Roth converstion strategy
I am 58 years old and file jointly with my husband. We’re in the 15% bracket and likely to stay there. I have about $200,000 in a taxable account consisting mostly of municipal bonds and $750,000 in various IRA accounts, including $70,000 in a nondeductible IRA account. I can’t make any further IRA contributions because we have no earned income. I don’t intend on taking any distributions until I’m required to. I would like to convert some assets to a Roth to avoid having to take distributions on the entire $750K all at once at age 70. Obviously, that $750K will have grown to considerably more than that by age 70. What is my best strategy?
Permalink Submitted by Alan Spross on Mon, 2008-06-23 20:06
Your reference to “all at once” overstates the tax impact of RMDs. In your first year, the RMD requirement is less than 4% of your balance at it does not exceed 5% until age 79. It is also surprising that a 15% bracket taxpayer would have that much in munis, so I hope your projection of 15% rates is accurate. Note that required inclusion of SS income for a 15% bracket taxpayer results in an actual rate of 27.75% while the SS income is being phased into AGI (15 X 1.85).
If neither of you have any Roth assets, converting some each year may pay off in the long run as long as you do not exceed the 15% bracket. After you start SS benefits, you will have to determine if conversions will trigger the 27.75 rate. Note that your first Roth assets are worth more than conversions done later on, since each Roth produces less income exposed later to higher tax rates. The more you convert the lower your marginal rate becomes because of reduced RMDs and eventually you reach a point where conversions are no longer advisable. In your case, since you have a basis, you can be a little more aggressive since you are not being taxed on around 10% of the converted amount.
I am not aware of any comprehensive software that includes all the variables to analyze this including estate planning considerations, increased Medicare premiums due to AGI, long term care planning, etc etc. The main factor continues to be your tax rate for the conversion vrs your estimated tax rate in retirement. This estimate is problematic since you must plan for a 30 year retirement at least, and tax rates that far out can not be accurately estimated. The general consensus however is that they will rise somewhat due to continued deficit spending and lack of fiscal restraint in Washington. In the last analysis, you should plan on re visiting your conversion plan every year or at least every other year. You should also have the money to pay the taxes from taxable accounts.
Remember that recharacterization also provides a safety valve after the fact if you mess up and want to reverse all or part of a prior year conversion.
Permalink Submitted by Bruce Steiner on Tue, 2008-06-24 03:36
I use Excel. Before that, I used Lotus. I can’t possibly consider every variable. But the Roth conversion usually makes sense, at least if you have enough non-IRA assets with which to pay the tax on the conversion.
There is a tradeoff between converting all at once (which gets more money into the tax-free Roth environment sooner, but bunches the income) and spreading the conversion out over several years.
In this case, you don’t have enough non-IRA money with which to pay the income tax if you were to convert your entire IRA. And you’re likely to need some distributions from your IRA at some point. So you may want to discuss with your advisors whether you might convert just enough each year to stay within the 15% bracket.