Spreading Out Roth Conversions

Submitted by Blue_Sky on Mon, 2020-10-05 19:14

Curious… if I intend to do incremental IRA conversions to a Roth starting in 2021, would it be better to try and have them all done by 2025 when current reduced tax rates are due to expire, or, extend them beyond that until my 70th birthday (2028) when RMDs and SS benefits kick in, giving me an extra three years to spread the tax payments?



Submitted by Alan - IRA critic on Mon, 2020-10-05 20:59

It is not predictable when tax rates will change.  They could be increased as early as 2021, or they could be increased only for those in higher brackets. Your RMDs do not begin until the year you reach 72, so your SS benefits will start prior to RMDs. Therefore, each year you need to determine how much you can convert that year at marginal rates you expect to be lower or at least not higher than what you expect your rate to be later on when your taxable income is higher. With future income rising starting with SS benefits, your best conversion opportunities are now. Perhaps you should convert to the top of your current bracket, or if you are expecting 85% of SS to be taxable and your RMDs to be large enough, perhaps you should convert beyond the top of your current bracket. Remember, once you are eligible for Medicare, you also have to be aware of the MAGI theshold for IRMAA, which surcharges your Medicare premiums, and could be analyzed as if it were a higher income tax for planning purposes.

Submitted by Blue_Sky on Mon, 2020-10-05 22:38

At 63, I’m not aware of how to determine if 85% of SS will be taxable, nor how large my RMD’s might be this far out, according to your suggestion.  Although you do state “your best conversion opportunities are now.” Please advise.

Submitted by Alan - IRA critic on Mon, 2020-10-05 23:33

  • I do not know how much your SS benefit will be or what your RMDs will be, but your tax rate after you are receiving these payments is likely to be higher than now or any year prior to 70. You should be able to determine an estimate of your SS benefits at the SS site. If you have any where near 35 years of paying into the system and your annual wages were average or higher, you will probably be taxed on the maximum of 85% of your benefit.  Of course, if you are married you have to include these estimates for your spouse as well. 
  • What marginal rate do you pay now without conversions?  The largest marginal rate increase is when your income moves from the 12% to 22% bracket. Is is usually a no brainer for most people to convert up to the top of the 12% bracket. You need to figure out where you stand each year in order to know how much to convert that year. You have until year end to complete your conversions.

Submitted by Blue_Sky on Tue, 2020-10-06 14:32

  • I have 40 yrs of credits in the SS system and am eligible for benefits whenever I decide to pull that trigger (as of now I’m planning to delay to age 70). Based on wages + waiting to 70 I qualify for $3482 a month.
  • 2019 marginal tax rate was 32%. 2021 (should) be less if we both retire in first quarter of 2021.
  • Was not planning to convert anything this year as I susect we’ll still be at 32% marginal rate for 2020 taxes, but would start next year and future years, if that makes sense.

Submitted by Alan - IRA critic on Tue, 2020-10-06 16:21

Yes, makes sense to not convert this year, and perhaps convert some incremental amount next year due to partial year earnings. 2022 and the few years thereafter prior to SS benefits are claimed appear to be your prime years to convert as long as the marginal rate you pay for the conversions is less than what you would expect after all SS benefits and RMDs are factored in. 

Submitted by Blue_Sky on Tue, 2020-10-06 17:04

So to summarize and confirm, if the plan is not to claim SS until age 70 (2028) …and… RMD’s don’t kick in until 2030 (age 72)….and….we have no employment income starting next year, then I take it the “sweet spot” years to convert to be 2021-2028.Assuming no big fluctuations during those years, can it be as simple as dividing the amount in my traditional IRA by 8 years and converting 1/8th each year in order to “distribute the tax pain equally?” Or, if there is concern about tax rates going up should I consider converting more $ in near-term years (i.e.,2021-2025)?

Submitted by Alan - IRA critic on Tue, 2020-10-06 20:54

You basically have it right, except the incremental amount you choose to convert each year should be driven by that year’s marginal rate vs what you expect it to be after 72.  Most people’s breakdown of income such as pensions, rentals, investments in taxable brokerage accounts, etc results in a conversion analysis that only will convert a part of their TIRA in the long term, not the entire balance. It depends on the amount of your IRA in relation to the total of other taxable income you have.

