Steering through the shoals of IRMAA past the SS Tax Torpedo

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McQ
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

WoodSpinner wrote: Mon Jan 09, 2023 2:06 pm
McQ wrote: Sun Jan 08, 2023 2:11 pm

Glad the OP engaged you, Woodspinner, and thank you for these posts. I was thinking of you when I prepared Post #4, due about Tuesday—specifically, the advice I gave you last year, which is that conversions into the IRMAA zone are not “robust.” I believe I can make a stronger claim now, that conversions into IRMAA are not wise; but you be the judge once you see it.

To address a few of your points:

1. Cheryl is not a real person seeking advice on the forum, but a composite designed to capture relatively general rules. So, no info on her investment policy, etc. She has a risk aversion consistent with holding a 30/70 portfolio as she approaches age 70, and is otherwise a utility-maximizer in the standard economic sense, preferring more (after-tax wealth) to less.

Which is more important to her, maximizing her after-tax wealth or passing an inheritance on to benificiaries in a higher tax bracket than she is as tax efficiently as possible?

Does she want to reserve funds in the TDA to cover Charity Bequeaths or Self Funding Long Term Care?

Am I correct, the primary goal is to Maximize her After Tax Wealth and this is more important than the Taxes paid across Retirement?

Cheryl's absolute, most primary goal is never to be a burden to members of her family, i.e., brother, sister, niece, nephew. That's what drives the utility maximization and the limited engagement with in-life charity.

She has no spouse, no child, and no long-term care insurance. She's quite well informed about what it might cost if she can no longer live independently. "After-tax wealth" is a convenient metric for "make sure I have enough never to be a burden on my loved ones."

Her secondary goal is to live as well as possible, for as long as she has her health, subject to meeting her primary goal.

PS: I hope I succeeded in painting her heir, niece Janice, in a relatively unflattering light...
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ResearchMed
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by ResearchMed »

McQ wrote: Sun Jan 08, 2023 10:19 pm
Soon2BXProgrammer wrote: Sun Jan 08, 2023 2:31 pm
McQ wrote: Sun Jan 08, 2023 2:11 pm

Bottomline: regardless of whether Cheryl could have done a better job with her retirement planning, it is what it is: now she’s high up in the social security tax torpedo staring down IRMAA.
I currently do not have time to model the scenario you have created, but from past experience, the sooner the better doing a Roth conversion up to the top or either the tax bracket or the IRMAA tier that the person has spilled over into. Because if your subject to the additional tax you should maximize the space it buys.

Then repeat the analysis and see if this is likely to pull you out of the IRMAA in the future, if no, add another year.

While this is painful and the exact opposite of pushing out paying the IRMAA, if you can get under the limit, it can be helpful. This might not play out with only a single person, I see the biggest benefit in the married plans where you model eventually switching to single.

The marginal rate of the IRMAA with this logic should be calculated not as a spike but as a tax on the whole window being bought and utilized. (If you fail to use it, it is a spike, but if you use the whole window conceptually it is a rate on the whole window)

I'd be interested to hear your thoughts.
Stay tuned for a more on-point post in the next few days. In the meantime, I wanted to ratify one of your points: if you must incur IRMAA, best to voluntarily withdraw all the way up to the next IRMAA boundary.

Taking the IRMAA payment as $1000, and the IRMAA span as $25,000, and the underlying tax rate as 24%, if you freeze/choke one dollar in, your marginal tax rate is ($1000 +0.24)/$1 or 100,024%. Oww...

But if you voluntarily withdraw (convert) an additional $24,999, your marginal rate is 24% + ($1000/$24,999), which rounds to 28%. Much more palatable, and likely to reduce next year's RMD by about $1000--not enough to escape IRMAA in year two, but maybe allowing a QCD of modest amount to take you home.

I'm not sure that looking at the marginal rate for the IRMAA surcharge makes much sense, compared with, say, the marginal tax for "the next income tax bracket".

With IRMAA, that first dollar over the cliff is painful. If one wants to consider that particular "marginal tax rate" as described just above, it is truly a phenomenal percentage.

However, because it is indeed a "cliff", there is not any additional IRMAA cost until one hits/exceeds the *next* IRMAA cliff. Once one is $1 over that IRMAA cutoff, it doesn't matter if one is $2 or $200++ over that cutoff, as long as one doesn't hit the next cutoff.

There actually isn't any additional [IRMAA] tax, "marginal" or otherwise, within an IRMAA "brackett" after that first dollar.

The IRS income tax rate may change within that IRMAA bracket, of course, so that is worth looking at. However, if one exceeds that, there is no "phenomenal" penalty. It's just a few extra percent (at most) and *only* on the excess above the income tax bracket cutoff.
This isn't punitive for income tax.

Was there a reason the IRMAA surcharge was created as a cliff?

RM
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FiveK
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by FiveK »

McQ wrote: Mon Jan 09, 2023 9:33 pmIt is good to see a graphic demonstration of how very different marginal and cumulative tax rates can be, when the tax torpedo and IRMAA apply.
If you can use Excel, the personal finance toolbox spreadsheet used for those graphs is publicly available.
FWIW, in the next few posts I'll be challenging the utility of folding IRMAA penalties into the marginal tax rate; and more generally, question the applicability of the fact that for a certain stretch of income, Cheryl's marginal rate is 40.7%.
ResearchMed wrote: Mon Jan 09, 2023 10:10 pm I'm not sure that looking at the marginal rate for the IRMAA surcharge makes much sense, compared with, say, the marginal tax for "the next income tax bracket".
With IRMAA, that first dollar over the cliff is painful. If one wants to consider that particular "marginal tax rate" as described just above, it is truly a phenomenal percentage.
However, because it is indeed a "cliff", there is not any additional IRMAA cost until one hits/exceeds the *next* IRMAA cliff. Once one is $1 over that IRMAA cutoff, it doesn't matter if one is $2 or $200++ over that cutoff, as long as one doesn't hit the next cutoff.
With Roth conversions, one can stop at any dollar amount. Usually that means the tax rates on the previous $X converted are irrelevant when it comes to analyzing whether one should convert dollar X+1. That's because usually the tax rate either stays the same or increases; in that case the cost of converting dollar X+1 is never less than converting dollar X.

But when there are spikes and mesas in the marginal rate terrain, one might want to "push through" those transient costs to reach more pleasant terrain. In other words, is it Worth pushing through the Social Security hump and/or IRMAA cliffs?

To answer that, it is helpful to forget (if one ever learned) differential calculus and use (change in tax)/(change in income) for the marginal tax rate where "change in income" is much larger than $1, e.g., the size of the gap between IRMAA tiers.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

How aggressive should Cheryl be with her Roth conversions?

Voluntary withdrawals and small Roth conversions only work for Cheryl 1.0 because her TDA was small enough, at $1.25 million at age 68. In this post I’ll introduce a more fortunate Cheryl 2.0 who has a larger TDA. (Or if you like, a Cheryl who was even more remiss in not doing Roth conversions early and often.)

In the projection below, I’ve increased Cheryl’s starting balance by about $200,000, to $1,447,000, and kept the living expenses and the pre-IRMAA conversions as before; net, Cheryl 2.0 now hits IRMAA exactly when RMDs begin. C’est la vie: Cheryl version 2.0 is somewhat better off, enough so to wipe out the effect of the voluntary withdrawals and no-IRMAA Roth conversions that were so successful for Cheryl 1.0 (no QCDs considered on the initial run).

Image

Back to square one: If nothing is done, Cheryl 2.0 will pay IRMAA from the get-go.

Sanity check: Is this level of wealth plausible for a single person age 68? I’d say neither more nor less plausible than Cheryl 1.0. The larger TDA of Cheryl 2.0 could reflect a somewhat more aggressive strategy, say a 60/40 portfolio; or retirement after a relatively more favorable period for investing; or a failure to do Roth conversions early and often.

In any case, now we have to look into what her brother Charles and cousin Celia suggested. They told Cheryl 1.0 to convert up through IRMAA #4 at least (Charles), or possibly until she converts enough of her TDA, in 2023 and 2024 (Celia), to never face IRMAA throughout some reasonable time horizon. Will these maneuvers succeed?

To begin, note the slightly paradoxical element here: “I detest future IRMAA s-o-o much that I’m willing to pay it right now, several times over, voluntarily and unnecessarily.” M’k …

The paradox only resolves if, for instance, one can pay four IRMAA in 2023, and four more IRMAA next year, to save, say, a dozen IRMAA down the road; and even then, only if those twelve future IRMAA, some over a decade out, have a discounted present value greater than eight present-day IRMAA paid this year and next. Depending on the discount rate, a ratio of 8 : 12 might go either way; an 8 : 20 payoff ratio would be a more definitive win / more comfortable expectation. But that may be too steep a hill to climb. No way to tell until we run the numbers.

Next wrinkle: although a substantial portion of Cheryl’s RMDs do fall into the SS tax torpedo, subject to a marginal rate of 40.7%, to be at risk of IRMAA #1 when RMDs begin she had first to obtain enough income to exit the torpedo. On torpedo exit she returns to the 22% rate seen in IRS tables. This necessary exit from the torpedo before IRMAA is an artifact of current IRMAA thresholds, the current 22% / 24% income tax threshold, the current maximum SS payment, and the current (and not inflation-adjusted) thresholds used to determine the taxable fraction of SS payments. A future legislative change to any of these values could potentially create a situation where the IRMAA #1 threshold gets passed while still inside the tax torpedo; but at present, that does not happen in any standard case.*

*BTW, the dollar gap between torpedo exit and IRMAA onset is larger in the couples case, because the fixed SS thresholds for couples, of $32,000 and $44,000, are not 2X those applied to singles.

**If Cheryl only had $40,000 in SS payments, not the $50,000+ shown, she would exit the torpedo at a still lower income, producing a still larger dollar gap between torpedo exit and IRMAA onset.

My point: to escape IRMAA #1 by income reduction through a Roth conversion is to save that IRMAA payment plus 22% of the dollar reduction as income tax savings—not 40.7%. If one gets to the point of saving 40.7%, as occurred for Cheryl 1.0, then one must have already dropped below the IRMAA threshold and cannot expect to save any IRMAA payment by further reductions in income, i.e., by Roth conversions that further reduce the TDA balance.

