the tax year and see how the markets move. Then if the markets don't look like they will go down much, withdraw or convert in November or early December. Don't wait until the last two weeks of December since the custodians are really busy then and if something goes wrong, you need time to fix it.
Thanks Celia,
I get the part about converting from tax deferred to Roth during a downturn.
However, i think I was trying to pose a different question regarding what to use during the RMD period and the market has tanked. What i was trying to determine was whether or not to have some of my tax deferred money in “cash” to use that for the RMD instead of having to take the loss by selling stock to meet the RMD. Also, wondered if instead of cash drawdown for the RMD, if I should withdraw from the bond allocation for the RMD during a stock meltdown? Does it matter whether I use cash or bonds? Any difference?
Thanks again for all of your insight.
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Re: Convert to Roth or stay in tax deferred?

Post by celia »

Your RMD can be taken in stock shares. You don’t have to sell it and probably wouldn’t until it recovered to its previous price.

Again, it doesn’t matter what you WITHDRAW. You are really asking about what to SELL, which I am intentionally not addressing. But I would sell and buy whatever I needed to get me closer to my desired portfolio Asset Allocation, whether withdrawing or not.

Those reading this thread assumedly have a large IRA (and future RMDs). To bring down the value of the TIRA faster, they would like withdraw/ convert stock funds first (and let the continued growth happen elsewhere).
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

celia wrote: Thu Jan 28, 2021 6:04 pm Your RMD can be taken in stock shares. You don’t have to sell it and probably wouldn’t until it recovered to its previous price.

Again, it doesn’t matter what you WITHDRAW. You are really asking about what to SELL, which I am intentionally not addressing. But I would sell and buy whatever I needed to get me closer to my desired portfolio Asset Allocation, whether withdrawing or not.

Those reading this thread assumedly have a large IRA (and future RMDs). To bring down the value of the TIRA faster, they would like withdraw/ convert stock funds first (and let the continued growth happen elsewhere).
Hi Celia,
Please excuse my ignorance but I am trying to learn here.
I’m really confused. But lets see if I am starting to understand or continuing to misunderstand. Are You are saying that I do not have to sell any shares to qualify as having fulfilled the RMD as long as I “take’ stock shares with an equivalent value of the dollar amount required for my RMD?
What does it mean to “take” shares? And what can I do with them? Move them into the Roth?
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Re: Convert to Roth or stay in tax deferred?

Post by Rajsx »

Celia,
I am impressed at your knowledge of Roth Conversions from above posts,
There is always a question in my if I am paying more tax when converting now, I have a similar question about my Roth Conversions which I do in a haphazard manner not knowing what Tax Bracket I will be in when I withdraw RMDs at age 72.
I do the Conversions to the top of the Bracket I am in. I have run i-orp, but am unable to find the projected Tax Brackets, I was in 22% MFJ in 2019 & will be in 24% in yr 2021.
Is there a way or software to project taxes ?
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Re: Convert to Roth or stay in tax deferred?

Post by FlamePoint »

I-ORP should show you the different tax brackets you’ll end up in by running different scenarios (unlimited Roth conversions, up to the 24% tax bracket, etc). Did you use the “extended version?
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Re: Convert to Roth or stay in tax deferred?

Post by Rajsx »

Yes, I ran the Extended iorp as suggested, the response was IORP Model Error -

Model M211300ybW6YlDnU
will not solve, possibly because:
Your Roth Conversion tax bracket limit may be over-constraing your taxable income.
Possible ACA income conflict; try solving without ACA limits to view your sources of taxable income.
Considering delaying your spouse's retirement to age 65 or later
Consider lowering your Social Security starting age from 70.

I emailed iorplanner@gmail.com with above as suggested, let us see what comes back.
Can I use this thread for a similar question I have with my numbers or should I start a new thread ?

I have read some having good success and some not with iorp.
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Re: Convert to Roth or stay in tax deferred?

Post by Big Dog »

our intention is to leave as much as we can as legacy money for our two daughters. (25 and 16 years old)
What they receive will be net of taxes, so for IRA's you should also think about their marginal tax rate. For example, if your 25 year old is making bank in IB or Big Law in NYC, her marginal rate can soon approach 50%. So if you leave her a traditional IRA, the state & feds will take a big chunk of that IRA over the 10 years after your death. Instead, you could do conversions at your rate of 22% and she'd be better off with the Roth.

