Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

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URSnshn
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Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

Post by URSnshn »

[***Edited for clarity***] I have two more questions that have come up as my FIL and I look at his tax situation in the future. We are hoping you might be able to shed some light on them.

1) Regarding a Roth Conversion: How large of a conversion makes sense when converting from a Rollover IRA to a Roth IRA with respect to future RMD's for the owner of the IRA? As an example: If one has $2,000,000 what's the point of converting only $100,000? What's the point between trying to squeeze a dollar out of a stone and deciding to just let it go? Any rules of thumb? [edited for clarity 6/24/21]

2) is it ever advisable do a Roth Conversion anyway even if you have to pay OUT OF the Roth conversion itself for taxes? My FIL will be 72 next year and is considering a conversion this year and possibly in future years. So will be taking RMDs next year. [edited for clarity 6/24/21]
Last edited by URSnshn on Thu Jun 24, 2021 4:26 pm, edited 3 times in total.
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arcticpineapplecorp.
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Re: Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

Post by arcticpineapplecorp. »

URSnshn wrote: Thu Jun 24, 2021 3:55 pm I have two more questions that have come up as my FIL and I look at his tax situation in the future. We are hoping you might be able to shed some light on them.

1) How much does one have to transfer from a Rollover IRA to a Roth IRA to make much of a difference going forward with respect to future RMD's? As an example: If one has $2,000,000 what's the point of converting only $100,000? What's the point between trying to squeeze a dollar out of a stone and deciding to just let it go? Any rules of thumb?

2) is it ever advisable do a Roth Conversion anyway even if you have to pay OUT OF the Roth conversion itself for taxes?
#1.
A. If the recipient (inheritor) will pay 0% tax
B. If the recipient (inheritor)'s tax bracket is higher than the converter's bracket.

#2. I wouldn't, but await other's answers.
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celia
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Re: Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

Post by celia »

URSnshn wrote: Thu Jun 24, 2021 3:55 pm 1) How much does one have to transfer from a Rollover IRA to a Roth IRA to make much of a difference going forward with respect to future RMD's? As an example: If one has $2,000,000 what's the point of converting only $100,000? What's the point between trying to squeeze a dollar out of a stone and deciding to just let it go? Any rules of thumb?
One rule of thumb is to plan to keep your Taxable Income level starting when you retire until your final days.

Another one is to convert at least the average annual growth in the account, to keep it from growing too much.

Another way to look at Roth conversions during retirement is by following my links in this thread to get the big picture of what you’re working with and then to build a plan using my spreadsheet method.
2) is it ever advisable do a Roth Conversion anyway even if you have to pay OUT OF the Roth conversion itself for taxes?
The referenced thread talks about this starting around the middle of the first page.


In 10 years, if you/your FIL look back at these ten years, expect to find that things weren’t perfect, but doing some conversions was a better choice than not doing anything. I would convert a little more than what you think is prudent each year. But you also need to be aware of the IRMAA surcharges on Medicare Part B and Part D premiums.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Re: Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

Post by David Jay »

URSnshn wrote: Thu Jun 24, 2021 3:55 pm 2) is it ever advisable do a Roth Conversion anyway even if you have to pay OUT OF the Roth conversion itself for taxes?
Yes. It still still makes sense if doing so significantly reduces the tax rate. Also, it always makes sense in the “0%” tax bracket: https://bogleheads.org/forum/viewtopic. ... 0&t=237277
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Re: Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

Post by Eagle33 »

David Jay wrote: Thu Jun 24, 2021 5:31 pm
URSnshn wrote: Thu Jun 24, 2021 3:55 pm 2) is it ever advisable do a Roth Conversion anyway even if you have to pay OUT OF the Roth conversion itself for taxes?
Yes. It still still makes sense if doing so significantly reduces the tax rate. Also, it always makes sense in the “0%” tax bracket: https://bogleheads.org/forum/viewtopic. ... 0&t=237277
It may be best to make a Roth conversion that excludes the tax amount, then withdraw the tax amount from tIRA & withhold 100% so you can avoid the need for quarterly estimated tax payments.
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Re: Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