Next, the general rule for Roth conversions requires that future tax rates move higher for the conversion to produce a gain in after-tax wealth. A conversion by Cheryl today that triggers IRMAA #1 but stops short of IRMAA #2 will be taxed partly at 22% and partly at 24%, net about 23% (the IRMAA #1 dollar span straddles the 22%/24% income tax threshold). Pay 23% now to save 22% later …?

Fine, call it a breakeven conversion, one percent here, one percent there, whatever.* This simply indicates that the payoff from an IRMAA-triggering Roth conversion today comes down to the present value of any future IRMAA averted thereby; it won’t be boosted by income tax savings if the future rate remains 22%.

*Or you could argue that TCJA will expire as scheduled, with the 22% rate reverting to 25%, so that a conversion today at 23% or even 24% will benefit from a mild boost in income tax savings. I repeat: whatever.

Begin: Convert and pay IRMAA #1 in 2023 but stop short of IRMAA #2

This will entail a conversion of $26,000, the span that separates the IRMAA #1 threshold from IRMAA #2. It will increase her 2023 income from $97,000 (just below the IRMAA #1 threshold) to $123,000 (just below the IRMAA #2 threshold). At an estimated 4% of that span, she can expect to pay an IRMAA dollar penalty of $1,040. Split across the 22% and 24% brackets, she’ll pay about 23%, or $6000, in income tax. With tax paid from inside the conversion, she’ll have a new Roth balance of just under $19,000, after IRMAA + income tax charges totaling $7,040.

As shown below, this 2023 conversion lowers her 2027 RMD by $1,102, putting her below the IRMAA threshold in 2027. But it does not move the needle enough get her out of IRMAA the following year.

Image

Oops: pay one IRMAA now to avoid (only) one IRMAA later. That doesn’t look too promising.

It gets worse. With 3% inflation, the 2027 IRMAA payment is expected to rise to $1171 (1.03 to the 4th power times $1,040). That doesn’t sound so bad, until one examines the counterfactual of no conversion at all. In that event, the $1,040 IRMAA payment not made in 2023 would have grown at the 6% rate projected for the TDA, to $1313.

Cheryl gave up a future TDA balance of $1313 to avert a future IRMAA payment valued at $1171. That doesn’t sound … smart.

Oh well, at least she saved $242.44 in income tax on the $1,102 reduction in 2027 RMD. That goes part of the way toward defraying the $6000 she paid in income tax to do the conversion.

Wait, what? She’s still in the hole on the conversion, in income tax terms, by $5,758?!? How can that be, when the 2027 tax rate is only one percentage point below what she paid to convert in 2023?

And now we come to the dirty little secret of Roth conversion payoff calculations (at least as I’ve done them in the past; I wouldn’t want to accuse anyone else). The typical payoff calculation applies the future tax rate to the entire balance of the counterfactual conversion amount, i.e., the future value of the $26,000 if the conversion had not occurred and the entire amount remained in the TDA to grow at the indicated return, 6% in the running example.

The amount stated above, of $242.44, is the income tax savings only on the RMD reduction that took place in 2027—the bird in the hand. Next year there will be another bird in the hand, and the year after, another. And then at some point Cheryl will die. If she has no heirs, then the accumulated birds in hand and the remaining birds flushed out of the bush by death (i.e., tax on the remaining balance) will show the payoff received, if any, from the Roth conversion undertaken many, many years ago.

It is never necessary to liquidate any portion of a TDA other than the required minimum distribution. Even at death, anticipated for twenty-five plus years from now for Cheryl, if there are heirs they will have ten more years to distribute, and need only liquidate 10% per year.

Realized tax savings from a conversion intended to reduce RMDs only accrue as those distributions are received. Eventually, the TDA will all be distributed, and eventually, the conversion will pay off in keeping with the difference between the tax rate at conversion and the tax rate(s) applied to the distributions over time. If niece Janice has to pay 48% a year on ten distributions commencing twenty-five years from now, she will be quite happy that Aunt Cheryl chose to do more Roth conversions rather than fewer. But Aunt Cheryl only earns back her Roth conversion taxes bit by bit, year by year, as RMDs take place. Her own RMD withdrawal won’t hit 10% until age 94, approximately her life expectancy, hence her realized tax savings will poke along for quite a while.

*historical note: the early calculations of Roth conversion outcomes, beginning two decades ago, tended to assume a single conversion and a single lump sum distribution. Example: If $10,000 is converted today at 12%, $8,800 will be placed in the Roth. Some years later, suppose the investment has tripled. The Roth can be liquidated, free of tax, to produce $26,400, enough to purchase a modest full-size sedan. If the future tax rate has risen to 25% and no conversion had been made, the $10,000 would have become $30,000, but only $22,500 would have been available to spend after-tax (i.e., a subcompact basic automobile).

The payoff is the difference between the tax rate prevailing at the time of payoff versus the tax rate at conversion, multiplied by the future value of the counterfactual (here, [25% - 12%] * $30,000, or $3,900 more future dollars from converting).

RMDs, which will continue for as long as Cheryl lives and for ten years afterwards, drastically slow down the conversion payoff relative to this old-fashioned liquidation analysis. Only 3.77% must be distributed when RMDs begin, and the pay off that year is, in the running example, [$30,000 * 3.77% * (25% - 12%)], or $147. (Payoffs will continue to accrete each year, of course).

And if Aunt Cheryl, alas, needs assisted living or even nursing home care for her last few years of life, she may draw down most of her remaining TDA balance at a tax rate near zero, if the expenses are deducted as medical expenses. In which case, in the final sum up, the Roth conversion probably will have failed (from the standpoint of saving Cheryl taxes; Cheryl’s niece Janice may still be better off, if there’s anything left to inherit).

Did you know that about Roth conversion payoff calculations under RMDs?

Ahem, moving right along: brother Charles didn’t say to do one single puny conversion into the IRMAA zone—he said to do a bunch of them (and cousin Celia went further still).

Maybe Cheryl can make it up on volume. Next post investigates.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Wannaretireearly »

Mind blown. I’m hoping the state takes care of me before I can understand this thread!
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by dagsboro »

That there are passionate aficionados of complicated financial and tax scenarios does not surprise me. It's an intellectual exercise for some and along the way, there is useful information provided by knowledgeable and experienced contributors. I have never read a more elaborate puzzle and will not do so in the future.
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McQ
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

Apologies to all for the mind-numbing complexity of IRMAA avoidance strategies (but of course, that's precisely what attracted my attention to the topic).

I promise that when my planned posts end (by Monday at the latest), I will conclude with a very simple "Do this/ Don't do this" recommendation.

In the meantime, I should probably remind everyone that "you can take the academic out of the classroom by retiring him, but you can't ever take the classroom out of his tone, style and manner of approach to a topic."
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by veggivet »

Inquiring minds would like to know what you taught in your previous life...
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by JohnDoh »

This excellent presentation by Wade Pfau that is part of the Bogleheads Chapter Series --- starting at about 0:36:00 --- seems on point. In any case well worth watching.

Bogleheads® Chapter Series – Wade Pfau on Retirement Income Style Analysis, Tax Efficiency
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by curmudgeon »

McQ wrote: Tue Jan 10, 2023 10:46 pm
It gets worse. With 3% inflation, the 2027 IRMAA payment is expected to rise to $1171 (1.03 to the 4th power times $1,040). That doesn’t sound so bad, until one examines the counterfactual of no conversion at all. In that event, the $1,040 IRMAA payment not made in 2023 would have grown at the 6% rate projected for the TDA, to $1313.

Cheryl gave up a future TDA balance of $1313 to avert a future IRMAA payment valued at $1171. That doesn’t sound … smart.
I have a problem with treating tax-deferred account balances as "real money". IRMAA payments are cash out of my pocket. TDA balances are not really mine, but subject to the whims of congress and generally expected to have a significant tax haircut before I can actually use them. If you don't expect to leave the TDA to charity, then even after death the taxes have to be paid before the rest is usable. The premise that the remainder of TDA may get withdrawn at 0% tax rate due to medical deductions gets mentioned here a lot, but I haven't seen it all that often in real life.

But the general point is quite true. If you get into the zone of maximum SS benefit, quite large TDA balance, and little time before SS at age 70, there's not much maneuvering room. I tend to think of these things in terms of a couple MFJ, which comparatively would be $110,000 SS income and $3 million in tax-deferred. If you add in a relative indifference to the value of the remainder (going to charity or an unloved relative), it's hardly worth the bother. The same can be said for the much, much larger set of people on the lower end of the SS/TDA scale.

Avoiding IRMAAs out in the future by paying more IRMAA now is somewhat of a mug's game anyway, because there is a significant chance that some of those IRMAAs would never have to be paid anyway (because death may come earlier than expected). Avoiding potential IRMAA in the future by paying taxes now (that will have to be paid in any case) is less problematic, though still somewhat of a gamble on future tax changes.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Harry Livermore »

Doctor McQ, I may have missed this, but did you build the spreadsheet you're screen-shotting examples from? Is that available somewhere?
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

veggivet wrote: Wed Jan 11, 2023 3:58 pm Inquiring minds would like to know what you taught in your previous life...
"Strategic profitability analysis for MBAs" would be most relevant to this thread; enter Edward McQuarrie into the search engine of your choice for a complete list of teaching and research interests.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

Harry Livermore wrote: Wed Jan 11, 2023 7:22 pm Doctor McQ, I may have missed this, but did you build the spreadsheet you're screen-shotting examples from? Is that available somewhere?
Cheers
Hello Harry: I've gotten out of the habit of posting the underlying spreadsheets, because under Boglehead policy I'm not allowed to link to my website where these would be posted.