Of course, the reverse is also true. If she becomes a pastor, for example, who is working for minimal wage, her marginal tax rate would be really low. In which case, probably better to let her take the IRA instead of you paying taxes on it today.
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Re: Convert to Roth or stay in tax deferred?

Post by celia »

Actmck3 wrote: Thu Jan 28, 2021 7:04 pm Are You are saying that I do not have to sell any shares to qualify as having fulfilled the RMD as long as I “take’ stock shares with an equivalent value of the dollar amount required for my RMD?
What does it mean to “take” shares? And what can I do with them? Move them into the Roth?
No problem asking questions here. If you have a question, there’s probably another dozen people who have the same question (or don’t yet realize what they don’t know). That’s what we’re here for. But I’m a little surprised that more Bogleheads aren’t answering in this thread.

By “take”, I mean “take out” [but not the food kind :D ] or “withdraw” or “remove”.

Anyway, each year starting with the year you turn 72, you MUST withdraw your RMD before withdrawing for anything else (like doing a Roth conversion). I think the IRS penalty for knowingly not withdrawing is 50% of the RMD for each year you miss and you’ll still have to take it out!

The RMD can go to taxable (in the form of cash or shares), to the IRS (in the form of cash), or to charity, as a QCD (usually as cash). Any of these (or a combination) will meet the RMD requirement. You can also withdraw more than the minimum.

Let’s say my RMD is $5,000 and I own 7,000 shares of a fund at $25 a share. I can withdraw (take out) my RMD any of these ways:

* sell 200 shares, then transfer $5,000 to a taxable account

* transfer 200 shares to a taxable account

* withdraw 200 shares while changing it to cash with 20% going to the IRS and $4,000 going to taxable

* withdraw 200 shares while withholding 20% going to the iRS and state (each gets $1,000) and 120 shares (worth $3,000) going to taxable.

* withdraw 200 shares and send it all to the IRS to cover Roth conversions I plan to do later. (I think Vanguard won’t withhold more than 98% for taxes so I’ll still have to specify where I want the other 2% to go.)

* request a QCD worth $2500 to charity and transfer 100 shares to taxable (the QCD withdrawal will not be taxed).


Suppose I wait a few months (in the same year) and the shares drop to $20 a share. Then I could meet my RMD by:
* transferring 250 shares to taxable.


In all cases, I could then convert anything else I choose to Roth later that year.

Note 1: Vanguard will liquidate any assets going to the tax man or charity.

Note 2: If you are withholding for taxes and are under 59.5, there will be an additional 10% early withdrawal penalty on whatever goes to taxable or to the taxman.

Note 3: if you transfer shares which can change value during the day and they drop in value making your RMD be a little less than the RMD you were trying to meet, you could tranfer cash or a few more shares a few days later to make up the difference. So just don’t put your order in and forget to check on it until next year. It is up to you to confirm the full RMD value was withdrawn.
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Re: Convert to Roth or stay in tax deferred?

Post by solar99999 »

As it is kind of hard to predict the future and it is still January of 2021:

1) Should one take RMDs now or wait till later this year?
2) Should one do a Roth conversion this year or wait till later this year?

Thoughts:

1) Unpredictable income situation (i.e. still own passive interest in businesses) should lean towards doing #2 later in year?
2) Bullish stance in markets should lean towards doing #1 later in year, unless also doing #2?
3) Unpredictable expense situation (i.e. medical expenses) should lean towards doing #2 later in year to avoid 5 year lock up?
4) Neutral stance on market should lean towards doing #1 and #2 now?
5) Bearish stance on market should sell out of market and lean towards doing #1 & #2 now?

