i-orp and roth conversions

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
tibbitts
Posts: 23589
Joined: Tue Feb 27, 2007 5:50 pm

Re: i-orp and roth conversions

Post by tibbitts »

randomguy wrote: Tue Oct 26, 2021 12:21 pm
Lee_WSP wrote: Tue Oct 26, 2021 11:51 am OP
It's a great tool and it's free. But you'll get much more intuitive results if you just create your own model of the rmd schedule and plugging in the average rmd into your retirement model.

Convert up to that marginal tax bracket or Irma's tier.
Your results might be more intuitive but are they right? I don't have much faith in my intuitions ability to resolve the interactions of SS taxations, IRMAA, ACA cliffs, tax drag, upcoming tax law changes and the rest. What I don't know is if I-ORP can really do much better given the uncertainties of the problem.
What i-ORP did for me what to alert me to the issue of conversions, but for deciding on amounts and timing I mostly used a simple RMD calculator. It's just not a precise process no matter what you do: for example not that long ago (late-2000s) IRMAA brackets weren't a thing (and part D IRMAA didn't start until the early 2010s.) So if you'd been planning at that time then you'd have been completely blindsided by those. And NIIT too. Not to mention the tax bracket changes during that time.
User avatar
Lee_WSP
Posts: 10346
Joined: Fri Apr 19, 2019 5:15 pm
Location: Arizona

Re: i-orp and roth conversions

Post by Lee_WSP »

randomguy wrote: Tue Oct 26, 2021 12:21 pm
Lee_WSP wrote: Tue Oct 26, 2021 11:51 am OP
It's a great tool and it's free. But you'll get much more intuitive results if you just create your own model of the rmd schedule and plugging in the average rmd into your retirement model.

Convert up to that marginal tax bracket or Irma's tier.
Your results might be more intuitive but are they right? I don't have much faith in my intuitions ability to resolve the interactions of SS taxations, IRMAA, ACA cliffs, tax drag, upcoming tax law changes and the rest. What I don't know is if I-ORP can really do much better given the uncertainties of the problem.
It's just as accurate as I orp. By retirement modeler, I meant tax calculator.

Neither will accurately predict future returns which drives ninety precent of the variation.
MathWizard
Posts: 6542
Joined: Tue Jul 26, 2011 1:35 pm

Re: i-orp and roth conversions

Post by MathWizard »

Lee_WSP wrote: Tue Oct 26, 2021 11:51 am OP
It's a great tool and it's free. But you'll get much more intuitive results if you just create your own model of the rmd schedule and plugging in the average rmd into your retirement model.

Convert up to that marginal tax bracket or Irma's tier.
Certainly agree with this.

I used i-orp as a starting point from which to develop my own plan.

I use exactly the current RMD schedule. It's easy enough to program into a spreadsheet.
Taxable income was trickier, due to the way SS benefits are taxed.
Exchme
Posts: 1323
Joined: Sun Sep 06, 2020 3:00 pm

Re: i-orp and roth conversions

Post by Exchme »

kvolkman wrote: Tue Oct 26, 2021 11:40 am I am the person who started this thread. I was looking for an intuitive, seat-of-the-pants understanding of i-orp's Roth conversion results. In maximizing lifetime spending, the i-orp linear regression solution results in way less Roth conversion that I had been planning.

Here is a bare-bones example that illustrates. In the tool, I clear the form so that it uses all defaults. Thus no pension, no social security income, and no ACA restrictions. We'll use $2.5 million in savings, and a $500k plan surplus. Add ages and account balances as follows:
Ages: 62, 62
Tax-deferred: 750, 750
Roth: 250, 250
After-tax: 500
After-tax cost basis: 500
Plan surplus: 500
Retire age: 63, 63
Conversions: 24% ceiling (or 32%, or unlimited; it doesn't matter, there is no change)
Allocation: Default. 100% stock for all accounts, no glidepath changes. There is NO difference between tax-deferred, Roth and after-tax.

The result is about $400k of conversions over 4 years from ages 63 to 66 ($93k, $99k, $105k, $112k).
I cannot imagine why it is not optimal to continue to convert a similar amount at age 67, 68, 69, etc.

INTERESTING VARIATIONS

1) Longer retirement: Increase the planning horizon to age 105. (The default is age 92.) It makes almost no difference. Result: $92k, $97k, $103k, $108k, $46k; ages 63-67. There was a long thread recently that Roth conversions always pay off if you wait long enough. Well, this model (a linear regression to maximize disposable income) suggests NOT.

2) Retire younger: Change the ages and the planning horizon, but NOT the duration of retirement. Instead of ages 63 to 105, use ages 43 to 85. STILL a 42-year retirement, just starting 20 years younger. All the same inputs as before, same starting balance, same ending balance.

