Rollover IRA conversion/ withholding strategy?
As 67 yo retired academic, I have a pretax savings of 3X either Roth or personal investments.
Prior to Social Security at age 70 and as prelude to potential nasty RMDs,
I plan to live on pretax for the next several years while allowing Roth and personal to grow.
Instead of taking pretax distributions to my private account up to the IRMAA level of ~180K, why shouldn’t I do a Roth conversion of approx. 130K with no withholding in January 2022, and plan on a pretax distribution of approx 30K in December with 100% tax witheld for state and federal to cover total total income including Roth conversion, spouse social sec.. etc.
A. Seems like even though it is ususally advisable to not pay conversion taxes with pre tax distribution, if I want to live off only pre- tax for a few years anyway, I may as well convert and when I need living expenses, take it from the Roth funds that have been there 5+ years. Then if I don’t need it all each year it is in Roth, not taxable. Comments please.
B. I would prefer this strategy obviate the need for estimated payments. Or would estimated be required with early year conversion and late year withhold?
Thanks.
Permalink Submitted by Alan - IRA critic on Fri, 2021-12-24 21:12
If you withhold enough to meet your safe harbor tax payment amount, there is no need for quarterly estimates, although if your taxable income increases over the prior year, you will owe on 4/15, but not incur a penalty. Withholding is deemed to have been paid equally throughout the year, so you could do a first quarter conversion and do the withholding distribution late in the year.
The other question is more complex, but if you do not have the cash to pay conversion taxes and RMD taxes, and you take another distribution just to withhold taxes, your taxable income will include all these TIRA distributions and could expose you to a higher marginal rate. It is generally preferable to plan for a roughly equal taxable income after inflation needs to avoid the higher brackets as much as possible.
Perhaps if you do not spend your entire RMD and save the rest in a taxable account, after awhile you can use that money to pay the conversion and RMD taxes and not have to take a withholding distribution to pay taxes. That will reduce your taxable income. As long as you have to take the withholding distribution the conversion cost in the form of your marginal tax rate will make the conversion less attractive, because after all the benefit of conversions is paying a rate that is no higher than the rate you would later pay on RMDs if you did not convert. As for IRMAA surcharges, you could determine the added IRMAA premiums due 2 years later and include them as if they were income taxes to determine the actual marginal rate for the conversion. This requires some complex tax modeling since the IRMAA tiers are not marginal rates and higher tiers phase in on an entirely different schedule than marginal rates.
Permalink Submitted by Arthur Foreman on Mon, 2022-01-03 19:39
Thanks for your comment on the safe harbor and obviating my need for quarterly estimates.As to the other question that is more complex, perhaps I made my original question overly complex.To restate: I have a larger percentage of retirement savings in pretax and modest amounts in roth and taxable accounts. As I am 67, my plan in the next 5 years prior to RMD’s is to withdraw as much from Pre tax as I can up to the level of marginal rate and IRMAA adversely affect taxes. For me, that will be MAGI of around 180K. By doing so, I will reduce future RMDs that will potentially require a MAGI of twice the 180K planned in later retirement years.So, my question is: If I am going to withdraw pre tax anyway at the 160K (including withholdings) level anyway to reduce my pretax allocation, why not convert all 160K to Roth instead of taking a 160 K withdrawal to a taxable brokerage account. Then, when I need living expenses, there seems to be no downside to merely taking that from first in first out Roth funds that have been in place for well over 5 years. If I don’t need the full conversion amount each year, it is now in Roth for future untaxed gains.The concept is a bit like the donor advised fund we use to uncouple the timing of deductions for charitable donations and grant dates.So please comment specifically on the strategy while ignoring where I will obtain tax payment. I am aware that at some varying level for MAGI and IRMAA I will begin to suffer with tax rates but I am willing to accept some pain now to avoid more in future.