ACA Subsidy / Roth Conversion

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
Post Reply
Topic Author
spartyfanaa
Posts: 44
Joined: Mon Oct 14, 2019 6:49 pm

ACA Subsidy / Roth Conversion

Post by spartyfanaa »

Hello Bogleheads,

I would appreciate some advice on whether to take an ACA subsidy for health insurance through the marketplace or convert traditional IRA $ into a Roth to help avoid taxes on RMD later in life. Perhaps doing a combination of both is also a possible option? I don't have complete details on the amount of the subsidy yet. I am trying to get some advice on key things to consider. For me, immediate cash flow is a strong consideration (i.e. ACA subsidy), but this may not be the best long term solution.

Background:
-Age 53, Married, empty-nesters
-Investment Portfolio - $2.7 mm, including $320k in short term liquid assets - I bonds, money market, demand notes; Asset Allocation 60/40
-Transitioning to part-time work/semi retirement in January; DW works part time and earns about $10-$15k/year. She will continue working. I anticipate working 15-20 hours a week at a hobby type job where pay is not the primary factor - - more about staying busy with something I enjoy. Likely to earn $20k+ annually. So, for these purposes, call it $40k total annual income.
-Estimated annual expenses, including healthcare, around $85-$90k; plan is to use cash reserves to cover balance of expenses
-Likely to sell primary residence next spring and relocate to 2nd home; plan is to pay off the 2nd home and will likely have $140k residual to invest back in the market - - in addition to portfolio value noted above
- Plan to take SS at age 70; estimated about $48,000.

Investment Breakdown:
- $1.1 mm in Traditional IRA/401(k)
- $760k in After Tax Account
- $423k in Roth Accounts
-$320k cash equivalent
- $80k PE real estate - likely to pay out equity in CY 2023.

Questions:
1. What are the key considerations for deciding whether to convert the Roth or take an ACA subsidy to offset healthcare costs? Given the portfolio allocation note above, any recommendations?
2. Unrelated to the ACA question.... I currently reinvest dividends. Would you turn them off in my situation when I transition to part-time work? Anticipated dividend income is $12k/year.

Thank you very much for your thoughts/opinions.
User avatar
FiveK
Posts: 15742
Joined: Sun Mar 16, 2014 2:43 pm

Re: ACA Subsidy / Roth Conversion

Post by FiveK »

1. Two references for you: Roth IRA conversion - Bogleheads and Roth Conversion and Capital Gains On ACA Health Insurance. Do those help?

2. If you anticipate that your part-time work will not provide enough cash flow, then taking the dividends as cash instead of reinvesting makes sense.
marcopolo
Posts: 8445
Joined: Sat Dec 03, 2016 9:22 am

Re: ACA Subsidy / Roth Conversion

Post by marcopolo »

Do you have any pensions, or other taxable income streams?

If not, I don't think there is much benefit to doing Roth Conversions in your case. I am sure others will disagree.

For this year and next year, since there is no ACA income cliff, the loss of tax-credits amounts to an additional 8.5% tax rate. With your other income, you would have some space in the 12% bracket. So, that would mean a tax rate of 20.5%. Without any pension, your withdrawal in retirement will most likely be in the 12% bracket, which may revert back to 15% in a few years, if not extended. It would not make sense to pay 20.5% now to save 13% (15%) later. One could make the argument that if one of you passes away early, the surviving spouse, filing single, would be in a higher bracket. To hedge against that possibility, you could do small conversions up to the top of the 12% bracket. I don't think even that would justify going into the 22% bracket (30.5% with loss of subsidy).

After 2022, the ACA cliff comes into play. The effect of that will depend on your insurance costs, but can often cause very steep loss of tax-credits once crossed (high marginal rate). In that case it would probably only make sense to convert to up to the cliff, at all.

One easy thing you could do to reduce the hit of future RMDs is to do tax-efficient asset location. whatever asset allocation you are comfortable with, put as much of the fixed income as possible in your tIRA. Keep equities mostly in Roth and taxable accounts. This will slow the growth of your tIRA, keeping a lid on the size of your RMDs.

Definitely turn off reinvestments in the taxable accounts. You are paying tax on this anyway, and it will count towards your income for ACA tax-credit calculation, so might as well put that towards your expenses before making other withdrawals.

Good luck to you.
Once in a while you get shown the light, in the strangest of places if you look at it right.
Northern Flicker
Posts: 15363
Joined: Fri Apr 10, 2015 12:29 am

Re: ACA Subsidy / Roth Conversion

Post by Northern Flicker »

Factor the estimated change in premium tax credit into your determination of the marginal rate of the conversion.
curmudgeon
Posts: 2630
Joined: Thu Jun 20, 2013 11:00 pm

Re: ACA Subsidy / Roth Conversion

Post by curmudgeon »

At your age, and with $1.1m in pre-tax, you've got quite a bit of time to work with (and also for congress to change the rules under your feet). A few thoughts for you:

1) Health insurance cost is a major factor in an early retirement situation like this. There's a lot of variation from state to state, and even county to county. Do research both for your current location and your potential retirement move. In most situations, premiums will go up significantly as you age further, though this may be offset by increased subsidy. ACA currently has relaxed subsidy limits, but those are currently due to pop back to the "ACA cliff" limits in 2023.

