Roth conversion to top of 24%? Early career high income, last year at 24%

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Topic Author
exces6
Posts: 19
Joined: Wed Jun 29, 2016 2:09 pm

Roth conversion to top of 24%? Early career high income, last year at 24%

Post by exces6 »

I'm trying to get feedback on whether a Roth conversion is the right decision for tax year 2021.

We are currently in the 24% tax bracket but will rise to (physician entering practice, so this is our only year in this bracket). I am concerned that if I leave too high of a traditional balance that once RMDs kick in I will wish I had converted at 24%, but I'm having trouble figuring out if this is the right move early in my career when I still have many years left to save (and for unknown policy changes to take effect). Most past discussions and spreadsheet models focus on those near/entering or already in retirement, so I've been trying to roll my own model, but this is complicated by many unknowns and a long time period for tiny assumptions to have a large effect.

Demographics:
My age: 32
Wife age: 35

Income:
2021 AGI: $272k (rough numbers entered in FreeTaxUSA
2021 taxable income: $244k
2022 gross income: 400k
Future years will be at least 400k (not including any bonus) assuming my wife and I keep working, and since we work in healthcare jobs are stable and salaries tend not to fluctuate.

Current Balances:
Traditional 401k: $117k
Traditional IRA: $0 (to allow Backdoor Roth)
Roth 401k: $44K
Roth IRA: $24k
Taxable: $0

Future savings:
401k: Max $41k/year (max employee contribution using 2022 values)
401k: Max $40,500/year (my employer will max their contribution)
Backdoor Roth: Max currently $6k/year
Taxable: Target at least $100k/year

Retirement Income:
Pension: $12k/year

Assuming a 5% growth rate and 3% inflation and excluding the existing balance I am thinking of converting, I predict our combined 401ks will have a balance of $2.9M at retirement, which exposes us to significant RMDs (this becomes significant when I turn 72, when my wife and I combined will have an RMD of $150k). This plus SS and a $12k/year pension my wife qualifies for would put us at a fairly high income floor, although there is no way to know what the tax brackets will look like then. I also worry about what happens if one of us dies and the survivor has to file as single, not to mention the various concerns about IRMAA and NIIT (which I am still learning about).

I have no idea when I will retire and I know that conversions could conceivably be done between retirement and RMDs, but some part of me thinks it's better to lock in a guarantee now and diversify my tax situation since we will be above 24% for the remainder of my career, making future contributions to Roth less attractive. We should have a rather large taxable account entering retirement if all goes as planned, so later conversions are certainly an option.

I've tried to use BigFoot48's spreadsheet and the Retiree Portfolio Model to compare converting vs. not but I can't get an answer that makes sense (sorry that is rather vague), and other recommended calculators like i-ORP are overwhelming and hard to interpret.

With a 2021 predicted taxable income of $244k, this leaves about $96k in the 24% bracket that I could conceivably convert, and my 401k allows in-plan Roth conversions. Conversion taxes would be paid with money that would otherwise be saved in cash for a house down payment or put in taxable. Obviously the Roth 401k would have to be rolled to a Roth IRA someday to avoid RMDs but this is easy enough.

Has anyone been in a similar situation or have any advice that would help me make this decision? Am I missing anything that is important to consider?

Thanks in advance!
tibbitts
Posts: 23726
Joined: Tue Feb 27, 2007 5:50 pm

Re: Roth conversion to top of 24%? Early career high income, last year at 24%

Post by tibbitts »

I don't believe you can calculate anything that far out so I wouldn't worry about your calculator confusion. Go with your best guess, a coin flip, or split the difference between wherever you are for this year and the top of 24%.
KlangFool
Posts: 31525
Joined: Sat Oct 11, 2008 12:35 pm

Re: Roth conversion to top of 24%? Early career high income, last year at 24%

Post by KlangFool »

exces6 wrote: Mon Nov 29, 2021 4:41 pm
Assuming a 5% growth rate and 3% inflation and excluding the existing balance I am thinking of converting, I predict our combined 401ks will have a balance of $2.9M at retirement,
exces6,

1) What is the retirement age that you assume?

