Roth conversion question

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Topic Author
kleiner
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Joined: Tue Jun 02, 2020 8:45 am

Roth conversion question

Post by kleiner »

Let me start by admitting that this is a very much a first world problem :-)

I retired at the end of 2020 at age 58 while my wife, who is in her mid 50s, is still working. We don’t lack for money! Our current situation is:
- I have $1.7M in my IRA (rolled over from various 401k) invested in index funds
- My wife has $1.5M in her 401k and makes about $300k per year. I think she will very likely keep working for a few more years.
- We have $2.6M in post-tax investments and cash.
- No debt - house is paid off, we both are entitled to decent pensions and have very good numbers for Social Security.

The main question is whether I should go ahead and start Roth conversions late this year after I turn 59.5 or wait until my wife stops working. The goal is to avoid getting hit by RMDs. We seem to have enough in post-tax money that we may not even have to touch the pre-tax accounts until our 70s (if at all).

I looked at the wiki and the Retiree Portfolio Model spreadsheet but it does not seem to really cover my case. The wiki says:
If you expect to be in a lower tax bracket in a future year, wait until that year to convert. Likewise, if converting the whole amount from a traditional IRA would push you into a higher tax bracket, convert only as much to keep you in the current bracket, and convert the remainder in future years.
But we are already in a high tax bracket so would it make any difference?
fabdog
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Re: Roth conversion question

Post by fabdog »

Well, if you do conversions now you know what the tax rate will be.. and you have some years to work on the problem.

It's not clear the goal should be "avoid getting hit by RMD's"

It should be how do we deploy our pre and post tax accounts to manage our tax hit over the course of retirement.

Once your wife stops working you can get more aggressive with the Roth conversions, and look at tapping pre tax accounts for living expenses before RMD time... to spread out how that money is spent. This allows your post tax accounts to grow.

If your spouse works 3 more years, then you have 11 years for you, and 13 to 14 years for your spouse, with lower income years to work thru Roth conversions in a much lower tax bracket.

I'd wait till she retires before starting conversions... and you have runway to work with

Mike
Stubbie
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Re: Roth conversion question

Post by Stubbie »

In your case it's not going to make much difference. You are wealthy and the tax man will get his share. I would do Qualified Charitable Distributions of your forced RMDs when the time comes and leave it at that. Or, if not charitably inclined, keep the RMD and pay the piper then.
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retired@50
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Re: Roth conversion question

Post by retired@50 »

kleiner wrote: Thu Jun 17, 2021 8:18 am
But we are already in a high tax bracket so would it make any difference?
What tax bracket will you be in when her $300k in wages stops?

That's the "lower tax bracket" in the future that the wiki is referring to.

You may be able to squeeze in a few years of low(er) income between her work stoppage, and RMDs beginning for you. That would probably be the best time to consider conversions.

Regards,
Last edited by retired@50 on Thu Jun 17, 2021 12:44 pm, edited 1 time in total.
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an_asker
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Re: Roth conversion question

Post by an_asker »

fabdog wrote: Thu Jun 17, 2021 8:35 am It's not clear the goal should be "avoid getting hit by RMD's"
[...]
Mike
I agree that this is a weird goal, because ... the only way one can avoid getting hit by RMDs is by not surviving till one's 70s! :oops:
tibbitts
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Re: Roth conversion question

Post by tibbitts »

kleiner wrote: Thu Jun 17, 2021 8:18 am The main question is whether I should go ahead and start Roth conversions late this year after I turn 59.5 or wait until my wife stops working. The goal is to avoid getting hit by RMDs. We seem to have enough in post-tax money that we may not even have to touch the pre-tax accounts until our 70s (if at all).
Although we all wish it weren't true, Roth conversions are basically a roll of the dice, where you can win or lose - sometimes dramatically. An example would be if you'd converted a significant percentage of your deferred balance at the market lows last March, you'd feel like a genius now. If we were still at those market lows (which we might well have been) and stayed stuck there for another decade or two, you'd feel stupid.

