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I HAVE A CONUNDRUM: In 2023, I’ll have ample opportunities for tax-free growth—but probably not enough cash to take advantage.
It doesn’t get much better than tax-free, right? I remember the excitement when Roth IRAs came into being, thanks to 1997’s Taxpayer Relief Act. But today, the Roth is just the tip of the tax-free iceberg. Indeed, for 2023, I’m eyeing four tax-free accounts.
I want to fund a health savings account and my solo Roth 401(k), while also stashing more money in a 529 college savings plan for my two-year-old grandson. On top of all that, I plan to convert part of my traditional IRA to a Roth, which will mean writing a large check to Uncle Sam to cover the conversion tax bill. Add it all up, and I might need some $70,000, with $14,000 going to Martin’s 529, $4,850 to my health savings account, $30,000 to my solo Roth 401(k) and perhaps $20,000 to cover the tax bill triggered by my Roth conversion.
I could put more than $14,000 in Martin’s 529. But I promised my daughter and son-in-law that I’d build up the account to $50,000. Another $14,000 will fulfill that promise, while also earning me a Pennsylvania state income-tax deduction. Beyond $50,000, the account’s growth will hinge on the savings habits of Martin’s parents and the kindness of the financial markets.
Meanwhile, in 2022, I converted $80,000 from my traditional IRA to a Roth. I hope to convert a similar sum in 2023, but it’ll depend on my total income for the year and hence what my marginal income-tax bracket will likely be.
But it isn’t just the allure of tax-free growth that’s got me excited. I also want to fund these accounts as early in the new year as possible. To be sure, that didn’t work out so well in 2022. Still, investing earlier in the year is usually a good idea because financial markets trend higher over time, and it seems especially appealing in 2023 because stocks and bonds are already at depressed prices.
There remains the small issue of rustling up that $70,000. I don’t currently have that sort of cash sitting in my taxable account—or, to be more precise, I won’t after paying for a big remodeling project I have planned for next year. But I’ll do the best I can. Step No. 1: On Jan. 3, I’m planning to make a $50,000 Roth conversion. Let’s hope it’s a down day in the stock market.
In regard to 529 plan choices I found the guide at Morningstar helped me to make the initial plan selection when picking the best 529 for my grandson. I picked the Illinois Brightstart plan, one of Morningstar’s three gold rated 529 plans, for it’s low investment costs and investment features.
https://www.morningstar.com/articles/1062917/the-top-529-education-savings-plans-of-2021
Given the more likely than not percentages that I will not be alive at the time my one year old grandson starts college I spoke with son-in-law and he agreed to be the 529 account owner. I made an initial contribution at the time of birth to the 529 and also make a small monthly contribution. My state, Tennessee, does not have a state income tax so a state deduction or tax credit is not a concern to me. I hope my small monthly gift will encourage my daughter and son-in-law to also make 529 contributions for benefit of my grandson as their finances permits.
As the years pass and my grandson becomes aware that a 529 plan is being funded for him I hope that knowledge will help create an expectation in my grandson that higher education is a worthy goal. I find the action of funding my small monthly contribution reminds me to think of my grandson which is a bonus for me.
Best, Bill
I used to do my Roth conversions the first week of the year and for the good reasons you gave. My problem was my self employment income was lumpy and my marginal tax rate estimates were off. This year I have spread the conversions across the year so that I can stay close to my marginal tax rate goal. Seems to work better so far.
That’s sort of what I did this year — a $60,000 conversion in July followed by a $20,000 conversion recently, when I had a better sense of my income for the year.
Fantastic advice for an early-year start to 2023 Roth conversions especially with the market down, however, we end every year cash short from paying for the current year (2022) Roth conversion. Large Roth conversions eat current cash but should provide returns down the road.
I’ve always wondered, Is there a point where a Roth conversion is not worth it? I never made one so if I did it now at age 79 there would be no benefit for five years.
But even if the five year wait didn’t apply, how long might it take to recoup the income taxes paid on the conversion?
I considered Roth conversions during four low-income years between retirement and my pension starting. Instead, I sold highly-appreciated stock up to top of 0% capital gains bracket. That got me back to my desired asset allocation, I mostly lived off that money, and didn´t pay capital gains tax.
Now, more assets are in my tax-deferred IRA than I´d like. But adding Social Security, when I start taking it at 70, to my pension may mean I never touch the IRA. In that case, I could satisfy RMD requirements by making a direct charitable contribution from my IRA each year. Not ideal if I had kids to leave money to, but my IRA will go to a charity, and they won´t mind a substantial gift each year, rather than getting all the money at the end.
My husband and I are both retired. Each of us has a large IRA . For about the past 5 years, we have done a $100,000 Roth conversion. Here’s our rationale.
To be honest, we have never done the kind of meticulous planning and estimations that many of the Humble Dollar authors and readers have done. We sort of bumbled our way to our present status. (I’ve actually thought of writing a piece about our fumbling.) But so far, it has worked, And perfection hasn’t been our goal.
What Jonathan said: there’s usually no quick answers to conversion questions. But if you’re asking if there is a point where Roth conversions can be over-done, when they do more harm to your bottom line than good, then the answer for almost everyone that needs to be considering them is a resounding “yes”. For example, once you’ve started drawing Social Security, there’s rarely a scenario where doing Roth conversions will enhance or improve your long-term wealth, and it’s easy to do more harm than good. And as you allude to, the older you are when considering them, the less relevant (and valuable)they become, and it can become just another thing to complicate your life. Personally, when I’m 79 I (hope!) I won’t be thinking much about the subject, except to advise other younger folks on the intricacies of such endeavors. In my opinion, conversions are most relevant and useful for those who are very early in their retirement, and both relevance and usefulness decreases with the passage of time.
It’s too involved for a quick answer. Your best bet is to read this piece by Rick Moberg:
https://humbledollar.com/2020/05/to-roth-or-not/