Submitted by Blue_Sky on Wed, 2020-10-07 12:33

Ok thanks…

  • But I’m still stumped by the statement “amount you choose to convert each year should be driven by that year’s marginal rate vs what you expect it to be after 72.”  How would you estimate your rate 9 yrs from now? Clueless on how to do this with any degree of accuracy.
  • “…conversion analysis…will convert a part of their TIRA in the long term, not the entire balance.” I interpret this to mean the goal should be to convert as much (preferably all) of a TIRA rather than just a portion. 
  • Let me try and bottom line it…1) if tax rates can go up at any time (and most likely will) …..AND…2) if my “window” is the next eight years before SS, then 3) isn’t it almost a given to start converting next year, and convert as much as is financially “comfortable” with the goal of converting the whole account in the next, say 4-5 yrs.? Or am I oversimplifying? I don’t want to get paralyzed with details and lose time/do nothing.

Submitted by Blue_Sky on Wed, 2020-10-07 13:27

One more variable…we are planning to move to another state next year, and it could be a no state tax state like NV or AZ. Better to wait until after that move to convert I suspect?

Submitted by Alan - IRA critic on Wed, 2020-10-07 22:06

  • Yes, but AZ does have a state income tax. Tax rates are comparatively low, but obviously not 0. If you are coming from a high tax state, you should wait until you clearly establish yourself as a permanent resident in the new state before converting. Certain high tax states like NY and CA can make it very rough on if you do not meet all requirements, and may try to levy their state taxes. 
  • As for conversion amounts in a given year, determining your current tax rate is easy. Estimating your tax rate in retirement is a crap shoot and educated guess at best. You just have to do the best you can in making that educated guess.
  • If you have a large TIRA, it is probably not wise to attempt to convert all of it, because that would force you into very large conversions each year which would increase your current marginal rate to perhaps even higher than if you do not convert or convert less. Each dollar converted represents a current accelerated tax payment in lieu of some amount of tax in the future. As your IRA balance drops from conversions or investment losses, that will lower future RMDs and future taxes. Therefore, you could over convert. Each year you should look at the current known tax rate you will pay for various conversion amounts and compare it with your future estimate which should drop with each conversion you have already done. There is no problem with converting only a portion of your TIRA, then stopping conversions after SS and RMDs kick in. 
  • I could be more specific, as you did not indicate when and if you are totally retiring, or anything about the size of your IRA. The balance of the IRA is critical in determining how much to convert each year.

Submitted by Blue_Sky on Wed, 2020-10-07 22:29

  • Both spouse and I retiring (totally) next year, probably sometime between March and June (provided the market doesn’t tank between now and then
  • My TIRA has $485k; spouse has $527k
  • Each of us has non-deductible contributions (form 8606). Mine total $80K and hers $50k

Submitted by Alan - IRA critic on Wed, 2020-10-07 23:54

  • Your pre tax total IRA balance is roughly 900k. The fact that any conversions done will only be taxed on roughly 87% of the gross conversion on average does make conversions more beneficial because you can convert more dollars pre each dollar of taxable income. You might convert more of YOUR IRA first since you have a higher basis % than she does (16.5% for you, only 9.5% for hers).
  • You might convert some next year, but including any paid vacation time, you will also have around 6 months of earned income next year that you will not have after next year. Probably less room for larger conversions.

Submitted by Blue_Sky on Thu, 2020-10-08 00:35

Does age difference play any role in timing of conversions? I will be 63 next year; she will be 55, so I have been assuming it would make more sense (as you suggested) to convert my IRA first before starting conversions on hers since she won’t be claiming SS until roughly 2036, give or take a year .

Submitted by Alan - IRA critic on Thu, 2020-10-08 01:28

It makes more sense to convert yours first for two reasons – you are older and would face RMDs 8 years sooner, and your basis % is higher than hers. Claiming SS benefits adds joint income and reduces the space for conversions, so if each spouse can delay until 70, it will create more space for conversions prior to claiming.

Submitted by Blue_Sky on Thu, 2020-10-08 15:20

Given all the great advice here, I have tried out various online “conversion” calculators to help pin down more specifics on numbers, taxes, etc. I keep getting “post-conversion numbers that suggest I’m less well-off by converting…but…I think it could be HOW I’m using the calculators and the numbers I’m entering. My questions:

  1. Are these tools reliable and are there ones that stand out as very good (accuracy + what they reveal)?
  2. Data entry:
  • Since I would be spreading my conversions over say 5 years, is it correct to only enter 1/5th  my total TIRA as the amount to convert? If I enter the entire amount the tool would assume I’m converting it all in one year, right?
  • Nondeductible contributions: same as above – only enter 1/5th?
  • If conversion happens after retiring, income should be zero, and tax rate adjusted as well (in other words don’t use current marginal rate)
  • Is the post-conversion Roth IRA total number being negatively impacted because of the short time between conversions and drawing from it? Said another way, is converting at age 63 less beneficial than had it been done 10 yrs earleir? And even if so, is it still recommended as a good strategy to avoid the “tax torpedo” later when RMD’s kick in?

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