How do you define your goals when considering Roth IRA conversion?

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DSBH
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How do you define your goals when considering Roth IRA conversion?

Post by DSBH »

Having read many threads on Roth IRA conversion (e.g. should/should not, how much, how long etc.) I am thinking that specific goals should be clearly defined first so that Roth conversion strategies can be evaluated on how well they meet the goals.

In my mind the goals should have at least 4 characteristics, having something to do with:

1. Money - for instance: "To leave as much after-tax as possible to surviving spouse/heirs/charities",
2. Lifestyle - for instance: "while spending W dollars/year and leaving X dollars in T-IRA at age Y for LTC",
3. Life expectancy - "and kicking the bucket at age Z",
4. (Last but not least) Risk - for instance: "and maintaining a portfolio asset allocation of SS% stock / BB% bond as long as possible".

How do you define your goals when considering Roth IRA conversion?
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Silk McCue
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Re: How do you define your goals when considering Roth IRA conversion?

Post by Silk McCue »

On #1. Charities don’t need “after-tax” dollars. No tax is due or withheld for qualified charitable beneficiaries. Roth conversions are not a strategy to benefit charities but rather the IRS.

Cheers
suewolf
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Re: How do you define your goals when considering Roth IRA conversion?

Post by suewolf »

One of my primary reasons for converting to Roth IRA is Asset Location. I want a better balance between my qualified plans (401k and IRAs), my taxable accounts and Roth IRAs. The goal is to convert now at relatively low tax rates but also to reduce my RMD's to no more than I expect to need (thus saving a tax hit later since I wont' have to distribute more from my IRA's than I really need). I think these goals: asset location balance and RMD optimization (maybe the same thing?) should be on your list.
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DSBH
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Re: How do you define your goals when considering Roth IRA conversion?

Post by DSBH »

Silk McCue wrote: Sat Jul 31, 2021 12:31 pm On #1. Charities don’t need “after-tax” dollars. No tax is due or withheld for qualified charitable beneficiaries. Roth conversions are not a strategy to benefit charities but rather the IRS.

Cheers
Yes, I guess in that case either No Conversion or 0% tax Conversion if applicable would be the appropriate strategies.
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DSBH
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Re: How do you define your goals when considering Roth IRA conversion?

Post by DSBH »

suewolf wrote: Sat Jul 31, 2021 12:36 pm One of my primary reasons for converting to Roth IRA is Asset Location. I want a better balance between my qualified plans (401k and IRAs), my taxable accounts and Roth IRAs. The goal is to convert now at relatively low tax rates but also to reduce my RMD's to no more than I expect to need (thus saving a tax hit later since I wont' have to distribute more from my IRA's than I really need). I think these goals: asset location balance and RMD optimization (maybe the same thing?) should be on your list.
I am thinking that "RMD Optimization" is the tool to achieve the goal of having more spendable money ("thus saving a tax hit later since I wont' have to distribute more from my IRA's than I really need") but I may have misinterpreted your post.
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Rotwang
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Re: How do you define your goals when considering Roth IRA conversion?

Post by Rotwang »

I would add flexibility to adapt (or course correct) based on future events.

e.g
What if my investments grow by X%/year more or less than predicted?
What if tax brackets/rates/laws/state of residency change in an unpredicted way?

While we can try to plan for some optimal strategy, how sensitive are the results to the predictions?
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Re: How do you define your goals when considering Roth IRA conversion?

Post by Lee_WSP »

Expected after tax dollars.

It's just a tax arbitrage decision. You won't live forever, so expected lifespan plays an important role, but the good news is that the RMD tax rate should remain about constant from age 78 on up making the decision a bit easier to do.

Or taxes paid today vs expected outcome fordoing nothing. Which is another way of saying tax rate on the amount converted vs tax rate on that same amount at the withdrawal. Which is just a long winded way of saying marginal tax rate.
Last edited by Lee_WSP on Sat Jul 31, 2021 2:55 pm, edited 3 times in total.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by retiredjg »

My goal is to convert as much as I can in the 22% bracket while staying under the first IRMAA limit.

My tax-deferred account is not large enough to "need" to do conversions so I don't need to take on any extra costs to get them done. I just give it a little haircut each year so it won't get larger.
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DSBH
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Re: How do you define your goals when considering Roth IRA conversion?

Post by DSBH »

Rotwang wrote: Sat Jul 31, 2021 1:04 pm I would add flexibility to adapt (or course correct) based on future events.

e.g
What if my investments grow by X%/year more or less than predicted?
What if tax brackets/rates/laws/state of residency change in an unpredicted way?

While we can try to plan for some optimal strategy, how sensitive are the results to the predictions?
Yes, flexibility for mid-course correction would be a good goal for a plan.
Lee_WSP wrote: Sat Jul 31, 2021 1:10 pm Expected after tax dollars.

It's just a tax arbitrage decision. You won't live forever, so expected lifespan plays an important role, but the good news is that the RMD tax rate should remain about constant from age 78 on up making the decision a bit easier to do.
It is a tax arbitrage decision, and it seems in my case that there is little payoff when converting after 2025 given current tax laws.
retiredjg wrote: Sat Jul 31, 2021 2:15 pm My goal is to convert as much as I can in the 22% bracket while staying under the first IRMAA limit.

My tax-deferred account is not large enough to "need" to do conversions so I don't need to take on any extra costs to get them done. I just give it a little haircut each year so it won't get larger.
Sounds good to me, different strategies for different tax-deferred account sizes.
John C. Bogle: "Never confuse genius with luck and a bull market".
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Re: How do you define your goals when considering Roth IRA conversion?

Post by Lee_WSP »

DSBH wrote: Sat Jul 31, 2021 3:01 pm It is a tax arbitrage decision, and it seems in my case that there is little payoff when converting after 2025 given current tax laws.
Correct.

Converting up to the 12% bracket is usually a no-brainer, but past that, you'd need at least $1.5 million (Single) or $4 million (MFJ) to really make converting up to the 22% a slam dunk. It's probably worth it given the scheduled changes, but if not for those, it's not clear a conversion is the best play in many scenarios.

And the largest variable in the calculation is actually the rate of return, which we have very little control over.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by friar1610 »

retiredjg wrote: Sat Jul 31, 2021 2:15 pm My goal is to convert as much as I can in the 22% bracket while staying under the first IRMAA limit.

My tax-deferred account is not large enough to "need" to do conversions so I don't need to take on any extra costs to get them done. I just give it a little haircut each year so it won't get larger.
Had not seen this expressed this way before but it fits our situation perfectly. Having said that, the main goal is to leave each of our 2 adult children an account that they can let grow for 10 years, unencumbered by taxes.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by sycamore »

DSBH wrote: Sat Jul 31, 2021 12:23 pm How do you define your goals when considering Roth IRA conversion?
Another goal for some people: how much can I convert without increasing my MAGI so much that I lose a tax benefit or even go over a tax cliff, e.g., the ACA premium tax credit.
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teen persuasion
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Re: How do you define your goals when considering Roth IRA conversion?

Post by teen persuasion »

My goals:

Convert annually as much as possible to take advantage of standard deduction space. Short term, to be able to access via Roth withdrawals when Roth contributions exhausted (Roth conversion ladder). Long term, to reduce SS taxation based on RMDs.