You should be able to recreate without much difficulty. Take any SS image and type the value for the first two cells in each column. You'll see that:
1. the TDA column is incrementing at 6%; expenses are deducted at the beginning of the year, conversions and RMDs at the end, after that year's appreciation.
2. RMDs per the 2022 schedule, which you can find on the web
3. IRMAA and tax brackets and SS at 3% (OP has actual 2023 tax values, also from the web)
4. Exit point from the SS tax torpedo increasing at 1.5%
Once you have values in each column and apply these rules using the fill function, you can replace with your own values for portfolio size, portfolio appreciation, how many Roth conversions, etc. and apply the analysis to your personal situation.
PS: if you have a copy of Acrobat, try pasting the image, save as pdf, and then see if you can extract as text/spreadsheet; might save a little typing
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Harry Livermore »

McQ wrote: Thu Jan 12, 2023 4:24 pm
Harry Livermore wrote: Wed Jan 11, 2023 7:22 pm Doctor McQ, I may have missed this, but did you build the spreadsheet you're screen-shotting examples from? Is that available somewhere?
Cheers
Hello Harry: I've gotten out of the habit of posting the underlying spreadsheets, because under Boglehead policy I'm not allowed to link to my website where these would be posted.

You should be able to recreate without much difficulty. Take any SS image and type the value for the first two cells in each column. You'll see that:
1. the TDA column is incrementing at 6%; expenses are deducted at the beginning of the year, conversions and RMDs at the end, after that year's appreciation.
2. RMDs per the 2022 schedule, which you can find on the web
3. IRMAA and tax brackets and SS at 3% (OP has actual 2023 tax values, also from the web)
4. Exit point from the SS tax torpedo increasing at 1.5%
Once you have values in each column and apply these rules using the fill function, you can replace with your own values for portfolio size, portfolio appreciation, how many Roth conversions, etc. and apply the analysis to your personal situation.
PS: if you have a copy of Acrobat, try pasting the image, save as pdf, and then see if you can extract as text/spreadsheet; might save a little typing
Understood, and thanks for the excellent guidance on rolling my own. I'll play around and see what I come up with.
Fascinating discussion. Thanks for starting this thread!
Cheers
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

More aggressive Roth conversions

Perhaps Cheryl needs to do more conversions. Maybe, as the conversions add up, she can start paying three IRMAA now to save four years of IRMAA later, or even get to where she is paying eight now to save twelve later.

Let’s see.

The spreadsheet below shows the effect of moving up through the IRMAA #2 span, i.e., converting up to an income of just short of $153,000 in 2023, the threshold for IRMAA #3.

Image

Good news: this second in-IRMAA conversion suffices to drop income below the 2028 IRMAA threshold (year #2 of RMDs). Bad news: Cheryl will still owe IRMAA in 2029. Future IRMAA savings from IRMAA’d conversions in 2023 continue to be one-for-one.

More good news: the second conversion pushes 2027 income down so far that $900 of the reduction occurs within the tax torpedo; income tax savings on this portion will be at 40.7% not 22%. That will go some way toward defraying the extra $7,200 paid in income tax on the second conversion, all of it in the 24% bracket. And hey, if TCJA expires, Cheryl will save at the rate of 1.85 * 25%, or 46.25%.

Really bad news: The dollar amount of the IRMAA #2, #3, and #4 penalties is 50% greater than IRMAA #1. Conversely, the dollar span is a little larger, $30,000 in 2023, not $26,000, allowing a slightly larger conversion.

Net, on this second conversion Cheryl pays a $1500 IRMAA #2 penalty in 2023 to avert a 2028 IRMAA #1. The future value of the $1500 after five years, had it been left in the TDA, would be about $2000;* in return, Cheryl averts the future value of the 2028 IRMAA #1 of … $1,206.

That is not looking good, not at all.

*Note, per Curmudgeon, that even applying tax to the $2,000 still produces a loss: forfeit $1,560 of future TDA wealth to save $1,206 of future IRMAA.

Sigh. Brother Charles didn’t say to stop at two IRMAA’d conversions; he said go all the way through IRMAA #4 up to the top of the 24% bracket (the IRMAA #4 bracket extends past the ceiling of the 24% income tax bracket on through the 32% bracket and well up into the 35% bracket before the IRMAA #5 threshold is reached). Cousin Celia would seem to argue for going even further; for Cheryl to convert all her TDA in two years will require conversions into the 37% bracket each year. I’ll hold off on that for now.

If Cheryl follows Charles’ advice, she’ll pay IRMAA #3 to convert another $30,000 to get to just shy of IRMAA #4 at $183,000; then, per Charles, if she pays IRMAA #4, she can convert $15,000 more, to top off the 24% bracket.

Pursing her lips, Cheryl started shaking her head, remembering all the years she’d spent helping Charles with his math homework, too often to no good effect. It had been such a surprise when his son Peter had gone on to become a CPA!

“Let me see, if I pay the fourth IRMAA, that gets me a conversion that is $15,000 larger before I hit the ceiling of the 24% bracket. But I have to pay the $1500 IRMAA #4, plus the 24% income tax, to get that extra $15,000 converted.”

Not needing to pull out her calculator, Cheryl figures the marginal tax rate as $1500/$15,000 + 24%, or … 34% on that final $15,000.

She swore. “Forget that.” She decides to stop short of IRMAA #4 this year; there is always next year to repeat IRMAA #1 etc.

Here is conversion through IRMAA #3:

Image

Starting with the good news: with this third IRMAA’d conversion in 2023, IRMAA #1 for 2029 is now averted. Bad news: IRMAA prevention is still one for one, three pre-paid and three forestalled.

Also good news: 2027 income is now pushed $2000 down into the torpedo. Bad news: 2028 income has not yet been reduced into the torpedo. She only enjoys the 40.7% tax savings in one year on a portion of the income reduction.

The bottom line on the bad news: She’s made another $1500 IRMAA payment in 2023. Future value of this payment is $2120 in 2029. That averted a 2029 IRMAA #1 with future value of $1242. Cheryl lost almost $1000 on this latest pre-paid IRMAA.

It does not appear that Cheryl will be able to “Make it up on volume.” She loses hundreds and hundreds of dollars on every prepaid IRMAA. The loss will be greater if she makes IRMAA’d conversions again in 2024 to reduce 2030 and subsequent IRMAA; here the future value will be figured over 6, 7 and 8 years.

Two phone calls

Cheryl called her brother Charles to explain that his advice to heavy up on IRMAA in 2023 did not appear to be sound, and that she was on the verge of just accepting the penalty on her prosperity that Congress in its wisdom had chosen to levy.

“Of course, Sis, you always had the math brains in the family. I was just throwing out scenarios for you to check out. If you ran the numbers and things didn’t work out, I’m good.”

The call to cousin Celia did not go so well. “You stopped running the numbers at IRMAA #3?” demanded Celia.

Cheryl explained that the trend was bad and getting worse--she was losing more money with each additional pre-paid IRMAA. It didn’t seem worthwhile to keep converting more, especially not above the 24% bracket.

Celia was not convinced. “Let me see, your total conversion in 2023, for three IRMAA payments, was about $86,000, right?”

“Yes,” replied Cheryl. “BTW, that would almost double my current Roth holdings. And with portfolio growth, it would reduce my 2027 TDA balance by over $100,000.”

Celia: “But that conversion amount is barely 6% of your current TDA balance, right? And it is not even twice your expected first year RMD!”

Cheryl’s tone stiffened: “The present value of the future IRMAA that I avoided is less than the present value of the IRMAA I have to pay now to avoid having to make those future payments. It is not rational to pay more to save less. The definition of insanity is repeating a money-losing endeavor over and over in the hope that it will start to make money if repeated often enough.”

Celia, softening her voice, tried a different tack. “Look, I’m not saying that converting a greater amount will work, these spreadsheets are your thing, not mine. But people tell me these spreadsheets that make future projections can eat your brain. The inner workings are obscure and results can be surprisingly non-linear. All I am asking is that you at least run the numbers on a more substantial conversion.”

Cheryl shot back: “No way am I converting into the 37% bracket when I only expect to be in the 22%, or maybe 25% bracket, once RMDs begin. That’s nuts!”

Celia tried a different tack. Soothingly: “You got down into the tax torpedo by the third conversion, right? And was Uncle Curmudgeon correct, that you saved 40.7% in income tax on some of those dollars in reduced income?”

Cheryl, hesitatingly: “yes … but only in the first year of RMDs.”

Celia, triumphant: “Because you only converted a small amount!” Speaking over Cheryl she continued: “I’m not asking you to convert into the 37% bracket. I’m asking you to go far enough into IRMAA #4 to dilute that penalty down to one or two percentage points of the conversion amount, to use our old teacher Kenneth Fiver’s math.”

Cheryl, doubtful: “But that means going all the way through the 32% bracket and some way into the 35% bracket.”

Celia: “Is it irrational to pay 35% to save 46.25%? Or even just 40.7%? Remember, I am not telling you to do this conversion, I am telling you to run the numbers and look at what they show. Trust me, you will never regret doing more Roth conversions rather than fewer. Every dollar is tax-free forever.”

Cheryl, sighing: “Fine. I’ll enter a conversion amount that dilutes the IRMAA #4 penalty down to 1% of the amount converted, no more.”

Celia, brightly: “But repeat these conversions again in 2024, okay? You’ve got to take it to the limit to give my recommendation a fair shake. Talk to you next week!”

Looking back at her spreadsheet, Cheryl groaned to herself. How was she going to keep track of the present day income tax payments, the IRMAA penalties, and the future value of same, relative to the future value of the income taxes and IRMAA saved across eight to twelve future years?

***

If you’ve stuck with me this far, care to make a prediction? Can a large enough conversion turn things around for Cheryl 2.0, and steer her through the shoals of IRMAA? Specifically, should she drive 2023 and 2024 Roth conversions up into the 32% bracket and beyond, per cousin Celia’s recommendation?
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by capran »

Abe wrote: Fri Jan 06, 2023 11:43 am I appreciate the OP posting this, but I had to quit reading about half way through before my brain exploded.
+1 except made it only a third.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by curmudgeon »

McQ wrote: Thu Jan 12, 2023 5:53 pm
If you’ve stuck with me this far, care to make a prediction? Can a large enough conversion turn things around for Cheryl 2.0, and steer her through the shoals of IRMAA? Specifically, should she drive 2023 and 2024 Roth conversions up into the 32% bracket and beyond, per cousin Celia’s recommendation?
It seems unlikely that large conversions over one or two years will help, in part because the "tax torpedo" is not all that wide. Avoiding high marginal rates on a smallish chunk of income by paying somewhat less high marginal rates on a much larger chunk of income is unlikely to pay off. There still may be value in doing conversions even after claiming SS, up to the boundary of the next IRMAA; that doesn't pay taxes that won't eventually get paid one way or another, and it might avoid some IRMAA (or reduce tax drag) at some point in the future.