Post by URSnshn »

Thank you all for your comments, resources and thoughts. We'll be re-reading and doing a little more work it looks like!
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Re: Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

Post by LilyFleur »

celia wrote: Thu Jun 24, 2021 4:22 pm
URSnshn wrote: Thu Jun 24, 2021 3:55 pm 1) How much does one have to transfer from a Rollover IRA to a Roth IRA to make much of a difference going forward with respect to future RMD's? As an example: If one has $2,000,000 what's the point of converting only $100,000? What's the point between trying to squeeze a dollar out of a stone and deciding to just let it go? Any rules of thumb?
One rule of thumb is to plan to keep your Taxable Income level starting when you retire until your final days.

Another one is to convert at least the average annual growth in the account, to keep it from growing too much.

Another way to look at Roth conversions during retirement is by following my links in this thread to get the big picture of what you’re working with and then to build a plan using my spreadsheet method.
2) is it ever advisable do a Roth Conversion anyway even if you have to pay OUT OF the Roth conversion itself for taxes?
The referenced thread talks about this starting around the middle of the first page.


In 10 years, if you/your FIL look back at these ten years, expect to find that things weren’t perfect, but doing some conversions was a better choice than not doing anything. I would convert a little more than what you think is prudent each year. But you also need to be aware of the IRMAA surcharges on Medicare Part B and Part D premiums.
Would it ever make sense to go big on Roth conversions one year and go ahead and pay the IRMAA, and then take a much lower income the following year, and not pay IRMAA? I guess you'd have to do the math.

Folks with big 401ks and IRAs have big tax problems :annoyed

Of course, if I hadn't joined this forum, I probably wouldn't have even become aware of the nuances of Roth conversions.
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Re: Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

Post by secondcor521 »

1. Personally I try to convert as much as possible until my current marginal rate exceeds my predicted age-75 marginal rate. I have a spreadsheet set up to help predict the latter. It includes traditional IRA account growth, SS benefits, basic federal income taxes, and IRMAA surcharges.

Depending on how old you are, trying to predict age-75 marginal rates may involve guessing what you think tax brackets will do in 2026. Nobody knows. I assume they stay the same.

I think it also depends on how much someone thinks locking in the current tax rates is a good idea and how likely it is to succeed.

2. Probably. It'd depend on how much you lose in taxes on the conversion vs. what you're going to save by doing the conversion. If the person is under 59.5 they'll also have to account for the 10% early withdrawal penalty.

3. On the "go big" question, it'd again depend on how much you save on IRMAA vs. how much it costs to "go big". It'd also depend on if there were other tax savings or costs...for example, going big one year might adversely impact other tax credits or thresholds, such as losing the AOTC or adding NIIT or AMT.
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Re: Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

Post by tibbitts »

LilyFleur wrote: Fri Jun 25, 2021 12:38 pm Would it ever make sense to go big on Roth conversions one year and go ahead and pay the IRMAA, and then take a much lower income the following?
That's what I'm doing this year. It should, if I understand, only result in 3 or 4 months (I need to check on that further) of higher IRMAA at the end of 2023 (due to when my 63rd birthday occurs this year.) But for future years, possibly it makes sense to lump conversions much like people lump deductions, although that was more common before the recent tax law changes that have made it less common to itemize. However the obvious advantage of lumping could be more than offset by the increase in marginal rate for any give year combined with the increase in IRMAA and maybe NIIT, so it's really an individual decision. I suspect that for many single people especially, it's easy for IRMAA to be a tail-wagging-the-dog situation relative to marginal tax rates.
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Re: Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