2) What is your total portfolio size at that age? Taxable, Roth, and Tax-deferred.

3) Do you think that you would continue working at that age and portfolio size?

4) Or, you may not find it worthwhile to work longer?

5) If you go through all the numbers, you may find that you would retire much earlier than you think.

KlangFool
30% VWENX | 16% VFWAX/VTIAX | 14.5% VTSAX | 19.5% VBTLX | 10% VSIAX/VTMSX/VSMAX | 10% VSIGX| 30% Wellington 50% 3-funds 20% Mini-Larry
JBTX
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Joined: Wed Jul 26, 2017 12:46 pm

Re: Roth conversion to top of 24%? Early career high income, last year at 24%

Post by JBTX »

If you expect to be in a much higher tax bracket for many years, and expect to accumulate substantial amounts of tax advantaged by retirement, in my mind doing conversions to the top of 24% is close to a no brainer, provided you have the liquidity for the additional tax payments. I would think the odds are pretty good that you will be at least that high in retirement, and the odds are low that you will be in a lot lower tax bracket. Once you start earning more your opportunities for Roth may be limited, and as proposed legislation shows, there's always the chance that you won't be able to convert in the future as easily as now.
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Wiggums
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Re: Roth conversion to top of 24%? Early career high income, last year at 24%

Post by Wiggums »

We are coming converting to the top of 24% for several reasons. Current Federal rates set to revert in a few years. High RMDs expected. RMD as single filer will increase tax burden. So we believe that it makes sense to convert even it’s a wash. We can’t convert it all and that is ok.
"I started with nothing and I still have most of it left."
KlangFool
Posts: 31525
Joined: Sat Oct 11, 2008 12:35 pm

Re: Roth conversion to top of 24%? Early career high income, last year at 24%

Post by KlangFool »

OP,

Unless somewhere down the road, you buy a 1 million to 2 million house, at your current pace, at 8% annual return rate, you would reach

3 million at 10 years, 5.45 millions at 15 years, 9 millions at 20 years, 14 million at 25 years.

Starting Net Worth $180,000
Annual Savings $180,000
Years
Annual Return Rate 10 15 20 25
4.00% $2,427,543 $3,928,416 $5,754,456 $7,976,114
5.00% $2,557,222 $4,258,349 $6,429,465 $9,200,422
6.00% $2,694,896 $4,621,055 $7,198,691 $10,648,149
7.00% $2,841,048 $5,019,850 $8,075,732 $12,361,765
8.00% $2,996,188 $5,458,371 $9,076,126 $14,391,795
9.00% $3,160,853 $5,940,612 $10,217,615 $16,798,316

Would you continue working even then?

KlangFool
30% VWENX | 16% VFWAX/VTIAX | 14.5% VTSAX | 19.5% VBTLX | 10% VSIAX/VTMSX/VSMAX | 10% VSIGX| 30% Wellington 50% 3-funds 20% Mini-Larry
Topic Author
exces6
Posts: 19
Joined: Wed Jun 29, 2016 2:09 pm

Re: Roth conversion to top of 24%? Early career high income, last year at 24%

Post by exces6 »

Wow! This really got some traction fast; thanks everyone!
tibbitts wrote: Mon Nov 29, 2021 5:00 pm I don't believe you can calculate anything that far out so I wouldn't worry about your calculator confusion. Go with your best guess, a coin flip, or split the difference between wherever you are for this year and the top of 24%.
This is a clever thought I could always do half of it (or some other split) just to hedge my bets.
KlangFool wrote: Mon Nov 29, 2021 5:06 pm
exces6 wrote: Mon Nov 29, 2021 4:41 pm
Assuming a 5% growth rate and 3% inflation and excluding the existing balance I am thinking of converting, I predict our combined 401ks will have a balance of $2.9M at retirement,
exces6,

1) What is the retirement age that you assume?
65 when I'm modeling. Early retirement is certainly on my radar but I don't know how I'll feel after 15 years in my career, and I'd need to find something I like enough to "retire to"

2) What is your total portfolio size at that age? Taxable, Roth, and Tax-deferred.
Wife and my traditional 401k with yearly max contributions and my employer matching theirs: $2.9M at age 65
Taxable at $100k/year savings rate: $5.2M

3) Do you think that you would continue working at that age and portfolio size?
Honestly it's hard to know, I'm early career now so not burned out but healthcare does have that problem and I have been there in the past. Ideally I'd find something non-work related to do once I don't need the money, but it's too early to know what that would be just yet

4) Or, you may not find it worthwhile to work longer?

