There seems to be an advantage to Roth conversion now until 12/31/2025

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ochotona
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There seems to be an advantage to Roth conversion now until 12/31/2025

Post by ochotona » Thu May 10, 2018 2:59 pm

My calculation suggests I should stop putting new money into investments and spend it all on Roth conversion until the new tax law expires 12/31/2025. (!!!!) Can someone look at my logic and see if I'm missing something?

https://docs.google.com/spreadsheets/d/ ... sp=sharing
Last edited by ochotona on Sat May 12, 2018 8:14 am, edited 1 time in total.
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Re: There seems to be a huge advantage to Roth conversion now until 12/31/2025

Post by eufo » Thu May 10, 2018 4:25 pm

You're changing it as I was looking at it. Ghosts in the machine! Lol!
Don't agree with me too strongly or I'm going to change my mind
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Re: There seems to be a huge advantage to Roth conversion now until 12/31/2025

Post by ochotona » Thu May 10, 2018 4:41 pm

eufo wrote:
Thu May 10, 2018 4:25 pm
You're changing it as I was looking at it. Ghosts in the machine! Lol!
Yes, I caught a flaw in my thinking, but it's stable now. It's not as huge as I thought, but you get 4% more after-tax money at the end. Have another look, I won't touch it.

I made it more conservative, comparing 22% to 25% marginal tax rates, not 22% to 28%.

Are viewers able to download it? You can comment, I turned on comments.
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Re: There seems to be a huge advantage to Roth conversion now until 12/31/2025

Post by eufo » Thu May 10, 2018 4:59 pm

ochotona wrote:
Thu May 10, 2018 4:41 pm
eufo wrote:
Thu May 10, 2018 4:25 pm
You're changing it as I was looking at it. Ghosts in the machine! Lol!
Yes, I caught a flaw in my thinking, but it's stable now. It's not as huge as I thought, but you get 4% more after-tax money at the end. Have another look, I won't touch it.

I made it more conservative, comparing 22% to 25% marginal tax rates, not 22% to 28%.

Are viewers able to download it? You can comment, I turned on comments.
Yes, able to download and/or make comments.

I'm a bit daft sometimes, but I'm having a hard time understanding the situation and how it applies to the two scenarios. I went through a Traditional IRA to Roth IRA conversion about 15 years ago. The tax hit wasn't great, but I still think it was the smart move.

So in your situation, you have a Traditional IRA with $29,545 that could grow to $71,200 if left alone, then taxed at 25% leaving $53,400. That part I get.

Converting to Roth IRA should incur a tax hit that I don't see calculated. Then you take the Roth IRA final amount after growth, $71,200 and subtract the growth of a $6,500 initial investment ($15,664) to compare. What is this initial investment amount? I'm really lost.
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Re: There seems to be a huge advantage to Roth conversion now until 12/31/2025

Post by ochotona » Thu May 10, 2018 5:11 pm

Scenario 1 is what happens to $6500 if I put it in a new Roth, what kind of after-tax value do I get? That's cell B6

Scenario 2 is what if I instead take that $6500, and use it to convert a chunk of IRA? Since my current marginal rate is 22%, I can convert 6500/0.22, which is cell B12

Cell B16 is what if I'd just let the Traditional IRA alone, but I get a tax haircut at the marginal rate

Cell B19 is the after-tax value of the Conversion, but I must also subtract the opportunity for the $6500 which I gave up, which is Scenario 1

B19 is 4% bigger than B16. For a $1,000,000 portfolio, that's $80,000.

If Congress extends the tax cuts, it's a wash.

If Congress gives us bigger tax cuts in 2025, when the debt is $30 trillion and every last Baby Boomer is retired, then you lose money. I don't consider this to be realistic. Not at all.
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Re: There seems to be a huge advantage to Roth conversion now until 12/31/2025

Post by eufo » Thu May 10, 2018 5:21 pm

ochotona wrote:
Thu May 10, 2018 5:11 pm
Scenario 2 is what if I instead take that $6500, and use it to convert a chunk of IRA? Since my current marginal rate is 22%, I can convert 6500/0.22, which is cell B12
Ah, this wording makes it crystal clear now. Thank you.