Post by LilyFleur »

tibbitts wrote: Fri Jun 25, 2021 1:01 pm
LilyFleur wrote: Fri Jun 25, 2021 12:38 pm Would it ever make sense to go big on Roth conversions one year and go ahead and pay the IRMAA, and then take a much lower income the following?
That's what I'm doing this year. It should, if I understand, only result in 4 months of higher IRMAA at the end of 2023 (due to when my 63rd birthday occurs this year.) But for future years, possibly it makes sense to lump conversions much like people lump deductions, although that was more common before the recent tax law changes that have made it less common to itemize. However the obvious advantage of lumping could be more than offset by the increase in marginal rate for any give year combined with the increase in IRMAA and maybe NIIT, so it's really an individual decision. I suspect that for many single people especially, it's easy for IRMAA to be a tail-wagging-the-dog situation relative to marginal tax rates.
The single tax brackets are quite challenging, especially in a high-income tax state. I have a huge spreadsheet that estimates my income taxes every year (including estimated deductions which usually I itemize because of high health insurance premiums and medical costs), including the effect of a conversion... (thanks for this reminder, I need to bump up my withholding). I have two more years before it will affect IRMAA, and who knows when the tax laws will be changed... :annoyed
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Re: Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

Post by CAsage »

Personally, we convert to the top of our MFJ tax bracket, and I include withdrawals to pay the taxes in that amount. E.g. convert 100K in January, send 30K in December to the tax men (IRS and CA FTB), add $130k to income. The "usual" advice on this is to pay it with after tax funds, but ... my after tax funds can be managed much more efficiently as capital gains or tax-free muni, vs growth in my IRA (always income). Also, once you are of retirement age, long term growth is more in my Roth for heirs. I plan to draw it down as fast and hard as I can, whether to pay taxes or do Roth, you have to pull it out at sometime.
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Re: Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

Post by David Jay »

Eagle33 wrote: Fri Jun 25, 2021 12:01 pm
David Jay wrote: Thu Jun 24, 2021 5:31 pm
URSnshn wrote: Thu Jun 24, 2021 3:55 pm 2) is it ever advisable do a Roth Conversion anyway even if you have to pay OUT OF the Roth conversion itself for taxes?
Yes. It still still makes sense if doing so significantly reduces the tax rate. Also, it always makes sense in the “0%” tax bracket: https://bogleheads.org/forum/viewtopic. ... 0&t=237277
It may be best to make a Roth conversion that excludes the tax amount, then withdraw the tax amount from tIRA & withhold 100% so you can avoid the need for quarterly estimated tax payments.
+1 In the case of a Vanguard brokerage accounts, one can withhold directly from the Roth Conversion, this plan can be accomplished in a single step.
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celia
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Re: Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

Post by celia »

secondcor521 wrote: Fri Jun 25, 2021 12:58 pm 2. Probably. It'd depend on how much you lose in taxes on the conversion vs. what you're going to save by doing the conversion. If the person is under 59.5 they'll also have to account for the 10% early withdrawal penalty.
Looking at what you "lose in taxes on the conversion" is not a good way to look at it. You are going to pay the exact same taxes whether you convert or withdraw to taxable. And if you do neither, that asset will continue to grow, meaning you will pay more taxes in the future, as your future RMDs will be larger.
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Re: Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

Post by secondcor521 »

celia wrote: Fri Jun 25, 2021 7:26 pm
secondcor521 wrote: Fri Jun 25, 2021 12:58 pm 2. Probably. It'd depend on how much you lose in taxes on the conversion vs. what you're going to save by doing the conversion. If the person is under 59.5 they'll also have to account for the 10% early withdrawal penalty.
Looking at what you "lose in taxes on the conversion" is not a good way to look at it. You are going to pay the exact same taxes whether you convert or withdraw to taxable. And if you do neither, that asset will continue to grow, meaning you will pay more taxes in the future, as your future RMDs will be larger.
My answer was in the context of paying the taxes out of the conversion (the second question in the OP), possibly before age 59.5. Of course there will always be taxes on the conversion, and I understand that as the assets grow, the taxes due will also grow. What I was referring to in the part that you emphasized was the taxes (and possible penalty) owed on the amount withdrawn from the traditional IRA to pay the taxes on the main converted amount.

