help me understand why Roth conversions after retirement?

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dred pirate
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help me understand why Roth conversions after retirement?

Post by dred pirate »

So - I often hear people talk about Roth conversions of their 401k after retirement.
Basically I think people roll over the 401k to a roll-over IRA, then take portions of it, pay income taxes, and make that portion now a Roth IRA.
What is the exact rationale for this? The reasons I can think of are:
1. You think your RMD's are going to put you in a higher tax bracket when they come due vs what you would pay now (take conversions to the top of the 22 or 24% tax bracket assuming you will be in an even higher tax bracket when RMD's come due). Wouldn't this require a very large 401k to put you into this territory?
2. You intend to pass on the IRA after your passing and inheriting a Roth IRA is better than a traditional IRA? (I honestly do not know if this is true - but I think I remember hearing that in the past)
3. You want to make the conversions while your tax rate is lower as the TCJA of 2017 will expire in 2026 if not renewed.

I do wonder what percentage of us BH's would fall into #1?

Cheers
DP
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Re: help me understand why Roth conversions after retirement?

Post by White Coat Investor »

The idea is to pay a lower overall rate on taxes by paying some now rather than later.

RMDs play in.

Going to the single tax brackets when a spouse dies plays in.

Just spending a lot less than you have/are making plays in.

Needs of heirs plays in.

Desire to avoid having to take as large of RMDs plays in.

Worried tax rates are going up plays in.

Sometimes irrational things play in.
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Re: help me understand why Roth conversions after retirement?

Post by 02nz »

Roth conversions are especially attractive when done in years between retirement and starting SS. Basically:

1) Fill up the low-tax space - a MFJ couple with no other income can withdraw/convert over $100K every year and pay an average of just 9% federal income tax;
2) Reduce future RMDs;
3) Reduce the exposure of future SS benefits to income tax; and
4) Mitigate the likelihood that when one of you predeceases the other, the survivor faces higher tax rates as a single filer.
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Re: help me understand why Roth conversions after retirement?

Post by willthrill81 »

All three of the reasons you cite are common. The often high taxation of SS benefits is another one. A single filer can temporarily be in a 40.7% marginal tax rate with total income below $60k. And the thresholds for reaching higher marginal rates is not adjusted for inflation, so the thresholds are dropping over time. Reducing future withdrawals from tax-deferred accounts by doing Roth conversions before starting SS benefits can be a great strategy.

I'm hoping that we'll be able to Roth convert most of our tax-deferred accounts in the 20+ years I'm hoping to have between retiring and claiming SS benefits at age 70.
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Re: help me understand why Roth conversions after retirement?

Post by samsoes »

Big negatives to Roth conversions in retirement are that they can drive up IRMAA and ACA costs. Something to be aware of.
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dred pirate
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Re: help me understand why Roth conversions after retirement?

Post by dred pirate »

thanks all - I hadn't thought of
1. the years between retirement and SS - I plan to be in that period - but also wanted to make myself eligible for ACA subsidies - will have to do some math when that time comes.
2. One spouse dies before the other and how that affects things.

Thanks all
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Re: help me understand why Roth conversions after retirement?

Post by willthrill81 »

dred pirate wrote: Sun Jan 23, 2022 12:03 pm thanks all - I hadn't thought of
1. the years between retirement and SS - I plan to be in that period - but also wanted to make myself eligible for ACA subsidies - will have to do some math when that time comes.
2. One spouse dies before the other and how that affects things.

Thanks all
#1 is also our biggest concern with doing Roth conversions in early retirement. They would reduce our ACA subsidies, which could easily be more valuable than the tax savings.

And yes, the 'surviving spouse is thrust into a higher tax bracket due to RMDs' is a real issue and becomes both more likely and severe when there is a significant disparity in the life expectancy of the spouses.
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Re: help me understand why Roth conversions after retirement?

Post by yog »

The simplest way to figure out whether or not you materially benefit from tax-optimized income sequencing is to use a commercial tax-optimized planning tool such as Pralana Gold or MaxiFi Planner Premium. It can't really be done accurately in a typical spreadsheet.

There are 5 distinct potential benefits for Roth conversions, each with different time frames & math involved to isolate the impact:
1) The marginal tax rate on a conversion now is lower than a future marginal tax rate at withdrawal
2) Gains when paying conversion taxes with funds outside retirement accounts due to reduced taxable drag and increased Roth space
3) Savings from reduced or eliminated RMD-induced tax drag as rising ordinary income crowds out more favorable tax space
4) Savings from reduced state estate taxes where applicable
5) Enhanced liquidity under 59.5 with penalty-free access to retirement funds subject to Roth conversion 5-year rules

Usually the largest potential benefit comes from changes in marginal tax rates caused by life events such as relocation to a lower tax state or a planned or unplanned tax status change going from MFJ -> Single. Occasionally if the horizon is long enough and growth is large enough, you can jump lifetime brackets due to a favorable sequence of returns or from inescapably rising RMDs. There is always the possibility of rate changes higher or lower due to legislative action, and personal viewpoints on this may break a tie.

The ACA complicates the decision of when and how much to convert. Roth conversions work by accelerating ordinary income. Qualifying for ACA often means deferring ordinary income. We made an informed decision to forego ACA and prioritize conversions unique to our situation, but this usually means converting at 24% MFJ due to the shape of ACA cliff/slope & the current TCJA expanded brackets.
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Re: help me understand why Roth conversions after retirement?

Post by dboeger1 »

Another consideration that is somewhat market-timing-adjacent but also akin to tax-loss harvesting (which Bogleheads don't seem to mind) is performing Roth conversions during market downturns. If the market crashes 50%, that's potentially 50% less taxable income required to convert the same percentage of the portfolio, and then any future gains in Roth are tax-free. Many people opportunistically performed Roth conversions in the short crash of 2020 and made out like bandits. I suppose the thing that makes it more sensible than market-timing is that you're never really out of the market for very long if at all, and while it may be impossible to time the very bottom, converting in any downturn is objectively better than converting at the previous high. There's no sense in delaying planned conversions in hopes of a crash, but if one does happen and an investor has funds ready to convert, they may want to take advantage in the moment, perhaps even converting more into higher tax brackets than usual if the expected long-term Roth benefits seem worth it.
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Re: help me understand why Roth conversions after retirement?