5) If you go through all the numbers, you may find that you would retire much earlier than you think.

KlangFool
So are you saying if I retire that much earlier that converting now may not be advantageous, because I would have enough to sustain possibly a decade or two of conversions before RMDs kick in?
JBTX wrote: Mon Nov 29, 2021 5:12 pm If you expect to be in a much higher tax bracket for many years, and expect to accumulate substantial amounts of tax advantaged by retirement, in my mind doing conversions to the top of 24% is close to a no brainer, provided you have the liquidity for the additional tax payments. I would think the odds are pretty good that you will be at least that high in retirement, and the odds are low that you will be in a lot lower tax bracket. Once you start earning more your opportunities for Roth may be limited, and as proposed legislation shows, there's always the chance that you won't be able to convert in the future as easily as now.
Yeah this is kind of where my head is right now (what prompted me to start digging into the details). I figure that with diligent savings I will have a high income retirement and (short of any policy changes), having a healthy Roth cushion would be a nice hedge against future tax changes.
Wiggums wrote: Mon Nov 29, 2021 5:25 pm We are coming converting to the top of 24% for several reasons. Current Federal rates set to revert in a few years. High RMDs expected. RMD as single filer will increase tax burden. So we believe that it makes sense to convert even it’s a wash. We can’t convert it all and that is ok.
Thanks! Glad I'm not the only one in this bracket who thinks this could be a good idea.
KlangFool wrote: Mon Nov 29, 2021 5:34 pm OP,

Unless somewhere down the road, you buy a 1 million to 2 million house, at your current pace, at 8% annual return rate, you would reach

3 million at 10 years, 5.45 millions at 15 years, 9 millions at 20 years, 14 million at 25 years.

Starting Net Worth $180,000
Annual Savings $180,000
Years
Annual Return Rate 10 15 20 25
4.00% $2,427,543 $3,928,416 $5,754,456 $7,976,114
5.00% $2,557,222 $4,258,349 $6,429,465 $9,200,422
6.00% $2,694,896 $4,621,055 $7,198,691 $10,648,149
7.00% $2,841,048 $5,019,850 $8,075,732 $12,361,765
8.00% $2,996,188 $5,458,371 $9,076,126 $14,391,795
9.00% $3,160,853 $5,940,612 $10,217,615 $16,798,316

Would you continue working even then?

KlangFool
Sadly we do live in a fairly HCOL city (nothing like NYC or LA but still thriving with an insane real estate market), so I anticipate a home purchase in the next year or so that may make a dent in that savings rate. I hope that that will be balanced out by some years of healthy bonuses once I make partner, but that is not guaranteed by any means.

I like your chart! I hadn't thought to break it out by years and different returns (I just picked a middle of the road return to model).
NuBogleHead
Posts: 27
Joined: Sun Jul 29, 2018 12:49 am

Re: Roth conversion to top of 24%? Early career high income, last year at 24%

Post by NuBogleHead »

Will your future 401k moving forward be 100% ROTH, and the question is if you should do a ROTH conversion on the Traditional 401k: $117k?
Topic Author
exces6
Posts: 19
Joined: Wed Jun 29, 2016 2:09 pm

Re: Roth conversion to top of 24%? Early career high income, last year at 24%

Post by exces6 »

NuBogleHead wrote: Mon Nov 29, 2021 7:03 pm Will your future 401k moving forward be 100% ROTH, and the question is if you should do a ROTH conversion on the Traditional 401k: $117k?
Future 401k will be traditional starting in 2022 (unless there is a compelling reason not to, but we will jump to the 32% marginal bracket in 2022 so I think the argument for Roth is less strong in that case). My only Roth contributions in 2022 onwards will likely be via the backdoor Roth IRA, but that isn't much per year and is mainly for tax diversification.