It would be interesting to take these exact numbers and move them from a single person to a couple MFJ. That's probably a larger segment of the population for two to have that much SS and that much TDA, as well as somewhat more likely to have gotten squeezed into the "little time left" segment of the graph by one of the couple working past age 65. In that case, the IRMAAs are double the cost, and the brackets (mostly) double the width. I think the couple would be unlikely to hit IRMAA naturally, but would be more likely to be in the "tax torpedo" zone.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by sc9182 »

McQ wrote: Thu Jan 12, 2023 5:53 pm More aggressive Roth conversions
..
If you’ve stuck with me this far, care to make a prediction? Can a large enough conversion turn things around for Cheryl 2.0, and steer her through the shoals of IRMAA? Specifically, should she drive 2023 and 2024 Roth conversions up into the 32% bracket and beyond, per cousin Celia’s recommendation?
Just a Acturial prediction (guess) - is Cheryll may get dinged if she follows Celia’s advice too closely.
Then again - with ever changing tax and actuarial landscape (reduced RMD withdrawal % , coupled with increased RMD age, and expiring TCJA - among other changes) — chances are that one Cheryll may be closer to demise - by the time RMDs hardly makes a dent in tax situation/impact ..

As for converting to Roth aggressively into IRMAA higher tiers !? Doubt those would be tax-efficient conversions..

Cheryl might be better off - using Trad IRA monies towards large medical needs (above 7% AGI) - SNF/LTC-care needs/memory-care or QCDs,
and/or leave towards inheritance.

With ever so frequently changing (and expiring) tax landscape — any math we work today will be history in couple/three years.

Tax diversification is key - do enjoy benefits of it !! But, going all-in to Roth bucket in this case (and in many BH cases), would likely lead to sub-optimal tax efficiency..

Hey - look forward to see the math ;-)
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Harry Livermore »

Hi Dr, McQ.
I bumbled my way to your website and found the Excel sheet for "simple" conversion analysis (no IRMAA consideration) I also downloaded the paper to read at my leisure.
Thank you for putting both up for us to consume.
I am not sure my small brain will make heads or tails of the spreadsheet but will work with that one first until I have some comfort, and then attempt to build one that mimics what you have put up here in your screenshots.
As a 56 year old who seems to be entering a phase of life where income and taxes will be lower for a time, I might be your prime target audience. Thanks for all the contributions here.
Cheers
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

Harry Livermore wrote: Fri Jan 13, 2023 8:30 am Hi Dr, McQ.
I bumbled my way to your website and found the Excel sheet for "simple" conversion analysis (no IRMAA consideration) I also downloaded the paper to read at my leisure.
Thank you for putting both up for us to consume.
I am not sure my small brain will make heads or tails of the spreadsheet but will work with that one first until I have some comfort, and then attempt to build one that mimics what you have put up here in your screenshots.
As a 56 year old who seems to be entering a phase of life where income and taxes will be lower for a time, I might be your prime target audience. Thanks for all the contributions here.
Cheers
Thanks for those kind words Harry. The spreadsheet you downloaded is an improvement on the spreadsheet the SSRN paper was written from, FYI, based on insightful comments made over several threads here by FiveK, cas, curmudgeon, marcopolo, chip and others; many will be found in this thread, along with a walk through of the spreadsheet: viewtopic.php?t=358688.

You are indeed in the target audience, and you have much more flexibility than Cheryl (just watch out for the pre-59.5 early withdrawal penalty).
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

curmudgeon wrote: Thu Jan 12, 2023 9:21 pm
McQ wrote: Thu Jan 12, 2023 5:53 pm
If you’ve stuck with me this far, care to make a prediction? Can a large enough conversion turn things around for Cheryl 2.0, and steer her through the shoals of IRMAA? Specifically, should she drive 2023 and 2024 Roth conversions up into the 32% bracket and beyond, per cousin Celia’s recommendation?
It seems unlikely that large conversions over one or two years will help, in part because the "tax torpedo" is not all that wide. Avoiding high marginal rates on a smallish chunk of income by paying somewhat less high marginal rates on a much larger chunk of income is unlikely to pay off. There still may be value in doing conversions even after claiming SS, up to the boundary of the next IRMAA; that doesn't pay taxes that won't eventually get paid one way or another, and it might avoid some IRMAA (or reduce tax drag) at some point in the future.

It would be interesting to take these exact numbers and move them from a single person to a couple MFJ. That's probably a larger segment of the population for two to have that much SS and that much TDA, as well as somewhat more likely to have gotten squeezed into the "little time left" segment of the graph by one of the couple working past age 65. In that case, the IRMAAs are double the cost, and the brackets (mostly) double the width. I think the couple would be unlikely to hit IRMAA naturally, but would be more likely to be in the "tax torpedo" zone.
Hello curmudgeon, I wanted to thank you for your participation in this thread. Your earlier post contains a nice summary of my priors: "Avoiding IRMAAs out in the future by paying more IRMAA now is somewhat of a mug's game anyway." But I haven't completed the analysis yet, and there are complexities still to be parsed, such as the worth of a TDA dollar.

I'll see if I can redo the analysis, once complete, for the couple case. If it is a professional couple, two Cheryls as it were, with equal SS payments, and equal TDAs, the analysis should be almost completely parallel, since all IRMAA thresholds except #5 are 2X the single level.

The one wrinkle: a couple may be more likely to enter at least the bottom of the tax torpedo. But they will exit it thousands rather than hundreds of dollars before the first IRMAA threshold. That will make it harder for a conversion now to both save a later IRMAA and save some income tax at the torpedo rate.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by CrazyCatLady »

capran wrote: Thu Jan 12, 2023 7:17 pm
Abe wrote: Fri Jan 06, 2023 11:43 am I appreciate the OP posting this, but I had to quit reading about half way through before my brain exploded.
+1 except made it only a third.
This thread has made me realize how rudimentary my personal calculations for the future are! Lol. I don’t know that I could do all the calculations myself, but once Dr. McQ explains it, I go back and look at the screenshots of his numbers and I understand generally why the numbers are what they are :). I may have to go spreadsheet hunting on his website myself, and see if I can figure some more out.

I’m with the group that doesn’t think larger Roth conversions are going to make sense. Both from a pure numbers perspective and because as a singleton she is more likely to end up needing nursing care so I suspect she should keep a higher TDA balance. With all these hoops and what ifs, it seems like you could easily get to the point where the tax tail starts wagging the dog.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by teen persuasion »

McQ wrote: Fri Jan 13, 2023 4:37 pm
Harry Livermore wrote: Fri Jan 13, 2023 8:30 am Hi Dr, McQ.
I bumbled my way to your website and found the Excel sheet for "simple" conversion analysis (no IRMAA consideration) I also downloaded the paper to read at my leisure.
Thank you for putting both up for us to consume.
I am not sure my small brain will make heads or tails of the spreadsheet but will work with that one first until I have some comfort, and then attempt to build one that mimics what you have put up here in your screenshots.
As a 56 year old who seems to be entering a phase of life where income and taxes will be lower for a time, I might be your prime target audience. Thanks for all the contributions here.
Cheers
Thanks for those kind words Harry. The spreadsheet you downloaded is an improvement on the spreadsheet the SSRN paper was written from, FYI, based on insightful comments made over several threads here by FiveK, cas, curmudgeon, marcopolo, chip and others; many will be found in this thread, along with a walk through of the spreadsheet: viewtopic.php?t=358688.

You are indeed in the target audience, and you have much more flexibility than Cheryl (just watch out for the pre-59.5 early withdrawal penalty).
There seem to be quite a few of us in the Cheryl-a-dozen-years-ago age range, avidly following along.

Perhaps a spreadsheet showing how earlier conversions/spenddowns of the TDA fare would be appropriate.

(I'm still trying to figure out why Cheryl had a sizeable taxable account to spend down, but not much in Roth IRA. Contributing to Roth IRA is generally much higher on the priority list than taxable). :confused
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Soon2BXProgrammer »

teen persuasion wrote: Fri Jan 13, 2023 7:46 pm
(I'm still trying to figure out why Cheryl had a sizeable taxable account to spend down, but not much in Roth IRA. Contributing to Roth IRA is generally much higher on the priority list than taxable). :confused
People who have all of their saving in the back half of their career end up with no Roth and more even amounts in pretax and taxable. (Closer to even the higher their savings rate playing catch up) Of course number vary, but late accumulators look different then lifetime diligent savers.
Earned 43 (and counting) credit hours of financial planning related education from a regionally accredited university, but I am not your advisor.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by teen persuasion »