However, in the immediate future, conversions are limited by high marginal cost when they crowd out EITC AGI, and high marginal cost of exceeding FAFSA auto EFC zero cliffs (waffling on when FAFSA Simplification goes into effect). DS5 is 16; 2021 income will be used on his first FAFSA next year due to prior-prior year rules.

After FAFSA and EITC are behind us, we can convert more freely. Convert enough to target ACA Essential plan 1 or 2, not above. Unfortunately, loss of dependent means AGI still limited to roughly standard deduction plus small amount. After Medicare starts, could convert more annually. After SS starts at 70, limit conversions to reduce SS taxation.

Ultimately want to slightly shift tIRA balance down, and then siphon off the growth (to Roth) annually to get it under $4-500k by RMDs. If growth outstrips our ability to convert at low tax cost, then we pay a bit more tax on larger balances/conversions. Not the worst outcome. :D
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Re: How do you define your goals when considering Roth IRA conversion?

Post by Free to Choose »

retiredjg wrote: Sat Jul 31, 2021 2:15 pm My goal is to convert as much as I can in the 22% bracket while staying under the first IRMAA limit.

My tax-deferred account is not large enough to "need" to do conversions so I don't need to take on any extra costs to get them done. I just give it a little haircut each year so it won't get larger.
I don't think this is a goal. Instead, it is a strategy or tactic to help meet a goal. Goals might be to spend maximum amount of money, meet a certain lifestyle, save for others.

Reducing lifetime taxes is a strategy to do something with the money. It really isn't a goal.

The OP is doing the right thing by asking what is the goal that a Roth conversion will support. My primary goal is to increase Disposable Income and spend the money. Unfortunately, Roth conversions don't appear to be that helpful for my situation. I am looking for other strategies.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by retiredjg »

Free to Choose wrote: Sat Jul 31, 2021 5:34 pm
retiredjg wrote: Sat Jul 31, 2021 2:15 pm My goal is to convert as much as I can in the 22% bracket while staying under the first IRMAA limit.

My tax-deferred account is not large enough to "need" to do conversions so I don't need to take on any extra costs to get them done. I just give it a little haircut each year so it won't get larger.
I don't think this is a goal. Instead, it is a strategy or tactic to help meet a goal. Goals might be to spend maximum amount of money, meet a certain lifestyle, save for others.
Ok, then.

My goal is to not let my tax-deferred account grow large enough that RMDs might push me into a higher tax bracket at some point.

I have/am accomplishing that by doing small Roth conversions along the way. This goal is not important enough to me to take on extra costs of IRMAA or whatever. Nor do I think extra costs are needed to achieve what I want.

Whatever I do not spend will go to heirs. Whether they receive more traditional or more Roth does not matter to me.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by MahoningValley »

retiredjg wrote: Sat Jul 31, 2021 5:51 pm
My goal is to not let my tax-deferred account grow large enough that RMDs might push me into a higher tax bracket at some point.

I have/am accomplishing that by doing small Roth conversions along the way. This goal is not important enough to me to take on extra costs of IRMAA or whatever. Nor do I think extra costs are needed to achieve what I want.

Whatever I do not spend will go to heirs. Whether they receive more traditional or more Roth does not matter to me.


:thumbsup
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Re: How do you define your goals when considering Roth IRA conversion?

Post by smitcat »

retiredjg wrote: Sat Jul 31, 2021 5:51 pm
Free to Choose wrote: Sat Jul 31, 2021 5:34 pm
retiredjg wrote: Sat Jul 31, 2021 2:15 pm My goal is to convert as much as I can in the 22% bracket while staying under the first IRMAA limit.

My tax-deferred account is not large enough to "need" to do conversions so I don't need to take on any extra costs to get them done. I just give it a little haircut each year so it won't get larger.
I don't think this is a goal. Instead, it is a strategy or tactic to help meet a goal. Goals might be to spend maximum amount of money, meet a certain lifestyle, save for others.
Ok, then.

My goal is to not let my tax-deferred account grow large enough that RMDs might push me into a higher tax bracket at some point.

I have/am accomplishing that by doing small Roth conversions along the way. This goal is not important enough to me to take on extra costs of IRMAA or whatever. Nor do I think extra costs are needed to achieve what I want.

Whatever I do not spend will go to heirs. Whether they receive more traditional or more Roth does not matter to me.
"My goal is to not let my tax-deferred account grow large enough that RMDs might push me into a higher tax bracket at some point."
Our goal is to reduce our tax-deferred account enough so that RMD's do not push us into higher tax brackets with our most likely future scenario runs.
Our goal us to also position our holdings so that our heirs do not get forced into higher tax brackets than non conversions would in the most likely future scenarios.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by KlangFool »

OP,

It is very simple but hard.

What is a good deal for you?

Roth convert up to 12%?

Roth convert up to 22%?

That is the ONLY ANSWER that you need.

My goal is to generate as much after-tax wealth for myself.

KlangFool
Last edited by KlangFool on Sat Jul 31, 2021 8:02 pm, edited 1 time in total.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by RickyAZ »

You’re missing a goal:

5. Tax Diversification. What happens if you need $300k for an emergency or family opportunity without blowing up your carefully calculated tax plans? That pile of tax free money will come in handy. This forum has countless articles on investment diversification and the benefits it provides; the same should apply to the decumulation phase. The worst that can happen is that your beneficiaries get tax free money
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Re: How do you define your goals when considering Roth IRA conversion?

Post by Free to Choose »

smitcat wrote: Sat Jul 31, 2021 7:40 pm
retiredjg wrote: Sat Jul 31, 2021 5:51 pm
Free to Choose wrote: Sat Jul 31, 2021 5:34 pm
retiredjg wrote: Sat Jul 31, 2021 2:15 pm My goal is to convert as much as I can in the 22% bracket while staying under the first IRMAA limit.

My tax-deferred account is not large enough to "need" to do conversions so I don't need to take on any extra costs to get them done. I just give it a little haircut each year so it won't get larger.
I don't think this is a goal. Instead, it is a strategy or tactic to help meet a goal. Goals might be to spend maximum amount of money, meet a certain lifestyle, save for others.
Ok, then.

My goal is to not let my tax-deferred account grow large enough that RMDs might push me into a higher tax bracket at some point.

I have/am accomplishing that by doing small Roth conversions along the way. This goal is not important enough to me to take on extra costs of IRMAA or whatever. Nor do I think extra costs are needed to achieve what I want.

Whatever I do not spend will go to heirs. Whether they receive more traditional or more Roth does not matter to me.

"My goal is to not let my tax-deferred account grow large enough that RMDs might push me into a higher tax bracket at some point."
Our goal is to reduce our tax-deferred account enough so that RMD's do not push us into higher tax brackets with our most likely future scenario runs.
Our goal us to also position our holdings so that our heirs do not get forced into higher tax brackets than non conversions would in the most likely future scenarios.
I do not want to appear mean while writing short responses. Sorry if it comes across this way. It is not my intention.

