IRA Conversion Laddering – Pros & Cons

Submitted by Blue_Sky on Sat, 2021-03-13 18:57

Contemplating a multi-year conversion plan for both spouse and I using this strategy (spreadsheet). Wondering if there are any special considerations I need to take into account, and if this has much value. We are retiring this year, but in no rush or need to use these funds for at least 5 years.

A few things I’ve taken into consideration in doing this are:
1) Acknowledging we cannot touch the first years converted funds until 5 years after it goes into the Roth
2) I’m adding 3% to each years withdrawal amount to account for inflation
3) Doing a separate sheet for both myself and spouse as she is 8 yrs younger and we would be spreading her conversions over a longer timeframe.

One big question I have is – does stretching our conversions out over 15 years (for mine) and 24 years (for her) make sense? My goal was to keep our AGI low to stay in a lower tax bracket, so that’s the rational behind smaller amounts over longer periods (also spreading out the tax pain too)

Would appreciate any thoughts on this and any IRS regs that may dictate a change in our strategy.



Submitted by Alan - IRA critic on Sat, 2021-03-13 19:28

Many people use laddering of conversions as a substitute for a 72t plan to avoid the penalty for any distributions before 59.5. You did not mention that possible application for conversions.  All penalties cease at 59.5  even if a distributed conversion has not been held 5 years. What is your age?
Generally, the period between retirement, the start of SS benefits, and the start of RMDs at 72 are low marginal rate years best for conversions. As this other income is added the conversions cost more, and would normally cease after 71. But you still need to make a rough attempt to determine if the marginal rates you will pay for these conversions will be lower, or at least not higher than your expected marginal rate starting at 72. 
If a spouse has a higher % IRA basis than the other spouse, the higher basis IRAs should be converted first. Of course, most people have no basis.
Composition of your employer plan also factors into long range planning. Does either spouse have highly appreciated employer shares in a 401k?  Any Roth or non Roth after tax balance in such plans?
Any regular Roth IRA contribution basis in either spouse’s Roth, or conversions already held 5 years. These amounts are already available without tax or penalty.

Submitted by Blue_Sky on Sat, 2021-03-13 19:41

If I’m interpreting you correctly, I (but not my spouse) can eliminate the 5 yr waiting period for withdrawals since i am over 59.5 in my spreadsheet? Other answers to your comments:
I am 63, she is 55. We will both stop working in 1-3 months, so I anticipate next year to be the first “much lower AGI” year tax-wise. We’re going from two high earnings careers to about one fifth our annual income* in 2022 (*the one fifth represents the first payout from a 10 year deferred compensation plan)
That period for me will be years 2022 to 2029 (when my SS starts at age 70) and 2031 (RMD’s start). For her it will be 2022-29 (a SS planning tool has her starting SS benefits at age 62 when I am 70) and her RMDs start in 2039
WE BOTH have made non-deductible contributions for many years to our TIRA’s, and WE BOTH have about the same basis (mine is slightly more but very small – maybe $10k more than hers)
No
No. We each have a Roth but they were opened many yrs ago and only contributed to for 2 yrs before we were no longer qualified to make contributions. Total combined balance of only $23k
My primary reason for doing these sheets had nothing to do with early withdrawals…it was to construct a year-by-year plan for mapping out what amounts we could/should consider converting, and over what timeframes taking into account our ages and age difference. So whether we call it “laddering” or just plain ole’ conversion planning – that was my goal.

Submitted by Alan - IRA critic on Mon, 2021-03-15 20:41

Yes, your Roth is fully qualified. Any distributions will be tax and penalty free. You might be able to squeeze in a small conversion this year since your AGI will be about 1 salary down.
Same situation in reverse once various future incomes are phased in in about 4 steps.
With respect to TIRA basis, the IRA with the higher % basis should be converted first, not necessarily the higher dollar basis.
You will probably have to revisit your general conversion plan each year to fine tune with respect to various changes such as tax rates, and various “cliff thresholds” where going just one dollar over the threshold will trigger a tax such as the IRMAA Medicare premium surcharge for Parts B, C, and D. Congress messes with the thresholds quite often with higher income taxpayers gradually losing govt premium support which averages about 75% for those below IRMAA thresholds. A major factor occurs when one spouse’s health declines, since filing single for the surviving spouse spikes marginal rates. Accelerated conversions might be wise in the couple years before the estimated year of the first spouse to pass.