The result is $1.7 million of conversions, continuing for 16 years, from ages 43 to 58 ($92k, $97k, $103k, $108k, $100k, $111k, $113k, $116k, $118k, $120k, $123k, $125k, $120k, $130k, $58k, $55k). Eh??
I repeated your inputs and get very slightly different numbers, so maybe missed something, but pretty close. As to why no Roth conversions ages 67-71, the program is recommending withdrawals but not Roth conversions from the IRA from ages 67-71, generating (after inflation) $47-50 K/yr cash for $2K/yr in taxes, it's also withdrawing from the Roth during that time to generate the disposable income. This example has 10% and 12/15% brackets throughout, so the opportunity for arbitrage between tax rates is very small, the program is doing what it can to get some money out at 12% to avoid 15% after expiration of TCJA at the end of 2025. Lots of folks fall into this category, where Roth conversions are just not very important. Also, the program is withdrawing from the Roth prior to RMDs in order to generate cash, so there isn't a lot of time for the incremental benefit of Roths to build up.

In your age 63-105 case, the output is quite similar, where the Roth conversions are creating several years with barely any taxes due while you live on the Roth + some withdrawals from the IRA. With $411K of conversions to Roth but then within a few years starting withdrawals from the Roth, there's not much of an effect, the total value increased from $5477K to $5506K, so the effect here was positive, but super small.

For the age 42-85 retirement, with more years before RMDs, the program found an improvement from $5317K to $5528K and real after tax disposable rose 4% from $124K to $129K with $1692K of conversions. Note that some of that improvement is unfair in that it is charging penalties for early withdrawal from the IRA due to the super early retirement in the no-Roth conversion case vs. converting to Roth and then withdrawing from the Roth to generate cash. A real person could set up a substantially equal withdrawal plan from the IRA and avoid those penalties. But you can see that there are years with some money taxed at a 25% bracket without Roth conversions whereas everything stays at 15% or less with Roth Conversions, so there is some savings there.

I have no idea whether I-orp is "right" in any of these, but it feels like there are at least plausible reasons why it's doing what it's doing. Any of these cases where the accounts are drawn down to small fractions of their initial value as part of the plan (instead of an accident of bad returns) would scare me too much anyway as a bad year after drawing down the account could wipe you out in a hurry.
BigJohn
Posts: 2626
Joined: Wed Apr 02, 2014 11:27 pm

Re: i-orp and roth conversions

Post by BigJohn »

Exchme wrote: Mon Oct 25, 2021 3:36 pm Maybe I'm just frustrated by the amount of time I spent to find what seems obvious in hindsight - future events drive the result.

So my feeling is tool shortcomings seem much less important than future events and the tool only has to get the first year directionally correct to be better than doing nothing and that may be as good as it gets.
I didn’t use these tools but came to the same conclusion with my own spreadsheets and TurboTax. There are just too many unknowns and their variability swamps any hope of a “correct” answer. After struggling for months I opted for a strategy that keeps my current taxable income with conversions about flat with expected future income with SS and RMDs. I adjust the details (returns, tax law changes, etc) at the end of the year to develop next years plan.

In my mind this is a middle of the road solution that is the best I can do with all the uncertainties involved. It also leaves me at about 50/50 traditional/Roth (started retirement at 100\0) which feels like a good middle ground as well. This may not be the answer for everyone but, once I accepted the uncertainty, I’m at peace with this as a practical, simple and easy to implement plan.

Best of luck with your decision :beer
"The greatest enemy of a good plan is the dream of a perfect plan" - Carl Von Clausewitz
randomguy
Posts: 11285
Joined: Wed Sep 17, 2014 9:00 am

Re: i-orp and roth conversions

Post by randomguy »

iceport wrote: Mon Oct 25, 2021 5:27 pm
chassis wrote: Mon Oct 25, 2021 5:10 pm James Welch holds similar views that Professor McQuarrie holds, which is that Roth conversion benefits, if any exist at all, are paltry and accrue to the investor very late in life. Roth conversions are generally oversold/overpromoted by people who do Roth conversions.
That's quite surprising to me, because the program has always recommended outlandishly aggressive Roth conversions for me. More so in the past, but even today it recommended converting from the bottom of the 22% bracket up to the top of the 24% bracket, and then left a few more years before the specified SS claiming age with no conversions. The more logical solution would be to spread out the Roth conversions across more years.

There's obviously some fundamental flaw in the analysis when it comes to Roth conversions — and probably other aspects as well, if you can't input real world data without getting gibberish back.

If I have to pretend I'm using the same AA in all accounts, how valuable can any of the results be?
Why do you think it is gibberish? From where I sit, it is a lot more logical to make large ROTH conversions early than to spread them out over time. Paying 24% now can easily end up cheaper than paying 22% ROTH conversion + LTGC taxes on the taxable funds sold + dividend tax drag from the taxable funds from waiting. And if you are converting, sooner is better than latter so going up to the top of the bracket makes a ton of sense.

ROTHs make a big difference if you can manipulate stuff to have money taxed at 12% instead of 22% or 24% instead of 32%. Or avoiding SS taxation. When talking about 22% now versus 22% later, the difference will be strictly in things like reducing tax drag and IRMAA.
Post Reply