Post by sjwoo »

dboeger1 wrote: Sun Jan 23, 2022 1:55 pm Another consideration that is somewhat market-timing-adjacent but also akin to tax-loss harvesting (which Bogleheads don't seem to mind) is performing Roth conversions during market downturns. If the market crashes 50%, that's potentially 50% less taxable income required to convert the same percentage of the portfolio, and then any future gains in Roth are tax-free. Many people opportunistically performed Roth conversions in the short crash of 2020 and made out like bandits. I suppose the thing that makes it more sensible than market-timing is that you're never really out of the market for very long if at all, and while it may be impossible to time the very bottom, converting in any downturn is objectively better than converting at the previous high. There's no sense in delaying planned conversions in hopes of a crash, but if one does happen and an investor has funds ready to convert, they may want to take advantage in the moment, perhaps even converting more into higher tax brackets than usual if the expected long-term Roth benefits seem worth it.
Jeez, this is brilliant! Now to avoid wash sale rules, you'd have to move to somewhat different funds, right? So let's say in my IRA I had VTI -- then I could sell that and recharacterize the proceeds to a Roth and buy...IWV? ( And 30 days later, I'd switch back to VTI. :) )
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Re: help me understand why Roth conversions after retirement?

Post by MileKing »

Mostly concerned about #1 and #3, ACA subsidies and potential IRMAA surcharges. Would not have luxury of converting between retirement and SS if pursuing ACA subsidies. Opened and contributed to Roth accounts in 2017 and started conversions in 2019 after moving from state with high income tax to state with no income tax. We are both still working and in recent years have been in upper range of 22% bracket or lower part of 24% bracket. Plan is for both of us to retire in about 18 months at which point we face up to 10 years on ACA (5 years for me and 10 years for wife). Subsidy worth an estimated $13,000 annually for the 5 years we are both on ACA.
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Re: help me understand why Roth conversions after retirement?

Post by Wannaretireearly »

yog wrote: Sun Jan 23, 2022 1:25 pm The simplest way to figure out whether or not you materially benefit from tax-optimized income sequencing is to use a commercial tax-optimized planning tool such as Pralana Gold or MaxiFi Planner Premium. It can't really be done accurately in a typical spreadsheet.

There are 5 distinct potential benefits for Roth conversions, each with different time frames & math involved to isolate the impact:
1) The marginal tax rate on a conversion now is lower than a future marginal tax rate at withdrawal
2) Gains when paying conversion taxes with funds outside retirement accounts due to reduced taxable drag and increased Roth space
3) Savings from reduced or eliminated RMD-induced tax drag as rising ordinary income crowds out more favorable tax space
4) Savings from reduced state estate taxes where applicable
5) Enhanced liquidity under 59.5 with penalty-free access to retirement funds subject to Roth conversion 5-year rules

Usually the largest potential benefit comes from changes in marginal tax rates caused by life events such as relocation to a lower tax state or a planned or unplanned tax status change going from MFJ -> Single. Occasionally if the horizon is long enough and growth is large enough, you can jump lifetime brackets due to a favorable sequence of returns or from inescapably rising RMDs. There is always the possibility of rate changes higher or lower due to legislative action, and personal viewpoints on this may break a tie.

The ACA complicates the decision of when and how much to convert. Roth conversions work by accelerating ordinary income. Qualifying for ACA often means deferring ordinary income. We made an informed decision to forego ACA and prioritize conversions unique to our situation, but this usually means converting at 24% MFJ due to the shape of ACA cliff/slope & the current TCJA expanded brackets.
Great write up. Head hurts ;) good tips on the planning tools. Thx.
Do the planning tools take into account ACA?
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Re: help me understand why Roth conversions after retirement?

Post by dboeger1 »

sjwoo wrote: Sun Jan 23, 2022 2:53 pm
dboeger1 wrote: Sun Jan 23, 2022 1:55 pm Another consideration that is somewhat market-timing-adjacent but also akin to tax-loss harvesting (which Bogleheads don't seem to mind) is performing Roth conversions during market downturns. If the market crashes 50%, that's potentially 50% less taxable income required to convert the same percentage of the portfolio, and then any future gains in Roth are tax-free. Many people opportunistically performed Roth conversions in the short crash of 2020 and made out like bandits. I suppose the thing that makes it more sensible than market-timing is that you're never really out of the market for very long if at all, and while it may be impossible to time the very bottom, converting in any downturn is objectively better than converting at the previous high. There's no sense in delaying planned conversions in hopes of a crash, but if one does happen and an investor has funds ready to convert, they may want to take advantage in the moment, perhaps even converting more into higher tax brackets than usual if the expected long-term Roth benefits seem worth it.
Jeez, this is brilliant! Now to avoid wash sale rules, you'd have to move to somewhat different funds, right? So let's say in my IRA I had VTI -- then I could sell that and recharacterize the proceeds to a Roth and buy...IWV? ( And 30 days later, I'd switch back to VTI. :) )
I honestly don't know much about wash sale rules. I *think* you can do such conversions without actually triggering a sale, assuming you're transferring between accounts within the same brokerage. But I don't actually know that for certain. I have never done it myself, but I just remember seeing a ton of videos being put out by financial advisors in 2020 talking about Roth conversions because of the sudden drop in stocks. Again, there's no way to time the bottom, but you can at least recognize when a conversion is better than it would have been in the weeks or months prior.
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Re: help me understand why Roth conversions after retirement?

Post by marcopolo »

dboeger1 wrote: Sun Jan 23, 2022 1:55 pm Another consideration that is somewhat market-timing-adjacent but also akin to tax-loss harvesting (which Bogleheads don't seem to mind) is performing Roth conversions during market downturns. If the market crashes 50%, that's potentially 50% less taxable income required to convert the same percentage of the portfolio, and then any future gains in Roth are tax-free. Many people opportunistically performed Roth conversions in the short crash of 2020 and made out like bandits. I suppose the thing that makes it more sensible than market-timing is that you're never really out of the market for very long if at all, and while it may be impossible to time the very bottom, converting in any downturn is objectively better than converting at the previous high. There's no sense in delaying planned conversions in hopes of a crash, but if one does happen and an investor has funds ready to convert, they may want to take advantage in the moment, perhaps even converting more into higher tax brackets than usual if the expected long-term Roth benefits seem worth it.
This only really beneficial if you are using cash/fixed income sitting around to pay the taxes due, and thus changing your asset allocation. if you use withdrawals from similarly invested assets to pay the tax, the benefits are marginal.
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Re: help me understand why Roth conversions after retirement?

Post by livesoft »

We are living off our taxable account assets. Our "income" consists mainly of qualified dividends, tax-free return-of-capital, realized capital gains that are offset by carryover losses, and Roth conversions. We don't care about ACA premium credits. If we didn't do Roth conversions, can you see that we would be wasting some 0%-tax-bracket "space" created by either the standard deduction or bunching of itemized deductions?
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Re: help me understand why Roth conversions after retirement?

Post by marcopolo »

dred pirate wrote: Sun Jan 23, 2022 11:51 am So - I often hear people talk about Roth conversions of their 401k after retirement.
Basically I think people roll over the 401k to a roll-over IRA, then take portions of it, pay income taxes, and make that portion now a Roth IRA.
What is the exact rationale for this? The reasons I can think of are:
1. You think your RMD's are going to put you in a higher tax bracket when they come due vs what you would pay now (take conversions to the top of the 22 or 24% tax bracket assuming you will be in an even higher tax bracket when RMD's come due). Wouldn't this require a very large 401k to put you into this territory?
2. You intend to pass on the IRA after your passing and inheriting a Roth IRA is better than a traditional IRA? (I honestly do not know if this is true - but I think I remember hearing that in the past)
3. You want to make the conversions while your tax rate is lower as the TCJA of 2017 will expire in 2026 if not renewed.