I struggle with having saving on taxes or not getting into a higher tax bracket being a goal. I also want to save on taxes, but unless it directly leads to something tangible, why do it? I may save on taxes and it may result in my wealth growing after many years in the future. What goal does this satisfy? I guess it provides some flexibility or a larger inheritance. But, will I spend more? Instead of paying a lot upfront on taxes for the Roth conversion, maybe I should take the withdrawal now and spend or give the money away. I think finding strategies that help me do this are more beneficial. I'll probably die earlier than I am planning my withdrawal strategy around anyway. Life is too short. My heirs will be fine.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by retiredjg »

Free to Choose wrote: Sun Aug 01, 2021 9:18 am I do not want to appear mean while writing short responses. Sorry if it comes across this way. It is not my intention.
Not to worry - I didn't take it that way. :happy
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WoodSpinner
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Re: How do you define your goals when considering Roth IRA conversion?

Post by WoodSpinner »

OP,

Great thread! I think a solid definition of your goals is the foundation for Conversion analysis.

Here are mine (prioritized):
- Provide Resiliency for our retirement to deal with unexpected opportunities or expenses
- Fund LTC needs for my wife (hopefully never needed) from our IRA.
- Inheritance, my Heirs are likely to be in the 12% Marginal Bracket
- Fund Charitable Giving via QCDs and Bequests from our IRA.

WoodSpinner
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Re: How do you define your goals when considering Roth IRA conversion?

Post by DSBH »

KlangFool wrote: Sat Jul 31, 2021 7:48 pm OP,

It is very simple but hard.

What is a good deal for you?

Roth convert up to 12%?

Roth convert up to 22%?

That is the ONLY ANSWER that you need.

My goal is to generate as much after-tax wealth for myself.

KlangFool
Yes it sounds simple but hard. I am pondering on how to judge when a deal is a "good deal", perhaps by defining before hand judging criteria.
John C. Bogle: "Never confuse genius with luck and a bull market".
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Re: How do you define your goals when considering Roth IRA conversion?

Post by DSBH »

RickyAZ wrote: Sat Jul 31, 2021 7:58 pm You’re missing a goal:

5. Tax Diversification. What happens if you need $300k for an emergency or family opportunity without blowing up your carefully calculated tax plans? That pile of tax free money will come in handy. This forum has countless articles on investment diversification and the benefits it provides; the same should apply to the decumulation phase. The worst that can happen is that your beneficiaries get tax free money
That's interesting. Would you invest conservatively with the Roth IRA account so when you need to spend that 300K you don't have to sell at a loss?
John C. Bogle: "Never confuse genius with luck and a bull market".
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Re: How do you define your goals when considering Roth IRA conversion?

Post by KlangFool »

DSBH wrote: Sun Aug 01, 2021 3:27 pm
KlangFool wrote: Sat Jul 31, 2021 7:48 pm OP,

It is very simple but hard.

What is a good deal for you?

Roth convert up to 12%?

Roth convert up to 22%?

That is the ONLY ANSWER that you need.

My goal is to generate as much after-tax wealth for myself.

KlangFool
Yes it sounds simple but hard. I am pondering on how to judge when a deal is a "good deal", perhaps by defining before hand judging criteria.
DSBH,

Choice A

Pay 12% now

Choice B

Pay 22% later

(A) is better than (B). And, so on.

KlangFool
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DSBH
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Re: How do you define your goals when considering Roth IRA conversion?

Post by DSBH »

KlangFool wrote: Sun Aug 01, 2021 4:55 pm
DSBH wrote: Sun Aug 01, 2021 3:27 pm
KlangFool wrote: Sat Jul 31, 2021 7:48 pm OP,

It is very simple but hard.

What is a good deal for you?

Roth convert up to 12%?

Roth convert up to 22%?

That is the ONLY ANSWER that you need.

My goal is to generate as much after-tax wealth for myself.

KlangFool
Yes it sounds simple but hard. I am pondering on how to judge when a deal is a "good deal", perhaps by defining before hand judging criteria.
DSBH,

Choice A

Pay 12% now

Choice B

Pay 22% later

(A) is better than (B). And, so on.

KlangFool
Yes, as BH Lee_WSP stated earlier:
Lee_WSP wrote: Sat Jul 31, 2021 3:08 pm
Converting up to the 12% bracket is usually a no-brainer, but past that, you'd need at least $1.5 million (Single) or $4 million (MFJ) to really make converting up to the 22% a slam dunk. It's probably worth it given the scheduled changes, but if not for those, it's not clear a conversion is the best play in many scenarios.

And the largest variable in the calculation is actually the rate of return, which we have very little control over.
If given
Choice A: Pay 22% now, and
Choice B: Pay potentially 25% several years later based on an assumed rate of return,
I think I need more conviction.
John C. Bogle: "Never confuse genius with luck and a bull market".
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Re: How do you define your goals when considering Roth IRA conversion?

Post by Dottie57 »

Tax deferred funds needs.
Tax paid (Roth) = wants that are larger.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by smitcat »

Free to Choose wrote: Sun Aug 01, 2021 9:18 am
smitcat wrote: Sat Jul 31, 2021 7:40 pm
retiredjg wrote: Sat Jul 31, 2021 5:51 pm
Free to Choose wrote: Sat Jul 31, 2021 5:34 pm
retiredjg wrote: Sat Jul 31, 2021 2:15 pm My goal is to convert as much as I can in the 22% bracket while staying under the first IRMAA limit.

My tax-deferred account is not large enough to "need" to do conversions so I don't need to take on any extra costs to get them done. I just give it a little haircut each year so it won't get larger.
I don't think this is a goal. Instead, it is a strategy or tactic to help meet a goal. Goals might be to spend maximum amount of money, meet a certain lifestyle, save for others.
Ok, then.

My goal is to not let my tax-deferred account grow large enough that RMDs might push me into a higher tax bracket at some point.

I have/am accomplishing that by doing small Roth conversions along the way. This goal is not important enough to me to take on extra costs of IRMAA or whatever. Nor do I think extra costs are needed to achieve what I want.

Whatever I do not spend will go to heirs. Whether they receive more traditional or more Roth does not matter to me.

"My goal is to not let my tax-deferred account grow large enough that RMDs might push me into a higher tax bracket at some point."
Our goal is to reduce our tax-deferred account enough so that RMD's do not push us into higher tax brackets with our most likely future scenario runs.
Our goal us to also position our holdings so that our heirs do not get forced into higher tax brackets than non conversions would in the most likely future scenarios.
I do not want to appear mean while writing short responses. Sorry if it comes across this way. It is not my intention.

I struggle with having saving on taxes or not getting into a higher tax bracket being a goal. I also want to save on taxes, but unless it directly leads to something tangible, why do it? I may save on taxes and it may result in my wealth growing after many years in the future. What goal does this satisfy? I guess it provides some flexibility or a larger inheritance. But, will I spend more? Instead of paying a lot upfront on taxes for the Roth conversion, maybe I should take the withdrawal now and spend or give the money away. I think finding strategies that help me do this are more beneficial. I'll probably die earlier than I am planning my withdrawal strategy around anyway. Life is too short. My heirs will be fine.
"I also want to save on taxes, but unless it directly leads to something tangible, why do it?"
Maximize your after tax dollars, maximize your heirs after tax inheritance.