Soon2BXProgrammer wrote: Fri Jan 13, 2023 8:09 pm
teen persuasion wrote: Fri Jan 13, 2023 7:46 pm
(I'm still trying to figure out why Cheryl had a sizeable taxable account to spend down, but not much in Roth IRA. Contributing to Roth IRA is generally much higher on the priority list than taxable). :confused
People who have all of their saving in the back half of their career end up with no Roth and more even amounts in pretax and taxable. (Closer to even the higher their savings rate playing catch up) Of course number vary, but late accumulators look different then lifetime diligent savers.
Can you explain why no Roth and go right to taxable? Why wouldn't you do a backdoor Roth (or mega) after exhausting tax-deferred space, before moving on to taxable?
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Soon2BXProgrammer »

teen persuasion wrote: Fri Jan 13, 2023 8:26 pm
Soon2BXProgrammer wrote: Fri Jan 13, 2023 8:09 pm
teen persuasion wrote: Fri Jan 13, 2023 7:46 pm
(I'm still trying to figure out why Cheryl had a sizeable taxable account to spend down, but not much in Roth IRA. Contributing to Roth IRA is generally much higher on the priority list than taxable). :confused
People who have all of their saving in the back half of their career end up with no Roth and more even amounts in pretax and taxable. (Closer to even the higher their savings rate playing catch up) Of course number vary, but late accumulators look different then lifetime diligent savers.
Can you explain why no Roth and go right to taxable? Why wouldn't you do a backdoor Roth (or mega) after exhausting tax-deferred space, before moving on to taxable?
They might do a backdoor Roth but late accumulators have a hard time building up a meaningful Roth balance if they didn't start a Roth IRA until the last 10 years. Also, conversions without income limits changed circa 2010 or so.. before that you couldn't do the backdoor if you income is too high, and most people have IRAs if they worked multiple jobs so the pro-rata is an issue, etc. (And mega isn't offered lots of places)

And if they had a financial advisor the financial advisor can't bill on a workplace plan, so they might not walk them through how to deal with eliminating the pro-rata rule, etc

Non-bogleheads have lots of challenges to create meaningful Roth balances especially if they are late accumulators taking the tax deduction in their workplace plan.
Earned 43 (and counting) credit hours of financial planning related education from a regionally accredited university, but I am not your advisor.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by CrazyCatLady »

teen persuasion wrote: Fri Jan 13, 2023 7:46 pm
Perhaps a spreadsheet showing how earlier conversions/spenddowns of the TDA fare would be appropriate.
I second this! :sharebeer
teen persuasion wrote: Fri Jan 13, 2023 7:46 pm
(I'm still trying to figure out why Cheryl had a sizeable taxable account to spend down, but not much in Roth IRA. Contributing to Roth IRA is generally much higher on the priority list than taxable). :confused
I would guess she rolled her 401(k) into a traditional IRA at some point (i.e. maybe switched jobs), so if she tried to do a backdoor Roth IRA she would have to deal with the pro rata rule. I think Roth 401(k)s only became prevalent within the last 15 years, and assuming her employer offered one while she was still working, she was probably in the 32% ish tax bracket so traditional 401(k) contributions made more sense. Good chance her employer didn’t offer a mega backdoor Roth option in their 401(k), so that wouldn’t be possible either.

My taxable account is about double my Roth money, and I did some Roth 401(k) contributions every year until I hit the 32% bracket. I also do a backdoor Roth every year. It seems like it’s hard to find Roth space…
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by andypanda »

"I think Roth 401(k)s only became prevalent within the last 15 years"

Pretty close to it. They began in 2006.

"The Roth IRA, named after the late Delaware Sen. William Roth, became a savings option in 1998, followed by the Roth 401(k) in 2006."
From www.kiplinger.com/retirement/retirement ... %20complex.

For those of us who began buying stocks in the late '60s, a Roth account was too little too late. I was planning to retire in 2002 and didn't bother with a Roth, but I needed surgery on my spine in 2003 so I kept working and by then my mother had severe Alzheimer's and then my parents had to move to a retirement community in early 2007 for the assisted living and nursing home care, etc. A year after my father died in 2011 I got around to retiring, but didn't take SSA retirement until 2016, a few months before my mother died.

So, thinking about the given scenario, I can see how taxable accounts happen. :) Different generations had different options. So we have our two pensions, two SSA retirement checks, and on and on. And last year I had to begin my RMDs from three accounts. My wife is five years younger so hers will be along shortly.

I want to be in the highest IRMAA tier, but it isn't going to happen unless we live to be 100+, and the highest federal bracket, but that isn't going to happen either. Oh well. Things could be a whole lot worse than having too much income and paying too many taxes.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by WoodSpinner »

teen persuasion wrote: Fri Jan 13, 2023 8:26 pm
Soon2BXProgrammer wrote: Fri Jan 13, 2023 8:09 pm
teen persuasion wrote: Fri Jan 13, 2023 7:46 pm
(I'm still trying to figure out why Cheryl had a sizeable taxable account to spend down, but not much in Roth IRA. Contributing to Roth IRA is generally much higher on the priority list than taxable). :confused
People who have all of their saving in the back half of their career end up with no Roth and more even amounts in pretax and taxable. (Closer to even the higher their savings rate playing catch up) Of course number vary, but late accumulators look different then lifetime diligent savers.
Can you explain why no Roth and go right to taxable? Why wouldn't you do a backdoor Roth (or mega) after exhausting tax-deferred space, before moving on to taxable?
At least in our case:

- Roths were NOT available when we started saving so we saved in a Traditional IRA
- When Ruth’s became available, Pro-Rata made a Backdoor Roth challenging.
- 401ks became available so we started saving there, BUT Mega-Backdoor Roths weren’t available till we were close to Retirement.

We retired with 95% in TDA accounts and 5% in Taxable (due to Inheritance).

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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by furwut »

CrazyCatLady wrote: Thu Jan 05, 2023 10:35 pm
My related question is is there anything Cheryl could have done 10-15 years out to lessen the impact? If she is single, childless and in the 32% bracket (and maybe even 24% bracket) I don’t think there are a lot of options.
If one has taxable, tax deferred, and tax-free accounts maybe concentrate your equites in the taxable and tax-free and leave tax deferred for bonds?
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by bsteiner »

There are so many variables so it may be difficult to quantify this. A comparison of choices should run through the date her beneficiaries will take their last RMD (most likely 10 years following her death), making reasonable assumptions as to investment returns, tax rates, and life expectancy.

In considering Roth conversions, people often compare the tax rate on a conversion to the tax rate that would otherwise apply to distributions. However, there are several additional benefits to a Roth conversion:

1. If you pay the tax on the conversion out of other money, you're effectively making a substantial additional contribution to your Roth IRA.

Example: Assume a constant 30% tax rate. You have a $100 traditional IRA and $30 of other money. You convert. You now have a $100 Roth IRA. Over some period of time it grows to $200, which you or your beneficiaries withdraw tax-free. If you didn't convert, your traditional IRA would grow to $200. You or your beneficiaries withdraw the $200, pay $60 tax, and have $140 left. But your $30 of cash grew to something less than $60 since the income and gains were taxable each year.

2. There are no RMDs from a Roth IRA during lifetime. This is a substantial benefit for those who have other money for living expenses.

3. Our clients generally provide for their children in trust rather than outright. That keeps their inheritances out of their estates for estate tax purposes, and protects their inheritances from their creditors and spouses, and Medicaid. However, in the case of traditional IRA benefits, the trustees have to decide each year between making distributions to save income taxes (which gives up the asset protection) or accumulating the IRA distributions (which preserves the asset protection but generally results in income tax at the higher trust rates). A Roth conversion avoids that tradeoff.

Other factors to consider are the beneficiaries' tax brackets, and whether she, her beneficiaries, or the trusts for their benefit, will be subject to state income taxes, and at what rates.

4. IRAs are protected against creditors in many states. Paying the tax on the conversion out of other money results in a more valuable IRA that may be protected from creditors, and less money exposed to creditors.

5. If she'll be subject to state estate or inheritance tax, paying the tax on the conversion will reduce her state estate or inheritance tax.

If she doesn't want to sort through all of this, she could simply convert up to the top of the 22% or 24% bracket, except trying to be near the top of an IRMAA bracket since each bracket is a cliff. Except for each IRMAA bracket being a cliff, it's about 4% of the conversion so it shouldn't otherwise be a major factor.

See my articles in this in the April 2013, https://www.kkwc.com/wp-content/uploads ... r_ATRA.pdf, and June 2018, https://www.kkwc.com/wp-content/uploads ... ations.pdf, issues of Trusts & Estates.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by teen persuasion »

McQ wrote: Fri Jan 06, 2023 3:53 pm

Here is the effect:

Image
I've been working thru recreating your spreadsheets, to gain familiarity with excel. I *think* I've found an error: in year 2026 the TDA does not seem to have been reduced by the withdrawals for expenses or Roth conversion. Only the inflation increase was applied.

Correcting this pushes IRMAA out one more year, to age 81.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by CrazyCatLady »

andypanda wrote: Sat Jan 14, 2023 8:29 am
I want to be in the highest IRMAA tier, but it isn't going to happen unless we live to be 100+, and the highest federal bracket, but that isn't going to happen either. Oh well. Things could be a whole lot worse than having too much income and paying too many taxes.
You are 100% correct, and yet the thought of paying that much tax makes me a little ill :). I appreciate being in a position where (hopefully) money won’t be much of a concern in retirement, but I’d rather the extra go to homeless cats and not Uncle Sam :D


furwut wrote: Sat Jan 14, 2023 8:57 am
CrazyCatLady wrote: Thu Jan 05, 2023 10:35 pm
My related question is is there anything Cheryl could have done 10-15 years out to lessen the impact? If she is single, childless and in the 32% bracket (and maybe even 24% bracket) I don’t think there are a lot of options.
If one has taxable, tax deferred, and tax-free accounts maybe concentrate your equites in the taxable and tax-free and leave tax deferred for bonds?
Thanks! I’m trying to do that for the most part. I’m doing I Bonds as a partial bridge to social security and some Tbills/VUSXX as my emergency fund, but otherwise all my bonds are in my 401(k). Though end of the day, I guess Andypanda’s point about this all being a first world problem is entirely valid.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Harry Livermore »

McQ wrote: Fri Jan 13, 2023 4:37 pm
Harry Livermore wrote: Fri Jan 13, 2023 8:30 am Hi Dr, McQ.
I bumbled my way to your website and found the Excel sheet for "simple" conversion analysis (no IRMAA consideration) I also downloaded the paper to read at my leisure.
Thank you for putting both up for us to consume.
I am not sure my small brain will make heads or tails of the spreadsheet but will work with that one first until I have some comfort, and then attempt to build one that mimics what you have put up here in your screenshots.
As a 56 year old who seems to be entering a phase of life where income and taxes will be lower for a time, I might be your prime target audience. Thanks for all the contributions here.
Cheers
Thanks for those kind words Harry. The spreadsheet you downloaded is an improvement on the spreadsheet the SSRN paper was written from, FYI, based on insightful comments made over several threads here by FiveK, cas, curmudgeon, marcopolo, chip and others; many will be found in this thread, along with a walk through of the spreadsheet: viewtopic.php?t=358688.