Betting on lower tax rates in the future is a gamble I know I'm not willing to take. That's why I converted.
Don't agree with me too strongly or I'm going to change my mind
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Re: There seems to be a huge advantage to Roth conversion now until 12/31/2025

Post by ochotona » Thu May 10, 2018 5:41 pm

eufo wrote:
Thu May 10, 2018 5:21 pm
ochotona wrote:
Thu May 10, 2018 5:11 pm
Scenario 2 is what if I instead take that $6500, and use it to convert a chunk of IRA? Since my current marginal rate is 22%, I can convert 6500/0.22, which is cell B12
Ah, this wording makes it crystal clear now. Thank you.

Betting on lower tax rates in the future is a gamble I know I'm not willing to take. That's why I converted.
That's right.
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Re: There seems to be a huge advantage to Roth conversion now until 12/31/2025

Post by stuper1 » Thu May 10, 2018 5:56 pm

I get confused easily with all this stuff, but let me ask a hypothetical question that would apply to me. If someone is currently in the 22% tax bracket but anticipates retiring at age 62 and being in say the 12%/15% tax bracket until age 70 (when social security and RMDs will kick in), would that change the calculation? In other words, wait until age 62 to start doing the Roth conversions?
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Re: There seems to be a huge advantage to Roth conversion now until 12/31/2025

Post by ochotona » Thu May 10, 2018 7:36 pm

Yes stuper1 that's a good point. You could definitely plan to not convert all of your IRAs, and instead eat them between age 62 and age 70 when your tax rates are low.
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Re: There seems to be a huge advantage to Roth conversion now until 12/31/2025

Post by sophie » Fri May 11, 2018 7:06 am

Nice, ochotona! However - taxes on 401K withdrawals should be calculated at the average tax rate, not marginal. I estimated my average tax rate in retirement will be no worse than 15%, including state/local taxes. This makes tax deferral a no-brainer for me regardless of what happens in 2026.

A perk for New York residents: if you're over age 59.5, 401K withdrawals are exempt from state/local taxes up to $20,000. Sadly, that amount isn't inflation-indexed, but it still makes a big difference in strategy compared to other states. My average tax rate could be as low as 10% if I arrange withdrawals correctly.
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Re: There seems to be a huge advantage to Roth conversion now until 12/31/2025

Post by ochotona » Fri May 11, 2018 10:28 am

sophie wrote:
Fri May 11, 2018 7:06 am
Nice, ochotona! However - taxes on 401K withdrawals should be calculated at the average tax rate, not marginal. I estimated my average tax rate in retirement will be no worse than 15%, including state/local taxes. This makes tax deferral a no-brainer for me regardless of what happens in 2026.

A perk for New York residents: if you're over age 59.5, 401K withdrawals are exempt from state/local taxes up to $20,000. Sadly, that amount isn't inflation-indexed, but it still makes a big difference in strategy compared to other states. My average tax rate could be as low as 10% if I arrange withdrawals correctly.
I was always taught to make these kinds of tax decisions for what to do with marginal dollars using the marginal tax rates, not the average tax rate. But the point raised by stuper1 earlier is well taken, after leaving work and before starting RMDs and SocSec at age 70, one's marginal tax rate is likely to be at a adult lifetime low. That would be a good time to eat Traditional IRA money.
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Re: There seems to be a huge advantage to Roth conversion now until 12/31/2025

Post by stuper1 » Fri May 11, 2018 11:32 am

It seems to me that whether to use the marginal rate or a lower rate when estimating taxes on 401k/IRA withdrawals depends on how much other reliable income you will have coming in from SS, pensions, etc. Some forms of income are non-discretionary, like SS, pensions, RMDs, and other forms are discretionary, like extra withdrawals that are more than RMDs. If your non-discretionary income will fill up the lower tax brackets, then your discretionary withdrawals will be taxed at the higher tax rate.
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Re: There seems to be a huge advantage to Roth conversion now until 12/31/2025

Post by hardlawjockey » Fri May 11, 2018 4:04 pm

If I were ever going to do a Roth conversion this would probably be the year for it. Next year I turn 70 and will start collecting both SS and taking RMD's from my IRA. Obviously this will result in a significant increase in my income. The way I figure it, if I send the whole RMD to the government it should pay the tax on my SS. So it's a case of the government giveth and the government taketh away.