I do wonder what percentage of us BH's would fall into #1?

Cheers
DP
There are lots of good reasons to do Roth conversions, as several people have articulated well above.

One consideration that does not get discussed as often I'd the asymmetric nature of doing so. Roth conversions save the most taxes when markets end up doing well, and your portfolio grows. But, they are actually detrimental when markets perform poorly, in which case you end up paying more taxes.

In the first case, the lower taxes are great (this is what most people focus on), but you probably don't get that much marginal utility out of those extra dollars because the growth already gave you way more than you needed.

In the second case, the extra dollars squandered on pre-paying higher taxes, could have made a meaningful difference in maintaining your standard of living if the scenario where the markets turn against you.

So, you have to give some thought to what problem you are trying to solve, maximizing spendable dollars when things go well, or minimizing risk of running out of money when things go poorly.
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Re: help me understand why Roth conversions after retirement?

Post by bsteiner »

Some IRA owners will be in a lower tax bracket after they retire.
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Re: help me understand why Roth conversions after retirement?

Post by samsoes »

sjwoo wrote: Sun Jan 23, 2022 2:53 pm
dboeger1 wrote: Sun Jan 23, 2022 1:55 pm Another consideration that is somewhat market-timing-adjacent but also akin to tax-loss harvesting (which Bogleheads don't seem to mind) is performing Roth conversions during market downturns. If the market crashes 50%, that's potentially 50% less taxable income required to convert the same percentage of the portfolio, and then any future gains in Roth are tax-free. Many people opportunistically performed Roth conversions in the short crash of 2020 and made out like bandits. I suppose the thing that makes it more sensible than market-timing is that you're never really out of the market for very long if at all, and while it may be impossible to time the very bottom, converting in any downturn is objectively better than converting at the previous high. There's no sense in delaying planned conversions in hopes of a crash, but if one does happen and an investor has funds ready to convert, they may want to take advantage in the moment, perhaps even converting more into higher tax brackets than usual if the expected long-term Roth benefits seem worth it.
Jeez, this is brilliant! Now to avoid wash sale rules, you'd have to move to somewhat different funds, right? So let's say in my IRA I had VTI -- then I could sell that and recharacterize the proceeds to a Roth and buy...IWV? ( And 30 days later, I'd switch back to VTI. :) )
Nope, wash sale does not apply in this situation. It only comes into play when you sell from a post-tax account for a loss. Not selling from an IRA, not selling from any kind of IRA. Besides, you can do a ROTH conversion by moving shares from your traditional IRA to the Roth IRA in-kind, without selling a thing.
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Re: help me understand why Roth conversions after retirement?

Post by loukycpa »

If one retires and has little other taxable income in the year following retirement, keep in my mind the first $26k or so of taxable income for a married couple you know is tax-free because that is your standard deduction. $26K in Roth conversion less $26k standard deduction equals $0 taxable income. So that is a no brainer move.

The next $20k or so above the standard deduction is taxable at only a 10% federal rate. Then the next $60k or so above that is taxable at only a 12% rate.

If you don't fill up these brackets every year and get some of your tax deferred converted to Roth at these rates, you could be missing out on a opportunity to do so later. You don't get to reach back and use those brackets again in the future when you might have other income pushing the same income into a higher tax bracket.

This is the basic thought process. When it comes to taxes though nothing is ever simple so yes as others have said use software or get professional help to model your actual scenario.
Last edited by loukycpa on Sun Jan 23, 2022 3:47 pm, edited 2 times in total.
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Re: help me understand why Roth conversions after retirement?

Post by retire2022 »

marcopolo wrote: Sun Jan 23, 2022 3:41 pm
There are lots of good reasons to do Roth conversions, as several people have articulated well above.

One consideration that does not get discussed as often I'd the asymmetric nature of doing so. Roth conversions save the most taxes when markets end up doing well, and your portfolio grows. But, they are actually detrimental when markets perform poorly, in which case you end up paying more taxes.

In the first case, the lower taxes are great (this is what most people focus on), but you probably don't get that much marginal utility out of those extra dollars because the growth already gave you way more than you needed.

In the second case, the extra dollars squandered on pre-paying higher taxes, could have made a meaningful difference in maintaining your standard of living if the scenario where the markets turn against you.

So, you have to give some thought to what problem you are trying to solve, maximizing spendable dollars when things go well, or minimizing risk of running out of money when things go poorly.
Best to convert pretax account when there is a crash as long as the cost basis is less than what it cost you and best to convert when one is unemployed, or no longer working.

Of course it gets harder to do when you invested in pretax majority of working years.

I am in this boat right now.
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Re: help me understand why Roth conversions after retirement?

Post by marcopolo »

loukycpa wrote: Sun Jan 23, 2022 3:45 pm If one retires and has little other taxable income in the year following retirement, keep in my mind the first $26k or so of taxable income for a married couple you know is tax-free because that is your standard deduction. $26K in Roth conversion less $26k standard deduction equals $0 taxable income. So that is a no brainer move.

The next $20k or so above the standard deduction is taxable at only a 10% federal rate. Then the next $60k or so above that is taxable at only a 12% rate.

If you don't fill up these brackets every year and get some of your tax deferred converted to Roth at these rates, you could be missing out on a opportunity to do so later. You don't get to reach back and use those brackets again in the future when you might have other income pushing the same income into a higher tax bracket.

This is the basic thought process. When it comes to taxes though nothing is ever simple so yes as others have said use software or get professional help to model your actual scenario.
This is largely true, but I wonder how common it is for early retirees. I would think many (most) will have some taxable income generated from the need to find living expenses in the form of dividends, pensions, capital gains, etc.

But, you are absolutely right that any 0%, 10%, and in many cases 12% brackets probably make sense to fill up in most situations. Beyond that, I think there are many complex issues that should be considered.
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Re: help me understand why Roth conversions after retirement?

Post by ROIGuy »

If a person decides to wait a few years before doing their conversion at retirement, what about the growth of the traditional IRA? If they had $100,000 at age 60 but at age 65 it was worth $150,000 when they start doing conversions, they have to pay taxes on $50,000 more money than if they had done it 5 years earlier. I guess you have to do the math on the tax brackets when you doing the conversions.
Last edited by ROIGuy on Sun Jan 23, 2022 3:57 pm, edited 1 time in total.
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Re: help me understand why Roth conversions after retirement?