"Instead of paying a lot upfront on taxes for the Roth conversion, maybe I should take the withdrawal now and spend or give the money away."
It is very possible to work the goal to give specific amounts of funds away and then plan to maximize the above.
Not so hard at all to coordinate all once you have the goal in mind.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by McQ »

RickyAZ wrote: Sat Jul 31, 2021 7:58 pm You’re missing a goal:

5. Tax Diversification. What happens if you need $300k for an emergency or family opportunity without blowing up your carefully calculated tax plans? That pile of tax free money will come in handy. This forum has countless articles on investment diversification and the benefits it provides; the same should apply to the decumulation phase. The worst that can happen is that your beneficiaries get tax free money
Your post succinctly captures one of the justifications for having a Roth account obtained by conversion or whatever means; this goal is often called tax diversification, per your label.

In your example, there is a sudden, unexpected need for $300,000. If funded from the Roth, only $300,000 need be deducted from the account balance. Funded any other way, a larger amount will have to be ponied up, and taxes paid, to get to $300,000. Advantage: Roth!

However, I think you have fallen into one of the cognitive errors catalogued in behavioral finance (=misframing). Here is a challenge (nothing personal, you speak for multitudes who, IMHO, have succumbed to the same error).

Assumptions: 1. All accounts return 10% pretax. 2. Tax rate is 25% throughout. 3. Retiree is affluent—all balances are a multiple of what is needed to fund a sudden $300,000 post tax expenditure (which might be a continuing care retirement community, loss of a lawsuit, child’s down payment on a house, etc.) 4. Last, IRS has simplified the RMD divisors to be 20, the year following the expense, then 19, 18, etc. (minor, but keeps the math simple)

Alternative #1: pay from Roth

Good news: only the $300,000 needs to be deducted. Bad news: that $300,000, had it been left in the Roth, would have become $330,000 next year, $363,000 the year after, and about $600,000 in seven years. Totally tax free.

Alternative #2: pay from the TDA

Bad news: $400,000 will have to be removed from the TDA, and $100,000 tax paid, to get $300,000 for the expenditure. Good news: as a result, next year the TDA balance will be $440,000 less than otherwise. The RMD will be $22,000 less than otherwise, and tax owed will be $5500 less. In the year following, the TDA, after removing the first year RMD, will be $459,800 less than otherwise; with an RMD divisor of 19, the RMD will be 24,200 lower, and taxes saved will be $6050.

Now suppose that at the end of that year, just after the RMD, you and your spouse die, so that the emergency expenditure saves heirs $104,544 in tax on the $435,600 that would have remained after the RMD. Instead of $331,056 after tax, they have the $363,000 in the un-debited Roth account. Thus, heirs are better off, because you expended from the most tax-vulnerable account first, and preserved the most tax-favored account for them.

My point: once you have a Roth, it is always best to let it ride and spend down TDA funds first. Absent dire circumstances, it is never optimal to tap it until the government says, “time is up” (=10 years after the second to die). Dire circumstances would be: not enough funds anywhere else to cover the expense.

Mutatis mutandis: if it is worthwhile to pay taxes now to convert to a Roth, then in any emergency spending situation, it is worthwhile to pay taxes on the TDA and fund the need that way, in order to preserve the Roth. If reducing the TDA balance is good (conversion), then reducing the TDA balance is good (fund the emergency). If paying taxes now to have a larger tax free balance later is good, then, you can’t ever touch the Roth. For any expense. Ever. So long as you have any TDA funds to spend instead.

Back to you: what did I miss?
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RickyAZ
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Re: How do you define your goals when considering Roth IRA conversion?

Post by RickyAZ »

I am assuming that tapping the Roth means the circumstances are extreme, perhaps not dire. The goal is to keep it for as long as possible but if need arises it can be tapped tax free. The point is that the money is accessible and tax free; it gives you a lot of options. If the nephew needs a kidney I don’t have to give it any tax thought, just whether the kid needs the help…

To another poster, no I would not have the Roth invested conservatively. It’s very much the growth sleeve of the portfolio. But, again if need arises, I would not consider it sacrosanct.

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JoMoney
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Re: How do you define your goals when considering Roth IRA conversion?

Post by JoMoney »

The goal I have for the small amount of Roth IRA conversions I started doing is to have the money available penalty free for early withdrawal.
I have a big chunk of Roth already available to use (from after-tax 401k contribution rollover), but I'd like to build that amount as a larger buffer should I decide to retire early or otherwise start making withdrawals.
I'm currently converting in the 24% bracket, which likely won't be optimal compared to converting in retirement with no other income, but as it is I could probably fill up the lower brackets into 22% converting/withdrawing from tax-deferred the rest of my life. Converting a little extra now at 24% instead of 22% isn't horrible, and if it saves me from a 10% early withdrawal it will have been worth it.
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Big Dog
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Re: How do you define your goals when considering Roth IRA conversion?

Post by Big Dog »

I'm in your #1 camp. Started building Roth's late in life, so it becomes the bucket for heirs, which right now are doing well and in a higher bracket than I. So it makes sense for me to pay the 22% tax now -- while staying under IRMAA -- instead of the kids. (Of course, there is no guarantee that they'll be in teh same bracket when I pass.)
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Re: How do you define your goals when considering Roth IRA conversion?

Post by Chip »

McQ wrote: Mon Aug 02, 2021 10:42 pm Assumptions: 1. All accounts return 10% pretax. 2. Tax rate is 25% throughout.
Umm, speaking of cognitive errors.....

Please explain how I can withdraw 300k from a TDA in one year and pay 25% on the entire withdrawal when I was already paying 25% on the base income before the withdrawal. Or perhaps it's just a spherical cow assumption? :)

I believe that tax diversification has some value, but it is perhaps overemphasized here. Just like the benefits of Roth conversions.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by Dantes »

Our primary goal was to reduce my RMD's, which are unneeded for day-to-day purposes, and we have managed to do so. We are in the range where each dollar of unneeded RMD adds to our taxable Social Security income. The current projection is that we will preserve at least some non-taxed SS income for another decade, and have some space for tax-free (except for adding to taxable SSI) capital gains for almost as long.

Because I worked past "normal" retirement age, and DW had income from an annuity, and took her SS at FRA (while I was able to file for a portion of her's while waiting or age 70) we had little or no 12% bracket to use for conversions. But I could see that our marginal rate was never going to be, under current tax law, beneath 28%, adding together a 12% federal rate, 85% of 12% for the additional Social Security income taxed for each marginal dollar, and our state marginal tax rate. So conversion up to IRMA, at a cost of 28%, looked good to me.

When deciding on whether or not to do Roth conversions I built a detailed spreadsheet, with account values and income for every year to age 90 (not that I am an optimist). Each year tracked income, estimated investment growth, and calculated taxable income, amount of taxable SSI, and corresponding federal and state taxes. All the Roth conversions made relatively little difference in my after-tax net worth, except perhaps with long life and high investment returns.

Now that I am almost done with conversions, I value having a substantial amount of money that can be retrieved without tax consequences - though it would be good if we never need to do so. Just as I value still having a larger chunk of money in a tax-deferred account, preserved to use for substantial medical expenses down the road - though it would be good, perhaps, if those funds are never needed,
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Re: How do you define your goals when considering Roth IRA conversion?

Post by deserat »

I would add that if you have a COLA pension (as well as SS), the Roth conversion equation can become complicated as well (and/or going from married to single/etc). If you are single, those brackets are much lower, so the no-brainer approach may have different thresholds. Moreover, tax policy and adjustments for 'income' tend to lag the economic indicators for several years - remember the AMT? I believe that still has not been adjusted for inflation.