2) Cash flow and taxable income are only loosely related; it's entirely possible to spend $120K per year while keeping your taxable income below the ~$69K ACA cliff for quite a while, if you can arrange your cash sources appropriately. Having no mortgage can definitely help reduce cash flow needs as well; a paid-off house doesn't count against your subsidy.

3) An HSA-eligible ACA plan (somewhat rare, but sometimes an option) can help manage income if you typically have low medical expenses. You can put $7K (plus $1K each after you hit 55) into the HSA and deduct that from taxable income to give you a little more room under the cliff. This does require having cash available to fund the HSA that is not triggering additional taxable income to access, though. Dental expenses often start to become significant as you age, and those can be paid out of the HSA.

4) It doesn't have to be a one-time choice. You might choose to give up the subsidy one year to replenish your cash reserves in a way that will let you get the subsidy for several years following.

5) Once you hit age 65 and go on medicare, there will be increased flexibility for Roth conversions (under current rules). You will want to be aware of IRMAA impacts, but those are much lower impact than the ACA cliff. Lots of folks plan to bump up Roth conversions significantly in the age 65-70 range. If you and spouse have different ages, that can complicate things somewhat.
calwatch
Posts: 1447
Joined: Wed Oct 02, 2013 1:48 am

Re: ACA Subsidy / Roth Conversion

Post by calwatch »

If you are working it might be possible to get health insurance through your job? Even if the subsidy was minimal or zero, it would have the benefit of being tax exempt (offsetting wages) and take advantage of group rates as opposed to the age based individual rates. You also would not need to worry about ACA in this instance.
User avatar
celia
Posts: 16774
Joined: Sun Mar 09, 2008 6:32 am
Location: SoCal

Re: ACA Subsidy / Roth Conversion

Post by celia »

1. I don’t know very much about the ACA but understand for 2021 and 2022, you will be eligible for it irregardless of your income for the year. Maybe you can call the department of insurance for your state to confirm this and ask any other questions you have.

2. Yes, if you will need to start spending your dividends, it makes sense to turn off automatic re-investong in your taxable accounts.

X. Your $1.1M in tax-deferred could double in 10 years or so. Then, it could double again before RMDs start at 72. This (and next) year seem like a good time to do significant Roth conversions, assuming ACA won’t hinder you tax-wise. I would at least fill up the current 22% tax bracket and convert stock funds/ETFs.
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.
marcopolo
Posts: 8445
Joined: Sat Dec 03, 2016 9:22 am

Re: ACA Subsidy / Roth Conversion

Post by marcopolo »

celia wrote: Thu Sep 16, 2021 1:12 am 1. I don’t know very much about the ACA but understand for 2021 and 2022, you will be eligible for it irregardless of your income for the year. Maybe you can call the department of insurance for your state to confirm this and ask any other questions you have.

2. Yes, if you will need to start spending your dividends, it makes sense to turn off automatic re-investong in your taxable accounts.

X. Your $1.1M in tax-deferred could double in 10 years or so. Then, it could double again before RMDs start at 72. This (and next) year seem like a good time to do significant Roth conversions, assuming ACA won’t hinder you tax-wise. I would at least fill up the current 22% tax bracket and convert stock funds/ETFs.
Filling up the 22% bracket would mean paying 30.5% rate with loss of ACA subsidy. Do you think the OP is likely to be in that high of a bracket when taking RMDs?

If they structure their portfolio to hold mostly fixed income assets in the tIRA, how will it quadruple in real terms by the time RMDs start? This just seems like a scare tactic.
Once in a while you get shown the light, in the strangest of places if you look at it right.
User avatar
celia
Posts: 16774
Joined: Sun Mar 09, 2008 6:32 am
Location: SoCal

Re: ACA Subsidy / Roth Conversion

Post by celia »

marcopolo wrote: Thu Sep 16, 2021 1:40 am
celia wrote: Thu Sep 16, 2021 1:12 am 1. I don’t know very much about the ACA but understand for 2021 and 2022, you will be eligible for it irregardless of your income for the year. Maybe you can call the department of insurance for your state to confirm this and ask any other questions you have.

2. Yes, if you will need to start spending your dividends, it makes sense to turn off automatic re-investong in your taxable accounts.

X. Your $1.1M in tax-deferred could double in 10 years or so. Then, it could double again before RMDs start at 72. This (and next) year seem like a good time to do significant Roth conversions, assuming ACA won’t hinder you tax-wise. I would at least fill up the current 22% tax bracket and convert stock funds/ETFs.
Filling up the 22% bracket would mean paying 30.5% rate with loss of ACA subsidy. Do you think the OP is likely to be in that high of a bracket when taking RMDs?

If they structure their portfolio to hold mostly fixed income assets in the tIRA, how will it quadruple in real terms by the time RMDs start? This just seems like a scare tactic.
Even you mentioned the temporary change in rules for the ACA subsidy. You likely know more about them than I do. So, please explain how they impact this.

And if you couple that with having a large amount in tax-deferred at a relatively younger age, that tells me OP/ spouse had higher income while working, likely was in a tax bracket above 22%. If they just let the $1.1M grow to $4.4M, their RMDs would start at $176K. Wouldn’t that alone put them in a higher tax bracket than 22% (not counting SS, pensions, capital gains in taxable, etc).
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.
marcopolo
Posts: 8445
Joined: Sat Dec 03, 2016 9:22 am

Re: ACA Subsidy / Roth Conversion

Post by marcopolo »

celia wrote: Thu Sep 16, 2021 10:28 am
marcopolo wrote: Thu Sep 16, 2021 1:40 am
celia wrote: Thu Sep 16, 2021 1:12 am 1. I don’t know very much about the ACA but understand for 2021 and 2022, you will be eligible for it irregardless of your income for the year. Maybe you can call the department of insurance for your state to confirm this and ask any other questions you have.