But the objective isn't always to eliminate RMDs; it's to get to where RMD plus your other retirement income gets you to the tax bracket you want to be in. And that depends on, for example, what you consider "decent" pensions. My pension is $24k/yr and I think it's decent. Maybe you consider your combined $240k/yr in pensions "decent." And I think my $30k in social security will be a "very good number", but maybe not by your standards.
tibbitts
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Re: Roth conversion question

Post by tibbitts »

an_asker wrote: Thu Jun 17, 2021 10:58 am
fabdog wrote: Thu Jun 17, 2021 8:35 am It's not clear the goal should be "avoid getting hit by RMD's"
[...]
Mike
I agree that this is a weird goal, because ... the only way one can avoid getting hit by RMDs is by not surviving till one's 70s! :oops:
No, you can eliminate RMDs by eliminating/converting deferred accounts.
smitcat
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Re: Roth conversion question

Post by smitcat »

kleiner wrote: Thu Jun 17, 2021 8:18 am Let me start by admitting that this is a very much a first world problem :-)

I retired at the end of 2020 at age 58 while my wife, who is in her mid 50s, is still working. We don’t lack for money! Our current situation is:
- I have $1.7M in my IRA (rolled over from various 401k) invested in index funds
- My wife has $1.5M in her 401k and makes about $300k per year. I think she will very likely keep working for a few more years.
- We have $2.6M in post-tax investments and cash.
- No debt - house is paid off, we both are entitled to decent pensions and have very good numbers for Social Security.

The main question is whether I should go ahead and start Roth conversions late this year after I turn 59.5 or wait until my wife stops working. The goal is to avoid getting hit by RMDs. We seem to have enough in post-tax money that we may not even have to touch the pre-tax accounts until our 70s (if at all).

I looked at the wiki and the Retiree Portfolio Model spreadsheet but it does not seem to really cover my case. The wiki says:
If you expect to be in a lower tax bracket in a future year, wait until that year to convert. Likewise, if converting the whole amount from a traditional IRA would push you into a higher tax bracket, convert only as much to keep you in the current bracket, and convert the remainder in future years.
But we are already in a high tax bracket so would it make any difference?
Perhaps run some of your most likely future scenarios through some calculators and see what the results are.
- IORP extended
- RPM
- Pralana
There are a number of threads on how these can be used so if you do use them please read up on pros & cans and their quirks.
an_asker
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Re: Roth conversion question

Post by an_asker »

tibbitts wrote: Thu Jun 17, 2021 11:15 am
an_asker wrote: Thu Jun 17, 2021 10:58 am
fabdog wrote: Thu Jun 17, 2021 8:35 am It's not clear the goal should be "avoid getting hit by RMD's"
[...]
Mike
I agree that this is a weird goal, because ... the only way one can avoid getting hit by RMDs is by not surviving till one's 70s! :oops:
No, you can eliminate RMDs by eliminating/converting deferred accounts.
Hmm ... yes, I failed to consider it, because I was looking at OP's current portfolio's standpoint. But yes, you make a good point!!
curmudgeon
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Re: Roth conversion question

Post by curmudgeon »

For many people, Roth conversions may not actually make that much difference. The most straightforward case to convert is during a taxable income "hole" between early retirement and claiming SS/hitting RMDs, to take advantage of lower tax rates during those years. If you have a substantial pension, that "hole" doesn't exist. It still may be worth smoothing income, but it's not likely to make a big overall difference.

If you are on the higher income and large IRA side, it may be worth nibbling around the edges a bit to minimize IRMAA surcharges on your medicare payments. If you are on the higher assets side, there may be value to paying the income tax during your lifetime and getting that much out of your estate for fed/state estate tax purposes.

Those without pensions, but substantial assets and SS benefits may be able to avoid taxation of their SS benefits by converting most of their IRA balances, but that's a bit of a narrow target that gets tighter every year because it's not inflation-indexed.

If you are leaving your IRA to charity, or plan to do QCDs instead of RMDs, then Roth conversions don't make much sense.

If you are afraid of tax law changes in the future, that can be an argument for doing some conversions now, though I wouldn't consider Roths to be fully protected against the actions of a future congress.
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FiveK
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Re: Roth conversion question

Post by FiveK »

kleiner wrote: Thu Jun 17, 2021 8:18 am I looked at the wiki and the Retiree Portfolio Model spreadsheet but it does not seem to really cover my case. The wiki says:
If you expect to be in a lower tax bracket in a future year, wait until that year to convert. Likewise, if converting the whole amount from a traditional IRA would push you into a higher tax bracket, convert only as much to keep you in the current bracket, and convert the remainder in future years.
But we are already in a high tax bracket so would it make any difference?
"High" and "low" are ambiguous. That's why the wiki uses "higher" and "lower". Does that help?
Topic Author
kleiner
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Joined: Tue Jun 02, 2020 8:45 am

Re: Roth conversion question

Post by kleiner »

tibbitts wrote: Thu Jun 17, 2021 11:15 am No, you can eliminate RMDs by eliminating/converting deferred accounts.
Thanks - this is exactly what I meant to ask in my original posting. I was indeed asking about the strategy of aggressively converting IRAs before RMDs kick in.