I've decided not to do it because I just can't get over the hurdle of writing a big check to the government this year for the Roth conversion and reducing the value of my portfolio in the here and now. I can do the math and perhaps prove that it will theoretically work out better in the long run but it still requires making predictions about the future and needing them to come to pass to achieve the desired result (like assuming this so-called Roth conversion advantage will end in 2025). So I'm going to stick with the old rule of a bird in the hand is worth two in the bush and see how that plays out.
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Re: There seems to be a huge advantage to Roth conversion now until 12/31/2025

Post by ochotona » Fri May 11, 2018 4:21 pm

hardlawjockey wrote:
Fri May 11, 2018 4:04 pm
If I were ever going to do a Roth conversion this would probably be the year for it. Next year I turn 70 and will start collecting both SS and taking RMD's from my IRA. Obviously this will result in a significant increase in my income. The way I figure it, if I send the whole RMD to the government it should pay the tax on my SS. So it's a case of the government giveth and the government taketh away.

I've decided not to do it because I just can't get over the hurdle of writing a big check to the government this year for the Roth conversion and reducing the value of my portfolio in the here and now. I can do the math and perhaps prove that it will theoretically work out better in the long run but it still requires making predictions about the future and needing them to come to pass to achieve the desired result (like assuming this so-called Roth conversion advantage will end in 2025). So I'm going to stick with the old rule of a bird in the hand is worth two in the bush and see how that plays out.
hardlaw, one of the fundamentals of financial analysis is the only thing that matters is after-tax cash flows. If you can write a big check and instantly increase your after-tax cash flows, then by all means do it. Pre-tax values or cash flows are illusions. Harvesting that kind of tax-related gain at your age carries no risk... there will be no tax law changes between now and next year. I wish I could buy you a case of beers so you could get some courage and just do it.

I myself just went literally instantly after doing that spreadsheet from maxing out my Roth 401(k) $24,500 per year to just putting in enough to catch the Company match. The rest will go to funding conversions. My CFP friend agrees with me. He's one of the best CFPs in Texas if not the country. He knows I'm a DIY guy, he writes, "Do surgical conversions every year, be mindful of your tax brackets".

Yes, it will hurt to write a big 1040-ES check every year in January. But the math proves it to be the right course of action. Also, my heirs will thank me.

There is a book out on the topic by David McKnight, “The Power of Zero". I haven't read it yet, but I heard him on a podcast, which is what prompted me to construct my spreadsheet. Now I'm not sure I need to read the book.
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Re: There seems to be a huge advantage to Roth conversion now until 12/31/2025

Post by sophie » Sat May 12, 2018 8:21 am

ochotona wrote:
Fri May 11, 2018 4:21 pm
hardlaw, one of the fundamentals of financial analysis is the only thing that matters is after-tax cash flows.
Spot on. Unfortunately, the balances in tax deferred accounts are sort of like a mythical mirage that you won't ever be able to realize. It's a question of when you pay the tax, not if. I think there's a huge tax-shaped hole in many retirement plans, because people (and calculators) forget to take taxes into account. I dealt with it by figuring my average tax rate in retirement and then multiplying my projected expenses by (1+(percentage of savings that is tax-deferred)* tax rate). Doing a Roth conversion would reduce that "percentage of savings" factor and effectively lower your expenses - that might help you write that check!

