Low taxes this year (heavy med expenses), possible $50K TIRA RO to ROTH opportunity to cut taxes on my wife as possible widow

Submitted by Ron Smith on Thu, 2019-12-26 20:51

I am 75, my bride is 7 years younger. As a widow she will be in the 22% bracket. MFJ we are in the 12% bracket.

* We had $55K in Deductions this year and would have ZERO Federal Tax (my wife would owe $2,500 in SE taxes). Looking to see if I could turn to an advantage in a possible $50K ROTH RO that could be made within the 12% tax bracket.
* If we move $23K from a TIRA to a ROTH, Fed tax would increase from ZERO to $5,000 ($2,700 on the $23K RO, plus $2,300 on $19K added Soc Sec that would not be taxed otherwise).
* $3,500 taxes would be due on the remaining $27K ROTH RO, making a total of $8,500 added taxes (approx. 12.4% on $69K, $50K RO and $19K taxed Soc. Sec.)
* If widowed, my wife would be in the 22% tax bracket, including any RMD or RO.

Would it be a stretch to make such a decision on the possibility of my wife being widowed? Am I trying too hard to get “something” other than no 2019 taxes out of the massive deductions?

Much obliged!
Ron



Submitted by Alan - IRA critic on Thu, 2019-12-26 23:05

  • Your concern is real, and it’s possible you should convert some amount even if you both planned to live forever. Normally you would want to have about the same tax liability every year, so in a year with a reduced tax liability you would convert enough to bring it up to your projected average.  That’s without the larger issue of the length of time one of you will be filing single. And while the chances of that person being her a larger, it is also possible that the person could be you. So you would attempt to determine the expected number of years that the odds would produce such a situation, and then increase the average accordingly. For example if you project to file jointly for 10 years and someone is single for 10 years, your weighted average would be the overall average. That would produce a higher conversion target for years like this. 
  • But am not sure that your underlying facts are accurate for this year. Apparently you are itemizing due to medical. Did you notice that the Tax bill restored the medical deduction floor to 7.5% of AGI for 2019 and 2020?  Also, since all your TIRAs are treated as a single TIRA, the only way you can generate a tax free RMD is to either have your QCD as large as your RMD or have so much basis in your TIRA that the QCD absorbs it all. You should also be completing your QCD first, and it does not matter which IRA account it comes from since a QCD is applied only against your combined pre tax IRA total. It would help you provided the actual or theoretical figure for your total IRA balance now, the amount of basis you have in your TIRA (if any), the RMD amount, and QCD amount. Can then determine if you already have a taxable portion of your TIRA distributions to date. In projecting the taxable income of the survivor, just eliminate the lower SS gross benefit. 
  • So yes, you should probably convert, but the challenge is how much, with only a couple days to act?

Submitted by Ron Smith on Mon, 2019-12-30 23:05

  1. As you anticipated, the survivor will have essentially the same income, with the lower Soc. Sec. dropping off. 
  2. “Did you notice that the Tax bill restored the medical deduction floor to 7.5% of AGI for 2019 and 2020?”  I did not notice that.  Thank you!

The signed paperwork is in hand with the trustee.Hopefully, there is still time…Thank you, Alan!

Submitted by Alan - IRA critic on Fri, 2019-12-27 15:14

  • I think your original post breaks down the converted amount into tranches, and due to the effective tax rate increase while SS income is absorbed, if you divide the first 23k conversion by 5000, the rate for that amount is 21.7% due to SS being absorbed. Then the rate for an additional 27k drops back to 13% since the max amount of SS (85%) had been mostly absorbed with the first 23k conversion. You probably ran these scenarios with a tax program, so you can break up the converted amounts into as many different options as you wish. But the main point is that if you are going to pay 21.7% for the first 23k, then you would obviously continue with additional amounts for which the rate drops back to the nominal rate of 12%.  You might convert until you hit the top of the 12% bracket, but it may not be much more until you actually hit the 22% bracket.
  • Once the single filing years begins, the higher SS benefit will likewise be taxed up to 85%, so there will be portion of income actually taxed at 22.2 (1.85*12%), then some at just 12%, and then alot at 22% and perhaps even into the 24% bracket. By converting now in the most efficient amounts possible, you would reduce the single filer’s income so that none of it reaches the 24% bracket, and less reaches the 22% bracket. Possibly, it works out to convert every other year, but when you do, go all the way to the top of the 12% bracket. If you just converted around 25K each year, you would be paying 22.2% on most all it because of SS phasein. If you convert every other year to 50k or top of the 12% bracket, you are only paying for the SS phasein one time for the 50k instead of each year.