2. Yes, if you will need to start spending your dividends, it makes sense to turn off automatic re-investong in your taxable accounts.

X. Your $1.1M in tax-deferred could double in 10 years or so. Then, it could double again before RMDs start at 72. This (and next) year seem like a good time to do significant Roth conversions, assuming ACA won’t hinder you tax-wise. I would at least fill up the current 22% tax bracket and convert stock funds/ETFs.
Filling up the 22% bracket would mean paying 30.5% rate with loss of ACA subsidy. Do you think the OP is likely to be in that high of a bracket when taking RMDs?

If they structure their portfolio to hold mostly fixed income assets in the tIRA, how will it quadruple in real terms by the time RMDs start? This just seems like a scare tactic.
Even you mentioned the temporary change in rules for the ACA subsidy. You likely know more about them than I do. So, please explain how they impact this.

And if you couple that with having a large amount in tax-deferred at a relatively younger age, that tells me OP/ spouse had higher income while working, likely was in a tax bracket above 22%. If they just let the $1.1M grow to $4.4M, their RMDs would start at $176K. Wouldn’t that alone put them in a higher tax bracket than 22% (not counting SS, pensions, capital gains in taxable, etc).
The changes for the next two years eliminated the cliff, which means there is not an abrupt loss of tax credits, and reduced the percentage of MAGI one is expected to pay from 9.8% to 8.5%.

Under the regular rules, one loses 9.8% of each additional dollar of income until the income hits 400% of FPL, at which point the tax-credits go to zero.

For the next two years, one loses 8.5% of each additional dollar of income until the tax-credit goes to zero, regardless of income. Adding the 8.5% loss if tax credit to the 22% tax rate, effectively results in a 30.5% marginal tax on those conversions.

So, the loss of tax credits currently amounts to 8.5% additional tax on each converted dollar, until it goes to zero, at which point the marginal tax rate goes back down.

I am not sure what their tax rates while working has to do with anything. You still didn't answer my question. If they structure their portfolio in a tax efficient manner and put mostly fixed income assets in the tIRA, how will it quadruple in real terms before they get to RMD age?
Once in a while you get shown the light, in the strangest of places if you look at it right.
Silk McCue
Posts: 8951
Joined: Thu Feb 25, 2016 6:11 pm

Re: ACA Subsidy / Roth Conversion

Post by Silk McCue »

Check out United Health Tri-Term plans. 1 day shy of three years coverage. You will have to see if they are available in your state. We just retired beginning of the year at 60/62. Doing this gives us great coverage and doesn’t restrict our spending.

https://www.uhone.com/shop/#/census?Lea ... ence-Exact

Cheers
secondcor521
Posts: 1604
Joined: Wed Sep 10, 2014 4:11 pm

Re: ACA Subsidy / Roth Conversion

Post by secondcor521 »

marcopolo wrote: Thu Sep 16, 2021 10:53 am Under the regular rules, one loses 9.8% of each additional dollar of income until the income hits 400% of FPL, at which point the tax-credits go to zero.
Emphasis added. This part is not true for two reasons:

1. The expected contribution amount is calculated by several line segments that increase over the 100% to 400% of FPL range. So under the regular rules, the expected contribution amount increases at a more rapid rate over that range; it is not a consistent percentage. Even in the ARP Act, although the line segment percentages change, it is still segmented. These line segments can be found described in the ARP Act, Section 9661 (page 180 of the PDF here: https://www.congress.gov/117/bills/hr13 ... 319enr.pdf).

2. The applicable figure is not the whole story; the actual marginal rate between 100% and 400% of FPL can be as high as 18% or so. See https://seattlecyclone.com/marginal-tax ... r-the-aca/ and https://seattlecyclone.com/aca-premium- ... 1-edition/

OP, I would consider my marginal rate now (including loss of ACA subsidies as a marginal tax - see the second graph in the second link in reason #2 above) vs. my marginal rate at age 75 (based on a taxable income of (at least) RMDs and 85% of SS less the standard deduction). Personally I convert up until my tax rate now would exceed my tax rate then. It doesn't have to be exact, as there are lots of unknowns (investment rate of return, governmental action around tax laws, where I live the rest of my life, my date of death, my kids' marginal tax rates in the 10 years after I die, etc.)
marcopolo
Posts: 8445
Joined: Sat Dec 03, 2016 9:22 am

Re: ACA Subsidy / Roth Conversion

Post by marcopolo »

secondcor521 wrote: Thu Sep 16, 2021 12:10 pm
marcopolo wrote: Thu Sep 16, 2021 10:53 am Under the regular rules, one loses 9.8% of each additional dollar of income until the income hits 400% of FPL, at which point the tax-credits go to zero.
Emphasis added. This part is not true for two reasons:

1. The expected contribution amount is calculated by several line segments that increase over the 100% to 400% of FPL range. So under the regular rules, the expected contribution amount increases at a more rapid rate over that range; it is not a consistent percentage. Even in the ARP Act, although the line segment percentages change, it is still segmented. These line segments can be found described in the ARP Act, Section 9661 (page 180 of the PDF here: https://www.congress.gov/117/bills/hr13 ... 319enr.pdf).