Post by marcopolo »

Mr.BB wrote: Sun Jan 23, 2022 3:54 pm If a person decides to wait a few years before doing their conversion at retirement, what about the growth of the traditional IRA? If they had $100,000 at age 60 but at age 65 it was worth $150,000 when they start doing conversions, they have to pay taxes on $50,000 more money than if you done it earlier. I guess you have to do the math on the tax brackets when you doing the conversions?
The effect is not as big as people make it out to be.
You have to take into consideration that the money you would have used to pay the taxes have grown as well.
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Re: help me understand why Roth conversions after retirement?

Post by ROIGuy »

marcopolo wrote: Sun Jan 23, 2022 3:57 pm
Mr.BB wrote: Sun Jan 23, 2022 3:54 pm If a person decides to wait a few years before doing their conversion at retirement, what about the growth of the traditional IRA? If they had $100,000 at age 60 but at age 65 it was worth $150,000 when they start doing conversions, they have to pay taxes on $50,000 more money than if you done it earlier. I guess you have to do the math on the tax brackets when you doing the conversions?
The effect is not as big as people make it out to be.
You have to take into consideration that the money you would have used to pay the taxes have grown as well.
I wonder if most people sell their taxable funds (pay the capital gains), and use that money for the conversions.
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Re: help me understand why Roth conversions after retirement?

Post by yog »

Wannaretireearly wrote: Sun Jan 23, 2022 3:19 pm
yog wrote: Sun Jan 23, 2022 1:25 pm The simplest way to figure out whether or not you materially benefit from tax-optimized income sequencing is to use a commercial tax-optimized planning tool such as Pralana Gold or MaxiFi Planner Premium. It can't really be done accurately in a typical spreadsheet.

There are 5 distinct potential benefits for Roth conversions, each with different time frames & math involved to isolate the impact:
1) The marginal tax rate on a conversion now is lower than a future marginal tax rate at withdrawal
2) Gains when paying conversion taxes with funds outside retirement accounts due to reduced taxable drag and increased Roth space
3) Savings from reduced or eliminated RMD-induced tax drag as rising ordinary income crowds out more favorable tax space
4) Savings from reduced state estate taxes where applicable
5) Enhanced liquidity under 59.5 with penalty-free access to retirement funds subject to Roth conversion 5-year rules

Usually the largest potential benefit comes from changes in marginal tax rates caused by life events such as relocation to a lower tax state or a planned or unplanned tax status change going from MFJ -> Single. Occasionally if the horizon is long enough and growth is large enough, you can jump lifetime brackets due to a favorable sequence of returns or from inescapably rising RMDs. There is always the possibility of rate changes higher or lower due to legislative action, and personal viewpoints on this may break a tie.

The ACA complicates the decision of when and how much to convert. Roth conversions work by accelerating ordinary income. Qualifying for ACA often means deferring ordinary income. We made an informed decision to forego ACA and prioritize conversions unique to our situation, but this usually means converting at 24% MFJ due to the shape of ACA cliff/slope & the current TCJA expanded brackets.
Great write up. Head hurts ;) good tips on the planning tools. Thx.
Do the planning tools take into account ACA?
Pralana Gold does account for ACA while calculating Roth conversions. I-ORP Extended is not as tax exact, but it can be used to run a lot of scenarios quickly once you know how to properly model your portfolio, and it supports constraining conversions for ACA as well.

I primarily use MaxiFi Planner Premium. It does a great job at tax optimizing lifetime cash flows, and we needed it for their superior SS claiming engine since we needed to verify we should claim early. MaxiFi does not automatically calculate Roth conversions for you, but conversions are easily modeled as alternative scenarios, compared to the optimized baseline, and promoted to the new baseline. Since MaxiFi doesn't calculate conversions, there is no need to constrain the overall optimization model for ACA. I'm comfortable with this design choice since it is easy to model around anyways, but if this is a major concern for someone, Pralana Gold may be a better tool to consider. MaxiFi is web-based and Pralana Gold requires MS Excel.
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Re: help me understand why Roth conversions after retirement?

Post by willthrill81 »

Mr.BB wrote: Sun Jan 23, 2022 3:54 pm If a person decides to wait a few years before doing their conversion at retirement, what about the growth of the traditional IRA? If they had $100,000 at age 60 but at age 65 it was worth $150,000 when they start doing conversions, they have to pay taxes on $50,000 more money than if they had done it 5 years earlier. I guess you have to do the math on the tax brackets when you doing the conversions.
The time involved does not change anything at all.

For instance, if I have $100 of tax-deferred contributions when I would have had to pay 30% (for illustrative purposes), it doubles to $200, and I then withdraw it and pay 30% in taxes, I'm left with $140. If I had pay 30% on the initial $100 and put the remaining $70 in Roth, which then doubled, I would also have $140, exactly the same amount.

The key with these situations is one's marginal tax rate at the time of the contribution vs. the time of the withdrawal.
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Re: help me understand why Roth conversions after retirement?

Post by dboeger1 »

Mr.BB wrote: Sun Jan 23, 2022 3:59 pm
marcopolo wrote: Sun Jan 23, 2022 3:57 pm
Mr.BB wrote: Sun Jan 23, 2022 3:54 pm If a person decides to wait a few years before doing their conversion at retirement, what about the growth of the traditional IRA? If they had $100,000 at age 60 but at age 65 it was worth $150,000 when they start doing conversions, they have to pay taxes on $50,000 more money than if you done it earlier. I guess you have to do the math on the tax brackets when you doing the conversions?
The effect is not as big as people make it out to be.
You have to take into consideration that the money you would have used to pay the taxes have grown as well.
I wonder if most people sell their taxable funds (pay the capital gains), and use that money for the conversions.
I wouldn't know what most people do as I'm still in the accumulation phase, but assuming one has sufficient income to max out tax-advantaged accounts and save some additional in taxable, you would think they would have accumulated enough of all forms by retirement so as to have flexibility in how to balance various types of withdrawals.

That might not be true for people with lower income, but then again, people with lower income probably don't have tax considerations this complicated either. The average American saves little and is generally better off deferring taxes.
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Re: help me understand why Roth conversions after retirement?

Post by willthrill81 »

dboeger1 wrote: Sun Jan 23, 2022 4:10 pmThe average American saves little and is generally better off deferring taxes.
I thought this too for a long time, but the taxation of SS benefits is such that I'm not sure how applicable it truly is. For instance, $20k of SS benefits and $15k of other income will have a single filer paying a marginal tax rate of 15%. Such a person likely spent most of his/her career paying no more than 12% taxes and would likely have been better off contributing mostly to Roth rather than tax-deferred.

However, if one retires well before starting SS benefits, that strongly favors tax-deferred contributions while working and then Roth conversions until SS benefits begin.
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Re: help me understand why Roth conversions after retirement?

Post by dboeger1 »

willthrill81 wrote: Sun Jan 23, 2022 4:21 pm
dboeger1 wrote: Sun Jan 23, 2022 4:10 pmThe average American saves little and is generally better off deferring taxes.
I thought this too for a long time, but the taxation of SS benefits is such that I'm not sure how applicable it truly is. For instance, $20k of SS benefits and $15k of other income will have a single filer paying a marginal tax rate of 15%. Such a person likely spent most of his/her career paying no more than 12% taxes and would likely have been better off contributing mostly to Roth rather than tax-deferred.