You are indeed in the target audience, and you have much more flexibility than Cheryl (just watch out for the pre-59.5 early withdrawal penalty).
Beat you to it; I had already spent the better part of my afternoon yesterday reading through the entirety of the 380 posts, which was no small task. The amount of brainpower on this board is staggering. The contributions made by those you name-checked, as well as by others, is appreciated by anyone reading the thread. I found myself re-reading previous posts, traveling back up-thread, in an effort to really absorb the points other posters were making. And I went down several rabbit holes, collecting the MDM spreadsheet, and various articles by Michael Kitces (always a good read) and a couple of others. I now have a folder full of stuff on the topic. I went to bed last night with a slight headache ;)
For a mere mortal like myself, staring at those spreadsheets, reading various articles by Kitces and others, and more abstract papers like yours and the mentioned "Combining Investment and Tax Strategies for Optimizing Lifetime Solvency under Uncertain Returns and Mortality" is tough work. Like going-back-to-college type work. For me, anyway...
I really pine for an online tool that allows mere mortals (like me) to input relevant data (age, marital status, filing status, amounts in taxable, TDA, Roth, income, age to stop work, age to start SS, age to start Medicare) and allows the input of goals, maybe the ability to choose 3 in order of importance (lifetime tax smoothing, largest after-tax spendable money, avoiding IRMAA, protection of a surviving spouse from higher taxes, etc.) The tool then spits out a strategy. Something along the lines of Pipher's opensocialsecurity.com. Maybe it uses standard data and assumptions like mortality tables, future tax rates, inflation, etc., but also has the ability to "go advanced" and change certain underlying data.
The tools that I can currently find, like the one at Fidelity, seem too coarse and don't capture enough of the moving parts being discussed here, and the other thread.
Oh well, a fella can dream.
In the meantime, I will start to pencil out a strategy for some conversions along the way. We have always been in the mid-high brackets, and don't expect to ever not be in the middle, so conversions in the 22% bracket seem logical.
Compounding our personal situation is the variable nature of my income. It's always made long-term planning difficult.
And, I've already made some historical mistakes: jumping on the change in 2010 that allowed conversions for higher-income folks like ourselves, during one of my higher-earning years; NOT converting the balance of our individual IRAs in 2020 when my income was effectively zero; and converting last year instead, when income was back up (though still much lower than it's been historically) Not a big deal, but not smart.
Eh, better to not dwell on the past. I've been lucky, and I've been smart at times too. I'm hoping I can craft a prosperous retirement by studying hard now.
And I appreciate the efforts of all here on this board. Here's to you, if you have read this far down on another thread-killing Harry Livermore long post.
Cheers
Last edited by Harry Livermore on Sat Jan 14, 2023 11:41 am, edited 1 time in total.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by LilyFleur »

headedwest wrote: Fri Jan 06, 2023 8:11 am Thank you so much for considering scenarios for people who are likely to file their taxes as single when they retire.

If nothing else, it seems like Cheryl would benefit from breaking down the target date account into stocks and bonds so she can shift her stock allocation out with either Roth conversions or distributions beyond her living expenses and invest them in a taxable account. That would help to slow the growth of her pre-tax account.
I agree. It's nice to have a scenario applicable to single seniors.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by mouth »

Soon2BXProgrammer wrote: Fri Jan 13, 2023 8:09 pm
teen persuasion wrote: Fri Jan 13, 2023 7:46 pm
(I'm still trying to figure out why Cheryl had a sizeable taxable account to spend down, but not much in Roth IRA. Contributing to Roth IRA is generally much higher on the priority list than taxable). :confused
People who have all of their saving in the back half of their career end up with no Roth and more even amounts in pretax and taxable. (Closer to even the higher their savings rate playing catch up) Of course number vary, but late accumulators look different then lifetime diligent savers.
This would be me. An early career in the military followed by a career in management consulting. My time in the military, with so much of my comp being tax free, should have meant a decent Roth pile. But a few things conspired against me; Youthful decisions (duh), still not being paid all THAT much, and most crucial TSP Roth not being available to me until 2 years before I retired (read: despite being paid well with low marginal tax rates!)

So I went from circa 15% marginal rate and no state income taxes to 28% + 5.75% state tax rates in a single year; and I moved to the 32% bracket very quickly. So while I was using my Roth IRA to some extent in my service days, and doing Backdoors now, for the most part I've been/am "stuck" contributing most of my available savings into pre-tax accounts and taxable.

Result: my $1M investment portfolio is 27% taxable, 23% Roth, and 50% pre-tax and contributions are 65%, 7%, 28% respectively. Note that I 'm in the 38.8 fed bracket and 5.75 state. Neither Mega-Backdoor Roth nor HSA are available to me either :annoyed

On Topic: I'm reading McQ's posts with the dread (but don't feel sorry for me) that my military retirement is going to totally bung up the math!!!

PS, I'm a single (but partnered), 50yo male looking to retire in the next 1-5 years, so the conversion discussion is very top of mind as soon as I retire.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by busdriver »

Harry Livermore wrote: Sat Jan 14, 2023 11:09 am I really pine for an online tool that allows mere mortals (like me) to input relevant data (age, marital status, filing status, amounts in taxable, TDA, Roth, income, age to stop work, age to start SS, age to start Medicare) and allows the input of goals, maybe the ability to choose 3 in order of importance (lifetime tax smoothing, largest after-tax spendable money, avoiding IRMAA, protection of a surviving spouse from higher taxes, etc.) The tool then spits out a strategy. Something along the lines of Pipher's opensocialsecurity.com. Maybe it uses standard data and assumptions like mortality tables, future tax rates, inflation, etc., but also has the ability to "go advanced" and change certain underlying data.
The tools that I can currently find, like the one at Fidelity, seem too coarse and don't capture enough of the moving parts being discussed here, and the other thread.
Oh well, a fella can dream.
Have you tried Income Strategy, (https://incomestrategy.com)? If not, for $20 it might be worth trying for a month. It goes way beyond what Fidelity has on their site.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Harry Livermore »

busdriver wrote: Sat Jan 14, 2023 12:21 pm
Harry Livermore wrote: Sat Jan 14, 2023 11:09 am I really pine for an online tool that allows mere mortals (like me) to input relevant data (age, marital status, filing status, amounts in taxable, TDA, Roth, income, age to stop work, age to start SS, age to start Medicare) and allows the input of goals, maybe the ability to choose 3 in order of importance (lifetime tax smoothing, largest after-tax spendable money, avoiding IRMAA, protection of a surviving spouse from higher taxes, etc.) The tool then spits out a strategy. Something along the lines of Pipher's opensocialsecurity.com. Maybe it uses standard data and assumptions like mortality tables, future tax rates, inflation, etc., but also has the ability to "go advanced" and change certain underlying data.
The tools that I can currently find, like the one at Fidelity, seem too coarse and don't capture enough of the moving parts being discussed here, and the other thread.
Oh well, a fella can dream.
Have you tried Income Strategy, (https://incomestrategy.com)? If not, for $20 it might be worth trying for a month. It goes way beyond what Fidelity has on their site.
Looks worthy of trying out anyway! Thanks for the tip. Have you used it?
Cheers
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by WhiteMaxima »

SS torpedo is unlikely to avoid to most of BH. IRAMMA might if BH do carefully (like Roth conversion before 63). Take SS at 67 might not a bad idea if you can do RMD at 75.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by busdriver »

McQ wrote: Wed Jan 11, 2023 3:52 pm Apologies to all for the mind-numbing complexity of IRMAA avoidance strategies (but of course, that's precisely what attracted my attention to the topic).

I promise that when my planned posts end (by Monday at the latest), I will conclude with a very simple "Do this/ Don't do this" recommendation.

In the meantime, I should probably remind everyone that "you can take the academic out of the classroom by retiring him, but you can't ever take the classroom out of his tone, style and manner of approach to a topic."
The complexity is indeed mind-numbing; however, a lot of people are in similar or more complex situations and would benefit by running thru the various plans.

While I glaze over at a lot of this, I am certainly looking forward to the very simple "Do this/Don't do this" recommendation. :sharebeer
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by Soon2BXProgrammer »

mouth wrote: Sat Jan 14, 2023 12:01 pm Result: my $1M investment portfolio is 27% taxable, 23% Roth, and 50% pre-tax and contributions are 65%, 7%, 28% respectively. Note that I 'm in the 38.8 fed bracket and 5.75 state. Neither Mega-Backdoor Roth nor HSA are available to me either :annoyed
and with another 5 years of work, with your current contribution distribution, your taxable will end up much closer to your pretax. (asset allocation by account could skew things) and your Roth will end up much smaller then taxable.
Earned 43 (and counting) credit hours of financial planning related education from a regionally accredited university, but I am not your advisor.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by busdriver »

Harry Livermore wrote: Sat Jan 14, 2023 12:31 pm
busdriver wrote: Sat Jan 14, 2023 12:21 pm
Harry Livermore wrote: Sat Jan 14, 2023 11:09 am I really pine for an online tool that allows mere mortals (like me) to input relevant data (age, marital status, filing status, amounts in taxable, TDA, Roth, income, age to stop work, age to start SS, age to start Medicare) and allows the input of goals, maybe the ability to choose 3 in order of importance (lifetime tax smoothing, largest after-tax spendable money, avoiding IRMAA, protection of a surviving spouse from higher taxes, etc.) The tool then spits out a strategy. Something along the lines of Pipher's opensocialsecurity.com. Maybe it uses standard data and assumptions like mortality tables, future tax rates, inflation, etc., but also has the ability to "go advanced" and change certain underlying data.
The tools that I can currently find, like the one at Fidelity, seem too coarse and don't capture enough of the moving parts being discussed here, and the other thread.
Oh well, a fella can dream.
Have you tried Income Strategy, (https://incomestrategy.com)? If not, for $20 it might be worth trying for a month. It goes way beyond what Fidelity has on their site.
Looks worthy of trying out anyway! Thanks for the tip. Have you used it?
Cheers
I subscribed in mid 2018 and continued with it for a couple years. I retired late 2018 at 65 and continue with the plan I chose, which is slightly more aggressive than the recommended optimal plan. Delaying pension & SS until 70 and doing Roth conversions thru 2025 with IRMAA going away by 2028. :D
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

teen persuasion wrote: Sat Jan 14, 2023 10:35 am
McQ wrote: Fri Jan 06, 2023 3:53 pm

Here is the effect:

Image
I've been working thru recreating your spreadsheets, to gain familiarity with excel. I *think* I've found an error: in year 2026 the TDA does not seem to have been reduced by the withdrawals for expenses or Roth conversion. Only the inflation increase was applied.