Submitted by Ron Smith on Sat, 2019-12-28 14:10

“…the main point is that if you are going to pay 21.7% for the first 23k, then you would obviously continue with additional amounts for which the rate drops back to the nominal rate of 12%.  You might convert until you hit the top of the 12% bracket, but it may not be much more until you actually hit the 22% bracket.”

  1. Alan, your explanation helps me to better grasp the concept, and begin to get a more comfortable with it. 
  2. For a tax avoider, it’s hard to get my mind around “voluntarily” paying taxes, even $8,500 in taxes for a ROTH conversion that includes paying taxes on an additional $19K Soc Sec – an avoidable tax, w/o a conversion. 
  3. A spreadsheet is used for projections and compared w/ projections from our CPA and Turbo Tax. 

“….Once the single filing years begins, the higher SS benefit will likewise be taxed up to 85%, so there will be portion of income actually taxed at 22.2 (1.85*12%), then some at just 12%, and then alot at 22% and perhaps even into the 24% bracket. ”

  1. Thank you for the formula to calculate the tax on the combined rollover and additional Soc Sec (to 85%).  Very helpful!
  2. W/o the huge deductions we will experience the scenario you mention for single filers in future years as we file MFJ.  The retirement savings time bomb will loom large again as future conversions will take place mostly in the 22% bracket.

“….Possibly, it works out to convert every other year, but when you do, go all the way to the top of the 12% bracket. If you just converted around 25K each year, you would be paying 22.2% on most all it because of SS phasein. If you convert every other year to 50k or top of the 12% bracket, you are only paying for the SS phasein one time for the 50k instead of each year….”

  • In your initial response, you said this:

“….Normally you would want to have about the same tax liability every year, so in a year with a reduced tax liability you would convert enough to bring it up to your projected average.”

  • Is the advantage of maintaining a “normal” tax liability come from predictable quarterly estimated tax payments? 
  • Thank you, Alan!!!  Very instructive, a great help!!!

Submitted by Alan - IRA critic on Sat, 2019-12-28 14:47

  • Having about the same tax liability every year is a general target, and conflicts with the every other year conversion strategy. The SS phasein is unique and if your AGI happens to fall in the narrow range where you can avoid the phasein or most of it every other year, then you would save enough in taxes over the two year window and doing this would trump the general target. 
  • Having high itemized deductions in a year (eg high medical costs) will reduce your taxable income, but this is different because it does not reduce SS phasein since it does not reduce your AGI, only your total tax bill or perhaps marginal tax rate. Therefore, this has a lesser effect since you still have the same amount of SS included in your AGI up to 85%, but you do get the benefit of lower taxes. 
  • Once your AGI gets to the point where you cannot avoid the SS phasein at all, things get simpler, but more expensive, and you might have only a small window in the 12% bracket to convert before hitting the 22. There is no inflation adjustment on the SS phasein AGI ranges, and never has been. This is why more lower middle income retirees run into phasein every year. Even an unpredictable cap gain distribution can trigger it even if you pay 0 on the actual cap gain, because it drags more SS into your AGI and taxable income.

Submitted by Ron Smith on Wed, 2020-01-01 07:37

Thankfully,  the conversion was made on the 30th!  Your inights have helped cut the stress for this rookie!

  • “…The SS phasein is unique and if your AGI happens to fall in the narrow range where you can avoid the phasein or most of it every other year, then you would save enough in taxes over the two year window and doing this would trump the general target. 
  • ….Having high itemized deductions in a year (eg high medical costs) will reduce your taxable income, but this is different because it does not reduce SS phasein since it does not reduce your AGI, only your total tax bill or perhaps marginal tax rate.

You make this easy to understand!   I should have asked my quesitons on this forum months ago.  How do I get permission to share a PDF of this thread w/ a friend?  Thank you, Alan!

Submitted by William Tuttle on Wed, 2020-01-01 14:46

  • It would be far easier and I’m sure preferable for the website for the friend to just register for their own account and reference the thread. Not only that, but there is a wealth of knowledge primarily provided by Alan with support from DMX. They will have an invaluable resource at their finger tips.
  • I learn something every week from this forum and read just aobut every thread even if it doesn’t affect me or my friends and family.
  • Small correction. I don’t read most of the NUA threads, because they make my head hurt with how complicated those issues can be.

Submitted by Ron Smith on Thu, 2020-01-02 15:10

Could not agree more about the quality of the counsel and especially the patience in making complex topics understandable.  Thankful for Alan and this resource!  It was worth a try on the PDF.  Just reviewed the https://irahelp.com/content-citation-guidelines ; they will be followed.  Thank you, Spiritrider! 

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