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

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hardlawjockey
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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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ochotona
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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 pugchief » Sat May 12, 2018 4:34 pm

sophie wrote:
Fri May 11, 2018 7:06 am
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.
IL currently does not tax income from any retirement plan [401k, IRA, pension, etc] however the state is broke due to underfunded pensions and profligate spending and one of the ideas that has been floated as a partial fix is to eliminate this preference.
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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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ochotona
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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

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/.
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ochotona
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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

ochotona wrote:
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.
New rates or not, my opinion is that you still can't compare marginal rates now with a fictitious guess at what they might be in the future. Here is a starter list on why I think the logic in your example is flawed:
1) Marginal Tax Rate vs Average Tax Rate. Conversions are taxed at the marginal rate or last dollar taxed, while traditional withdrawals are taxed at the first dollar rate (after SS and pension if anyone is lucky enough to still have one).
2) Current State Taxes vs Retirement State Taxes. If you work in a high tax state anticipating a more tax friendly state you are paying unnecessary taxes that could be saved by moving in retirement. Whether or not this is true in your situation you have the power to move in order to save on taxes if you haven't paid them yet.
3) Working Year Income vs Retirement Income. You will not be making more in retirement than in your working years. Most retirees make <70% of their working wages, and this works fine as you need less given that housing is typically owned by that point. This makes marginal tax brackets not comparable (even though that is likely an incorrect comparison to begin with) as your retirement marginal rate is likely to be in a lower bracket.
4) Tax Increases Unlikely. The $125,000 and below income level for single filers is the protected middle class where no politician dare assaults. The middle class is what puts politicians in office and therefore, taxes will unlikely ever go up for this income group.
5) Fake Savings. The government spends millions on marketing to highlight why converting to a Roth idea because it gets them more taxes upfront. What if you die before 59, tax rates decrease or stay the same in the future, or the government taxes Roth withdrawals then you will never realize any savings.

I am not trying to be argumentative but I disagree that converting is the best use of funds in many cases and that your comparison oversimplifies the decision to do so.

IG
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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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