Any other factors to consider when it comes to timing?
- Buffetthead | | "[Cash is] thought of as “safe.” In truth they are among the most dangerous of assets."
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Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

celia wrote: Sat Jan 30, 2021 9:31 pm
Actmck3 wrote: Thu Jan 28, 2021 7:04 pm Are You are saying that I do not have to sell any shares to qualify as having fulfilled the RMD as long as I “take’ stock shares with an equivalent value of the dollar amount required for my RMD?
What does it mean to “take” shares? And what can I do with them? Move them into the Roth?
No problem asking questions here. If you have a question, there’s probably another dozen people who have the same question (or don’t yet realize what they don’t know). That’s what we’re here for. But I’m a little surprised that more Bogleheads aren’t answering in this thread.

By “take”, I mean “take out” [but not the food kind :D ] or “withdraw” or “remove”.

Anyway, each year starting with the year you turn 72, you MUST withdraw your RMD before withdrawing for anything else (like doing a Roth conversion). I think the IRS penalty for knowingly not withdrawing is 50% of the RMD for each year you miss and you’ll still have to take it out!

The RMD can go to taxable (in the form of cash or shares), to the IRS (in the form of cash), or to charity, as a QCD (usually as cash). Any of these (or a combination) will meet the RMD requirement. You can also withdraw more than the minimum.

Let’s say my RMD is $5,000 and I own 7,000 shares of a fund at $25 a share. I can withdraw (take out) my RMD any of these ways:

* sell 200 shares, then transfer $5,000 to a taxable account

* transfer 200 shares to a taxable account

* withdraw 200 shares while changing it to cash with 20% going to the IRS and $4,000 going to taxable

* withdraw 200 shares while withholding 20% going to the iRS and state (each gets $1,000) and 120 shares (worth $3,000) going to taxable.

* withdraw 200 shares and send it all to the IRS to cover Roth conversions I plan to do later. (I think Vanguard won’t withhold more than 98% for taxes so I’ll still have to specify where I want the other 2% to go.)

* request a QCD worth $2500 to charity and transfer 100 shares to taxable (the QCD withdrawal will not be taxed).


Suppose I wait a few months (in the same year) and the shares drop to $20 a share. Then I could meet my RMD by:
* transferring 250 shares to taxable.


In all cases, I could then convert anything else I choose to Roth later that year.

Note 1: Vanguard will liquidate any assets going to the tax man or charity.

Note 2: If you are withholding for taxes and are under 59.5, there will be an additional 10% early withdrawal penalty on whatever goes to taxable or to the taxman.

Note 3: if you transfer shares which can change value during the day and they drop in value making your RMD be a little less than the RMD you were trying to meet, you could tranfer cash or a few more shares a few days later to make up the difference. So just don’t put your order in and forget to check on it until next year. It is up to you to confirm the full RMD value was withdrawn.
Celia,
The light bulb just went on! :idea: Thank you for a perfect explanation. I get it now. You have been sooo helpful. Really appreciate your patience.
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Re: Convert to Roth or stay in tax deferred?

Post by celia »

solar99999 wrote: Sat Jan 30, 2021 10:01 pm As it is kind of hard to predict the future and it is still January of 2021:

1) Should one take RMDs now or wait till later this year?
2) Should one do a Roth conversion this year or wait till later this year?
I think if you know you will be doing Roth conversions this year, you should get the RMD out of the way early in the year. Then if the market goes up or down quickly, you can concentrate on how much to convert, with more shares being converted when the share price is down and probably fewer when the market is up.
3) Unpredictable expense situation (i.e. medical expenses) should lean towards doing #2 later in year to avoid 5 year lock up?
Can you explain this further? When would you need to consider a 5 year look-up?
2) Bullish stance in markets should lean towards doing #1 later in year, unless also doing #2?
5) Bearish stance on market should sell out of market and lean towards doing #1 & #2 now?
These depend on if you are trying to "stretch" out the IRA for the rest of your life or you want to bring down the IRA balance in order to pay less in taxes later on. These statements would be true if you were trying to "stretch", but would be the opposite if you want to bring the balance down quicker.
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Re: Convert to Roth or stay in tax deferred?

Post by celia »

Rajsx wrote: Fri Jan 29, 2021 1:58 pm There is always a question in my if I am paying more tax when converting now, I have a similar question about my Roth Conversions which I do in a haphazard manner not knowing what Tax Bracket I will be in when I withdraw RMDs at age 72.