However, if one retires well before starting SS benefits, that strongly favors tax-deferred contributions while working and then Roth conversions until SS benefits begin.
You're right that SS is complicated, but I would argue that your proposed difference is 3% is far outweighed by:
  • The risk of a shortened career.
  • The benefits of buying a home earlier vs. renting longer.
  • The risk of SS being underfunded.
  • That $20k of SS you quoted being adjusted by COLAs.
  • A combination of needing to save to get employer matches with needing the tax deferrals to pay for living expenses during the accumulation phase.
Sadly, most people aren't in a position, either financially or mentally, to optimize their long-term finances the way Bogleheads do. I know for a fact that if you offered people $10 now or $20 later, the vast majority would take the $10 now, and that's way more than a 3% difference. Using your $15k of other income as a target, 25x of that is $375k. I know these surveys are far from perfect as they often look at single account balances rather than total household values, but according to one recent article, the age range with the highest median 401k balance is 55-64 with $69k. Doubling that for a working couple gives $138k, which is only about 1/3 of that $375k with a target 4% SWR. For reference, the average balance is more like $200k, but that's extremely skewed and not indicative of very many people's situations. This also excludes everybody who isn't participating in any kind of retirement plan.

The point is, most Americans fall waaaay short of where they would even worry about an extra 3% marginal (not even effective) tax rate in retirement. Anyone worrying about traditional vs. Roth decades in advance is inherently setting themselves up for a very comfortable retirement, by comparison. That being said, to your point, there are ranges in which SS taxation complicates optimized strategies. I suspect in most cases, it makes minimal differences to anyone's retirement lifestyle, and for those with exceptional circumstances who might run into various cliffs, they probably know who they are and can come up with plans to mitigate the damage.
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Re: help me understand why Roth conversions after retirement?

Post by marcopolo »

Mr.BB wrote: Sun Jan 23, 2022 3:59 pm
marcopolo wrote: Sun Jan 23, 2022 3:57 pm
Mr.BB wrote: Sun Jan 23, 2022 3:54 pm If a person decides to wait a few years before doing their conversion at retirement, what about the growth of the traditional IRA? If they had $100,000 at age 60 but at age 65 it was worth $150,000 when they start doing conversions, they have to pay taxes on $50,000 more money than if you done it earlier. I guess you have to do the math on the tax brackets when you doing the conversions?
The effect is not as big as people make it out to be.
You have to take into consideration that the money you would have used to pay the taxes have grown as well.
I wonder if most people sell their taxable funds (pay the capital gains), and use that money for the conversions.
I suspect a lot of people do that. There is some added benefit to that. But, it is still the case that those dollars left on the taxable account would continue to grow, thus largely offsetting the bigger tax hit later.
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Re: help me understand why Roth conversions after retirement?

Post by Exchme »

willthrill81 wrote: Sun Jan 23, 2022 4:09 pm
Mr.BB wrote: Sun Jan 23, 2022 3:54 pm If a person decides to wait a few years before doing their conversion at retirement, what about the growth of the traditional IRA? If they had $100,000 at age 60 but at age 65 it was worth $150,000 when they start doing conversions, they have to pay taxes on $50,000 more money than if they had done it 5 years earlier. I guess you have to do the math on the tax brackets when you doing the conversions.
The time involved does not change anything at all.

For instance, if I have $100 of tax-deferred contributions when I would have had to pay 30% (for illustrative purposes), it doubles to $200, and I then withdraw it and pay 30% in taxes, I'm left with $140. If I had pay 30% on the initial $100 and put the remaining $70 in Roth, which then doubled, I would also have $140, exactly the same amount.

The key with these situations is one's marginal tax rate at the time of the contribution vs. the time of the withdrawal.

As Willthrill81 says, the most important parameter is the marginal tax rate. Note that is not necessarily the tax bracket, there are steps and phase-ins where the marginal rate on any particular conversion can be huge (such as missing out on an ACA credit, crossing an IRMAA tier, capital gains 15% bracket phase in, taxation of SS phase-in). You need a good tax package to navigate the waters.
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Re: help me understand why Roth conversions after retirement?

Post by tibbitts »

Mr.BB wrote: Sun Jan 23, 2022 3:54 pm If a person decides to wait a few years before doing their conversion at retirement, what about the growth of the traditional IRA? If they had $100,000 at age 60 but at age 65 it was worth $150,000 when they start doing conversions, they have to pay taxes on $50,000 more money than if they had done it 5 years earlier. I guess you have to do the math on the tax brackets when you doing the conversions.
Math won't solve this problem because the math will be based entirely on guesses. What if the $100k IRA is worth $50k less five years later? Math will only tell you what the current cost of the conversion will be, not whether you'd be better off converting today or tomorrow.
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Re: help me understand why Roth conversions after retirement?

Post by loukycpa »

marcopolo wrote: Sun Jan 23, 2022 3:52 pm
loukycpa wrote: Sun Jan 23, 2022 3:45 pm If one retires and has little other taxable income in the year following retirement, keep in my mind the first $26k or so of taxable income for a married couple you know is tax-free because that is your standard deduction. $26K in Roth conversion less $26k standard deduction equals $0 taxable income. So that is a no brainer move.

The next $20k or so above the standard deduction is taxable at only a 10% federal rate. Then the next $60k or so above that is taxable at only a 12% rate.

If you don't fill up these brackets every year and get some of your tax deferred converted to Roth at these rates, you could be missing out on a opportunity to do so later. You don't get to reach back and use those brackets again in the future when you might have other income pushing the same income into a higher tax bracket.

This is the basic thought process. When it comes to taxes though nothing is ever simple so yes as others have said use software or get professional help to model your actual scenario.
This is largely true, but I wonder how common it is for early retirees. I would think many (most) will have some taxable income generated from the need to find living expenses in the form of dividends, pensions, capital gains, etc.

But, you are absolutely right that any 0%, 10%, and in many cases 12% brackets probably make sense to fill up in most situations. Beyond that, I think there are many complex issues that should be considered.
If one can keep their marginal tax rate at 12% or less, the tax rate on qualified dividends and long term capital gains is 0%. This is a really sweet spot to be in and what I am aiming for when we retire.

We may be unusual in that we are low spenders (aiming for about $72k annually) and don't have a mortgage or pension. I have quite a bit of tax deferred space ($1.1M) relative to taxable space (700k), and fortunately we aren't sitting on a lot of unrealized gains in the taxable space (mostly new money).