It is truly an individual decision and needs to be mapped out on a spreadsheet to determine one's strategy. As for goals, to be honest, my goal would be to optimize my tax burden, ie, pay as little as legally required to the best of my ability with all of the moving parts or variables. In the end, my hope is to have more resources (money) for my discretional spending.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by VanGar+Goyle »

sycamore wrote: Sat Jul 31, 2021 3:51 pm
DSBH wrote: Sat Jul 31, 2021 12:23 pm How do you define your goals when considering Roth IRA conversion?
Another goal for some people: how much can I convert without increasing my MAGI so much that I lose a tax benefit or even go over a tax cliff, e.g., the ACA premium tax credit.
I may be confusing strategy and tactics, but what is the goal of avoiding taxes?
Is it for your spending ( after-tax ) money, and if so when? This year, when retired, in 30 years?
Is it for your family, beneficiaries, charity, or world peace?
Perhaps this is like Maslow's hierarchy of needs pyramid, and most people are just trying to survive safely,
digging a bigger shelter in their backyard.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by sycamore »

VanGar+Goyle wrote: Tue Aug 03, 2021 9:34 am
sycamore wrote: Sat Jul 31, 2021 3:51 pm
DSBH wrote: Sat Jul 31, 2021 12:23 pm How do you define your goals when considering Roth IRA conversion?
Another goal for some people: how much can I convert without increasing my MAGI so much that I lose a tax benefit or even go over a tax cliff, e.g., the ACA premium tax credit.
I may be confusing strategy and tactics, but what is the goal of avoiding taxes?
Is it for your spending ( after-tax ) money, and if so when? This year, when retired, in 30 years?
Is it for your family, beneficiaries, charity, or world peace?
Perhaps this is like Maslow's hierarchy of needs pyramid, and most people are just trying to survive safely,
digging a bigger shelter in their backyard.
Good question. The end goal is not avoiding taxes per se. Focusing on after-tax is key.

This is critical for people who rely on ACA Premium Tax Credit (or other large credits) to meet their family budget. If they convert so much that their MAGI goes over the ACA tax cliff, they may lose thousands of dollars in PTC.

So the general goal is "stick to the budget".
Specifically, so you don't have to cut back on other spending needs to pay for insurance premiums otherwise paid for with PTC.
The "when" is now.
The "for whom" is you and your family or who is targeted in your budget (e.g., maybe the budget includes $1000 for charity).
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Re: How do you define your goals when considering Roth IRA conversion?

Post by Broken Man 1999 »

My goal is to stash some additional $$$$ in my Roth as I will most likely leave my Roth to DDs and grandchildren as an early inheritance if I pass earlier than my wife. Might help DDs retire earlier. Grandchildren might use for university expenses, what ever.


My TIRA goes into trust first for DW, then DDs and grandchildren.

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Re: How do you define your goals when considering Roth IRA conversion?

Post by NancyABQ »

I think this is why I keep going around in circles regarding Roth conversions.

I am single with no dependents and no concerns about my heirs' taxes.
I also seem to have plenty of money, so running out of money is not a concern.

So what is my motivation for doing Roth conversions?
It seems to be just to flatten out the tax curve and pay less taxes when RMDs kick in, even though I can afford to pay the taxes.

My projections are that I will be solidly in the current 24% (future 28%) marginal bracket post RMDs, unless my investments do really well and I have even more money. In which case I can definitely afford to pay more taxes. And I will also do more QCDs.

Basically I just retired and am 59, with a modest pension coming at age 65.
So I have ~5 years, which also happen to mostly correspond to the years when the income tax brackets are at 12/22/24, when it seems to make sense to do Roth conversions.

But does it really? Maybe I should I just take advantage of those 10-12% brackets to do tax-gain-harvesting (or more accurately, mainly pull money from the taxable account that I need to spend anyway for living expenses) and pay 0 cap gains and low taxes for a few years? That's a guaranteed 15% savings now vs. paying early at 22%...

This thread isn't for personal advice, but I'm sharing my latest calculation spreadsheet modelling my situation, in case it's useful to others:
https://docs.google.com/spreadsheets/d/ ... sp=sharing

I think the whole situation for doing Roth conversions is much less clear for somebody in my situation (single, no heirs, plenty of money).
I really do think people need to ask themselves "What are your goals for Roth conversions?" as the thread title says.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by DSBH »

NancyABQ wrote: Tue Aug 03, 2021 4:37 pm I think this is why I keep going around in circles regarding Roth conversions.

I am single with no dependents and no concerns about my heirs' taxes.
I also seem to have plenty of money, so running out of money is not a concern.

So what is my motivation for doing Roth conversions?
It seems to be just to flatten out the tax curve and pay less taxes when RMDs kick in, even though I can afford to pay the taxes.

My projections are that I will be solidly in the current 24% (future 28%) marginal bracket post RMDs, unless my investments do really well and I have even more money. In which case I can definitely afford to pay more taxes. And I will also do more QCDs.
I only glanced briefly at your spreadsheet, but yes it appears to me that you don't have anything major to worry about from a financial perspective.
Basically I just retired and am 59, with a modest pension coming at age 65.
So I have ~5 years, which also happen to mostly correspond to the years when the income tax brackets are at 12/22/24, when it seems to make sense to do Roth conversions.

But does it really? Maybe I should I just take advantage of those 10-12% brackets to do tax-gain-harvesting (or more accurately, mainly pull money from the taxable account that I need to spend anyway for living expenses) and pay 0 cap gains and low taxes for a few years? That's a guaranteed 15% savings now vs. paying early at 22%...
Or perhaps you can look at withdrawing from T-IRA instead of Taxable for expenses at least in those ~5 years.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by averagedude »

I don't know if I will do Roth conversions in the future, but if I do, it will be to optimize tax savings and tax savings only.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by McQ »

Chip wrote: Tue Aug 03, 2021 5:21 am
McQ wrote: Mon Aug 02, 2021 10:42 pm Assumptions: 1. All accounts return 10% pretax. 2. Tax rate is 25% throughout.
Umm, speaking of cognitive errors.....

Please explain how I can withdraw 300k from a TDA in one year and pay 25% on the entire withdrawal when I was already paying 25% on the base income before the withdrawal. Or perhaps it's just a spherical cow assumption? :)

I believe that tax diversification has some value, but it is perhaps overemphasized here. Just like the benefits of Roth conversions.
I take your point. Outside of a simplified example, if you were in the 25% bracket before the $300K withdrawal, it might drive you through the then 28%, and 33%, and part of the 35% bracket, for a weighted average rate of, say, 31%. So you would have to withdraw about $430,000 from the TDA to get the $300,000 to spend. Which means that the year after, your reduced RMDs, if still alive, might even drop you out of the 25% bracket (because of the greater reduction).

