Tax case study: Roth conversion, "wasted" capital losses, & Premium Tax Credit

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Topic Author
pangolin.
Posts: 2
Joined: Wed May 05, 2021 6:07 pm

Tax case study: Roth conversion, "wasted" capital losses, & Premium Tax Credit

Post by pangolin. »

I became financially independent and stopped working full time this year, which has opened up some tax planning opportunities (fun! :happy). Given that my taxable income will be very low for the foreseeable future, I'm thinking about doing a partial Roth conversion in order to fill up space within the 12% bracket while staying within the 0% bracket for qualified dividends and LTCG. However, doing so would result in receiving a smaller Premium Tax Credit and paying more taxes.

I'm looking for some outside perspective on the following scenarios, which involve potentially "wasting" capital losses and making the most of the PTC changes with the American Rescue Plan.

Scenario 1
- Convert $25K to Roth IRA, bringing taxable income just under $40K and filling up 0% LTCG bracket
- Pay approximately $2,100 total tax (fed)
- Receive a tax credit, reducing healthcare premium cost to about $2,900 for the year
- Some income generated by selling from taxable account, incurring $37K in LTCG. This is entirely covered by capital loss carryover, with none "wasted" given filled 0% bracket

Scenario 2
- Convert $5K to Roth IRA. Taxable income is ~$20K after deductions
- Pay no federal taxes (income is mostly qualified dividends)
- Receive a tax credit, reducing healthcare premium cost to $0
- Same $37K in LTCG covered by capital loss carryover, but a significant portion of the loss carryover is wasted given that some of the 0% LTCG bracket is unfilled

I imagine that whichever scenario I follow will also apply to the next couple years. Scenario 2 allows me to keep ~$5K more invested annually, which is not much now but significant in the long run (I am 33 yo). Admittedly, I was thinking about scenario 1 mostly because the idea of wasting a large capital loss carryover doesn't sit well! I have ~$140K in capital loss carryover and much of it would be wasted if scenario 2 were followed for a few years.

At the same time, I have about $300K total in TIRA + 401K that I'd like to convert over time. Those accounts will likely outpace $5K/year, so perhaps I should make the most of current circumstances and convert larger sums at the expense of some tax.

Am I missing anything major? Are there other avenues that I should consider?
Many thanks in advance!
terran
Posts: 3049
Joined: Sat Jan 10, 2015 9:50 pm

Re: Tax case study: Roth conversion, "wasted" capital losses, & Premium Tax Credit

Post by terran »

Do you plan to stay retired forever or do you expect to have additional earned income at some point. If you're not planning to work again then you have a lot of years ahead of you to convert that $300k. I might think about shooting to have it depleted by the the time you plan to start social security, although I haven't looked closely enough at social security taxation to say that for sure. I think you might be able to have some other income without causing social security to be taxed. I'd certainly at least fill up the standard deduction + $3000 capital loss deduction (as long as you have it) with Roth conversions, interest and non-qualified dividends so you don't "waste" that 0% tax bracket. If you are planning to go back to work then I might convert more if you expect to rebuild your tax deferred balance when you're working.
Topic Author
pangolin.
Posts: 2
Joined: Wed May 05, 2021 6:07 pm

Re: Tax case study: Roth conversion, "wasted" capital losses, & Premium Tax Credit

Post by pangolin. »

Thanks for the input terran; I'll likely have some income in the future, but it's difficult to anticipate how much (I'm planning on starting a business based on my hobbies and would probably fund a solo Roth 401K first).
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