Think we're an edge case for Roth Conversions?

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jbinpa59
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Joined: Wed Jul 10, 2019 3:29 pm

Think we're an edge case for Roth Conversions?

Post by jbinpa59 »

Appologize for a longish post, thought the detail might be needed

I'm considering going into the 22% bracket up to below 1st IRMAA cliff with Roth conversions between retirement and 2025
the BIG ? is by how much $ iinto 22% f any?
we will be converting to top of 12% at least.

me 63 in Oct dw61
MFJ 12% FED
no state tax on conversions but no deductions for Fed Tax Deffered (Pa)

I'm eligible for a FERs diet cola'd (1% shrink /yr)pension anytime I choose to retire of 28K+ planning on retiring in less than 1yr from now
pension has 55% Survivor benifit

I'm planning to apply for SS at age 70
DW planning to apply for SS at 62-1 but might hold of till Jan 2026 (age 64-5)
since its only ~ $4K less overall on a "normal LE" and gives a little more 12% Roth Conversion room

combined SS as planned would be in 58.5k to 60K / yr range depending on DW start date till 2034
we expect SS to take a 23% drop in 2034

Retirement Expenses penciled in as $65K per yr including taxes on Conversions to top of 12/15% brackets
planning on income tax leveling in retirement near to the top of the 12-15% tax brackets which is where our working incomes had/has us
we expect the Tax brackets to revert for 2026 on
we'll just have to deal with the SS taxation ghost brackets of 22.2/27.75%
we would of have to of been doing Tax deffered just to the match ,and only Roth past that since Roth were first offered to do anything else

only debt: vehicle loan @1.99% ~30K balance 4.5 yrs left so not planning to pay it off early in this inflation enviorment

own 2 modest homes outright no mortgages (son#1 occuping one and covering utils/taxes/ins /some maint till we decide where we're retiring)

will max out my TSP $27K + already maxed 2xRoth Ira's $7k @ partly from cash and partly from taxable account transfers

current account balances:
880K Tax deffered accounts mix of stock index funds / Fixed income

250k Roth accounts
21k Taxable
87k DW inherited 2 small trust accounts
all non Tax defferred accounts are 100% stock index funds

~30K in cash/non Ira cd's

total portfolio overll AA is ~75% stocks / 22% Fixed Inc 3% cash
~1.2 mil net worth

I-orp extended recomended ~200-300k of Roth Conversions going into the 22% bracket in early retirement

when I spreadsheet out our Existing Tax Defferred balances after income leveling using any real ROI rates below 5%
as long as we're both alive we stay in the 12-15% brackets including RMDs while moving more than I-orp suggested slowly to Roth's

any ROI above 5% real ROI long term we go up a tax bracket filing MFJ

AND as soon as first to go passes the survivor goes up a tax bracket at any long term ROI of 3% or greater

Large tax deductable LTC/Medical costs could change that some
Son #2 MFJ 1 child income at top of 22% bracket edging into 24% so Roth $ as legacy is better for him
Son #1 single not likely to marry has modeate job so legacy$ as Tax Deferred is not as bad for him
we don't expect strech IRA's to come back
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FiveK
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Re: Think we're an edge case for Roth Conversions?

Post by FiveK »

When you are receiving $60K/yr SS and $28K/yr pension, practically all your traditional account withdrawals (whether for RMDs, Roth conversions, or spending) will be hit with 22-23% federal marginal tax rates (using 2022 tax law).

Given that, yes, doing Roth conversions to the top of the 12/15% bracket should be advantageous.

Doing conversions into the 22% bracket will be pretty much a wash, unless one of the extreme cases you mention (extremely large medical costs or one of you predeceasing the other by many years) occurs.

If the extra tax for converting into the 22% bracket is available from cash on hand, I'd be inclined to convert up to the first IRMAA tier this year. Maybe even beyond that, to the top of the 22% bracket, because it would cost you only 3 months of the higher premiums in two years. But that's a matter of taste.

See the Roth IRA conversion wiki (if you haven't already) for more. Because you mention using a spreadsheet, the ones referenced there may be of interest to you.

Don't know if that addresses any question(s) you have - does it?
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celia
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Re: Think we're an edge case for Roth Conversions?

Post by celia »

The first thing I look at when Roth conversion planning comes up is how much is in the tax-deferred pot? I see your $880k as very close to the border of needing to do Roth conversions or not. If the value was the same come age 72, the RMDs would start at about $35k a year (but don’t have to be spent).

It’s not clear to me if you have your living expenses of $65k covered for each year or not. But if you withdraw from tax-deferred enough to give you that income (when added to other income streams), then convert up to the top of the 12% bracket, it looks like you would be fine.