For example, if you convert $10K and are in the 12% bracket and want to pay taxes out of the traditional IRA, you'll have to remove about $11,364, sending $1,364 to the federal government and $10K to your Roth. Even a bit more if you're under 59.5 and have to pay the 10% penalty on the 1,364 and want to pay that 10% penalty from the traditional IRA also.

For the more typical conversion scenario, you convert $10K and pay the $1,200 from taxable.

So what I was referring to was the additional $164 in taxes, plus another $136 or so in EWP in the situation the OP was asking about in their second question.
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Re: Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

Post by David Jay »

secondcor521 wrote: Fri Jun 25, 2021 8:22 pm
celia wrote: Fri Jun 25, 2021 7:26 pm
secondcor521 wrote: Fri Jun 25, 2021 12:58 pm 2. Probably. It'd depend on how much you lose in taxes on the conversion vs. what you're going to save by doing the conversion. If the person is under 59.5 they'll also have to account for the 10% early withdrawal penalty.
Looking at what you "lose in taxes on the conversion" is not a good way to look at it. You are going to pay the exact same taxes whether you convert or withdraw to taxable. And if you do neither, that asset will continue to grow, meaning you will pay more taxes in the future, as your future RMDs will be larger.
My answer was in the context of paying the taxes out of the conversion (the second question in the OP), possibly before age 59.5. Of course there will always be taxes on the conversion, and I understand that as the assets grow, the taxes due will also grow. What I was referring to in the part that you emphasized was the taxes (and possible penalty) owed on the amount withdrawn from the traditional IRA to pay the taxes on the main converted amount.

For example, if you convert $10K and are in the 12% bracket and want to pay taxes out of the traditional IRA, you'll have to remove about $11,364, sending $1,364 to the federal government and $10K to your Roth. Even a bit more if you're under 59.5 and have to pay the 10% penalty on the 1,364 and want to pay that 10% penalty from the traditional IRA also.

For the more typical conversion scenario, you convert $10K and pay the $1,200 from taxable.

So what I was referring to was the additional $164 in taxes, plus another $136 or so in EWP in the situation the OP was asking about in their second question.
Father-in-law is age 72.
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Re: Questions on Rollover IRA conversion rule of thumb AND taxes out of the conversion itself

Post by secondcor521 »

David Jay wrote: Fri Jun 25, 2021 8:30 pm
secondcor521 wrote: Fri Jun 25, 2021 8:22 pm
celia wrote: Fri Jun 25, 2021 7:26 pm
secondcor521 wrote: Fri Jun 25, 2021 12:58 pm 2. Probably. It'd depend on how much you lose in taxes on the conversion vs. what you're going to save by doing the conversion. If the person is under 59.5 they'll also have to account for the 10% early withdrawal penalty.
Looking at what you "lose in taxes on the conversion" is not a good way to look at it. You are going to pay the exact same taxes whether you convert or withdraw to taxable. And if you do neither, that asset will continue to grow, meaning you will pay more taxes in the future, as your future RMDs will be larger.
My answer was in the context of paying the taxes out of the conversion (the second question in the OP), possibly before age 59.5. Of course there will always be taxes on the conversion, and I understand that as the assets grow, the taxes due will also grow. What I was referring to in the part that you emphasized was the taxes (and possible penalty) owed on the amount withdrawn from the traditional IRA to pay the taxes on the main converted amount.

For example, if you convert $10K and are in the 12% bracket and want to pay taxes out of the traditional IRA, you'll have to remove about $11,364, sending $1,364 to the federal government and $10K to your Roth. Even a bit more if you're under 59.5 and have to pay the 10% penalty on the 1,364 and want to pay that 10% penalty from the traditional IRA also.

For the more typical conversion scenario, you convert $10K and pay the $1,200 from taxable.

So what I was referring to was the additional $164 in taxes, plus another $136 or so in EWP in the situation the OP was asking about in their second question.
Father-in-law is age 72.
Right. My answer was intended to be general for others who may have the same question.
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