Re 401K withdrawals at average vs marginal rate: yes, it's true that other income may come into the picture but it's still unlikely for most people that *all* 401K withdrawals are at the marginal rate. Retirement tax planning is so hellaciously complicated!!!! I think I'll either have to just pick a strategy based on best guess, or go all out and write a simulator.
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Re: There seems to be a huge advantage to Roth conversion now until 12/31/2025

Post by Dieter » Sat May 12, 2018 3:41 pm

sophie wrote:
Sat May 12, 2018 8:21 am
<snip>
Re 401K withdrawals at average vs marginal rate: yes, it's true that other income may come into the picture but it's still unlikely for most people that *all* 401K withdrawals are at the marginal rate. Retirement tax planning is so hellaciously complicated!!!! I think I'll either have to just pick a strategy based on best guess, or go all out and write a simulator.
Married filing jointly here -- all t401(k)/tIRA contributions avoid fed marginal rate of 22% (25% last few years), plus high income tax state.

At withdrawal time, with 19k - 77k of income taxed at 12% (18 - 75k at 15% old tax law; then 22% vs 25% depending on future laws, minus deductions), seems like traditional wins until get significantly above 75k in income.

Given how things are going, I don't expect to have that, um, "problem".

I'm vaguely aware of complicated Social Security rules on taxability that _should_ be incorporated, and I'm sure there are other things that I"m missing. I do plan to start putting a little more into Roth (~8% of existing retirement savings) to have more options, esp. for years of 'surge' spending if need to keep in lower bracket....
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Re: There seems to be a huge advantage to Roth conversion now until 12/31/2025

Post by hardlawjockey » Sat May 12, 2018 5:13 pm

ochotona wrote:
Fri May 11, 2018 4:21 pm
hardlawjockey wrote:
Fri May 11, 2018 4:04 pm
If I were ever going to do a Roth conversion this would probably be the year for it. Next year I turn 70 and will start collecting both SS and taking RMD's from my IRA. Obviously this will result in a significant increase in my income. The way I figure it, if I send the whole RMD to the government it should pay the tax on my SS. So it's a case of the government giveth and the government taketh away.

I've decided not to do it because I just can't get over the hurdle of writing a big check to the government this year for the Roth conversion and reducing the value of my portfolio in the here and now. I can do the math and perhaps prove that it will theoretically work out better in the long run but it still requires making predictions about the future and needing them to come to pass to achieve the desired result (like assuming this so-called Roth conversion advantage will end in 2025). So I'm going to stick with the old rule of a bird in the hand is worth two in the bush and see how that plays out.
hardlaw, one of the fundamentals of financial analysis is the only thing that matters is after-tax cash flows. If you can write a big check and instantly increase your after-tax cash flows, then by all means do it. Pre-tax values or cash flows are illusions. Harvesting that kind of tax-related gain at your age carries no risk... there will be no tax law changes between now and next year. I wish I could buy you a case of beers so you could get some courage and just do it.

I myself just went literally instantly after doing that spreadsheet from maxing out my Roth 401(k) $24,500 per year to just putting in enough to catch the Company match. The rest will go to funding conversions. My CFP friend agrees with me. He's one of the best CFPs in Texas if not the country. He knows I'm a DIY guy, he writes, "Do surgical conversions every year, be mindful of your tax brackets".

Yes, it will hurt to write a big 1040-ES check every year in January. But the math proves it to be the right course of action. Also, my heirs will thank me.

There is a book out on the topic by David McKnight, “The Power of Zero". I haven't read it yet, but I heard him on a podcast, which is what prompted me to construct my spreadsheet. Now I'm not sure I need to read the book.
Sorry but math cannot prove it to be the right course of action in the real world. The math only works because you are plugging constant values into the equations. In the real world of finance+economics+government policy those values are anything but constant. So I'm sticking with my bird in the hand philosophy, for now at least.
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Re: There seems to be an advantage to Roth conversion now until 12/31/2025

Post by ochotona » Sat May 12, 2018 6:24 pm

Sure you can never know the future, but the modeling I did only assumes we go back to 2017 rates in 2026. The way things are headed, future tax rates may move even higher. I don't want to be in my 80s in the 2040s with high RMDs due to age and facing really awful rates.

