Which account to pay Roth Conversion taxes?

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cegibbs
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Joined: Sun Jan 25, 2015 6:27 am

Which account to pay Roth Conversion taxes?

Post by cegibbs »

I have the very good fortune of having a very sizable Rollover. The last five years I’ve been doing Roth conversions and paid the federal and state taxes from my taxable account cash. When I reach RMD age in seven years, the annual RMD will be significant and put me in the 32% federal tax bracket. I’ve been taking regular monthly distributions from my Rollover since retiring to cover all living expenses and my Rollover has continued to grow significantly. My taxable account is nearly 100% in an S&P500 index which has significant capital gains because I’ve held it for decades. I want to do much larger Roth Conversions as compared with past years, and don’t want to pay taxes from the Conversion because I want 100% of the converted amount to be moved to the Roth. To pay taxes, I’d have to either sell portions of the S&P500 index in my taxable account or take additional distributions from my Rollover. I’m inclined to take additional distributions from my Rollover because of its size and because my taxable account is only 8% of my investable assets. I like the idea of having my taxable account as a source of funds if needed for some other reason in the future or to leave for heirs. Likewise a larger Roth account is also desirable in case needed n the future for some purpose or to pass along to heirs. Because of the size of my Rollover, paying taxes from it has no meaningful impact on its balance. Is my intent to take additional distributions from my Rollover to pay federal and state taxes from Roth conversions a sound approach? Taxes paid during those years would be below the federal tax rate anticipated during RMD years. But even it was paid at the 32% federal tax rate, the sooner I move money to my Roth the longer it has to grow in that account rather in my Rollover which creates more of a future tax burden.
ehh
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Re: Which account to pay Roth Conversion taxes?

Post by ehh »

OP, you may wish to consider your capital gains tax rate vs the tax rate on money coming out of your rollover. If your capital gains tax rate is less, that is a point in favor of taking capital gains in your taxable account. Eric
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retiredjg
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Re: Which account to pay Roth Conversion taxes?

Post by retiredjg »

Paying taxes "from the conversion" and paying taxes from the rollover IRA are the same thing, aren't they? Or are you thinking of taking the taxes out of the money already in Roth IRA (which seems essentially the same to me)?

It sounds like you are converting at 24%. Capital gains rate would be 15%...but you end up with less in taxable...maybe less than you want to maintain in taxable.

If the goal is to reduce the amount of your IRA, I would take the taxes from the IRA (do a conversion and have some withheld for taxes).

If you are 63 or older, don't forget to consider IRMAA.
SGM
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Re: Which account to pay Roth Conversion taxes?

Post by SGM »

We had a very large traditional 401k and IRA. We converted it all starting in 2010 when the law allowed conversions regardless of income and over a six year period before taking my delayed SS. We have a large taxable account as well, so I only paid the taxes out of the taxable account. I would not have made conversions if I had to pay taxes out of the traditional IRAs. In your situation with a too small taxable account, I would have continued working to use that income to pay the taxes for conversions.

i had similar investments in my traditional IRAs as my taxable accounts, mostly in index funds. But I did have a few long held individual stocks in both accounts. I put the most I was allowed into tax deferred accounts. I don't see how they could have outgrown my large taxable accounts without taking very large risks in the traditional IRAs.

Maybe I would put bonds in the traditional IRAs so that it wouldn't grow fast and have stock funds in the Roth accounts.
tibbitts
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Re: Which account to pay Roth Conversion taxes?

Post by tibbitts »

I don't think anyone can comment without seeing the actual numbers - like the amount of your taxable account and amount that's actually taxable (the capital gains) and the rate you'd pay on those (federal and state combined.)

I'm the same number of years from RMDs and chose to pay the tax on the rollover from taxable even with about 50% of my withdrawals for that payment being taxable at a high rate (25%, high for capital gains.) But it's probably not going to make a huge difference in most cases.
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FiveK
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Re: Which account to pay Roth Conversion taxes?

Post by FiveK »

You may want to look at a recent thread, How do RMDs affect Roth conversion choices?.

Looking at the spreadsheet linked in that thread, it appears to allow you to investigate all the options you describe. Of course, any result will be no better than the assumptions made but it might be useful.

The interaction of RMDs with the "how much to convert?" choice is something that hasn't received all that much attention (that I'm aware of) until recently, e.g., Roth Conversions - McQuarrie study - Bogleheads.org. if you do the analysis, it would be interesting to get your perspective.
JBTX
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Re: Which account to pay Roth Conversion taxes?

Post by JBTX »

Do you have a mortgage? Perhaps a cash out refi or a new mortgage, presumably if you can get good interest rate.

Or take out a brokerage/margin loan at something like interactive brokers, which would likely involve an I kind transfer of some of your taxable funds to IB. Im not familiar with them, or recommending thst per se, just throwing it out there. Obviously such an approach has some risks.
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