...Is there a way or software to project taxes ?
So, now you want me to predict the future? :confused Sorry, but I can't find my crystal ball.

Congress (and your state legislature) write the laws that define the tax code. The IRS is there to implement them. The current tax brackets that took effect in 2018 are temporary and will revert back to 2017 tax brackets in 2026 unless Congress decides to make the current law permanent. Of course, Congress can change them in any other way before then.

We aren't allowed to speculate in this forum on future laws. But there's nothing to stop you from your own speculation, knowing that our current tax brackets are at a historic low and the federal government has increased it's debt in the last year, due to the unplanned pandemic that no-one predicted.

Here's two ideas you might want to think about (from my perspective, not on any research). Those who were highly paid in their working years will likely be the ones with the most in tax-deferred in retirement. They will have the highest amount of SS and are more likely to have a pension. Of course, there are lots of exceptions here.

And I am one of several Bogleheads that I know about that found ourselves in higher tax brackets in retirement than when working. That is because we retired when our mortgage was paid off, the kids were done with college (and K-12 tuition), and we thought we had "enough" saved for retirement. Those three items were more than half of our yearly spending while working. But now we have no exemptions or deductions to lower our income come tax time. Our income is a little lower now, but not our tax bracket.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Re: Convert to Roth or stay in tax deferred?

Post by solar99999 »

3) Unpredictable expense situation (i.e. medical expenses) should lean towards doing #2 later in year to avoid 5 year lock up?
Can you explain this further? When would you need to consider a 5 year look-up?
The way I understand it is that withdrawals from a Roth IRA before January of the year five years after the year of conversion are subject to a 10% penalty (if under 59.5 years old) and applied using the first in, first out method.

If one has unpredictible medical expenses that could warrant early withdrawal from their Roth IRA, doing conversions early in the year, then withdrawing later in the year would use up amounts from earlier conversions first, extending the 5 year lock up period.

If one waits till later in the year to convert, he/she could reduce the conversion amount by the expenses first to preserve the time elapsed against the older contributions.

Example: Jack and Jill (50 yrs old) each had $30,000 in cash in a tIRA on January 1, 2019. Jack converted $10,000 from tIRA to Roth IRA on January 30, 2019, $10,000 again on January 30, 2020, and then again on January 30, 2021. Jill converted $10,000 on December 1, 2019, $10,000 again on December 1, 2020 and is waiting until December 1, 2021 to convert the final $10,000.

Jack and Jill each get an unexpected medical bill of $8,000 on December 1, 2021 and have to tap into their retirement funds to pay it. Jack has to withdraw $8,000 from his Roth IRA while Jill withdraws $8,000 from her tIRA and converts the remaining $2,000 to her Roth IRA. Both have a balance of $22,000 in their Roth IRAs.

Jack is eligible to withdraw $2,000 on January 1, 2024, $10,000 on January 1, 2025 and $10,000 on January 1, 2026 free of penalty.

Jill is eligible to withdraw $10,000 on January 1, 2024, $10,000 on January 1, 2025 and $2,000 on January 1, 2026 free of penalty.

By doing the Roth conversion later in the year, Jill has avoided the 5 year lock up period on $8,000 having essentially reduced the period to three years and one month as compared to Jack.

Essentially, there's not any benefit from what I can see in doing Roth conversions earlier in the year from a 5 year lock up perspective.

Roth converting earlier in the year could be beneficial if one has a bullish bias in the market.
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Re: Convert to Roth or stay in tax deferred?

Post by Rajsx »

celia wrote: Sat Jan 30, 2021 11:52 pm
Rajsx wrote: Fri Jan 29, 2021 1:58 pm There is always a question in my if I am paying more tax when converting now, I have a similar question about my Roth Conversions which I do in a haphazard manner not knowing what Tax Bracket I will be in when I withdraw RMDs at age 72.

...Is there a way or software to project taxes ?
So, now you want me to predict the future? :confused Sorry, but I can't find my crystal ball.

Congress (and your state legislature) write the laws that define the tax code. The IRS is there to implement them. The current tax brackets that took effect in 2018 are temporary and will revert back to 2017 tax brackets in 2026 unless Congress decides to make the current law permanent. Of course, Congress can change them in any other way before then.