And you are correct, the question is whether to convert all or part of the $117k traditional 401k balance I have now to Roth before the end of 2021 while I still have room in the 24% bracket.
phoreal
Posts: 1
Joined: Sun Dec 05, 2021 6:54 pm

Re: Roth conversion to top of 24%? Early career high income, last year at 24%

Post by phoreal »

Following this thread, as I'm in basically the exact situation. OP, did you make a decision? I think I'm going to go ahead and convert as much as we can up to the 24% threshold, since we jump up to the 32% bracket next year.
Topic Author
exces6
Posts: 19
Joined: Wed Jun 29, 2016 2:09 pm

Re: Roth conversion to top of 24%? Early career high income, last year at 24%

Post by exces6 »

phoreal wrote: Sun Dec 05, 2021 6:58 pm Following this thread, as I'm in basically the exact situation. OP, did you make a decision? I think I'm going to go ahead and convert as much as we can up to the 24% threshold, since we jump up to the 32% bracket next year.
I’m still percolating on it, have been helping my family through some health issues this last week so had kind of put this on the back burner. I think I’ll at least split the difference and convert half of what I can in the 24% bracket (probably about $40k for me). I’d really love some time to finish fleshing out my spreadsheet to see how much I might be able to convert in early retirement, but locking it in now seems like a good deal to me. Helps hedge against Roth conversions being disallowed in any future policy changes as well.

Now I just have to hope my plan will process the paperwork before the end of the year and not mess me up by processing in TY 2022. Everything in the world is super delayed!
inbox788
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Joined: Thu Mar 15, 2012 5:24 pm

Re: Roth conversion to top of 24%? Early career high income, last year at 24%

Post by inbox788 »

exces6 wrote: Tue Nov 30, 2021 9:24 pm
NuBogleHead wrote: Mon Nov 29, 2021 7:03 pm Will your future 401k moving forward be 100% ROTH, and the question is if you should do a ROTH conversion on the Traditional 401k: $117k?
Future 401k will be traditional starting in 2022 (unless there is a compelling reason not to, but we will jump to the 32% marginal bracket in 2022 so I think the argument for Roth is less strong in that case). My only Roth contributions in 2022 onwards will likely be via the backdoor Roth IRA, but that isn't much per year and is mainly for tax diversification.

And you are correct, the question is whether to convert all or part of the $117k traditional 401k balance I have now to Roth before the end of 2021 while I still have room in the 24% bracket.
I would convert all you can now and expect to add to tax deferred while in the 32%+ tax brackets. It's possible to likely that you will have too much tax-deferred if you max out your tax deferred, market grows at historic or higher rates, and you work for many years or don't retire too early. Opportunity to convert later is unknown and may be limited, and it's likely you will be doing conversions later, so you might as well get started now.

Try to maximize Roth, backdoor Roth, Mega Backdoor Roth, HSA, etc. after you max out tax deferred.

I think you're underestimating the tax-deferred balance at retirement. The returns estimates are conservative, so better chance of exceeding them, IMO.

You may face another choice later: Roth Conversions vs. Harvesting Capital Gains.
Once into the “mid-tier” tax brackets – 22% and 24% - the priority shifts again, as capital gains quickly become subject to an 18.8% tax bracket (at $200,000 of AGI for individuals, or $250,000 for married couples), leaving only a potential 5 percentage point increase at the top capital gains rates (23.8%), while ordinary income tax rates jump by 8 percentage points to the next (32%) tax bracket (and can climb further from there to 35% and 37%). Especially since the increase in ordinary income rates comes sooner (the 32% tax bracket begins at $163,300 for individuals or $326,600 for married couples) than the increase for capital gains (which doesn’t kick in until $441,500 for individuals or $496,600 for married couples). Which makes it more appealing to capture ordinary income at those 22% and 24% rates to ensure the 32%+ rates that may loom larger never actually come.