When both of us are retired, I intend to begin converting the tax deferred to Roth. Annually enough to fill up the standard deduction and the 10% bracket every year, and likely some of the 12% bracket as well. I will keep all the fixed income in tax deferred and taxable space will be mostly equities. Sell equities in the taxable to fund our spend (tax loss harvest or 0% long term capital gain opportunity), meanwhile using the fixed income in the tax deferred to buy equities to stay at my target asset allocation (55/45). I will eventually need more taxable space because I have a lot of years to get to 59 1/2 (we are both planning to retire at 50, 48 and 46 currently).

The Roth conversions are smart for us from a state tax standpoint also. The first $30k of income from IRA distributions or Roth conversions for each of us annually will be state tax free as well. It is smart to use some of that state annual exclusion every year so that we don't end up paying more state tax during retirement years.
Last edited by loukycpa on Tue Jan 25, 2022 6:26 am, edited 3 times in total.
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Re: help me understand why Roth conversions after retirement?

Post by Tubes »

willthrill81 wrote: Sun Jan 23, 2022 12:17 pm
dred pirate wrote: Sun Jan 23, 2022 12:03 pm thanks all - I hadn't thought of
1. the years between retirement and SS - I plan to be in that period - but also wanted to make myself eligible for ACA subsidies - will have to do some math when that time comes.
2. One spouse dies before the other and how that affects things.

Thanks all
#1 is also our biggest concern with doing Roth conversions in early retirement. They would reduce our ACA subsidies, which could easily be more valuable than the tax savings.

And yes, the 'surviving spouse is thrust into a higher tax bracket due to RMDs' is a real issue and becomes both more likely and severe when there is a significant disparity in the life expectancy of the spouses.
We're in the "in between" years. Our income is primarily from dividends, and very little. If we had to go on the market for medical, we'd be in the Medicaid zone.

It only makes sense to bite into the 12% bracket now. Use it or lose it during the RMD years.
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Re: help me understand why Roth conversions after retirement?

Post by IowaFarmBoy »

dred pirate wrote: Sun Jan 23, 2022 11:51 am 1. You think your RMD's are going to put you in a higher tax bracket when they come due vs what you would pay now (take conversions to the top of the 22 or 24% tax bracket assuming you will be in an even higher tax bracket when RMD's come due). Wouldn't this require a very large 401k to put you into this territory?

I do wonder what percentage of us BH's would fall into #1?

Cheers
DP
We land in #1. We are currently in the years between retiring and starting SS. Currently we only have significant income from a pension and are in the 12% bracket. Once SS kicks in, it will push us into the 22% (possibly 25%) bracket and any RMDs will be in the 22% bracket. So it makes sense to move as much as we can at the 12% rate.

Additionally, our kids are all in at least the 22% bracket now so having the money in Roths should be better for them, too.
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Re: help me understand why Roth conversions after retirement?

Post by Exchme »

loukycpa wrote: Tue Jan 25, 2022 6:16 am If one can keep their marginal tax rate at 12% or less, the tax rate on qualified dividends and long term capital gains is 0%. This is a really sweet spot to be in and what I am aiming for when we retire.
I've used this shorthand explanation before too, but I think it confuses people since it isn't a very accurate explanation of the trouble spot. The trouble happens when the sum of the long term capital gains & qualified dividends (line 6 on Schedule B) plus ordinary income (including Roth Conversions) less the standard deduction ($25,900 MFJ) exceeds the top of the 0% capital gains bracket ($83,350 MFJ).

Above that and every $ of Roth Conversions is taxed at 12% and pushes a $ of LTCG+QDiv to also be taxed at 15%. So this 15% capital gain phase-in range creates a zone at 12%+15% = 27% marginal rate. Once you get to the top of the 12% bracket and into the 22% (at $83,550 MFJ) for ordinary income, you are through the capital gains phase-in so your marginal tax rate actually declines to 22%.

So if you had say $20,000 in LTCGs + qualified dividends, then your capital gains are taxed at zero if you keep the ordinary income (including Roth conversions) to less than:
$83,350 (top of 0% LTCG bracket) + $25,900 (std ded) - $20,000 (LTCG for the example) = $89,250 (max ordinary inc for the example)

For folks that don't have a lot of Roth conversions to do, they can use this idea to sell some appreciated assets to reset their taxable basis higher and get some capital gains taxed at 0%. They can even immediately re-buy the same investment as there is no wash sale rule applicable to taking a gain.
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Re: help me understand why Roth conversions after retirement?

Post by loukycpa »

Exchme wrote: Tue Jan 25, 2022 7:05 am
loukycpa wrote: Tue Jan 25, 2022 6:16 am If one can keep their marginal tax rate at 12% or less, the tax rate on qualified dividends and long term capital gains is 0%. This is a really sweet spot to be in and what I am aiming for when we retire.
I've used this shorthand explanation before too, but I think it confuses people since it isn't a very accurate explanation of the trouble spot. The trouble happens when the sum of the long term capital gains & qualified dividends (line 6 on Schedule B) plus ordinary income (including Roth Conversions) less the standard deduction ($25,900 MFJ) exceeds the top of the 0% capital gains bracket ($83,350 MFJ).
I guess in my mind, in this situation you aren't in the 12% bracket. My personal goal is to keep the sum of LTCG, qualified dividends and ordinary income (including Roth conversions) below the $83k threshold. If you can do this, this is the sweet spot in IMO.

Worth reiterating also 83k in taxable income is really $109k in gross income because of the $26k standard deduction.

ACA and health insurance adds another of layer of complexity to all of this and many have to manage it as well.

I just hope Congress continues to be so generous to us poor, pitiful early retiree millionaires. :wink:
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Re: help me understand why Roth conversions after retirement?

Post by firebirdparts »

sjwoo wrote: Sun Jan 23, 2022 2:53 pm Jeez, this is brilliant! Now to avoid wash sale rules, you'd have to move to somewhat different funds, right? So let's say in my IRA I had VTI -- then I could sell that and recharacterize the proceeds to a Roth and buy...IWV? ( And 30 days later, I'd switch back to VTI. :) )
No. No wash sales in a Traditional 401k/IRA.
This time is the same
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Re: help me understand why Roth conversions after retirement?

Post by Exchme »

loukycpa wrote: Tue Jan 25, 2022 9:06 am My personal goal is to keep the sum of LTCG, qualified dividends and ordinary income (including Roth conversions) below the $83k threshold. If you can do this, this is the sweet spot in IMO.
Agreed, but it's a confusing point in the tax code, so my New Year's resolution is to never call this spot the top of the 12% bracket again as that may lead folks that don't study it in detail into making excess conversions. :D
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Re: help me understand why Roth conversions after retirement?

Post by marcopolo »

loukycpa wrote: Tue Jan 25, 2022 6:16 am
marcopolo wrote: Sun Jan 23, 2022 3:52 pm
loukycpa wrote: Sun Jan 23, 2022 3:45 pm If one retires and has little other taxable income in the year following retirement, keep in my mind the first $26k or so of taxable income for a married couple you know is tax-free because that is your standard deduction. $26K in Roth conversion less $26k standard deduction equals $0 taxable income. So that is a no brainer move.