We aren't allowed to speculate in this forum on future laws. But there's nothing to stop you from your own speculation, knowing that our current tax brackets are at a historic low and the federal government has increased it's debt in the last year, due to the unplanned pandemic that no-one predicted.

Here's two ideas you might want to think about (from my perspective, not on any research). Those who were highly paid in their working years will likely be the ones with the most in tax-deferred in retirement. They will have the highest amount of SS and are more likely to have a pension. Of course, there are lots of exceptions here.

And I am one of several Bogleheads that I know about that found ourselves in higher tax brackets in retirement than when working. That is because we retired when our mortgage was paid off, the kids were done with college (and K-12 tuition), and we thought we had "enough" saved for retirement. Those three items were more than half of our yearly spending while working. But now we have no exemptions or deductions to lower our income come tax time. Our income is a little lower now, but not our tax bracket.
Maybe, I did not put it it right & in any case I apologize for the miscommunication, no, I did not mean to ask you to predict the future.
As the talk was of Roth Conversions, I needed some help in planning our Roth Conversions in the coming years, that is all.
Anyway, I think I learnt from your above explanations, thank you
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Re: Convert to Roth or stay in tax deferred?

Post by 3feetpete »

Right now stocks are near an all time high and you will be paying tax on that elevated amount. The decision to convert to Roth becomes a lot clearer after a correction. Last March was a great time to convert. Let's say you converted 100k in march and paid 33k in taxes. That 100k is now worth almost 200k and can grow indefinitely without ever being subject to tax. The difference between tax brackets ends up being insignificant. March was a particularly good time because it was a short lived correction and it was possible to pay the taxes in December after the market had already recovered.

If you do convert over a period of years, do it slowly and take advantage of any corrections that occur.
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Re: Convert to Roth or stay in tax deferred?

Post by David Jay »

The OP got into a discussion on another thread and we are splitting out just the Roth conversion issue in this thread, as the title fits well with the discussion. The newer thread is here: viewtopic.php?f=2&t=346498

First, let's do a quick review a few principles:

The way to optimize between traditional IRA (tIRA) and Roth is to level the "marginal rate" of income tax on the money coming out of tax-deferred. Marginal Rate is the rate paid on the next dollar of money withdrawn or converted (the tax is the same whether the money is withdrawn or converted) from the tIRA.

By leveling, I mean if we don't convert now, we will have big RMDs later and that will cost us more in taxes because the additional income will push us into a higher tax bracket. We want to take all of the money out at the same marginal tax rate if possible.

As I said on the other thread, the future is uncertain so one should construct a plan that is "good enough", rather than trying to get it perfect because what is perfect today won't be perfect next year because things change.

There are three issues to think about that add complexity:
1. Tax rates are scheduled to go up in 2026. The current 22% tax bracket goes up to 25%, the current 24% tax bracket goes up to 28% and the current 32% tax bracket goes up to 33%. No one knows the future so our best guide is the current law.
2. After the death of the first spouse, the surviving spouse will be filing taxes as a "single" , so the allowance for each tax bracket will be cut dramatically .
3. The money that you do not withdraw from your tIRA will be passed to your two adult children. They will have to withdraw the money over 10 years and they will pay their personal/family marginal tax rate on those withdrawals so we have to consider that tax rate. Uncle Sam expects to be paid on the money either way, in your lifetimes or from your kids' in first 10 years.

The only way around paying taxes on tIRA funds is to donate them to charity. There is a way to do that tax free after age 70.5 so if you want to support some charitable causes you can do that tax free down the road.

Let's split this into two posts, I will get into the numbers in next post.
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David Jay
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Re: Convert to Roth or stay in tax deferred?

Post by David Jay »

I have looked at your numbers, and here is the conclusion that I come to: You should fill a portion of 24% tax bracket with Roth conversions for the next 5 years, with the goal to be able to stay in the 25% (that's your current 22% tax bracket, the rate changes in 2026) tax bracket after the 5 years is over.