On the other hand, for those in the 35% ordinary income tax bracket, the potential ordinary income rate increase is at least only 2 percentage points more (from 35%to 37%), while those subject to the 18.8% capital gains tax rate may soon face a 5 percentage point increase (to 23.8%). Which makes it more appealing to once again harvest capital gains at “just” 18.8% and avoid 23.8%. Until the upper end of the 35% bracket is reached (and 23.8% capital gains rates have already been breached), at which point any remaining room in the 35% tax bracket is the best deal remaining (albeit only a 2 percentage point savings before the top 37% tax bracket kicks in).
https://www.kitces.com/blog/navigating- ... nversions/
viewtopic.php?f=10&t=320854
Topic Author
exces6
Posts: 19
Joined: Wed Jun 29, 2016 2:09 pm

Re: Roth conversion to top of 24%? Early career high income, last year at 24%

Post by exces6 »

inbox788 wrote: Tue Dec 07, 2021 7:38 pm
exces6 wrote: Tue Nov 30, 2021 9:24 pm
NuBogleHead wrote: Mon Nov 29, 2021 7:03 pm Will your future 401k moving forward be 100% ROTH, and the question is if you should do a ROTH conversion on the Traditional 401k: $117k?
Future 401k will be traditional starting in 2022 (unless there is a compelling reason not to, but we will jump to the 32% marginal bracket in 2022 so I think the argument for Roth is less strong in that case). My only Roth contributions in 2022 onwards will likely be via the backdoor Roth IRA, but that isn't much per year and is mainly for tax diversification.

And you are correct, the question is whether to convert all or part of the $117k traditional 401k balance I have now to Roth before the end of 2021 while I still have room in the 24% bracket.
I would convert all you can now and expect to add to tax deferred while in the 32%+ tax brackets. It's possible to likely that you will have too much tax-deferred if you max out your tax deferred, market grows at historic or higher rates, and you work for many years or don't retire too early. Opportunity to convert later is unknown and may be limited, and it's likely you will be doing conversions later, so you might as well get started now.

Try to maximize Roth, backdoor Roth, Mega Backdoor Roth, HSA, etc. after you max out tax deferred.

I think you're underestimating the tax-deferred balance at retirement. The returns estimates are conservative, so better chance of exceeding them, IMO.

You may face another choice later: Roth Conversions vs. Harvesting Capital Gains.
Once into the “mid-tier” tax brackets – 22% and 24% - the priority shifts again, as capital gains quickly become subject to an 18.8% tax bracket (at $200,000 of AGI for individuals, or $250,000 for married couples), leaving only a potential 5 percentage point increase at the top capital gains rates (23.8%), while ordinary income tax rates jump by 8 percentage points to the next (32%) tax bracket (and can climb further from there to 35% and 37%). Especially since the increase in ordinary income rates comes sooner (the 32% tax bracket begins at $163,300 for individuals or $326,600 for married couples) than the increase for capital gains (which doesn’t kick in until $441,500 for individuals or $496,600 for married couples). Which makes it more appealing to capture ordinary income at those 22% and 24% rates to ensure the 32%+ rates that may loom larger never actually come.

On the other hand, for those in the 35% ordinary income tax bracket, the potential ordinary income rate increase is at least only 2 percentage points more (from 35%to 37%), while those subject to the 18.8% capital gains tax rate may soon face a 5 percentage point increase (to 23.8%). Which makes it more appealing to once again harvest capital gains at “just” 18.8% and avoid 23.8%. Until the upper end of the 35% bracket is reached (and 23.8% capital gains rates have already been breached), at which point any remaining room in the 35% tax bracket is the best deal remaining (albeit only a 2 percentage point savings before the top 37% tax bracket kicks in).
https://www.kitces.com/blog/navigating- ... nversions/
viewtopic.php?f=10&t=320854
Just wanted to say I really appreciated all the details in this post!

I filed the paperwork on Monday to convert as close to the top of 24% as I could estimate based on projections of year-end income, and it processed this morning.

Thanks so much to everyone for all of your help and advice!
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