Correcting this pushes IRMAA out one more year, to age 81.
Teen persuasion, you've done it again, same as when you caught an error in the widow tax hit thread. That does push IRMAA out one more year. That doesn't change much for Cheryl 1.0, but the error continued when I switched to Cheryl 2.0. I'll go back and see how I have to change Cheryl 2.0's starting balance, it will probably move a little higher.

You are among the reasons I get so much value from posting at BH ... along with cas finding an error in the original Roth paper spreadsheet, FiveK finding an excruciatingly embarrassing error in the second Roth spreadsheet ... and I think I left out some other BH's names ...

To answer your earlier question about why Cheryl 1.0 didn't have much in Roth to begin with:
1. She does have $100K or so, from earlier contributions and the pre-IRMAA conversion last year.
2. As others have suggested, her working tax rate was high enough to make conversions unattractive, given her anticipated tax rate in retirement (for quite some time she imagined that she would be in the 15% (now 12%) bracket. As mentioned in my reply to Woodspinner a few days back, she didn't really understand how high her SS payment would be or how powerfully a bull market could boost her TDA.)
3. The final problem is she never had much in taxable; maxing out her TDA contributions, and paying down her mortgage, seemed the better path. After leaving enough for an emergency fund, she was just able to fund last year's Roth outside the conversion.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by mouth »

Soon2BXProgrammer wrote: Sat Jan 14, 2023 12:36 pm
mouth wrote: Sat Jan 14, 2023 12:01 pm Result: my $1M investment portfolio is 27% taxable, 23% Roth, and 50% pre-tax and contributions are 65%, 7%, 28% respectively. Note that I 'm in the 38.8 fed bracket and 5.75 state. Neither Mega-Backdoor Roth nor HSA are available to me either :annoyed
and with another 5 years of work, with your current contribution distribution, your taxable will end up much closer to your pretax. (asset allocation by account could skew things) and your Roth will end up much smaller then taxable.
You're dead right. I left out (but you might have guesstimated) that my annual savings this year is projected at roughly $105K +/- 15k depending on bonus and splurge spending. With my 75/25 AA, all of that 25% is in TDA (which makes it 50% of that bucket) and everything else is Total Stock Market; so as you guessed, that TDA account is indeed growing (well shrinking recently) much slower than the rest.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by trueblueky »

I do Roth conversions to the top of 12% because:

* taxes are on sale for everyone. When they revert in a few years, we'll pay 15%.

* taxes are especially on sale for DW and me. When we start RMD, she starts SS, or one of us pass (any of the above), we will never again be in 12% under existing tax law (that is, even if rates never revert).

We avoid IRMAA until one passes, then likely have it forever. 85% of SS will be taxed.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

bsteiner wrote: Sat Jan 14, 2023 10:18 am There are so many variables so it may be difficult to quantify this. A comparison of choices should run through the date her beneficiaries will take their last RMD (most likely 10 years following her death), making reasonable assumptions as to investment returns, tax rates, and life expectancy.

In considering Roth conversions, people often compare the tax rate on a conversion to the tax rate that would otherwise apply to distributions. However, there are several additional benefits to a Roth conversion:

1. If you pay the tax on the conversion out of other money, you're effectively making a substantial additional contribution to your Roth IRA.

Example: Assume a constant 30% tax rate. You have a $100 traditional IRA and $30 of other money. You convert. You now have a $100 Roth IRA. Over some period of time it grows to $200, which you or your beneficiaries withdraw tax-free. If you didn't convert, your traditional IRA would grow to $200. You or your beneficiaries withdraw the $200, pay $60 tax, and have $140 left. But your $30 of cash grew to something less than $60 since the income and gains were taxable each year.

2. There are no RMDs from a Roth IRA during lifetime. This is a substantial benefit for those who have other money for living expenses.

3. Our clients generally provide for their children in trust rather than outright. That keeps their inheritances out of their estates for estate tax purposes, and protects their inheritances from their creditors and spouses, and Medicaid. However, in the case of traditional IRA benefits, the trustees have to decide each year between making distributions to save income taxes (which gives up the asset protection) or accumulating the IRA distributions (which preserves the asset protection but generally results in income tax at the higher trust rates). A Roth conversion avoids that tradeoff.

Other factors to consider are the beneficiaries' tax brackets, and whether she, her beneficiaries, or the trusts for their benefit, will be subject to state income taxes, and at what rates.

4. IRAs are protected against creditors in many states. Paying the tax on the conversion out of other money results in a more valuable IRA that may be protected from creditors, and less money exposed to creditors.

5. If she'll be subject to state estate or inheritance tax, paying the tax on the conversion will reduce her state estate or inheritance tax.

If she doesn't want to sort through all of this, she could simply convert up to the top of the 22% or 24% bracket, except trying to be near the top of an IRMAA bracket since each bracket is a cliff. Except for each IRMAA bracket being a cliff, it's about 4% of the conversion so it shouldn't otherwise be a major factor.

See my articles in this in the April 2013, https://www.kkwc.com/wp-content/uploads ... r_ATRA.pdf, and June 2018, https://www.kkwc.com/wp-content/uploads ... ations.pdf, issues of Trusts & Estates.
Thanks for those references, bsteiner. And I agree that there can be "non-financial" utility to making more rather than fewer Roth conversions. But I think those factors tip the decision mostly in cases where the conversion is near-breakeven. In Cheryl's case, a conversion at 24%, that might save only 22%, but might perhaps save 25%, could be elected based on the non-financial utility.

But there is also risk when more Roth conversions are done without a clear tax benefit (BHs like to convert at 12% to save 25% later; that's low-hanging fruit, an easy call, and a good example of a clear tax benefit). By risk I mean future Congressional action in the same vein as past Congressional action, chipping away at Roth privileges.

1. first the recharacterization privilege went away
2. then the stretch IRA went away.
3. An example of a future Congressional action in that vein would be adding Roth distributions to MAGI, same as municipal bond interest is already added to MAGI.

Roth funds will still be [income] tax-free; but niece Janice, if she is 63 or older when Aunt Cheryl passes and she inherits a large Roth account, may find the distributions, now added to MAGI, enough to push her up an IRMAA boundary or into the SS tax torpedo.

So, in the next post, I'll continue with a strictly financial analysis of whether more Roth conversions make sense for Cheryl.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

How about really, really big Roth conversions?

[Teen Persuasion found an error in the 2026 row of the spreadsheet. After correcting it, to get Cheryl 2.0’s TDA to where she pays IRMAA from the beginning required a balance now of $1,481,000.]

Back to our story:
Cheryl opened her laptop and set about implementing cousin Celia’s suggestion. To dilute the IRMAA #4 penalty of $1,500 down to one percent required a further conversion of $150,000 beyond the $86,000 already converted while moving through IRMAA #1, #2, and #3, even as these conversions had been piled on top of the pre-IRMAA conversion and the voluntary withdrawal for living expenses (see earlier posts).

Cheryl gulped. It hadn’t been that long ago that her retirement savings had first passed the million-dollar mark. She’d started the year hoping to see $1.5 million; now it looked like the TDA balance was headed back down to under a million!

“Get a grip, girl” Cheryl muttered to herself. It wasn’t all going to taxes; the majority of the reduction was just money changing places by being moved into a Roth account, which cousin Celia seemed to feel was a much better place for money to be.

Still, Cheryl decided to stop before repeating the conversions in 2024 as cousin Celia had insisted; she wanted to see what a $236,000 IRMAA'd conversion in 2023 alone could do.

“Huh!” Cheryl sat back. “Well, now we are starting to get somewhere.” She saw that the new $150,000 conversion had dropped her out of IRMAA for the first eight years, through 2033, five more than before; and that some income was now depressed into the SS tax torpedo for the first five years, rather than just one.

Image

Not quite ready to calculate how much tax she had to pay to achieve this result, Cheryl shrugged and entered the numbers to duplicate the conversion for 2024: a total of about $243,000, about 3% more as tax brackets moved up according to her projection of inflation, and again, with these 2024 IRMAA’d conversions coming on top of the expenses and pre-IRMAA conversions already entered for 2024.

Cheryl’s finger hovered over the enter key as she shook her head. “Half a million dollars in IRMAA’d Roth conversions!” Okay … she’d promised cousin Celia to take a look.

Image

Bingo. Cheryl’s mouth dropped. Adding the 2024 conversion had dropped her out of IRMAA altogether, through life expectancy.* In fact, it appeared to be a permanent reprieve. Her TDA balance tops out at age 84; the higher and higher RMD withdrawal rate keeps her RMD income growing faster than inflation through age 94; but after that point, her balance has dropped enough that the ever-increasing RMD rate no longer keeps income up with inflation, indicating that she would fall further and further behind the IRMAA threshold from that point. Excitedly, Cheryl notes that she will now harvest some savings within the tax torpedo for eleven years; in fact, the reduction in 2027 takes her right to the bottom of the 40.7% zone.

*On IRS unisex tables, 68-year-old Cheryl lives to 88 ; I’ve taken the spreadsheet out to 94, allowing two extra years for being female and four more for family history. Plus, only by that point does it become clear that the escape from IRMAA is permanent.

