A Roth IRA conversion can be a big tax win when retirement portfolio loses value
https://www.cnbc.com/2022/07/19/why-roth-ira-is-tax-winner-w…
Minimizing “the skim” of taxes.
intercst
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Any thoughts on converting now when I’m in the 22% bracket when I plan to stay in the 12% bracket in retirement?
SkyHigh asks,
Any thoughts on converting now when I’m in the 22% bracket when I plan to stay in the 12% bracket in retirement?
The only reason to do Roth conversions is if your IRA is so large that the start of RMDs will push you into a higher tax bracket.
If you’re sure you can stay in the 12% bracket after the RMDs commence, I’d say you’re good.
intercst
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Any thoughts on converting now when I’m in the 22% bracket when I plan to stay in the 12% bracket in retirement?
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Not sure how you ‘plan’ to stay in the 12% bracket when, under current law, the 12% bracket will go back to 15% in 2026. So, based on current law, at a minimum, you should ‘plan’ for a 15% bracket if your retirement will extend past that time.
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If you are MFJ, you need to look at what happens to the survivor when one of you dies. A ‘plan’ to stay in the 15% bracket may not work so well once the survivor is filing Single.
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Have you modeled what your RMDs will be without any conversions, and where that will put you in the tax brackets, along with SS and any other expected income? Please note that the delay in RMDs due to the SECURE Act (and proposed additional delays) mean that your portfolio will have additional time to grow before RMDs start, making your RMDs even larger.
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If you are getting a real return on your Traditional accounts (i.e. your returns are above inflation), you will experience bracket creep on the ordinary income that those accounts will generate. This bracket creep is exacerbated because the tax brackets are now indexed to the chained CPI, which is generally 0.25% - 0.5% below the previously used CPI. So, again, a ‘plan’ to stay in a low bracket may not be workable.
AJ
9 Likes
Any thoughts on converting now when I’m in the 22% bracket when I plan to stay in the 12% bracket in retirement?
I’ve posted several times about how drawing your living expenses from a taxable IRA can make your taxable income high enough to cause your social security to go from untaxed to taxed on 50% or 85% of the amount. Here’s a link to one on another board:
https://discussion.fool.com/you-are-basically-doing-tax-arbitrag…
Also:
-The tax rates are set to change upwards after 2025 (along with the higher standard deduction)
-If you project that you’ll the in the 12%, not only does that become 15% in 2026, if you’re planning on married filing jointly, that will change with the death of the first spouse, and the survivor is put in a higher bracket alone with a lower standard deduction
-When you are old enough to be subject to RMDs on your regular IRA, they might push into a higher tax bracket or even cause you to pay a Medicare surcharge.
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A Roth IRA conversion can be a big tax win when retirement portfolio loses value
If you are currently making RMD withdrawals from your traditional IRA, I doubt that there is much, if any, tax win in a Roth IRA conversion. Your RMD must be withdrawn before you can consider a Roth IRA conversion.
The biggest value from this year’s traditional IRA losses will be a significant reduction in next year’s RMD withdrawal plus the reduction in next year’s Federal, state, and local income taxes.
Hi MCCrockett,
“I doubt that there is much, if any, tax win in a Roth IRA conversion.”
You aren’t thinking about percents …
First, RMD comes out as a dollar amount.
Next, the IRA holder wants to convert $25,000.
Last year that $25K might have been 5% of the IRA. This year, it is closer to 10% depending on how much value evaporated.
5% vs 10% moving from taxable to tax-free.
That is a bargain.
Does that help you?
Gene
All holdings and some statistics on my Fool profile page
http://my.fool.com/profile/gdett2/info.aspx
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If you are currently making RMD withdrawals from your traditional IRA, I doubt that there is much, if any, tax win in a Roth IRA conversion. Your RMD must be withdrawn before you can consider a Roth IRA conversion.
It depends on each individual’s circumstances, since the percent of the IRA that must be withdrawn also increases each year. Depending on where they are in their marginal tax brackets (Fed and state, as appropriate) and Medicare surcharge bracket, conversions may still make sense - especially since the Federal tax brackets are now based on chained CPI, so they won’t rise as quickly as they would have.
The biggest value from this year’s traditional IRA losses will be a significant reduction in next year’s RMD withdrawal plus the reduction in next year’s Federal, state, and local income taxes.
Maybe. Maybe not. It depends on how much your IRA balance will be by the end of the year (not now) and what age you are. If markets recover some by the end of the year, or you happen to be invested heavily in something that hasn’t dropped as much as the market, your balance by the end of the year may not be down enough to offset the increase in your RMD. For example, from 72 to 73 the percent of your balance that must be withdrawn increases from 3.65% to 3.77% That’s only a 3.4% increase. But from 82 to 83 (10 years later), the percent of your balance that must be withdrawn increases from 5.41% to 5.65% That’s a 5.2% increase. And as you age, the percent of increase continues to accelerate.
AJ
2 Likes
Last year that $25K might have been 5% of the IRA. This year, it is closer to 10% depending on how much value evaporated.
5% vs 10% moving from taxable to tax-free.
That is a bargain.
That is exactly what I did earlier this year.