2. The applicable figure is not the whole story; the actual marginal rate between 100% and 400% of FPL can be as high as 18% or so. See https://seattlecyclone.com/marginal-tax ... r-the-aca/ and https://seattlecyclone.com/aca-premium- ... 1-edition/

OP, I would consider my marginal rate now (including loss of ACA subsidies as a marginal tax - see the second graph in the second link in reason #2 above) vs. my marginal rate at age 75 (based on a taxable income of (at least) RMDs and 85% of SS less the standard deduction). Personally I convert up until my tax rate now would exceed my tax rate then. It doesn't have to be exact, as there are lots of unknowns (investment rate of return, governmental action around tax laws, where I live the rest of my life, my date of death, my kids' marginal tax rates in the 10 years after I die, etc.)
You are correct. I was trying to be succinct, and didn't provide full details. Thanks for the detailed references.

The multi-stepwise rate increases do create odd marginal rates. The 9.8% is the highest rate level as one approaches the cliff. Also, unlike income tax rates, i believe the applicable highest rate applies to all income, not just the amount over the breakpoint.

The same is true for the next two years, there are a set of breakpoints, with the highest level being 8.5%.
Once in a while you get shown the light, in the strangest of places if you look at it right.
User avatar
celia
Posts: 16774
Joined: Sun Mar 09, 2008 6:32 am
Location: SoCal

Re: ACA Subsidy / Roth Conversion

Post by celia »

marcopolo wrote: Thu Sep 16, 2021 10:53 am I am not sure what their tax rates while working has to do with anything.
Since the general rule of thumb is to pay the taxes when you have a lower tax rate, I assume they used to be in higher brackets than now. Being able to save so much in tax-deferred, which originally had contributions come from wages (as opposed to an inheritance or lottery winnings), also tells me their tax rate was higher. Right now is likely to be their lowest-ever tax bracket years, even with the temporary ACA hit they would have, which would be better than when ACA returns to normal. Good overview, by the way!
You still didn't answer my question. If they structure their portfolio in a tax efficient manner and put mostly fixed income assets in the tIRA, how will it quadruple in real terms before they get to RMD age?
Even if they put their 2.7mm portfolio in tax-efficient locations, it would look like this:

Investment Breakdown:
- $1.1 mm in Traditional IRA/401(k) <-- (need to calculate this in a minute)
- $760k in After Tax Account <--all stocks
- $423k in Roth Accounts <--all stocks
- $320k cash equivalent <--part of bonds+cash
- $80k PE real estate - likely to pay out equity in CY 2023 <--include as bonds+cash

To have 40% of the $2,683K portfolio be bonds+cash, they need a total of $1,073K bonds in the portfolio. They already have $400K as bonds+cash, so they need another $673K of bonds in the IRA. To have 60% of the $2,683K portfolio be stocks, they need a total of $1,610K in stocks in the portfolio and already have $1,183K in stocks outsides the IRA, leaving $427K for the IRA.

This leaves the IRA to be needing $673K bonds and $427K stocks. If they don't convert (preferably the stocks), the $427K stocks will double in 10 years and again in another 10 years with an average growth rate of 7% a year, according to the Rule of 72. Let's say the bonds will grow an average of 4%. (Although we are at very low rates now, we likely won't be in 20 years. See 200 Years of Interest Rates in the U.S.) That will take the bonds 18 years to double.

So in 18-20 years, the bonds become $1,346K and the stocks become $1,708K for a total of $3mm. However, if they keep some stocks and bonds in each account, the IRA will grow even more. So I move my target value down a million. This is likely still more than what you would project. And if you think they should withdraw/convert when the tax bracket will be the lowest, when would that be? Waiting until 65 would still give them significant growth that will have conversions/withdrawals likely pushing them into higher tax brackets.

Since their expected SS will be about the same as their working/hobby income for the next few years, don't you agree that their tax bracket will be more than it is now, if they don't convert? And if one of them dies and the survivor files as Single, the tax bracket will be even higher.
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.
Exchme
Posts: 1335
Joined: Sun Sep 06, 2020 3:00 pm

Re: ACA Subsidy / Roth Conversion

Post by Exchme »

celia wrote: Thu Sep 16, 2021 1:29 pm If they don't convert (preferably the stocks), the $427K stocks will double in 10 years and again in another 10 years with an average growth rate of 7% a year, according to the Rule of 72. Let's say the bonds will grow an average of 4%. (Although we are at very low rates now, we likely won't be in 20 years. See 200 Years of Interest Rates in the U.S.) That will take the bonds 18 years to double.
It looks like the plan is to spend down the $320K short term money first and let taxable stocks run, both of those will require a build up of bonds in the t-IRA. So the t-IRA will grow and Roth conversions strategies should be investigated, but I don't see the t-IRA quadrupling by age 72 as likely.

As Curmudgeon mentioned, it's possible the best strategy is an occasional large conversion followed by one to a few years of no (or very small) conversions. The Retiree Portfolio Model latest beta version is a great place to start as it supports the tax efficient portfolio.
User avatar
celia
Posts: 16774
Joined: Sun Mar 09, 2008 6:32 am
Location: SoCal

Re: ACA Subsidy / Roth Conversion

Post by celia »

Exchme wrote: Thu Sep 16, 2021 2:08 pm It looks like the plan is to spend down the $320K short term money first and let taxable stocks run, both of those will require a build up of bonds in the t-IRA. So the t-IRA will grow and Roth conversions strategies should be investigated, but I don't see the t-IRA quadrupling by age 72 as likely.

