Roth Conversion or not

Submitted by Kelvin Smith on Thu, 2023-09-07 16:29

I am a 69-year-old retiree and have a $1.4 million traditional IRA and about $600k in a taxable brokerage account. Currently comfortably living on Social Security, pension, etc.
Eventually will need some of the IRA and taxable monies to supplement income and would like to leave some money to my kids.
My thought was to Roth convert $225k per year for the next 4 years (prior to RMDs) paying the taxes from the taxable brokerage account. The $225k number is to keep the taxes in the 24% bracket as much as possible. I estimate the total taxes for the 4 conversions are between $200k and $240k.
My reasoning for the conversions is:
-believe Roth conversions avoid RMDs (which are not tax efficient)
-provide continued growth of the money but tax free going forward
-believe the conversion is relatively cost neutral in the long run
-allows passing on to heirs’ tax-free money
-believe taxes are going up because the 2018 tax cuts are expiring in 2025 and our federal (and State) debt is totally out of control

Does it make economic sense to make these conversions?



Submitted by David Mertz on Thu, 2023-09-07 20:02

Sounds like a reasonable plan, but be aware of any side effects of increasing AGI such as any increase in Net Investment Income Tax, the taxable amount of Social Security benefits, and Medicare Part B or Part D IRMAA.  If side effects would increase your effective marginal tax rate above 24%, you might want to consider converting smaller amounts over more years.  Since you will eventually need to spend money from the traditional IRA, amounts that you receive as RMDs for years beginning with the year that you reach age 73 can be moved to the brokerage account where subsequent gains can be taxable at long-term capital gains rates instead of as ordinary income.  Investments that remain in your brokerage account at your death will also be eligible for a step-up in basis.

Submitted by Kelvin Smith on Thu, 2023-09-07 23:55

Thanks so much for the feedback. I looked into the Medicare cost increases which I believe are off-set by 2 years but yes that is surely a cost to understand. I assumed I would pay taxes on 85% of Social security.  Are there more taxes than that for social security due to to higher income?I’m not sure what Net Investment income tax is. Can you explain that?

Submitted by David Mertz on Fri, 2023-09-08 01:33

  • If 85% of Social Security is already taxable without the increase in AGI, the increase in AGI won’t cause any further increase in the taxable amount of Social Security income.  For those who are not already having 85% of Social Security income being taxed, additional income can nearly double the marginal tax rate until the 85% limit is reached.  To gauge the marginal tax rate, I use tax software to prepare a simulated tax return, then test to see how much additional tax is due on a $1,000 increase in reported income.  Of course, this does not take into account Medicare Part B and D IRMAA since these are not present on the tax return.
  • Net Investment Income Tax adds 3.8% of tax on investment income that takes your modified AGI for the purpose above $200,000 for single or head of household, $250,000 for married filing jointly or qualifying widow(er), $125,000 for married filing separately.  That wouldn’t be an issue if filing single and staying below the 32% tax bracket, but the 24% tax bracket for MFJ goes well above $250,000.  Investment income would typically be amounts reported on Forms 1099-INT, 1099-DIV, 1099-B and the taxable amount of a distribution from a nonqualified annuity reported on Form 1099-R (code D included in box 7).

Submitted by Ken Fitzgerald on Fri, 2023-09-08 03:48

https://thefinancebuff.com/medicare-irmaa-income-brackets.html#htoc-2023-irmaa-brackets   It is correct that the tax year you exceed the cutoff for regular Medicare premium rates based on your MAGI income (which includes Muni Bond interest added to AGI which includes the Roth conversion amount and all other income on the tax return AGI line) is charged monthly at higher Part B and Part D rates (for both if filing jointly) two years after the tax year.  Tables showing the estimated cutoffs for 2023 income levels are in the link I added above under 2025 IRMAA BRACKETS, if you scroll down.   These are projections (not guaranteed yet) for where the final max 2023 income brackets may land in each category.   I have relied on his math for the past 3 years of Roth conversions in terms of staying below the ceiling in the 1.4 x regular Medicare costs affected.  

Submitted by Kelvin Smith on Sat, 2023-09-09 14:16

Thanks for the very insightful helpful comments to my post. Its great to have so many knowledgeable people taking the time to help people like me. Thanks for clarifying the 85% social security issue. That is helpful. I was not familiar with the term Net Investment Income Tax but it seems like what is often referred to as the “Capital gains tax”. In my very unprofessional modelling, I just used 24% marginal tax rate for all excess income during the conversion years which is close to the 23.8% capital gains rate. Thanks for the helpul estimates of 2025 IRMAA BRACKETS to help me understand possible future costs (not guaranteed). I suspect Medicare will also go up in the future because its trust fund is worse off than the SS trust fund.Again you guys are great to help us folks who are not into reading the tax code and trying to decifer it. You should be commended for your work.

Submitted by David Mertz on Sun, 2023-09-10 02:19

Net Investment Income Tax and Capital Gains Tax are two different things.  NIIT is calculated on Form 8960.

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