I like to look at a tax bracket chart like this one each year:
https://taxfoundation.org/2022-tax-brackets/

The number you use to do a lookup in the tax bracket charts is your “Taxable Income” (a line on the 1040 tax return after you subtract the standard deduction of $26K (or your itemized deductions) from your AGI (Adjusted Gross Income). So if we look at your living expenses of $65K, the first $26K of that would not be taxed, but the remainder of $39K would have about $20K be taxed at 10% and the remaining $19k at 12%. That leaves $83.5K - $39K = $44.5K that can be converted to use up the rest of the 12% tax bracket. (Always convert stock funds to maximize tax-free growth in Roths.)

If you have Qualified Dividends or LTCG on top of that, instead of being taxed in the next bracket of 22%, they would get preferential tax treatment of 15%.

If this sounds confusing, I suggest drawing a picture of these “blocks” of money being stacked up on top of each other to help understand how they relate to the tax brackets. From top to bottom they would be:


TBD (Qualified Dividend/ LTCG) preferential 15% instead of 22%

44.5k Roth conversions in 12% (unless pension/SS supplies this money)

$19K living Expenses in 12%

$20K living expenses in 10%

$26K living expenses for MFJ (std deduction)


Please run a sample tax return through tax software to confirm my numbers. Note that I see some withdrawals from tax-deferred to also cover living expenses until the pension and SS kick in. And some of SS will not be taxed.

Please also consider your wife’s living expenses should you die first. What would her income streams be and how will that relate to the tax brackets? Write down a plan to show how her expenses would be covered, both before and after RMDs kick in.

As far as your heirs, I would treat them the same after both you and your wife die. There’s no way you can estimate how much will be in tax-deferred and Roth ahead of time. Son #1 has the advantage of cheaper housing for many years. Son #2 has the advantage of being able to file MFJ. Things will likely change throughout life, but we can’t keep going out of our way to ensure things are “fair”, just as we can’t account for one son having bad health or financial woes after we die.
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.
Topic Author
jbinpa59
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Re: Think we're an edge case for Roth Conversions?

Post by jbinpa59 »

FiveK wrote: Sat Aug 13, 2022 2:40 am When you are receiving $60K/yr SS and $28K/yr pension, practically all your traditional account withdrawals (whether for RMDs, Roth conversions, or spending) will be hit with 22-23% federal marginal tax rates (using 2022 tax law).

Given that, yes, doing Roth conversions to the top of the 12/15% bracket should be advantageous.

already planning on this as part of income leveling 65K / yr to live on 40k Roth convrted
we will still be in a edge case situation as explained in original post.
maybe I'm just too far into the weeds with Life Expectacies ,potential Medical Costs, and ROI on tax deffered none of which I can control
DW's filing single potential RMDs are all over the heat map due to those factors anywhere from $10k to $35k per yr


If the extra tax for converting into the 22% bracket is available from cash on hand, I'd be inclined to convert up to the first IRMAA tier this year. Maybe even beyond that, to the top of the 22% bracket, because it would cost you only 3 months of the higher premiums in two years. But that's a matter of taste.
we can cover ~30k in Conversion taxes this year from Cash on hand and paying from taxable account which is what got me considering
going into the 22% bracket for a year or two, plus wouldnt even have IRMAA in 2024, I'm still working but planning to retire in 2023 so a
QLE appeal if I went over IRMAA cliff in 2022 /b]
Topic Author
jbinpa59
Posts: 150
Joined: Wed Jul 10, 2019 3:29 pm

Re: Think we're an edge case for Roth Conversions?

Post by jbinpa59 »

celia wrote: Sat Aug 13, 2022 4:21 am The first thing I look at when Roth conversion planning comes up is how much is in the tax-deferred pot? I see your $880k as very close to the border of needing to do Roth conversions or not. If the value was the same come age 72, the RMDs would start at about $35k a year (but don’t have to be spent).
balance should be lower at age 72 due to funding expenses (35K/yr) and Roth Conversions (40K/yr) for 6yrs till I'm 70

It’s not clear to me if you have your living expenses of $65k covered for each year or not. But if you withdraw from tax-deferred enough to give you that income (when added to other income streams), then convert up to the top of the 12% bracket, it looks like you would be fine.
planned on doing that thats part of what I think makes this a flip a coin case

I like to look at a tax bracket chart like this one each year:
https://taxfoundation.org/2022-tax-brackets/
I do similar

The number you use to do a lookup in the tax bracket charts is your “Taxable Income” (a line on the 1040 tax return after you subtract the standard deduction of $26K (or your itemized deductions) from your AGI (Adjusted Gross Income). So if we look at your living expenses of $65K, the first $26K of that would not be taxed, but the remainder of $39K would have about $20K be taxed at 10% and the remaining $19k at 12%. That leaves $83.5K - $39K = $44.5K that can be converted to use up the rest of the 12% tax bracket. (Always convert stock funds to maximize tax-free growth in Roths.)