As Curmudgeon mentioned, it's possible the best strategy is an occasional large conversion followed by one to a few years of no (or very small) conversions. The Retiree Portfolio Model latest beta version is a great place to start as it supports the tax efficient portfolio.
Yes, although the primary question is choosing the ACA benefits or doing Roth conversions, OP is probably open to other suggestions. A Roth conversion ladder would often be suggested for someone retiring before age 55, like OP is. If the OP converted this year and next, there would be more back-up money available to spend in 5 years, by being able to withdraw the converted amount (but not the growth). And the existing Roth contributions can be withdrawn at any time, without penalty. OP just needs good records of how much in contributions and conversions were done each year.
spartyfanaa wrote: Wed Sep 15, 2021 9:35 pm So, for these purposes, call it [part-time jobs] $40k total annual income.
-Estimated annual expenses, including healthcare, around $85-$90k; plan is to use cash reserves to cover balance of expenses
Brackets are mine.

Assuming they will be able to continue working part-time, there is still a 40-50K shortfall they would need to get from somewhere (like the $320K cash account). They also need money for the Roth conversion taxes from taxable or from the conversion itself. But if withheld from the conversions, there will be a 10% early withdrawal penalty for any amount that does not go into the Roth. These are just options to consider.
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.
marcopolo
Posts: 8445
Joined: Sat Dec 03, 2016 9:22 am

Re: ACA Subsidy / Roth Conversion

Post by marcopolo »

celia wrote: Thu Sep 16, 2021 1:29 pm
marcopolo wrote: Thu Sep 16, 2021 10:53 am I am not sure what their tax rates while working has to do with anything.
Since the general rule of thumb is to pay the taxes when you have a lower tax rate, I assume they used to be in higher brackets than now. Being able to save so much in tax-deferred, which originally had contributions come from wages (as opposed to an inheritance or lottery winnings), also tells me their tax rate was higher. Right now is likely to be their lowest-ever tax bracket years, even with the temporary ACA hit they would have, which would be better than when ACA returns to normal. Good overview, by the way!
You still didn't answer my question. If they structure their portfolio in a tax efficient manner and put mostly fixed income assets in the tIRA, how will it quadruple in real terms before they get to RMD age?
Even if they put their 2.7mm portfolio in tax-efficient locations, it would look like this:

Investment Breakdown:
- $1.1 mm in Traditional IRA/401(k) <-- (need to calculate this in a minute)
- $760k in After Tax Account <--all stocks
- $423k in Roth Accounts <--all stocks
- $320k cash equivalent <--part of bonds+cash
- $80k PE real estate - likely to pay out equity in CY 2023 <--include as bonds+cash

To have 40% of the $2,683K portfolio be bonds+cash, they need a total of $1,073K bonds in the portfolio. They already have $400K as bonds+cash, so they need another $673K of bonds in the IRA. To have 60% of the $2,683K portfolio be stocks, they need a total of $1,610K in stocks in the portfolio and already have $1,183K in stocks outsides the IRA, leaving $427K for the IRA.

This leaves the IRA to be needing $673K bonds and $427K stocks. If they don't convert (preferably the stocks), the $427K stocks will double in 10 years and again in another 10 years with an average growth rate of 7% a year, according to the Rule of 72. Let's say the bonds will grow an average of 4%. (Although we are at very low rates now, we likely won't be in 20 years. See 200 Years of Interest Rates in the U.S.) That will take the bonds 18 years to double.

So in 18-20 years, the bonds become $1,346K and the stocks become $1,708K for a total of $3mm. However, if they keep some stocks and bonds in each account, the IRA will grow even more. So I move my target value down a million. This is likely still more than what you would project. And if you think they should withdraw/convert when the tax bracket will be the lowest, when would that be? Waiting until 65 would still give them significant growth that will have conversions/withdrawals likely pushing them into higher tax brackets.

Since their expected SS will be about the same as their working/hobby income for the next few years, don't you agree that their tax bracket will be more than it is now, if they don't convert? And if one of them dies and the survivor files as Single, the tax bracket will be even higher.
The tax rate while contributing to tIRA has absolutely no bearing on the decision today whether to perform Roth Conversions or not. That is water under the bridge. The fact that you keep bringing that up makes me wonder if you have yet another fundamental misunderstanding (like this, or this) of the factors that affect this decision. By the way, did you ever get a chance to run the numbers in that second thread? I don't recall seeing a follow-up.

As to the growth of the tIRA, first i would put the entire Fixed income allocation of $1,073k into the tIRA. There is no reason to keep that cash in the taxable account.

Are you expecting bonds/cash to yield 4% real over the next 20 years? Or, are you talking about nominal returns, even that seems high. But, if nominal, then you need to adjust the tax bracket for inflation.

But, lets be generous and assume your returns to be real returns. Let's also concede that OP really wants to keep cash position in taxable accounts, and use your resulting tIRA size of $3M at time of RMD, in real dollars.

Using 4% as the RMD withdrawal number, that put the RMD at $120k.
Let's also take the worst case tax scenario of one spouse passing. That will reduce the Soc Sec to something less than 2/3 of their combined number, so figure 36k.

We are now at $156k of income, minus the standard deduction puts us at $144k.