One worked out (the current price is higher than when I converted the stock) and one didn’t. Yet.
The market is down more now than when I did the conversions.
Maybe you need to do a bit at a time instead of doing one large conversion. Kinda like DCA’ing.
Gene:
Your Roth conversion example missed a key element of the conversion: cost!
The market has been far too generous to me since retiring in 2013 and beginning RMD in 2015. After my wife died in 2019, I am forced to file as single. My current RMD results in any Roth conversion taking place in the 32% Federal and 9.3% California tax brackets.
As a result, I would need to have $10,325 available to convert $25,000 from traditional IRA to a Roth IRA. Alternatively, I could have the taxes withheld from the withdrawal from my traditional IRA with only $14,675 being deposited in the Roth IRA.
Perhaps I’m too concerned about the total cost of conversion to see the tax win.
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Hi MCCrockett,
You are still missing the point.
Percent!
If you choose to do a conversion, doing it when the market is down severely, like 40% or more, is the best time to do it.
When I did Roth conversions in the past, I did it purely as a dollar amount.
When I chose to convert $100K and my portfolio was down 30%, I transferred more shares of stock than I would if the prices had not dropped. I paid the same tax but on much higher future growth potential.
One more tidbit: I always chose the “highest potential” stock to move. If a company was hit hard based on general market or because a sector was hammered because of a different company, that was what I would move. Failing having a down-turn, I just looked at pure growth potential, so I moved Netflix before I moved Coke.
It made a noticeable different in growth rates between out trad IRA’s and out Roth IRA’s.
But that is all in the past. I did my first RMD this year and my last Roth conversion afterwards.
I did a small conversion every year starting in 2010. Now our portfolio is 99.85% Roth IRA and 0.15% taxable brokerage.
"As a result, I would need to have $10,325 available to convert $25,000 from traditional IRA to a Roth IRA. Alternatively, I could have the taxes withheld from the withdrawal from my traditional IRA with only $14,675 being deposited in the Roth IRA.
Perhaps I’m too concerned about the total cost of conversion to see the tax win."
This a concern for the individual to chose whether to make a conversion or not.
It does not affect whether a conversion is more advantageous during a bear market.
Does that help you?
Gene
All holdings and some statistics on my Fool profile page
http://my.fool.com/profile/gdett2/info.aspx
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Perhaps I’m too concerned about the total cost of conversion to see the tax win.
This a concern for the individual to chose whether to make a conversion or not.
It does not affect whether a conversion is more advantageous during a bear market.
Another part of the “conversion is more advantageous during a bear market” thought is what you’re paying the taxes with. If you have cash, you can pay the taxes on the Roth conversion with something that hasn’t gone down. If you have to cash in more of a stock fund that has gone down to take advantage of converting the stock fund that has gone down, it’s back to merely tax arbitrage.
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Another part of the “conversion is more advantageous during a bear market” thought is what you’re paying the taxes with. If you have cash, you can pay the taxes on the Roth conversion with something that hasn’t gone down. If you have to cash in more of a stock fund that has gone down to take advantage of converting the stock fund that has gone down, it’s back to merely tax arbitrage.
Money is fungible. If you trace out all the money flows, you’ll see that it doesn’t matter where the money comes from to pay the taxes. Emphasis on “all”.
It’s all and only the tax arbitrage. And the main part of that is when your go from filing joint to filing single when one of the couple dies.
Pay the MFJ tax rate now rather than the Single tax rate later.
I’m still thinking over the bit about converting in a bear market, to move the future capital gains from the IRA to the Roth. You’d need to map out all the money flows…and make sure you have accounted for everything…which is tough because it can get very complex and confusing.
The idea sounds appealing–which is a reason to tread carefully.
**"The answer you like the most is the one you should trust the least."**
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Hi Rayvt,
“I’m still thinking over the bit about converting in a bear market, to move the future capital gains from the IRA to the Roth. You’d need to map out all the money flows…and make sure you have accounted for everything…which is tough because it can get very complex and confusing.”
Here are 2 scenarios:
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During normal times, convert $25K of closely valued stock ABCD, say 200 shares.
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During times of turmoil, convert $25K of 50% value depressed stock ABCD, say 400 shares.
In both cases, ABCD is a well run, thriving, growing business.
In #1, you expect a 100% gain in 5 years.
In #2, because it was “dragged down”, you expect a 100% gain in 3 years.
In both cases, you will pay, let’s say, $5,000 in taxes. Same dollar amount of conversion and the same tax rate.
Understand one very important point: If the 50% haircut is based on company issues, I would probably sell it, not convert it.
I used this only when the decline was based on market noise and I believed the company growth would continue.
I was going to pay the same tax bill at conversion, and I wanted the “higher possible growth” to be in the Roth IRA.
With a choice between Kimberly Clark (KMB) and Netflix (NFLX) in 2010, I chose NFLX to convert first. Without going back to find numbers, NFLX rose 10X to 20X all in Roth while KMB might have tripled at best over the same time period.
Future tax-free growth.
Do you understand what I tried to do during each of my conversions?
Does that help you?
Gene
All holdings and some statistics on my Fool profile page
http://my.fool.com/profile/gdett2/info.aspx
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