I would select the second IRMAA limit as my cutoff, which is $222,000 of income. This increases the cost of your Medicare by about $70 a month for those years but I think it is worth for the long term benefit. This means your would convert at least $100,000 to Roth in 2021 and 2022. You have some other deductions (mortgage interest, etc.) so you will actually be able to do a bit more for these two years. Then you could convert about $60,000 for the next 3 years. All told you will have reduced your tIRA future balance by more than $320,000 in just 5 years.

After that, you would fill the 25% bracket (which is your current 22% bracket) which will be about $35,000 per year beginning in 2026.

One other "hint" is to hold 100% stock funds in Roth and leave all the lower yielding instruments in the tIRA to control the growth of the tIRA. Grow the tax-free account instead of the tax-deferred account.

NOTE: If you are not covered under Medicare, you can get really radical and fill 24% tax bracket for the next 5 years! That would convert some $800,000 to Roth, or nearly half of your tIRA balance. All at a rate that is lower than your "new normal" rate of 25% in 2026.
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
Topic Author
Actmck3
Posts: 44
Joined: Tue Feb 04, 2020 4:00 pm

Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

David Jay wrote: Sun Apr 18, 2021 1:05 pm I have looked at your numbers, and here is the conclusion that I come to: You should fill a portion of 24% tax bracket with Roth conversions for the next 5 years, with the goal to be able to stay in the 25% (that's your current 22% tax bracket, the rate changes in 2026) tax bracket after the 5 years is over.

I would select the second IRMAA limit as my cutoff, which is $222,000 of income. This increases the cost of your Medicare by about $70 a month for those years but I think it is worth for the long term benefit. This means your would convert at least $100,000 to Roth in 2021 and 2022. You have some other deductions (mortgage interest, etc.) so you will actually be able to do a bit more for these two years. Then you could convert about $60,000 for the next 3 years. All told you will have reduced your tIRA future balance by more than $320,000 in just 5 years.

After that, you would fill the 25% bracket (which is your current 22% bracket) which will be about $35,000 per year beginning in 2026.

One other "hint" is to hold 100% stock funds in Roth and leave all the lower yielding instruments in the tIRA to control the growth of the tIRA. Grow the tax-free account instead of the tax-deferred account.

NOTE: If you are not covered under Medicare, you can get really radical and fill 24% tax bracket for the next 5 years! That would convert some $800,000 to Roth, or nearly half of your tIRA balance. All at a rate that is lower than your "new normal" rate of 25% in 2026.
Thanks David.
One other thing related to “running the numbers” is that I do not have outside money to pay the taxes. Lange rec’d to use a HELOC to pay those taxes on the conversion money rather than having to dip deeper into the traditional IRA to pay the taxes. He said that otherwise, I’d need to take out 133K to get 100K into the Roth.
So, if I don’t have any money outside the IRA to pay any conversions, does it change any of your thoughts regarding the plan you have laid out?

I really appreciate your guidance.
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David Jay
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Location: Michigan

Re: Convert to Roth or stay in tax deferred?

Post by David Jay »

Actmck3 wrote: Sun Apr 18, 2021 4:55 pmOne other thing related to “running the numbers” is that I do not have outside money to pay the taxes. Lange rec’d to use a HELOC to pay those taxes on the conversion money rather than having to dip deeper into the traditional IRA to pay the taxes. He said that otherwise, I’d need to take out 133K to get 100K into the Roth.

So, if I don’t have any money outside the IRA to pay any conversions, does it change any of your thoughts regarding the plan you have laid out?
I had already realized that this was the case, based on your numbers. Of course, if you have cash to pay the taxes it increases the amount that ends up in the Roth, but here is another perspective:

That tIRA money is going to get taxed when it is withdrawn. If you withdraw the money anytime after 2026 you will pay 25% federal income tax (plus any state tax) until RMDs get large or one spouse passes. At that point your marginal tax rate goes way up. If you leave it to your daughters, they will have to take it all out within 10 years and that will bump up their tax rates, very likely above 25%.

So any money you can take out at a tax rate less than 25% is a “win”. It is even better that you can use a conversion instead of a simple withdrawal so the withdrawn money (after paying taxes) continues to grow tax-free and your daughters get to take it out tax free. It takes a multi-generational understanding of taxes to understand why you need to take out everything you can at 22% and 24% in the next 5 years.

