IRA Planning
Hello
I’m 67-1/2, wife is 62, both retired, in the bottom of the 28% marginal tax bracket, and expect to remain there. We have combined 401ks valued at $629k, R/O IRAs valued at $324k, T-IRAs valued at $22.5k, and Roths valued at $94k. Social Security and pensions will supply our current income requirements for the next 13 years, at which point expense inflation will catch up with income flow. I’m trying to determine whether it would be financially advantageous for us to convert any or all of the 401ks, R/Os and T-IRAs to Roths. Other than no RMD requirements and estate planning issues relative to Roths, is there a specific financial advantage to conversions (gradual) or would it be a wash? For tax planning purposes, should I use the marginal tax rate (28%) or the combined effective tax rate (0.168%) calculated from actual return data to figure the tax cost of conversion? I will greatly appreciate all insights.
Many thanks in advance!!
Jeff W.
Permalink Submitted by Alan Spross on Thu, 2012-08-09 04:27
About the only statement possible without a complete analysis of your situation is that it would NOT be wise to convert all or most of the pre tax assets. I assume that you both have filed for SS benefits, and that 85% of those benefits are included in your AGI and taxable income. If you have not filed yet, there may be potential to delay benefits as part of an overall strategy to accumulate delayed retirement credits.
Once your RMDs kick in, you will move up into the higher portions of the 28% bracket, but you did not mention any investment income in taxable accounts that could eventually be surtaxed under the ACA. But you are not in the more obvious taxable income band where you can convert up to the top of the 15% bracket.
A thorough analysis may even include such factors as whether you have long term care insurance or not. If you do NOT carry it, you would tend to convert less because your RMDs in years with LTC expenses could be partially offset by the medical deduction. Estate factors to be considered are your marginal bracket vrs the expected bracket of your beneficiaries. If the beneficiaries will be in higher brackets, a Roth conversion would benefit them vrs inheriting pre tax assets. A factor that discourages conversions now is whether you plan to relocate to a low income or no income tax state.
The real challenge is to determine how much, if any, you should convert in incremental conversions each year. You would react to changes in the tax law or individual circumstances as you go. For example, if you have high deductible expenses (eg contributions or medical costs) in a given year that reduces your bracket, it presents an opportunity to convert somewhat more in that particular year.
In a pure hedging consideration, a ratio of 90 to 10 for pre tax vrs Roth assets is a little high, and you should probably try to get that down to 80-20.
NOTE: If any of the 401k accounts include highly appreciated employer stock shares, then you also need to analyze NUA potential as part of a lump sum distribution. (Other assets go to an IRA). And if you have a basis from after tax contributions in either plan, it would be more tax efficient to do any conversions directly to a Roth IRA from the plan.