Let's also assume tax rate revert back to previous level, this put the OP, or spouse, squarely in the 28% tax bracket.
Paying 30.5% now to do the conversions does not seem like a winning strategy, and that is even with all the assumption made in favor of doing Roth Conversions.

In reality, the tIRA, being mostly bonds, probably yields something like 1-2% real, growing to ~$1.5m (real), they are both alive into their 70's and are withdrawing from their tIRA in the 12% (or 15%) bracket. Doing conversions now at a cost of 30.5% (in the 22% bracket) would have been a costly mistake. Even conversions in the 12% bracket (costing 20.5%) is debatable.
Once in a while you get shown the light, in the strangest of places if you look at it right.
sc9182
Posts: 2178
Joined: Wed Aug 17, 2016 7:43 pm

Re: ACA Subsidy / Roth Conversion

Post by sc9182 »

marcopolo wrote: Thu Sep 16, 2021 4:31 pm
celia wrote: Thu Sep 16, 2021 1:29 pm ..

Even if they put their 2.7mm portfolio in tax-efficient locations, it would look like this:

Investment Breakdown:
- $1.1 mm in Traditional IRA/401(k) <-- (need to calculate this in a minute)
- $760k in After Tax Account <--all stocks
- $423k in Roth Accounts <--all stocks
- $320k cash equivalent <--part of bonds+cash
- $80k PE real estate - likely to pay out equity in CY 2023 <--include as bonds+cash

To have 40% of the $2,683K portfolio be bonds+cash, they need a total of $1,073K bonds in the portfolio. They already have $400K as bonds+cash, so they need another $673K of bonds in the IRA. To have 60% of the $2,683K portfolio be stocks, they need a total of $1,610K in stocks in the portfolio and already have $1,183K in stocks outsides the IRA, leaving $427K for the IRA.

This leaves the IRA to be needing $673K bonds and $427K stocks. If they don't convert (preferably the stocks), the $427K stocks will double in 10 years and again in another 10 years with an average growth rate of 7% a year, according to the Rule of 72. Let's say the bonds will grow an average of 4%. (Although we are at very low rates now, we likely won't be in 20 years. See 200 Years of Interest Rates in the U.S.) That will take the bonds 18 years to double.

So in 18-20 years, the bonds become $1,346K and the stocks become $1,708K for a total of $3mm. However, if they keep some stocks and bonds in each account, the IRA will grow even more. So I move my target value down a million. This is likely still more than what you would project. And if you think they should withdraw/convert when the tax bracket will be the lowest, when would that be? Waiting until 65 would still give them significant growth that will have conversions/withdrawals likely pushing them into higher tax brackets.

Since their expected SS will be about the same as their working/hobby income for the next few years, don't you agree that their tax bracket will be more than it is now, if they don't convert? And if one of them dies and the survivor files as Single, the tax bracket will be even higher.
The tax rate while contributing to tIRA has absolutely no bearing on the decision today whether to perform Roth Conversions or not. That is water under the bridge. The fact that you keep bringing that up makes me wonder if you have yet another fundamental misunderstanding (like this, or this) of the factors that affect this decision. By the way, did you ever get a chance to run the numbers in that second thread? I don't recall seeing a follow-up.

As to the growth of the tIRA, first i would put the entire Fixed income allocation of $1,073k into the tIRA. There is no reason to keep that cash in the taxable account.

Are you expecting bonds/cash to yield 4% real over the next 20 years? Or, are you talking about nominal returns, even that seems high. But, if nominal, then you need to adjust the tax bracket for inflation.

But, lets be generous and assume your returns to be real returns. Let's also concede that OP really wants to keep cash position in taxable accounts, and use your resulting tIRA size of $3M at time of RMD, in real dollars.

Using 4% as the RMD withdrawal number, that put the RMD at $120k.
Let's also take the worst case tax scenario of one spouse passing. That will reduce the Soc Sec to something less than 2/3 of their combined number, so figure 36k.

We are now at $156k of income, minus the standard deduction puts us at $144k.

Let's also assume tax rate revert back to previous level, this put the OP, or spouse, squarely in the 28% tax bracket.
Paying 30.5% now to do the conversions does not seem like a winning strategy, and that is even with all the assumption made in favor of doing Roth Conversions.

In reality, the tIRA, being mostly bonds, probably yields something like 1-2% real, growing to ~$1.5m (real), they are both alive into their 70's and are withdrawing from their tIRA in the 12% (or 15%) bracket. Doing conversions now at a cost of 30.5% (in the 22% bracket) would have been a costly mistake. Even conversions in the 12% bracket (costing 20.5%) is debatable.
+1

I’ve seen comments and sense when someone has (or approaching) $3-5 Million in Traditional is when taxes ever becomes much of a concern - especially pre-RMD (assuming no Two toppped-off pensions, no big annuities, nor 5+ million Brokerage portfolios)

If we are not talking those Supersized IRAs., not even sure why someone continue to push Roth-conversions — in the face of losing-ACA subsidy to the tune of 8.x% of AGI.

If I were OP - we could even consider living just at 400% FPL (?) full subsidy level AGI; for any excess living expense needs — can be drawing some cash, or properly-aged Roth principal prior to 59.5; and/or limited 1% margin or Low HELOC line, to get thru the critical years prior to 59.5 thus not losing 8.x% guaranteed subsidy/discount. Then decide, either to live off TDA withdrawals and/or Roth-convert to what extent — assuming life/markets etc all in good shape.