Are you on Medicare (or will your spouse be on Medicare?) or do you have another insurance plan? The only reason not to make conversions to the top of the 24% tax bracket is the IRMAA penalty, so this is an important question. That is the last remaining piece of the puzzle.
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
Sahara
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Joined: Tue Dec 04, 2018 5:21 pm

Re: Convert to Roth or stay in tax deferred?

Post by Sahara »

David Jay wrote: Sun Apr 18, 2021 5:59 pm
That tIRA money is going to get taxed when it is withdrawn. If you withdraw the money anytime after 2026 you will pay 25% federal income tax (plus any state tax) until RMDs get large or one spouse passes. At that point your marginal tax rate goes way up. If you leave it to your daughters, they will have to take it all out within 10 years and that will bump up their tax rates, very likely above 25%.
David, I haven't been able to follow all of the numbers here. Is that the rationale here that the OP's withdrawals after age 2026 are large enough to exceed the standard deduction and place the OP in the 22% bracket at that time?

Also, could you speak to holding some tax-deferred funds to be used for medical expenses and included in itemized deductions, thus avoiding taxation? Is this something one should consider?
Topic Author
Actmck3
Posts: 44
Joined: Tue Feb 04, 2020 4:00 pm

Re: Convert to Roth or stay in tax deferred?

Post by Actmck3 »

David Jay wrote: Sun Apr 18, 2021 5:59 pm
Actmck3 wrote: Sun Apr 18, 2021 4:55 pmOne other thing related to “running the numbers” is that I do not have outside money to pay the taxes. Lange rec’d to use a HELOC to pay those taxes on the conversion money rather than having to dip deeper into the traditional IRA to pay the taxes. He said that otherwise, I’d need to take out 133K to get 100K into the Roth.

So, if I don’t have any money outside the IRA to pay any conversions, does it change any of your thoughts regarding the plan you have laid out?
I had already realized that this was the case, based on your numbers. Of course, if you have cash to pay the taxes it increases the amount that ends up in the Roth, but here is another perspective:

That tIRA money is going to get taxed when it is withdrawn. If you withdraw the money anytime after 2026 you will pay 25% federal income tax (plus any state tax) until RMDs get large or one spouse passes. At that point your marginal tax rate goes way up. If you leave it to your daughters, they will have to take it all out within 10 years and that will bump up their tax rates, very likely above 25%.

So any money you can take out at a tax rate less than 25% is a “win”. It is even better that you can use a conversion instead of a simple withdrawal so the withdrawn money (after paying taxes) continues to grow tax-free and your daughters get to take it out tax free. It takes a multi-generational understanding of taxes to understand why you need to take out everything you can at 22% and 24% in the next 5 years.

Are you on Medicare (or will your spouse be on Medicare?) or do you have another insurance plan? The only reason not to make conversions to the top of the 24% tax bracket is the IRMAA penalty, so this is an important question. That is the last remaining piece of the puzzle.
I am starting Medicare next month. Due to a large payout at separation from my job (which was split over two years, I retired in 4/2019) I already got my letter advising of an almost $400/month IRMAA.
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David Jay
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Location: Michigan

Re: Convert to Roth or stay in tax deferred?

Post by David Jay »

Sahara wrote: Sun Apr 18, 2021 6:29 pmDavid, I haven't been able to follow all of the numbers here. Is that the rationale here that the OP's withdrawals after age 2026 are large enough to exceed the standard deduction and place the OP in the 22% bracket at that time?

Also, could you speak to holding some tax-deferred funds to be used for medical expenses and included in itemized deductions, thus avoiding taxation? Is this something one should consider?
The OP has 1.7M in tIRA and essentially no other retirement accounts. Current pensions plus SS put them in the 22% tax bracket already, before any IRA withdrawals. The 22% bracket is scheduled to revert to 25% in 2026. Their primary goal is to maximize inter-generational transfer.

I would like to see them get below 1M it tIRA before RMDs start but that will depend how much IRMAA (if any is due) they are willing to pay to get the tIRA “under control”.
It's not an engineering problem - Hersh Shefrin | To get the "risk premium", you really do have to take the risk - nisiprius
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