If you have Qualified Dividends or LTCG on top of that, instead of being taxed in the next bracket of 22%, they would get preferential tax treatment of 15%.

If this sounds confusing, I suggest drawing a picture of these “blocks” of money being stacked up on top of each other to help understand how they relate to the tax brackets. From top to bottom they would be:


TBD (Qualified Dividend/ LTCG) preferential 15% instead of 22%

44.5k Roth conversions in 12% (unless pension/SS supplies this money)

$19K living Expenses in 12%

$20K living expenses in 10%

$26K living expenses for MFJ (std deduction)

I like the Engaging Data Tax Bracket Graphic for that

Please run a sample tax return through tax software to confirm my numbers. Note that I see some withdrawals from tax-deferred to also cover living expenses until the pension and SS kick in. And some of SS will not be taxed.

I have been running dummy returns using 2022 brackets and non inflation adjusted $ to guesstimate future brackets

Please also consider your wife’s living expenses should you die first. What would her income streams be and how will that relate to the tax brackets?
DW would have 16.5k in todays $ of pension + 34K of SS also todays$ (assuming SS takes a 23% hit in 2034) plus the RMDs which could vary from 10k to 35K due to variables we can't control such as ROI , my taxes would be worse if she passes first as I'd get the full pension vs her 50%

Write down a plan to show how her expenses would be covered, both before and after RMDs kick in.
Done

As far as your heirs, I would treat them the same after both you and your wife die. There’s no way you can estimate how much will be in tax-deferred and Roth ahead of time. Son #1 has the advantage of cheaper housing for many years. Son #2 has the advantage of being able to file MFJ. Things will likely change throughout life, but we can’t keep going out of our way to ensure things are “fair”, just as we can’t account for one son having bad health or financial woes after we die.

Understood , already planned that they will get a 50:50 split across all accounts reguardless of type or balance,
just reconizing that one would have a preference for a Roth legacy since he's in 22/24% MFJ FED brackets currently + CA state taxes ~225k/yr before deductions
What would be a miniimun recomeded amount for us to hold to the end in Tax deffered? $250,000ish ?
even with FERS having a partial cola and SS possiblly taking a reduction our essintial cost baring Major medical episodes would be covered from Pension and SS alone once I start drawing SS
Knowing any surplus between what we need for living $ and the 0% ltcg limit will be Roth converted from retirement on.
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retiredjg
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Re: Think we're an edge case for Roth Conversions?

Post by retiredjg »

I agree that you are probably an "edge case" for Roth conversions. You don't necessarily "need" to do serious conversions, but will get some income smoothing (and inheritance benefits for kids) by doing some.

$880k in tax-deferred is not a particularly worrisome number in itself. But with your very low expenses and with a very high SS income later on, trimming down the tax-deferred account is a reasonable idea.

You can do large conversions in 2022 and 2023 without a large IRMAA effect if you retire in 2023. Even if they don't give you a waiver for your 2023 income (because you retire early in the year or something like that) there will only be 3 months in 2025 where you would be affected by IRMAA. No big deal.

Since one of you alone will eventually be in at least the 25% bracket (after taxes revert to previous rates) I see no issue in converting in 2022 and 2023 up to near the top of the 22% bracket for a few years. If you prefer, go to the top of 22% bracket in 2022 and up to just under IRMAA in 2023. That is not a great difference and it would assure no IRMAA when you reach 65.

After that, I'd just convert to the top of the 12% (later to be 15%) bracket each year and not worry about it anymore. RMDs will happen but not be particularly significant - at least early on. If one of you needs to pay tax at 28% in your 80s, so be it. Everything cannot be predicted or fixed or avoided.
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retiredjg
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Re: Think we're an edge case for Roth Conversions?

Post by retiredjg »

jbinpa59 wrote: Sat Aug 13, 2022 5:52 am What would be a miniimun recomeded amount for us to hold to the end in Tax deffered? $250,000ish ?
I think $250k is a reasonable minimum. But I also think you don't need to get that low to get a benefit from Roth conversions. My guess is $250k to $500k is a good target.
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Watty
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Re: Think we're an edge case for Roth Conversions?