All it takes is one or more possibilities such as: disability, bad-health, divorce or death at personal level, or a big-market correction to have most of the portfolio to cut in half .. then go figure/calculate how the conversion and/or withdrawal math works out..

The current OP numbers appear healthy - but we are not talking generational wealth here.
Topic Author
spartyfanaa
Posts: 44
Joined: Mon Oct 14, 2019 6:49 pm

Re: ACA Subsidy / Roth Conversion

Post by spartyfanaa »

Thank you for all of the excellent responses. It certainly gives me lots to think about and assess. As a side note, our IRA is mostly comprised of fixed income while our Roth and after-tax accounts are invested much more aggressively while still maintaining an overall portfolio allocation of 60/40. We did this to lessen the potential tax implications of RMD later in life.

Any additional insight is certainly welcome...
KlangFool
Posts: 31525
Joined: Sat Oct 11, 2008 12:35 pm

Re: ACA Subsidy / Roth Conversion

Post by KlangFool »

spartyfanaa wrote: Thu Sep 16, 2021 8:58 pm Thank you for all of the excellent responses. It certainly gives me lots to think about and assess. As a side note, our IRA is mostly comprised of fixed income while our Roth and after-tax accounts are invested much more aggressively while still maintaining an overall portfolio allocation of 60/40. We did this to lessen the potential tax implications of RMD later in life.

Any additional insight is certainly welcome...
Unless the job provides health insurance, why is it worthwhile to work? This applies to both you and your spouse. What is the marginal cost of taking a 10K to 20K job?

You could use the space for Roth conversion.

KlangFool
30% VWENX | 16% VFWAX/VTIAX | 14.5% VTSAX | 19.5% VBTLX | 10% VSIAX/VTMSX/VSMAX | 10% VSIGX| 30% Wellington 50% 3-funds 20% Mini-Larry
Topic Author
spartyfanaa
Posts: 44
Joined: Mon Oct 14, 2019 6:49 pm

Re: ACA Subsidy / Roth Conversion

Post by spartyfanaa »

One additional question..... until we sell our primary residence next spring, my wife and I will split time between our two homes. Our son lives in AZ and would still be covered under our health plan. For those of you more familiar with the ACA, I understand there may be limitations for coverage outside of the state in which you are enrolled?? Unfortunately, the 3 year coverage plan with United Health, noted in one of the responses to my original post, isn't available in our home state.

Thank you.
Topic Author
spartyfanaa
Posts: 44
Joined: Mon Oct 14, 2019 6:49 pm

Re: ACA Subsidy / Roth Conversion

Post by spartyfanaa »

KlangFool,

Working part-time is an option. It fills 2 potential needs. First, it provides me with some nominal income to reduce cash withdrawals. I've also been in a structured, corporate environment for 30 years. Part-time work doing something I enjoy may help ease the transition to full time retirement (i.e. help fill my time/days yet still have the freedom to pursue hobbies.
KlangFool
Posts: 31525
Joined: Sat Oct 11, 2008 12:35 pm

Re: ACA Subsidy / Roth Conversion

Post by KlangFool »

spartyfanaa wrote: Thu Sep 16, 2021 9:32 pm KlangFool,

Working part-time is an option. It fills 2 potential needs. First, it provides me with some nominal income to reduce cash withdrawals. I've also been in a structured, corporate environment for 30 years. Part-time work doing something I enjoy may help ease the transition to full time retirement (i.e. help fill my time/days yet still have the freedom to pursue hobbies.
spartyfanaa,

1) Which would offset by the higher amount of tax that you would have pay for Roth conversion and lower ACA subsidy.

2) No, I am not saying that you should not work. But, at 20K per year without health insurance, the financial cost may out weight the gain.

KlangFool
30% VWENX | 16% VFWAX/VTIAX | 14.5% VTSAX | 19.5% VBTLX | 10% VSIAX/VTMSX/VSMAX | 10% VSIGX| 30% Wellington 50% 3-funds 20% Mini-Larry
Topic Author
spartyfanaa
Posts: 44
Joined: Mon Oct 14, 2019 6:49 pm

Re: ACA Subsidy / Roth Conversion

Post by spartyfanaa »

Understand your point, KlangFool. Will continue to give it some thought... appreciate your input.
KlangFool
Posts: 31525
Joined: Sat Oct 11, 2008 12:35 pm

Re: ACA Subsidy / Roth Conversion

Post by KlangFool »

spartyfanaa wrote: Wed Sep 15, 2021 9:35 pm
- $1.1 mm in Traditional IRA/401(k)
spartyfanaa,

You have 1.1 million in the tax-deferred account. If you do not at least Roth convert the annual growth of this 1.1 million, it will grow bigger. Then, you would pay more taxes in the future.

Your 10K to 15K plus 20K = 30K to 35K of salary income is coming at the cost paying more taxes for your tax-deferred account.

If either of the jobs come with health insurance, then, it might be worth it. You no longer need to worry about the ACA subsidy.