That would seem to reinforce the central point of my post. If you have a Roth, you have the highest possible return asset (after-tax). And, if gained through conversion, you probably got the Roth to reduce your taxable income from TDA RMDs, and/or provide a larger after-tax bequest to heirs. So why not be consistent, and further reduce taxable income, by taking a further big chunk out of the TDA, and paying the expense that way? Once you have a Roth, it's too good to give up, assuming the funds can be found elsewhere. That's the argument I want to trot out for community feedback.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by cas »

McQ wrote: Tue Aug 03, 2021 6:08 pm
I take your point. Outside of a simplified example, if you were in the 25% bracket before the $300K withdrawal, it might drive you through the then 28%, and 33%, and part of the 35% bracket, for a weighted average rate of, say, 31%.
The progressive step-up in nominal brackets is likely far from the entirety of additional taxes. For example ... since you seem to be quoting pre-TGCA/post-2025 brackets ... under that tax law, of the top of my head, the $300K would also incur, for some or all of the range,
  • PEP (Personal Exemption Phaseout) ( +1%ish per family member )
  • Pease Limitation (on itemized deduction) ( +1%ish )
  • pushing whatever investment income you have*** into NIIT (3.8% on relevant income)
  • likely pushing some/all qualified dividends*** from 15% into 20% QD/LTCG special bracket (+5% on relevant income)
  • additional IRMAA bracket(s) (+3-4% ish).
And that is assuming that Alternative Minimum Tax didn't rear its head. (AMT is an unpredictable beast, but pulling all/part of the 300K from a taxable account with significant unrealized gains would increase the risk of AMT appearing. Pulling from pre-tax account would likely have less of a risk than pulling from taxable. Pulling from Roth wouldn't affect AMT risk.)


*** Your third condition possibly implies a sizeable taxable account:
3. Retiree is affluent—all balances are a multiple of what is needed to fund a sudden $300,000 post tax expenditure
Of course, one could say that all that doesn't really matter, because the $300K is just an example number pulled out of thin air. However, the tax code is full of these additions to marginal rate beyond just the progressive nominal tax brackets. The current 24% bracket (where the example in your paper was located) is somewhat of an anomaly in how free it is from additional taxes and credit phase-outs. (Off the top of my head ... just additional IRMAA brackets (i.e., phase-out of Medicare premium subsidy) and NIIT hit in that range under current tax law. )
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Re: How do you define your goals when considering Roth IRA conversion?

Post by WoodSpinner »

averagedude wrote: Tue Aug 03, 2021 5:34 pm I don't know if I will do Roth conversions in the future, but if I do, it will be to optimize tax savings and tax savings only.
Why this choice?

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Re: How do you define your goals when considering Roth IRA conversion?

Post by McQ »

cas wrote: Tue Aug 03, 2021 6:43 pm
McQ wrote: Tue Aug 03, 2021 6:08 pm
I take your point. Outside of a simplified example, if you were in the 25% bracket before the $300K withdrawal, it might drive you through the then 28%, and 33%, and part of the 35% bracket, for a weighted average rate of, say, 31%.
The progressive step-up in nominal brackets is likely far from the entirety of additional taxes. For example ... since you seem to be quoting pre-TGCA/post-2025 brackets ... under that tax law, of the top of my head, the $300K would also incur, for some or all of the range,
  • PEP (Personal Exemption Phaseout) ( +1%ish per family member )
  • Pease Limitation (on itemized deduction) ( +1%ish )
  • pushing whatever investment income you have*** into NIIT (3.8% on relevant income)
  • likely pushing some/all qualified dividends*** from 15% into 20% QD/LTCG special bracket (+5% on relevant income)
  • additional IRMAA bracket(s) (+3-4% ish).
And that is assuming that Alternative Minimum Tax didn't rear its head. (AMT is an unpredictable beast, but pulling all/part of the 300K from a taxable account with significant unrealized gains would increase the risk of AMT appearing. Pulling from pre-tax account would likely have less of a risk than pulling from taxable. Pulling from Roth wouldn't affect AMT risk.)


*** Your third condition possibly implies a sizeable taxable account:
3. Retiree is affluent—all balances are a multiple of what is needed to fund a sudden $300,000 post tax expenditure
Of course, one could say that all that doesn't really matter, because the $300K is just an example number pulled out of thin air. However, the tax code is full of these additions to marginal rate beyond just the progressive nominal tax brackets. The current 24% bracket (where the example in your paper was located) is somewhat of an anomaly in how free it is from additional taxes and credit phase-outs. (Off the top of my head ... just additional IRMAA brackets (i.e., phase-out of Medicare premium subsidy) and NIIT hit in that range under current tax law. )
Again, I take your point: when the post continues below, I will stipulate $450,000 or more to be withdrawn from the TDA to fund the $300,000 expenditure. But I will still make the same argument, to which no one has as yet responded: don’t touch the Roth.

But first, a wonkish interlude (wonkish meaning, if you can’t define PEP and Pease without resort to a search engine, don’t read this snippet)

Yes, post-2026, either PEP or Pease or AMT could raise the tax rate further than my weighted average of 31%. But the first two are mutually exclusive with the third. PEP doesn’t affect AMT; personal exemptions were not deductible under the AMT. Likewise, loss to Pease actually reduces AMTI. Whereas deductions for state and local tax would have increased AMT relative to regular, when a portion of these is lost to Pease, AMT is reduced relative to baseline. (It was one of my favorite features of the old tax code: state and local taxes aren’t deductible under the AMT, except as lost to Pease, whereupon they are).

As to NIIT: how many dollars? If dividends had been received on top of total income of, say, $150,000 (middle of the 22%/25% bracket), they would have been taxed at 15%. With the $450,000 one-time withdrawal, they will be taxed at a mix of 15%, 18.8%, and some at 23.8%. Let’s give the OP a $400,000 taxable account (oh my!) with dividends at 2%. So, the $8000 of dividends is taxed at an extra 4.5% (weighted rate 19.5%), or $3600, adding another ~1% to the marginal rate on a TDA withdrawal.

Next, IRMAA: there’s a big gap between IRMAA #4, just short of the current 32% bracket (future 33%), and IRMAA #5. The excess withdrawal might trigger IRMAA equivalent to 2% marginal (+3 IRMAA ). Or less, if the OP had been at the top of the 22%/25% bracket.

End, wonkish tax digression.

Now, back to the OP, and the question of appropriate goals for a Roth conversion. Acknowledging cas, and chip, it may take more than a $400,000 withdrawal from a TDA to fund the unexpected expense. Maybe $450,000, or $460,000. Difficult for me to motivate an exact calculation under a now vanished tax regime that might or might not return.

Okay; not $400,000, and not $430,000, but $450,000 or somewhat more will need to be taken from the TDA. But then, future withdrawals from the TDA are going to save that much more tax; or the heirs are going to have to deal with that much less tax (if similar to the OP, they would likely be subject to PEP, Pease, & AMT, if the OP was, correct? And if they didn’t have that income level, then why did the OP contemplate conversion?)

I repeat my main argument, still not addressed: why would I ever give up my precious, beautiful Roth, for which I paid so much in conversion tax, and which has so high a relative future after-tax value, when instead, I could further liquidate my TDA to cover the unexpected expense, thus further reducing my taxable income next year and in the years to come, in the same spirit that motivated the Roth conversion in the first place?

The goal of Roth conversions is to make the best use of surplus funds; and this anticipated surplus is the prerequisite for undertaking a Roth conversion. When you have a surplus, you can commence to scheming how to reduce taxes. If you choose a Roth per that goal, then as soon as you have it, the Roth balance, taking its future after-tax appreciation into account, becomes your most precious account. Pity, to spend it on a trifling expense that could have instead, in the spirit of the original conversion, been covered from the TDA, with the same sort of anticipated tax savings generated in the first place by the Roth conversion.