The next $20k or so above the standard deduction is taxable at only a 10% federal rate. Then the next $60k or so above that is taxable at only a 12% rate.

If you don't fill up these brackets every year and get some of your tax deferred converted to Roth at these rates, you could be missing out on a opportunity to do so later. You don't get to reach back and use those brackets again in the future when you might have other income pushing the same income into a higher tax bracket.

This is the basic thought process. When it comes to taxes though nothing is ever simple so yes as others have said use software or get professional help to model your actual scenario.
This is largely true, but I wonder how common it is for early retirees. I would think many (most) will have some taxable income generated from the need to find living expenses in the form of dividends, pensions, capital gains, etc.

But, you are absolutely right that any 0%, 10%, and in many cases 12% brackets probably make sense to fill up in most situations. Beyond that, I think there are many complex issues that should be considered.
If one can keep their marginal tax rate at 12% or less, the tax rate on qualified dividends and long term capital gains is 0%. This is a really sweet spot to be in and what I am aiming for when we retire.

We may be unusual in that we are low spenders (aiming for about $72k annually) and don't have a mortgage or pension. I have quite a bit of tax deferred space ($1.1M) relative to taxable space (700k), and fortunately we aren't sitting on a lot of unrealized gains in the taxable space (mostly new money).

When both of us are retired, I intend to begin converting the tax deferred to Roth. Annually enough to fill up the standard deduction and the 10% bracket every year, and likely some of the 12% bracket as well. I will keep all the fixed income in tax deferred and taxable space will be mostly equities. Sell equities in the taxable to fund our spend (tax loss harvest or 0% long term capital gain opportunity), meanwhile using the fixed income in the tax deferred to buy equities to stay at my target asset allocation (55/45). I will eventually need more taxable space because I have a lot of years to get to 59 1/2 (we are both planning to retire at 50, 48 and 46 currently).

The Roth conversions are smart for us from a state tax standpoint also. The first $30k of income from IRA distributions or Roth conversions for each of us annually will be state tax free as well. It is smart to use some of that state annual exclusion every year so that we don't end up paying more state tax during retirement years.
We have been doing essentially the same thing for the last 4 years after retiring at age 51.
How are you getting health insurance? If on ACA plan just be aware that those conversions in 12% bracket are really costing you ~22% marginal tax rate and make sure that is still worth doing. It is for us, but conversions in the 22% bracket, costing 32% does not seem worth it.
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Re: help me understand why Roth conversions after retirement?

Post by willthrill81 »

Tubes wrote: Tue Jan 25, 2022 6:21 am
willthrill81 wrote: Sun Jan 23, 2022 12:17 pm
dred pirate wrote: Sun Jan 23, 2022 12:03 pm thanks all - I hadn't thought of
1. the years between retirement and SS - I plan to be in that period - but also wanted to make myself eligible for ACA subsidies - will have to do some math when that time comes.
2. One spouse dies before the other and how that affects things.

Thanks all
#1 is also our biggest concern with doing Roth conversions in early retirement. They would reduce our ACA subsidies, which could easily be more valuable than the tax savings.

And yes, the 'surviving spouse is thrust into a higher tax bracket due to RMDs' is a real issue and becomes both more likely and severe when there is a significant disparity in the life expectancy of the spouses.
We're in the "in between" years. Our income is primarily from dividends, and very little. If we had to go on the market for medical, we'd be in the Medicaid zone.

It only makes sense to bite into the 12% bracket now. Use it or lose it during the RMD years.
Aside from something like ACA premiums going up, it seems like doing Roth contributions and conversions to the top of the 12% bracket is close to a no-brainer for almost everyone. About the only exception I can of is early retirees, who likely need to keep at least enough in tax-deferred to fill up the standard deduction and 10% brackets before starting SS benefits.
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Re: help me understand why Roth conversions after retirement?

Post by loukycpa »

marcopolo wrote: Tue Jan 25, 2022 10:00 am
loukycpa wrote: Tue Jan 25, 2022 6:16 am
marcopolo wrote: Sun Jan 23, 2022 3:52 pm
loukycpa wrote: Sun Jan 23, 2022 3:45 pm If one retires and has little other taxable income in the year following retirement, keep in my mind the first $26k or so of taxable income for a married couple you know is tax-free because that is your standard deduction. $26K in Roth conversion less $26k standard deduction equals $0 taxable income. So that is a no brainer move.

The next $20k or so above the standard deduction is taxable at only a 10% federal rate. Then the next $60k or so above that is taxable at only a 12% rate.

If you don't fill up these brackets every year and get some of your tax deferred converted to Roth at these rates, you could be missing out on a opportunity to do so later. You don't get to reach back and use those brackets again in the future when you might have other income pushing the same income into a higher tax bracket.

This is the basic thought process. When it comes to taxes though nothing is ever simple so yes as others have said use software or get professional help to model your actual scenario.
This is largely true, but I wonder how common it is for early retirees. I would think many (most) will have some taxable income generated from the need to find living expenses in the form of dividends, pensions, capital gains, etc.

But, you are absolutely right that any 0%, 10%, and in many cases 12% brackets probably make sense to fill up in most situations. Beyond that, I think there are many complex issues that should be considered.
If one can keep their marginal tax rate at 12% or less, the tax rate on qualified dividends and long term capital gains is 0%. This is a really sweet spot to be in and what I am aiming for when we retire.

We may be unusual in that we are low spenders (aiming for about $72k annually) and don't have a mortgage or pension. I have quite a bit of tax deferred space ($1.1M) relative to taxable space (700k), and fortunately we aren't sitting on a lot of unrealized gains in the taxable space (mostly new money).

When both of us are retired, I intend to begin converting the tax deferred to Roth. Annually enough to fill up the standard deduction and the 10% bracket every year, and likely some of the 12% bracket as well. I will keep all the fixed income in tax deferred and taxable space will be mostly equities. Sell equities in the taxable to fund our spend (tax loss harvest or 0% long term capital gain opportunity), meanwhile using the fixed income in the tax deferred to buy equities to stay at my target asset allocation (55/45). I will eventually need more taxable space because I have a lot of years to get to 59 1/2 (we are both planning to retire at 50, 48 and 46 currently).

The Roth conversions are smart for us from a state tax standpoint also. The first $30k of income from IRA distributions or Roth conversions for each of us annually will be state tax free as well. It is smart to use some of that state annual exclusion every year so that we don't end up paying more state tax during retirement years.
We have been doing essentially the same thing for the last 4 years after retiring at age 51.
How are you getting health insurance? If on ACA plan just be aware that those conversions in 12% bracket are really costing you ~22% marginal tax rate and make sure that is still worth doing. It is for us, but conversions in the 22% bracket, costing 32% does not seem worth it.
2022 we are both still working and coverage for both of us is through spouse's employer
2023-2024 will continue to be through spouse's employer (we are staggering our retirements by a couple of years)
2025 and beyond - ACA and/or part time employer plan

I have researched ACA subsidies and plans in our state marketplace and it seems to be a good solution for us as of right now, but I know the game could change a lot between now and then so it seems this will be a constant reevaluation for us.
Last edited by loukycpa on Tue Jan 25, 2022 1:17 pm, edited 1 time in total.
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Re: help me understand why Roth conversions after retirement?