Submitted by Blue_Sky on Tue, 2021-03-16 20:48

Our gross income will drop dramatically this year (50% what it was in 2020) and again in 2022 (by about half again – only income will be from the first of ten annual deferred compensation payments, but still only about 20% of what we grossed in 2020). So, my plan was to hold off on any conversions until next year. It may be simplistic, but my thinking is:
Convert my TIRA in equal amounts, starting in 2022 and finishing in 2028. I’ll be 70 in 2029, when ss starts and RMD’s right around the corner. Seems like my best time window to convert.
Starting in 2029, we’d convert spouses TIRA in equal amounts over 9 yrs (ending 2037; age 62-70 for her).
The reason for the sequenced approach is the added income we’ll realize from 2022-2031 from the deferred compensation. Those payouts are set in stone.
If we tried converting portions of BOTH our TIRA’s during any year, we’d likely drive up our income and tax rate. So…spreading out the pain during the age ranges between next year and age 70 for each of us, is what this amounts amounts to.
Based on these basic facts, and setting aside the basic question of “does it make financial sense,” does this logic hold water?

Submitted by Alan - IRA critic on Tue, 2021-03-16 21:40

You will be filing jointly with all taxable income treated equally regardless of source, therefore it does not matter which spouse’s IRA is converted when looking at conversion year taxes. That said, you will be exposed to RMDs first due to your age, so it does make sense to convert from your IRA first. You might utilize 2021 for reduced conversions since you would benefit from not letting any lower bracket tax space go to waste.  You will just have less of it in 2021 than in the following few years.
In the overall picture, the first converted dollars tend to be the most beneficial because each conversion will reduce your future RMDs and in total will reduce income in the higher brackets. At some point you may have converted enough such that your future marginal rates will have dropped to the rate you are paying for the conversion. Once the future rates appear to be lower, then the conversions would cease. Another reason the first converted dollars are more beneficial than later ones is they reduce the growth in the TIRA for more years and allow more time in the Roth to generate tax free gains. 
The largest bracket to bracket hike is from the 12 to the 22% bracket. While your income is such that you may never be in the 12% bracket, if you ever are be sure to convert enough to utilize the entire space in the 12% bracket. Alot of this strategy depends on where you end up in each bracket each year. 
One challenge is those DC payments since they will be made in the prime conversion years, reducing the amount of lower bracket space available for conversions. The actual numbers are important. Will the end of the DC distributions just be replaced with even higher RMD and taxable SS payments, or will the completion of the payments result in lower taxable income?

Submitted by Blue_Sky on Wed, 2021-03-17 15:45

“so it does make sense to convert from your IRA first.” -Got it. You might utilize 2021 for reduced conversions since you would benefit from not letting any lower bracket tax space go to waste.  You will just have less of it in 2021 than in the following few years. We were required to exercise a large number of stock options this year (you must exercise within 90 days of terminating or w’ed lose them), so this added another $160k of taxable income. So what we didn’t earn in salaries this year we made up for (mostly) through this transaction, which is why I’m thinking even this year won’t be a great year to start conversions (still too high). But NEXT year, all we will bring in is the deferred comp (see numbers below), so it will be MUCH lower.
The largest bracket to bracket hike is from the 12 to the 22% bracket. While your income is such that you may never be in the 12% bracket, if you ever are be sure to convert enough to utilize the entire space in the 12% bracket. Alot of this strategy depends on where you end up in each bracket each year. Deferred Comp will be 88k/yr for years 2022-2026, and reduced to about half from 2027-2031. BUT in 2028 I turn 70, so SS kicks in. I just don’t think we’d get down to 12% except maybe just one year (2027)
One challenge is those DC payments since they will be made in the prime conversion years, reducing the amount of lower bracket space available for conversions. Correct. The actual numbers are important. Will the end of the DC distributions just be replaced with even higher RMD and taxable SS payments, or will the completion of the payments result in lower taxable income? There is one year where we have all three. My SS starts in 2028, RMD’s start in 2030. The Open Social Security calculator advises spouse claim at age 62, so we need to add in her SS, which puts us over the DC payments . The i-ORP calculator shows top tax brackets of –  age 63-66 (12%); age 67-69 (15%); age 70-on 71 (25%)

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