Back to you, chip and cas. If you had ample TDA, and taxable, and Roth funds, either of which could cover an unanticipated, after-tax $300,000 expense—would you sacrifice the Roth? What is your calculation?

If not, then I submit to the OP that “having funds available to pay a large unexpected expense without having to first pay tax,” cannot be among the goals of a Roth conversion.
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Re: How do you define your goals when considering Roth IRA conversion?

Post by sandramjet »

McQ wrote: Wed Aug 04, 2021 12:11 am I submit to the OP that “having funds available to pay a large unexpected expense without having to first pay tax,” cannot be among the goals of a Roth conversion.
I still think tax diversification is a reasonable reason in certain cases. Say for example, an unexpected 10K expense comes up but if I take that from my TDA then it bumps me up over the IRMAA bracket by a small amount. Given that IRMAA is a cliff, the worst place to be is "just over" rather than "just under" the bracket amount.

I am curious as to what YOU think the goals of Roth conversions should be....Reading all your various posts you seem to think that most conversions rarely pay off, and that tax diversification should not be a goal ....given that what would you consider as legitimate goals for conversions?
cas
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Re: How do you define your goals when considering Roth IRA conversion?

Post by cas »

McQ wrote: Wed Aug 04, 2021 12:11 am Back to you, chip and cas.
I'm sorry, I'm not going to be able to engage with you right now. The "answer" requires careful work with a spreadsheet. (Requiring at least hours for doing if for one's own consumption. Days/Weeks, if it is supposed to be of a quality to discuss on a public forum.) For discussion on a forum, very specific assumptions would have to be agreed upon by everyone. (See *** below for just one example.) (You know how the discussion of spreadsheets and models has gone in WoodSpinner's thread.). In the end, there will not be single generic answer, but it will be "It Depends..." on exact income requirement and individual income profile.

I know this sounds like an evasion, but I literally do not have hours to spend indoors with a spreadsheet right now. My garden is in full production, so I need to focus on harvesting and processing so I can have my usual diet this winter. Plus Delta is about to break hard over where I live, and I have an immunocompromised person in my life, so I'm running around trying to get supplies laid in/appointments done so I can minimize going places with people over the next stretch of time.

You have an example in your own paper (detailed assumptions mostly laid out already. Spreadsheet already exists.) that you can work on if you have time. (Poster curmudgeon suggested examining this scenario part way through the thread on your paper, but no discussion ensued.)

This is getting to be a hijacking of this thread, so another thread would probably be necessary. (And I probably would not be able to participate.)

Take your paper's couple, with the paper's assumptions except:

Couple actually reached age 70 this year.
They *did* do the $100K Roth conversion back when they were 65 at 24%. (Or some number of years ago when TJCA/24% bracket existed.)
Minimum funds needed for annual expenses is $170K, as calculated by curmudgeon. (Not including taxes?)
Due to pandemic considerations, the spouse who was planning on retiring at age 72 decided to retire this year (at 70) instead.
So now, to meet their $170K income needs for age 70 and 71, they have their social security, plus will need to withdraw from either pre-tax, Roth, or a combination.
With their $100K(ish) in SS income , they have a large 40.7% segment of their SS hump. (Squinting at the graph, somewhere between $20K-$30K wide?)

What is their best option?
Do they withdraw all pre-tax, preserve the Roth, and go through the 40.7% marginal rate segment of the SS tax hump?
Or do they withdraw pre-tax up to the point where that 40.7% marginal rate starts, then Roth for the rest?
Some other combination?

How does that play out on your spreadsheets? (Except you'll have to decide where the tax-saved portion of the accounts goes if Roth is used, which may require column(s) added to the scenarios.)

Except then we'll fall back into the same unresolved "breakeven" argument on whether you have to do comparisons on a tax-adjusted basis or not.

*** Example of why detailed assumptions have to be agreed upon before detailed discussion is possible:
McQ wrote: Wed Aug 04, 2021 12:11 am
Let’s give the OP a $400,000 taxable account (oh my!) with dividends at 2%.
To be picky, your assumption #3 was an affluent couple where every account type had "a multiple of" the $300K, which my personal grammar parsing took to mean that the multiple was not 1. In the general scheme of discussion, focusing on differences in grammar parsing are just annoying. However, if a spreadsheet analysis becomes involved, it really does have to be a specific number that everyone agrees upon.

Apologies for lack of editing; I have someplace I need to be.
Last edited by cas on Wed Aug 04, 2021 11:43 am, edited 12 times in total.
Chip
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Re: How do you define your goals when considering Roth IRA conversion?

Post by Chip »

McQ wrote: Tue Aug 03, 2021 6:08 pm That would seem to reinforce the central point of my post. If you have a Roth, you have the highest possible return asset (after-tax). And, if gained through conversion, you probably got the Roth to reduce your taxable income from TDA RMDs, and/or provide a larger after-tax bequest to heirs. So why not be consistent, and further reduce taxable income, by taking a further big chunk out of the TDA, and paying the expense that way? Once you have a Roth, it's too good to give up, assuming the funds can be found elsewhere. That's the argument I want to trot out for community feedback.
I don't agree with this reasoning at all. My Roth isn't precious, it's merely some money on which I've already paid taxes. The only reason to do conversions at all was tax rate arbitrage. Taking money from the Roth to pay that large expense is tax rate arbitrage in action. I can replace that Roth money with future conversions at 25% in your example. Why would I pay 30-35% now to avoid 25% taxes in the future?
McQ wrote: Wed Aug 04, 2021 12:11 am If you choose a Roth per that goal, then as soon as you have it, the Roth balance, taking its future after-tax appreciation into account, becomes your most precious account. Pity, to spend it on a trifling expense that could have instead, in the spirit of the original conversion, been covered from the TDA, with the same sort of anticipated tax savings generated in the first place by the Roth conversion.
Future after tax appreciation is a bit of a red herring. If account allocations are properly tax-adjusted there's no difference in appreciation between TDA and Roth. Commutative property of multiplication and all that.

Let me turn this on its head: if you're willing to fund a 300k expense from the TDA and have the "same sort of anticipated tax savings", why wouldn't you be willing to convert 300k right now in the absence of the expense?
Back to you, chip and cas. If you had ample TDA, and taxable, and Roth funds, either of which could cover an unanticipated, after-tax $300,000 expense—would you sacrifice the Roth? What is your calculation?
As I'm sure you realize, this is absolutely dependent on individual circumstances and forecasts of the future. In our particular case we have converted enough that we expect to be below the first IRMAA tier as a couple once full SSA and RMDs are online. A surviving spouse would likely be in the 24/28% bracket and IRMAA Tier 2, though QCDs will have some impact on this. Assets in our taxable accounts have appreciated 60+%. Our TDAs are 100% fixed income, plus some fixed income in the Roths. Our heirs are mostly charities.

So my answer is that right now we would fill up the standard deduction with TDA withdrawals. After that we would realize capital gains to max out the 0% LTCG/QDI bracket, then withdraw the rest from the Roth. Perhaps even borrow some and pay it off after a few years.

My answer would be different if we were already receiving RMDs and full SSA. In that case we would probably take everything from the Roth, though we might realize some LTCGs up to the first IRMAA tier.

