Roth Conversions and Taxation of S.S.
I am interested in opinions having to do with a Roth conversion for someone in their mid-sixties currently receiving S.S. of about $26,000/yr. They can convert ~$40,000 and still stay in a 15% bracket, but this will cause their S.S. to become taxable. The spouse has not started taking S.S. and could delay beyond 62. Most of their financial assets are in IRAs. They might have the option to remain in a very low tax bracket for a few years with little to not taxation of S.S. benefits or to stay in a 15% bracket while doing a Roth conversion, however this will cause some taxation of S.S. They are likely to be in a 28% bracket once RMDs start in 2011.
I think the Roth conversion at a 15% bracket offset the taxation of S.S. especially if the Roths are not tapped for 15+ yrs. or perhaps ever.
Thoughts?
Thanks!
Permalink Submitted by Alan Spross on Wed, 2008-05-21 02:46
None of that 26,000 is included in their AGI now? That would mean that other AGI would have to be under 19,000. This is key to whether current conversions would have an effective tax rate of 27.75% or somewhat less because some of the SS is already included in AGI.
Does this couple have any Roth assets now?
Permalink Submitted by Richard Alpert on Wed, 2008-05-21 13:49
No, they do not have any Roth assets currently. The $26,000 is included in their AGI now, but one spouse is still working (until later this year). Their only income in 2009 will be S.S. unless they do a Roth conversion. They younger spouse may also start taking early S.S. in ’09. Otherwise, they have some taxable assets which they can begin to liquidate with little to no tax liability, prior to reaching age 701/2, but these assets may not be sufficient to cover their income needs. Their tax bracket jumps at age 70.5 due to RMDs and the fact that mose of their assets are in IRAs.
Thanks.
Permalink Submitted by Richard Alpert on Thu, 2008-05-22 00:19
Anyone?
Permalink Submitted by Alan Spross on Thu, 2008-05-22 02:21
Having no Roth assets at all at this time argues for starting to fill up the 15% bracket, even though more SS will be included in AGI. If the first year of RMDs is going to result in a 28% marginal rate, that must mean that the older spouse has a 7 figure TIRA balance. The first year RMD is less than 4% and that I why I assumed a considerable balance.
This decision is driven mainly by tax brackets and estimated future brackets, but there are other variable to consider that individually are not critical but collectively can add up. One of these is their plan for long term care, another is their estate plan. More minor considerations even extend to having conversion AGI substantially increase their Part B Medicare premiums. The first conversions are more of a no brainer, but the key question is how much and for how long since each dollar converted reduces RMDs from the TIRA and therefore eventually the top marginal rate they will pay. After the first conversions, the benefit of more conversions continues to diminish.
Even if there were a software program that included all the variables, the conversion plan of necessity would have to be re visited almost annually to account for changes in tax law and their individual fortunes, health, investments etc. After coming up with an optimum amount to convert, they would have to opt out of the 2010 two year deferral so they would be able to utilize their bracket in 2010. Otherwise they lose the 2010 bracket and eat up more of 2011 and 2012.
Permalink Submitted by Richard Alpert on Thu, 2008-05-22 12:03
Thanks for taking the time to reply Alan. Very helpful.