Post by Watty »

jbinpa59 wrote: Sat Aug 13, 2022 2:06 am current account balances:
880K Tax deffered accounts mix of stock index funds / Fixed income

250k Roth accounts
21k Taxable
87k DW inherited 2 small trust accounts
all non Tax defferred accounts are 100% stock index funds

~30K in cash/non Ira cd's
You don't have a lot of money in taxable accounts to pay for the Roth conversions so that could make them less favorable. After you sell one of your houses and have a lot of cash sitting in a money market account then doing some Roth conversion might be easier to justify.

I did not crunch the numbers but after you retire it would be good to see if you could qualify to take any long term capital gains in the federal 0% LTCG tax bracket. That could be worth more to you than doing the Roth conversions.

To me it would take a real compelling argument to do Roth conversions in the 22% federal tax bracket since after the rates revert in 2026 at you will likely be in a 28% federal tax bracket at worst when RMDs start at 72(or maybe later if it is increased). (plus any taxation of SS) Saving 6% might be nice but it is not like not saving that 6% would be a dire mistake.

The best case scenario would not be worth enough to me to pay my taxes decades before they need to be paid. The question is not just if you will save some taxes, but if you will save enough taxes to make it worthwhile.

You are doing great but it isn't like you are a multimillionaire who will be in really high tax brackets in retirement.
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retiredjg
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Re: Think we're an edge case for Roth Conversions?

Post by retiredjg »

I know this is not a very popular approach, but I would leave the small amount in taxable and pay the taxes out of the IRA.

That will accomplish the goal of reducing the tax deferred accounts and what you lose (tax free growth on the amount of money you used to pay taxes) would be less important to me than reducing the IRA.

It is true that you get more in Roth if you pay the taxes out of taxable. But that also leaves you will less in taxable. There is a benefit, but I don't see it as big a benefit as some do.
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David Jay
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Re: Think we're an edge case for Roth Conversions?

Post by David Jay »

retiredjg wrote: Sat Aug 13, 2022 9:29 amMy guess is $250k to $500k is a good target.
It's pretty easy to deal with $500,000 in tax-deferred without a "tax bomb" when the first spouse passes.

That is pretty close to our level of tax deferred. Between gifting (to adult children) and QCDs my spreadsheet says that the surviving spouse will be staying in the 12% / 15% bracket.
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tibbitts
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Re: Think we're an edge case for Roth Conversions?

Post by tibbitts »

I look mostly at the total amount in deferred that's subject to RMDs. For filing single at your age probably $1M or less probably not dangerous, so I'd only convert up to some reasonable bracket. Roughly double that for MFJ. Most people, at least on Bogleheads, should convert at up to the 15% you mentioned no matter what. It's a tougher call as you get in to the 20%s or higher. Mainly my objective is to get to where withdrawing from deferred through RMDs combined with other "mandatory" income won't leave you in a worse tax (including IRMAA) situation permanently. At some point you get to where average market returns going forward will make your deferred grow faster than you can withdraw from it at "reasonable" tax rates, and that's where you have to decided whether take a significant one-time or two-time hit to get the balance back under control.
Topic Author
jbinpa59
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Re: Think we're an edge case for Roth Conversions?

Post by jbinpa59 »

retiredjg wrote: Sat Aug 13, 2022 9:26 am I agree that you are probably an "edge case" for Roth conversions.
snipped a bit for brevity
You can do large conversions in 2022 and 2023 without a large IRMAA effect if you retire in 2023. Even if they don't give you a waiver for your 2023 income (because you retire early in the year or something like that) there will only be 3 months in 2025 where you would be affected by IRMAA. No big deal.

Since one of you alone will eventually be in at least the 25% bracket (after taxes revert to previous rates) I see no issue in converting in 2022 and 2023 up to near the top of the 22% bracket for a few years. If you prefer, go to the top of 22% bracket in 2022 and up to just under IRMAA in 2023. That is not a great difference and it would assure no IRMAA when you reach 65.

After that, I'd just convert to the top of the 12% (later to be 15%) bracket each year and not worry about it anymore. RMDs will happen but not be particularly significant - at least early on. If one of you needs to pay tax at 28% in your 80s, so be it. Everything cannot be predicted or fixed or avoided.
Thankyou for your insights retiredjg
I know this is an edge case outside of normal do/do' not Roth modeling, but barring major "DONT DO THAT" comments from BH foroum,
What you've laid out in this and your follow on posts is what I had tenatively planned to do including paying the taxes mostly from the IRA funds
I go to top of 22% this year and the IRMAA limit next year DW should be in 12/15 brackets at any long term ROI averaging under 5.5%
if it goes higher than that its a first world problem and there's always QCDs
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