Post by RedDog »

02nz wrote: Sun Jan 23, 2022 11:55 am Roth conversions are especially attractive when done in years between retirement and starting SS. Basically:

1) Fill up the low-tax space - a MFJ couple with no other income can withdraw/convert over $100K every year and pay an average of just 9% federal income tax;
2) Reduce future RMDs;
3) Reduce the exposure of future SS benefits to income tax; and
4) Mitigate the likelihood that when one of you predeceases the other, the survivor faces higher tax rates as a single filer.
5) Simplicity
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Re: help me understand why Roth conversions after retirement?

Post by susan123 »

Exchme wrote: Tue Jan 25, 2022 7:05 am

Above that and every $ of Roth Conversions is taxed at 12% and pushes a $ of LTCG+QDiv to also be taxed at 15%. So this 15% capital gain phase-in range creates a zone at 12%+15% = 27% marginal rate. Once you get to the top of the 12% bracket and into the 22% (at $83,550 MFJ) for ordinary income, you are through the capital gains phase-in so your marginal tax rate actually declines to 22%.
I don't think it's 12%+15%=27% marginal rate. It should be 12% x Taxable Income +15% x LTCG_QDiv.

Next bracket is 22% x Taxable Income +15% x LTCG_QDiv. There is no decline.
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Re: help me understand why Roth conversions after retirement?

Post by Exchme »

susan123 wrote: Tue Jan 25, 2022 1:22 pm
Exchme wrote: Tue Jan 25, 2022 7:05 am

Above that and every $ of Roth Conversions is taxed at 12% and pushes a $ of LTCG+QDiv to also be taxed at 15%. So this 15% capital gain phase-in range creates a zone at 12%+15% = 27% marginal rate. Once you get to the top of the 12% bracket and into the 22% (at $83,550 MFJ) for ordinary income, you are through the capital gains phase-in so your marginal tax rate actually declines to 22%.
I don't think it's 12%+15%=27% marginal rate. It should be 12% x Taxable Income +15% x LTCG_QDiv.

Next bracket is 22% x Taxable Income +15% x LTCG_QDiv. There is no decline.
Nope, it is as I said. Once above the 0% capital gains bracket, an extra $ of ordinary income like a Roth conversion is both taxed at 12% and pushes a $ of capital gains into the 15% bracket, so you get 27% for the marginal tax rate. It's due to the phase-in of the 15% capital gains tax rate. It's a very nasty trick the government plays on us and it means a lot of times the top of the 0% capital gains bracket is the place to stop for Roth Conversions.
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Re: help me understand why Roth conversions after retirement?

Post by ncbill »

dred pirate wrote: Sun Jan 23, 2022 11:51 am So - I often hear people talk about Roth conversions of their 401k after retirement.
Basically I think people roll over the 401k to a roll-over IRA, then take portions of it, pay income taxes, and make that portion now a Roth IRA.
What is the exact rationale for this? The reasons I can think of are:
1. You think your RMD's are going to put you in a higher tax bracket when they come due vs what you would pay now (take conversions to the top of the 22 or 24% tax bracket assuming you will be in an even higher tax bracket when RMD's come due). Wouldn't this require a very large 401k to put you into this territory?
2. You intend to pass on the IRA after your passing and inheriting a Roth IRA is better than a traditional IRA? (I honestly do not know if this is true - but I think I remember hearing that in the past)
3. You want to make the conversions while your tax rate is lower as the TCJA of 2017 will expire in 2026 if not renewed.

I do wonder what percentage of us BH's would fall into #1?

Cheers
DP
I view #3 as a given since we're not allowed to speculate here. :)

#1...converting only up to the top of the (MFJ) 12% bracket, but over several years...should be done the year we both turn 59 1/2.
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LilyFleur
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Re: help me understand why Roth conversions after retirement?

Post by LilyFleur »

dboeger1 wrote: Sun Jan 23, 2022 1:55 pm Another consideration that is somewhat market-timing-adjacent but also akin to tax-loss harvesting (which Bogleheads don't seem to mind) is performing Roth conversions during market downturns. If the market crashes 50%, that's potentially 50% less taxable income required to convert the same percentage of the portfolio, and then any future gains in Roth are tax-free. Many people opportunistically performed Roth conversions in the short crash of 2020 and made out like bandits. I suppose the thing that makes it more sensible than market-timing is that you're never really out of the market for very long if at all, and while it may be impossible to time the very bottom, converting in any downturn is objectively better than converting at the previous high. There's no sense in delaying planned conversions in hopes of a crash, but if one does happen and an investor has funds ready to convert, they may want to take advantage in the moment, perhaps even converting more into higher tax brackets than usual if the expected long-term Roth benefits seem worth it.
This strategy also worked well for me in 2020 with an inherited IRA. I emptied it when the market was quite low. (I knew an inherited, inherited-IRA would be difficult for one of my children to manage, so I already had the goal of getting rid of it to streamline my estate.) Under current law, my children will inherit the stepped-up basis in my taxable account.
sandman59
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Re: help me understand why Roth conversions after retirement?

Post by sandman59 »

If you are taking advantage of a down turn in the market to do a conversion, do you (can you) transfer actual shares from your ira to your Roth account? Or do you sell them first in your ira and transfer the proceeds and buy back in Roth?
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willthrill81
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Re: help me understand why Roth conversions after retirement?

Post by willthrill81 »

sandman59 wrote: Tue Jan 25, 2022 4:32 pm If you are taking advantage of a down turn in the market to do a conversion, do you (can you) transfer actual shares from your ira to your Roth account? Or do you sell them first in your ira and transfer the proceeds and buy back in Roth?
Transferring shares keeps you invested. Some brokers will do it but not all.
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OhBoyUhoh
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Re: help me understand why Roth conversions after retirement?

Post by OhBoyUhoh »

marcopolo wrote: Tue Jan 25, 2022 10:00 am
[
We have been doing essentially the same thing for the last 4 years after retiring at age 51.
How are you getting health insurance? If on ACA plan just be aware that those conversions in 12% bracket are really costing you ~22% marginal tax rate and make sure that is still worth doing. It is for us, but conversions in the 22% bracket, costing 32% does not seem worth it.
Marcopolo
Can you elaborate on your comment re "conversions in 12% bracket are really costing you ~22% marginal tax rate "

Thank you.
I had money, I had none. I had money, I had none. But I never been so broke that I couldn't leave town. (Jim, Ray, Robby, John)
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