KlangFool
30% VWENX | 16% VFWAX/VTIAX | 14.5% VTSAX | 19.5% VBTLX | 10% VSIAX/VTMSX/VSMAX | 10% VSIGX| 30% Wellington 50% 3-funds 20% Mini-Larry
swampwiz
Posts: 123
Joined: Thu Jan 03, 2013 2:55 am

Re: ACA Subsidy / Roth Conversion

Post by swampwiz »

marcopolo wrote: Wed Sep 15, 2021 10:36 pm For this year and next year, since there is no ACA income cliff, the loss of tax-credits amounts to an additional 8.5% tax rate.
That is not entirely accurate. The "expected contribution", which is basically like a negative tax credit, has an escalating rate, so the actual implicit tax rate of losing benefits is higher. That said, once you go north of some ratio to poverty income, you flatline at 8.5%.

The proper analysis must take into account the derivative of the product of terms. I'd done the analysis using the old rates, and as I recall, the real implicit tax rate was like 20% at times, and irrespective of the step functions. And then for lower-income folks, there is the steady erosion in the level of the cost-savings benefit, which is realized by the actuarial-payout level going down from 138% of poverty to 300%.

I'm in the Medicaid expansion, and I've calculated that if I have a baseline of ~$18K income (i.e., the maximum amount an individual could have as income and still get Medicaid), for the next $22K that I would make in 1099 earnings, I would only end up with about $2K more in my pocket. :oops: To say that this completely demotivates me from working past that $18K income would be a huge understatement. (I live cheaply and have laddered Roth conversion basis from which to tap to spend more than that nominal income.)
marcopolo
Posts: 8445
Joined: Sat Dec 03, 2016 9:22 am

Re: ACA Subsidy / Roth Conversion

Post by marcopolo »

swampwiz wrote: Thu Sep 16, 2021 10:12 pm
marcopolo wrote: Wed Sep 15, 2021 10:36 pm For this year and next year, since there is no ACA income cliff, the loss of tax-credits amounts to an additional 8.5% tax rate.
That is not entirely accurate. The "expected contribution", which is basically like a negative tax credit, has an escalating rate, so the actual implicit tax rate of losing benefits is higher. That said, once you go north of some ratio to poverty income, you flatline at 8.5%.

The proper analysis must take into account the derivative of the product of terms. I'd done the analysis using the old rates, and as I recall, the real implicit tax rate was like 20% at times, and irrespective of the step functions. And then for lower-income folks, there is the steady erosion in the level of the cost-savings benefit, which is realized by the actuarial-payout level going down from 138% of poverty to 300%.

I'm in the Medicaid expansion, and I've calculated that if I have a baseline of ~$18K income (i.e., the maximum amount an individual could have as income and still get Medicaid), for the next $22K that I would make in 1099 earnings, I would only end up with about $2K more in my pocket. :oops: To say that this completely demotivates me from working past that $18K income would be a huge understatement. (I live cheaply and have laddered Roth conversion basis from which to tap to spend more than that nominal income.)
You are correct.
Someone else also pointed this out as well.

I am aware of the piece wise function for the tax credits.
I intentionally simplified my response because the OP is planning to have part-time work income, and a dividends from taxable investments that will likely put them into the flat part of the complex calculations.

But, i should have at least mentioned the complex nature of the tax credit calculation.
Once in a while you get shown the light, in the strangest of places if you look at it right.
secondcor521
Posts: 1604
Joined: Wed Sep 10, 2014 4:11 pm

Re: ACA Subsidy / Roth Conversion

Post by secondcor521 »

spartyfanaa wrote: Thu Sep 16, 2021 9:21 pm One additional question..... until we sell our primary residence next spring, my wife and I will split time between our two homes. Our son lives in AZ and would still be covered under our health plan. For those of you more familiar with the ACA, I understand there may be limitations for coverage outside of the state in which you are enrolled?? Unfortunately, the 3 year coverage plan with United Health, noted in one of the responses to my original post, isn't available in our home state.

Thank you.
Generally speaking, with some exceptions in, I think Florida and California, almost all ACA plans have only emergency/urgent care out of state, and they imply that you should get back to your home state as soon as you can for treatment. The reason for this is that they have contracts with hospitals and doctors in your general geographic area but not anyone halfway across the country, so they want to limit their financial exposure.

What you can do, although it is a bit clunky, is to have your son on a separate AZ ACA plan and cover yourself and your wife on two different ACA plans, one in each state. The clunky part is that for you and your wife, you'll either double-cover yourselves, have a bit of a coverage gap (most people abhor the thought), or be restricted on moving between homes to the 1st of the month as you move back and forth. And I'm not sure if you'll be able to retain any progress towards deductibles and OOP maximums even if you move back to a state in the same calendar year.

When you get all your 1095s (which are the documents from your ACA plan providers that help you do your taxes), you can just add up all of the various 1095s and put them on your tax return. This is assuming that your son is a tax dependent that year; if he isn't it gets somewhat more complicated.

HTH.
dillrob
Posts: 49
Joined: Sat Oct 18, 2014 2:38 pm

Re: ACA Subsidy / Roth Conversion

Post by dillrob »

Another data point is the estimated healthcare cost provided by healthcare.gov. This rough estimate considers estimated healthcare usage (high, med, or low) and is based on the healthcare plan you choose. The net premium is included in the calculation and this is based off you Modified AGI. You have to have a good estimate of your MAGI. This may be more than you regular AGI and is NOT your taxable income.

The reason I suggest this is that in addition to the premium costs the estimated cost of healthcare itself is higher for a plan based on $115,000 MAGI than for a plan based on $34,400 MAGI (based on 2 adults) since the latter can have a $0 deductible and cost sharing reductions while the former will not.

Although it's a rough estimate it does consider more than just the subsidy amount and is more instructive.
Post Reply