I did some more computations, and I think converting half of my IRA space will be fine. I especially want to convert the physical gold IRA, so I don't have to liquidate it via RMDs.

I guess Congress could fark us all and tax Roths too. Anything is possible I suppose.

The "bird is not in the hand" with a Traditional IRA. Part of the bird is in your hand. The other part goes to the Treasury. That's the entire point.
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Re: There seems to be an advantage to Roth conversion now until 12/31/2025

Post by InsuranceGuy » Sat May 12, 2018 8:25 pm

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Re: There seems to be an advantage to Roth conversion now until 12/31/2025

Post by ochotona » Sat May 12, 2018 10:07 pm

With respect, that article was written years before the new tax law. It could not have anticipated the current opportunity to arbitrage tax rates across time.
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Re: There seems to be an advantage to Roth conversion now until 12/31/2025

Post by InsuranceGuy » Sun May 13, 2018 1:23 am

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Re: There seems to be an advantage to Roth conversion now until 12/31/2025

Post by Dieter » Sun May 13, 2018 4:22 am

InsuranceGuy wrote:
Sat May 12, 2018 8:25 pm
I'm not excited about trading a future effective tax rate for today's marginal rate. This guy explains it better than I could, worth a read https://www.gocurrycracker.com/roth-sucks/.
Thanks for posting -- I've read this before, which is the basis for me putting most of my money into traditional retirement accounts. Even if I don't expect to retire early.
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Re: There seems to be an advantage to Roth conversion now until 12/31/2025

Post by ochotona » Sun May 13, 2018 6:51 am

As I am getting reasonably close to retirement, I have visibility as to what my future tax brackets might be. Based on the certain return to the old brackets on 1-1-26 just months before my 65th birthday, I am highly likely to benefit from Roth conversion. All of the reasons you state are fine, but in my individual case, I still see a benefit in spite of your list. Everyone else's conclusion will vary.

I have a pension, and I'm going to take SS at 70. Together they will be $75k. That means my possibly $100k IRA distribution on top of that (fingers crossed, c'mon GEM) is going to land into brackets which on 1-1-26 are firmly higher than my current "last dollar" conversion brackets.

I just took a swipe at the Schwab RMD calc, and at age 80 assuming only 5% CAGR my RMD will be $86k if I keep all of my Traditional IRA space. Ugh.

This is an affluenza problem, yes. Not everyone is a candidate for Roth conversion.
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Re: There seems to be an advantage to Roth conversion now until 12/31/2025

Post by sophie » Sun May 13, 2018 7:33 am

Don't be too sure the tax rates will go up in 2026. Congress passing extensions on various spending/tax bills are nothing new, and I'm sure they'll be aware that letting the tax cuts lapse would make them the nation's most-hated group ever. In fact, it's hard to think of an action that would alienate more people.
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Re: There seems to be an advantage to Roth conversion now until 12/31/2025

Post by barrett » Sun May 13, 2018 10:18 am

InsuranceGuy wrote:
Sat May 12, 2018 8:25 pm
I'm not excited about trading a future effective tax rate for today's marginal rate. This guy explains it better than I could, worth a read https://www.gocurrycracker.com/roth-sucks/.
Thanks for posting that, IG. That gocurrycracker article is really well done.

Crap, this tIRA/Roth debate is complicated, especially when one factors in that a younger spouse may continue to work after one turns 59.5 (my case). Most of my decisions about what to put where have already been made due to the fact that I'm pretty much retired.

When figuring out whether or not to do conversions and what one's longterm overall tax hit will be, cost basis in taxable accounts also comes into play, right? In my case that cost basis, apart from my big whack of savings bonds, is very high. So, I wonder if I might not be better off just taking some withdrawals from my tIRAs for now and not doing Roth conversions. Hmm.

I'm curious to know if anyone has used this i-orp calculator:

https://i-orp.com/GOPtax/extended.html

When I have plugged our numbers in, the tIRA to Roth conversions seem to be overly aggressive but overall it's a terrific tool.
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