I have always envisioned the Roth as a "safety valve" for us to avoid high tax rates in years with lumpy expenses. Someone with more of a bequest motive would likely see things quite differently.
bradpevans
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Re: How do you define your goals when considering Roth IRA conversion?

Post by bradpevans »

McQ wrote: Mon Aug 02, 2021 10:42 pm
RickyAZ wrote: Sat Jul 31, 2021 7:58 pm You’re missing a goal:

5. Tax Diversification. What happens if you need $300k for an emergency or family opportunity without blowing up your carefully calculated tax plans? That pile of tax free money will come in handy. This forum has countless articles on investment diversification and the benefits it provides; the same should apply to the decumulation phase. The worst that can happen is that your beneficiaries get tax free money
Your post succinctly captures one of the justifications for having a Roth account obtained by conversion or whatever means; this goal is often called tax diversification, per your label.

In your example, there is a sudden, unexpected need for $300,000. If funded from the Roth, only $300,000 need be deducted from the account balance. Funded any other way, a larger amount will have to be ponied up, and taxes paid, to get to $300,000. Advantage: Roth!

However, I think you have fallen into one of the cognitive errors catalogued in behavioral finance (=misframing). Here is a challenge (nothing personal, you speak for multitudes who, IMHO, have succumbed to the same error).

Assumptions: 1. All accounts return 10% pretax. 2. Tax rate is 25% throughout. 3. Retiree is affluent—all balances are a multiple of what is needed to fund a sudden $300,000 post tax expenditure (which might be a continuing care retirement community, loss of a lawsuit, child’s down payment on a house, etc.) 4. Last, IRS has simplified the RMD divisors to be 20, the year following the expense, then 19, 18, etc. (minor, but keeps the math simple)

Alternative #1: pay from Roth

Good news: only the $300,000 needs to be deducted. Bad news: that $300,000, had it been left in the Roth, would have become $330,000 next year, $363,000 the year after, and about $600,000 in seven years. Totally tax free.

Alternative #2: pay from the TDA

Bad news: $400,000 will have to be removed from the TDA, and $100,000 tax paid, to get $300,000 for the expenditure. Good news: as a result, next year the TDA balance will be $440,000 less than otherwise. The RMD will be $22,000 less than otherwise, and tax owed will be $5500 less. In the year following, the TDA, after removing the first year RMD, will be $459,800 less than otherwise; with an RMD divisor of 19, the RMD will be 24,200 lower, and taxes saved will be $6050.

Now suppose that at the end of that year, just after the RMD, you and your spouse die, so that the emergency expenditure saves heirs $104,544 in tax on the $435,600 that would have remained after the RMD. Instead of $331,056 after tax, they have the $363,000 in the un-debited Roth account. Thus, heirs are better off, because you expended from the most tax-vulnerable account first, and preserved the most tax-favored account for them.

My point: once you have a Roth, it is always best to let it ride and spend down TDA funds first. Absent dire circumstances, it is never optimal to tap it until the government says, “time is up” (=10 years after the second to die). Dire circumstances would be: not enough funds anywhere else to cover the expense.

Mutatis mutandis: if it is worthwhile to pay taxes now to convert to a Roth, then in any emergency spending situation, it is worthwhile to pay taxes on the TDA and fund the need that way, in order to preserve the Roth. If reducing the TDA balance is good (conversion), then reducing the TDA balance is good (fund the emergency). If paying taxes now to have a larger tax free balance later is good, then, you can’t ever touch the Roth. For any expense. Ever. So long as you have any TDA funds to spend instead.

Back to you: what did I miss?
The assumption of constant 25% is the one I might not subscribe too, especially for MFJ living on $100-150K / year.
The 300K (incremental) challenges that assumption, no?
McQ
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Re: How do you define your goals when considering Roth IRA conversion?

Post by McQ »

Responses since my last post have been helpful, at least to me. Specific responses below. Big learning: small withdrawals present a different issue than large ones. Second learning: whether the Roth is to be preserved depends, as always, on the goals of having it. Post ends with a query to the OP.

Sandramjet:
Great counter example using IRMAA. That gives me a concrete case where the TDA should *not* be tapped. It stimulated my “small amounts present a different case.” Howevr, had the withdrawal instead been several hundreds of thousands of dollars, from a base not too far from IRMAA #4, then the IRMAA hit expressed as a percent would be less than some of the other factors introduced by chip.

Cas:
Yes, by all means, garden first, spreadsheets second if at all. But your post, however abbreviated, nonetheless provided insight. First, apologies to the OP for the (oh my!) crack; I wasn’t actually thinking of taxable funds when I wrote “accounts are a multiple of the needed funds;” I had in mind a straight comparison of TDA versus Roth withdrawals.

I do take your point about the social security tax torpedo, in the case of a couple that had very high social security payments ($100,000 joint is still a bit beyond the age 70 max, in my understanding, but will soon be possible). However, I was not able to reproduce Curmudgeon’s social security taxation results. Using the calculator here https://www.covisum.com/resources/taxab ... calculator a couple whose only income in 2021 was $100,000 in SS has taxable income of $11,100—less than the standard deduction, so zero taxes. From that point, each additional dollar of income, i.e., each dollar of TDA withdrawal, will bring total income up by $1.85. Let’s see how the torpedo plays out.
More specifically, a $19,500 withdrawal from the TDA, with SS dollars dragged into taxation, will take AGI to just over $47000, the top of the 10% bracket, for a $2000 tax hit. A withdrawal of $52,500 will take AGI up to the top of the 12% bracket, about $9500 in taxes; and if we take the entire missing $70,000 out of the TDA, AGI will be $140,600, and total tax owed will be just under $16,500, or 22% more or less on the withdrawals. I would not jeopardize a Roth I obtained at a conversion rate of 24% to meet that need. But the rates are close enough to be a wash—unless we enter future appreciation (Roth) or future taxable income (which TDA withdrawal reduces, year after year).

So yes, your example falls into the SS tax torpedo, with very high marginal rates; but the picture looks different if we track total dollars paid in tax, not marginal rates.

You made other good points but I await your return from gardening to engage.

Chip:
Good point about future conversions being possible to restore the Roth. And about bequest goals as a hinge point in the analysis. And best of all, your final point: that modest Roth withdrawals can handle “lumpy” scenarios involving onetime tax bumps, as when an IRMAA cliff, social security tax torpedo, or other transitory event approaches.

Last, and then handing the microphone back to the OP to determine whether this subthread is still of interest:
1. If a very low rate was paid on the Roth conversion (12% or less), and the Roth is ample for all anticipated needs, of course drawing on it rather than the TDA might be better, especially for small expenses. Same if the Roth was built from contributions with no subsidy—0% tax on creation, as in backdoor Roths, and had appreciated to more than planned.
2. But in my brief time at BH I have encountered many who agonize over whether to convert at 22% or 24%--and with state taxes, as much as 31% or 33%. If I had created a Roth at that cost, and if I had a bequest motive, I would be loath to tap the Roth for a substantial expense if I could cover it with a TDA withdrawal, even at a somewhat higher rate now, given ongoing tax savings later.

What say you, OP: do you accept “have funds that can be liquidated tax-free for subsequent expenses” as a worthy goal for undertaking a Roth conversion?
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
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