In any case, many thanks to everyone for your help. I will definitely hold off on Roth conversions until my wife retires. As for what we do at that point, we will just have to play it by ear at that point.
Topic Author
kleiner
Posts: 346
Joined: Tue Jun 02, 2020 8:45 am

Re: Roth conversion question

Post by kleiner »

curmudgeon wrote: Thu Jun 17, 2021 12:51 pm For many people, Roth conversions may not actually make that much difference. The most straightforward case to convert is during a taxable income "hole" between early retirement and claiming SS/hitting RMDs, to take advantage of lower tax rates during those years. If you have a substantial pension, that "hole" doesn't exist. It still may be worth smoothing income, but it's not likely to make a big overall difference.

If you are on the higher income and large IRA side, it may be worth nibbling around the edges a bit to minimize IRMAA surcharges on your medicare payments. If you are on the higher assets side, there may be value to paying the income tax during your lifetime and getting that much out of your estate for fed/state estate tax purposes.

Those without pensions, but substantial assets and SS benefits may be able to avoid taxation of their SS benefits by converting most of their IRA balances, but that's a bit of a narrow target that gets tighter every year because it's not inflation-indexed.

If you are leaving your IRA to charity, or plan to do QCDs instead of RMDs, then Roth conversions don't make much sense.

If you are afraid of tax law changes in the future, that can be an argument for doing some conversions now, though I wouldn't consider Roths to be fully protected against the actions of a future congress.
Thanks! This is a very useful summary of the available strategies. Your term "taxable income hole" really makes the situation clear.

I have a relatively modest pension worth about $200k lumpsum at age 65 while my wife has accumulated a much bigger pension probably worth $800k when she reaches 65. Furthermore, we are each likely to get SS over $3k per year at 70 (seems like a no-brainer to delay collecting SS as much as possible). Looks like we will have to be careful with our Roth conversion strategy to thread this needle.
curmudgeon
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Re: Roth conversion question

Post by curmudgeon »

kleiner wrote: Thu Jun 17, 2021 1:28 pm
I have a relatively modest pension worth about $200k lumpsum at age 65 while my wife has accumulated a much bigger pension probably worth $800k when she reaches 65. Furthermore, we are each likely to get SS over $3k per year at 70 (seems like a no-brainer to delay collecting SS as much as possible). Looks like we will have to be careful with our Roth conversion strategy to thread this needle.
If you add your pension valuations to your IRA/401K, you end up with $4M+ of tax-deferred assets. There will be a lot of tax to pay no matter how you slice it. As you say, "first world problem", but you might as well manage it and keep flexibility as much as you can. When you've accumulated this much, it's definitely a good idea to be thinking about retirement spending plans (and estate planning as well). Some folks want to "spend it all", some want to "save it for future generations", some want to be a key charitable donor, and some don't have particularly strong feelings in any particular direction.

I would suggest using a tax estimating tool like: https://www.mortgagecalculator.org/calc ... ulator.php
Estimate next year's taxes, then a guess as to what it would look like if your wife retires 5 years from now, when you start SS, when RMDs start, at age 80, age 90 and single, etc. Repeat the exercise every few years to take account of tax law changes, investment returns, etc.

One thing you might do now is to at least make sure you each have a Roth account open with some basic funding, as a hedge. Years ago higher income folks couldn't have Roths, and while I'm not aware of any active movement to restrict them again, unpleasant surprises do come out of the tax committees. There's no age restriction on doing conversions. If your wife has a Roth 401K option, she should think about using it to some degree; if not, converting part of an old tIRA ( or doing "back-door Roth" if she doesn't have any tIRA) would be an option. While there is a low probability of changes, this also starts one of the "5-year clocks" on the Roth accounts.

One nice factor of having a decent chunk of money in Roths is that you can draw a big lump sum in one year (maybe you want to do an around-the-world cruise) without messing up your tax planning.
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