[not shown: her RMD income will begin to decline around age 99, and fall below the inflation-adjusted age 73 RMD by about age 103, after which exponential exhaustion will begin to drop it more and more rapidly, as withdrawal rates climb to 16%, 25%, 33% …] Charts of this “RMD hump” can be found here: https://papers.ssrn.com/sol3/papers.cfm ... id=4001986

“Hurrah! IRMAA free forever!” Cheryl danced a little jig.

And then she sat down hard. Free indeed, but at what cost? She decided to sleep on it before conducting the present value analysis; these super-sized conversions had pushed $10,000s into the 35% bracket to achieve this happy result...

Interlude

Cost is going to be the crucial element in evaluating the “really, really big” conversion strategy for escaping IRMAA. Please note that it is always possible to avoid IRMAA for life by reducing the TDA to a small enough value, whether by large Roth conversions, or simply by never having amassed much of a TDA balance in the first place. Other than Roth conversions/contributions, there are two major paths by which an affluent professional like Cheryl can end up with a small TDA balance:

1. Earn lousy investment returns
2. Don’t save much

For instance, if Cheryl had done either or both of these, her age 68 TDA balance might have been less than $840,000, rather than the $1,481,000 assumed for Cheryl 2.0; in which case, she would have less than $1.1 million when RMDs begin, same as shown in the image above, and her lifetime income curve would stay under the IRMAA line same as shown above.

IRMAA really is a penalty on prosperity; if you are not prosperous enough, you won’t have to pay it.

I hasten to add that $840,000-at-age-68 is not any kind of hard-set hurdle. If Cheryl’s risk aversion allowed her to be comfortable with a 60/40 mix, estimated annual return 7.5%, she’d have to reach age 68 with less than $500,000 if she hoped to stay out of IRMAA through life expectancy.

Conversely, if Cheryl was super-conservative, with the entire TDA invested in TIPS, earning 0.5% over inflation, or 3.5%, she could have as much as $1,350,000 in her TDA at age 68 and never quite hit the IRMAA threshold.

And all the numbers just given assume a near-max social security payment starting at $50,000+; if Cheryl had a less remunerative occupation, spells of unemployment, and / or took social security early, so that her SS payment was only $30-40,000, the amounts just stated would have to be hundreds of thousands of dollars higher.

Regardless, for any combination of investment return and other income, there is always a starting TDA balance, as RMDs approach, below which you will not pay IRMAA because your life course of RMD income will never quite touch the IRMAA line projected forward.

That value divides the prosperous from the rest.

Next post: What doth it profit Cheryl, if she saveth all her IRMAA, but loses more on income tax?
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by capran »

CrazyCatLady wrote: Fri Jan 13, 2023 5:09 pm
capran wrote: Thu Jan 12, 2023 7:17 pm
Abe wrote: Fri Jan 06, 2023 11:43 am I appreciate the OP posting this, but I had to quit reading about half way through before my brain exploded.
+1 except made it only a third.
This thread has made me realize how rudimentary my personal calculations for the future are! Lol. I don’t know that I could do all the calculations myself, but once Dr. McQ explains it, I go back and look at the screenshots of his numbers and I understand generally why the numbers are what they are :). I may have to go spreadsheet hunting on his website myself, and see if I can figure some more out.

I’m with the group that doesn’t think larger Roth conversions are going to make sense. Both from a pure numbers perspective and because as a singleton she is more likely to end up needing nursing care so I suspect she should keep a higher TDA balance. With all these hoops and what ifs, it seems like you could easily get to the point where the tax tail starts wagging the dog.
Yes, my spreadsheets are pretty basic, but I have "the attention span of a gnat". (well, maybe not quite that bad). We always contributed the max regular Roth contribution, and because of so much deferred savings, we were always allowed to do the Roth while working. As a single, she may need care, but her mom only needed it her last year at 92. Seems like the tax free earnings on the combined Roths should be sufficient to make up the gap between care costs and income. (I took a slightly reduced pension to give her 100% of my pension going forward, and by delaying her SS to 70, her regular pensions and SS should be 90k plus whatever dividends she'll get. (currently all dividends are over 60k). When the tax cuts expire we may start to slow play her conversion which might leave a tIRA balance of 300k. The nice thing about the Roth dividends is that they don't figure into the IRMAA MAGI.
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Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by capran »

[/quote]

Thanks for those references, bsteiner. And I agree that there can be "non-financial" utility to making more rather than fewer Roth conversions. But I think those factors tip the decision mostly in cases where the conversion is near-breakeven. In Cheryl's case, a conversion at 24%, that might save only 22%, but might perhaps save 25%, could be elected based on the non-financial utility.

But there is also risk when more Roth conversions are done without a clear tax benefit (BHs like to convert at 12% to save 25% later; that's low-hanging fruit, an easy call, and a good example of a clear tax benefit). By risk I mean future Congressional action in the same vein as past Congressional action, chipping away at Roth privileges.

1. first the recharacterization privilege went away
2. then the stretch IRA went away.
3. An example of a future Congressional action in that vein would be adding Roth distributions to MAGI, same as municipal bond interest is already added to MAGI.

Roth funds will still be [income] tax-free; but niece Janice, if she is 63 or older when Aunt Cheryl passes and she inherits a large Roth account, may find the distributions, now added to MAGI, enough to push her up an IRMAA boundary or into the SS tax torpedo.

So, in the next post, I'll continue with a strictly financial analysis of whether more Roth conversions make sense for Cheryl.
[/quote]
Indeed, the future could bring a host of complicating factors, and maybe the electorate will ignore a possible inclusion of Roth distributions as MAGI just like the loss of the stretch IRA. All we can do is plan the best we can with the ever-changing circumstances. So far, we have yet to need any of our Roth balance or distributions. I shudder to think they would tax withdrawals of the original taxed contributions, but I guess anything is possible. In some examples, it seems like folks might be considering tIRA to Roth conversions that put them into a substantially higher tax bracket now. I am suggesting it may be feasible to convert up to the 22% income as a MFJ rather than face a larger RMD in the future at a substantially higher rate when filing as s Single.
Topic Author
McQ
Posts: 1414
Joined: Fri Jun 18, 2021 12:21 am
Location: California

Re: Steering through the shoals of IRMAA past the SS Tax Torpedo

Post by McQ »

IRMAA Forestalled Forever—But at What Cost?

Cheryl sat down with her morning coffee, determined to nail down the tax cost of the huge Roth conversions that, it appeared, could drop her out of the IRMAA zone for life (IRMAA’d conversions equal to about $479,000 over 2023 & 2024, see previous post).

“Okay. First, I lay out the dollar amount of future IRMAA payments avoided. I model these as increasing with inflation each year at 3%.”

“Next, I enter what my future RMDs would have been if I’d done no IRMAA’d conversions. I compare those values to the much reduced RMDs I will have if I do those huge Roth conversions that cousin Celia urged. Reducing my RMDs saves me income tax as well as keeping me out of IRMAA."

"Plus, some portion will be saved in my income tax bracket, but some portion will be saved at the SS tax torpedo rate, and I’ll have to keep track of both.”

She thought for a while: “I’m looking at streams of savings over decades, received for a one-time upfront payment. How do I put everything on the same basis?”

Remembering her Finance 101 class, she exclaimed: “Discount to present value!”

But at what discount rate, she asked herself? Then she realized: Of course, it had to be the 6% return that would have been earned by these present-day tax payments if no conversion had been done and the funds had remained in the TDA.

She decided to look at a best case scenario and another less favorable scenario. The best case would stack the deck in favor of the strategy of massive Roth conversions:
1. Post-TCJA tax rate reverts to 25% (46.25% in the tax torpedo)
2. An extra six years of life expectancy, beyond IRS tables (female, family longevity).

The less favorable case would stop at life expectancy and assume that the 22% (40.7% in the torpedo) rate continues.

She adds and hides columns to her spreadsheet, as explained below the image

Image

Hidden:
Columns E,F, showing living expenses and non-IRMAA’d conversions
Column M, showing dollar shortfall/excess relative to IRMAA threshold

Added:

Column K, in blue, showing what her RMDS would have been without any IRMAA’d conversions
Columns O,P, in goldenrod, showing her tax savings outside and inside the tax torpedo
Column Q, the discount factor, which is 1.06 raised to a power equal to the elapsed years from 2024
Columns R, S, in pink, showing the discounted value of the tax and IRMAA savings (IRMAA 1 dollar penalty in Column N)

New rows


Beginning row 31, I’ve totaled:
On the left, income taxes paid in 2023 and 2024 and IRMAA penalties paid. The large values in the fourth cell over--$49,350 in 2023—are figured as:
-$15,000 topping off the 24% bracket
-$50,000 filling the 32% bracket
-$85,000 in the 35% bracket

On the right, you see the sum of the discounted values of the taxes and IRMAA avoided via these 2023 and 2024 conversions.

Bad news

Cheryl blew out her lips. Matters were just as she feared. The tax torpedo and the complete exit from IRMAA were powerful, but not powerful enough. She was under water on the conversions.

“Okay, I paid eight IRMAA penalties, and that kept me out of IRMAA for the 22 years through age 94. That’s a win, I save just over $5,000 in PV terms.”

“But the income tax is a killer. True, I save almost $10,000 in the tax torpedo the first year, and thousands of dollars more in the next few years. But it doesn’t last and it’s not enough.”

“In sum: I paid over $141,000 in income tax to make those large conversions. The present value of my future income tax savings is only $109,000. Net of income tax and IRMAA, these conversions would cost me almost $27,000 in present value!”

Cheryl snapped her laptop shut. And then she remembered: that was the best case analysis. Opening her laptop again, she made a copy of the spreadsheet and this time, stopped the totals at age 88, her IRS unisex life expectancy. She substituted 22% and 40.7% for tax rates, and peeked at the new bottom line: savings of about $89,000. Against a total tax cost of $152,000 to convert.

“Oww … those huge conversions could cost me more than $60,000! Ai yi yi.” Cheryl stood up. “IRMAA payments starting at $1,171 in 2027 don’t sound so bad now. I can afford an extra 1% of my income.
***
Almost ready for the sum up post. I’ll wait a day or two for comments.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
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