RMD and Roth Conversion Choices
My wife and I have just reached RMD age this year and will be taking out low 6 figures in RMD’s starting in 2021. The funds are not needed at the moment. The new taxable income from RMD’s will mean I have to pay each year an additional $2000 or so in 3.8% Medicare investment income tax, an additional $3000 or so in Medicare premiums and will lose a $1500 state tax credit for long term care insurance premiums. The RMD income is taking us to near the top of our federal tax bracket.
The question is at this stage (and considering higher tax brackets that would be involved) should we do some Roth conversions each year , do fairly big conversions over the next few years, convert all of it at once and pay huge taxes for one year or leave the IRA’s and 401K alone letting the balances continue to grow in full – tax deferred- taking out only the RMD each year going forward ?
Should we not convert at all in case Ed’s idea( that since beneficiaries have to withdraw within 10 years and pay the tax that RMD’s should no longer be required under the law) actually comes to fruition at some point ? Difficult choices.
Thank you.
hoopsjs12
Permalink Submitted by Alan - IRA critic on Wed, 2021-11-17 19:37
There is pending legislation that would delay the first RMD to age 75 and possibly eliminate RMDs for small balance IRAs (under 100k), I think the chance of eliminating future RMDs altogether for those owners with over 100k in their IRAs is quite remote.
Your basis question has no clear answer, since there are several factors that will vary from year to year, and also possible changes to future tax brackets. You could calculate your marginal rate for various conversion amounts and incorporate the NIIT and IRMAA charges into a marginal tax rate to determine the cost of various conversion amounts each year. You would then compare that rate to your estimated future such rate if you do not convert. If the current rate is lower, or in some cases not more than the estimated future rate, you would determine the amount you could convert currently without increasing your marginal rate for the conversion year. You would have to perform these calculations each year. One huge factor to consider is the chance of an early death for either spouse resulting in the survivor having to use the higher single rates for several years. Such a factor would argue for higher conversions while both spouses remain alive.
The IRMAA tiers are cliff thresholds, therefore once a tier is entered, a conversion could be done without incurring more IRMAA surcharges to the point of entering the next higher tier. In that respect IRMAA is different than the usual nominal tax rates.
You might also wait to see how the Biden tax bill would affect you if your taxable income is expected to exceed 450k or so. Both parties are likely to mess with the marginal rates, not waiting for the current rates to expire in 2026.
I suspect that there is no particular conversion calculator that addresses all these variables. It is more art than science.
Permalink Submitted by John Schwarz on Thu, 2021-11-18 01:39
Thanks so much for your well thought out response. On the point of the legislation changing the starting age to 75, while that would be too late for us as we’ve reached the current age threshold to start RMD’s, it also is proposed to not go all the way to 75 till 2032 and start increasing the starting point in one year increments over several years to get to 75. That issue is therefore for the next group of retirees as they get older. The NIIT and the IRMAA, while not insignificant in dollar terms, pale in comparison to the impact on tax payments from higher brackets required for a large Roth conversion. The debate is then should the funds be allowed to grow ( assuming they do) fully tax deferred to get to a higher place- that in turn depends on how many years remain for us. This brings me to your excellent point about the risk of only one of us remaining alive and then having to withdraw at the single rate. (maybe my wife could quickly remarry to solve that problem) :). Seriously, the single filer tax rate is a big concern as you mentioned as far as eating into the principal in future years. I agree the decision is more of an art, that we have to evaluate the future tax rates and whether we expect that the IRA’s investment portfolio’s growth, if allowed to remain full, can be sustained and outweighs the other possible downsides. It almost seems to lead to the idea of converting a reasonably large amount each of the next few years – not doing it all at once, not doing nothing and leaving it as is. I don’t have a scientific analysis to offer but rather a gut feel given the potential bracket issue, the political uncertainty of rates and mostly the uncertainty of each of our individual futures. Any thoughts? Thank you again.
Permalink Submitted by Undocumented Newcomer on Tue, 2021-11-23 11:13
My wife & I deferred substantial income during our working years and have been blessed with significant balances in both tax deferred and tax free accounts, the latter from ongoing Roth conversions. We have designated the children as primary beneficiaries for the tax deferred accounts. At least they will not contend with IRMAA.Michael