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John Yeigh posted excellent information yesterday entitled Roth Conversion Opportunities Extended
Despite my feeling that I am fairly well conversed in this matter I still read everything I can, assuming correctly, that I don’t know everything. When reading the article below:
https://humbledollar.com/2023/01/securing-lower-taxes/
This line struck me:
Take earlier IRA distributions and invest that money in a taxable account. Subsequent gains would be taxed at lower capital gains tax rates. If held until death, the investments could receive a step-up in basis and pass income-tax-free to heirs.
As I have written before I am trying to convert all of my wife’s traditional IRA into a Roth 100% invested in a world stock fund so: 1) I will only have to take RMDs from my traditional account, thus reducing our portfolio maintenance requirements, 2) my children can potentially inherit it and decades of gains tax free, and 3) lower my RMDs when I turn 73. Today I posted a comment on another of John’s linked articles on how reducing the balance in my wife’s traditional IRA to zero is harder to accomplish, due to compounding growth, than I realized (Truly a problem of the affluent)
After hopefully completing the Roth conversions and before we turn 70 (and claiming our Social Security benefits) I figured we would only withdraw funds from my traditional IRA in what limited amount was necessary to meet our expenses.
After reading this article I’m now considering continuing to withdraw enough from my traditional IRA to top off the 12% tax bracket each year until we turn 73 and investing the unspent balance 100% in a world stock fund in our taxable account. These funds could also be inherited tax free due to the step up in basis. I was already planning to increase our portfolio’s stock allocation once we claim Social Security as our income will meet most if not all of our expenses. This plan seems to make more sense than adjusting our stock allocation in my traditional IRA.
Two questions the:
1) Does this plan make sense?
2) Are others also topping off their top tax rate with the same philosophy?
My brain aches when I read these helpful pieces. Why does everything have to be so complicated?
I continue to take RMDs and haven’t done a Roth conversion, although I do have a traditional IRA and a Roth. My actual tax rate is 7.5% (tax paid divided by total income). I decided to avoid the headaches. When my spouse takes her RMDs in a few years the tax rate could change.
This discussion is making my head hurt and making me want to just take the 10% penalty on all my IRA and 401K money right now, dump it into my dividend growth portfolio and just pay the 15-20% on the dividends above 85K (married) and just move on with my life. lol
Another consideration would be to leave enough in the IRA for future Qualified Charitiable Donations/QCDs, should you be so inclined.
David, I’m not sure how converting after starting to draw Social Security would be beneficial, tax-wise. Once Social Security starts, your minimum tax rate for IRA withdrawals (be it for conversion or for income) is going to be 18.5%+ state tax, and will quickly ramp up to 22.2%+ state from there.
As you have noted, you can rarely get burned when you convert at 12%, but as you ramp up from there it gets a lot easier to do more harm than good. And, when you consider that loads of potential tax law changes could, in one swift stroke, make all but the most modest of conversions backfire, considerable caution is warranted. I’d definitely advise stress-testing your plans with some of these mind. Things such as RMD’s for Roths, adding Roth income to the provisional formula for computing the amount of tax due on Social Security benefits, possible adjustments to the provisional formula itself, and now another wrinkle–a possible increased standard deduction for seniors, all deserve a serious look. Throw in potential (and unpredictable) life changes,such as the need for (deductible!) long-term care, changes to tax rates, changes to your heir’s future circumstances, to name just a few–all combine to make a gaze into the future crystal ball very cloudy indeed.
Good luck in your pursuits, and proceed with care.
Thanks for commenting. Maybe I was not clear in my writing, but I hope to complete all Roth conversions before we claim Social Security.
If you are referring to “converting” as withdrawing to the maximum of the 12% tax level, the source of those funds would be my traditional IRA. The idea in the article as I understand it, was if I were to withdraw the maximum amount in the 12% tax level this would accomplish several things: 1) I would maximize the amount I withdraw at a lower rate than when later on in my when my RMDs piggy backed on the increasing Social Security income most likely would force us into the next higher tax bracket, 2) when one of us dies there is the widow(er) tax penalty which would also most likely increase the survivor’s tax rate above the 12% level, 3) on inheritance of any of these funds upon the death of both of us our beneficiaries would not have to pay any taxes on the remaining stock funds’ balance due to the (current) step up in tax basis in the brokerage account upon inheritance.
PS Before I were to make this jump I would consult with a fee only CFP after I turn 70. Right now the focus on maximizing Roth conversions stay in the 12% tax bracket.
BTW we live in NH and there is no income tax. 😊
That makes sense David. And it still might actually be worthwhile to do some Roth-converting even after starting Social Security, in an attempt to smooth out your tax bill over more years, as John suggests in his excellent article. Just pretend the RMD age is still 70 1/2, and off you go! You won’t be able to “move the needle” as much, but you still might be able to reduce future headaches for your heirs with a fairly reasonable tax cost. Still a worthwhile goal, IMO.
Yes, instead of transferring from traditional IRA to taxable account, why not do Roth conversions on your IRA, David, up to the top of the 12% marginal rate. The problem is that you may not have much room, as wtf states, after starting Soc Sec. Doing my mother-in-law’s taxes, I noticed that her rates were 22.2% (12% * 1.85 for the Soc Sec tax torpedo), then back to 12%, 27% (add 15% for qualified dividends/capital gains), and finally 22%. Itemizing medical deductions would cause these marginal rates to increase by 7.5% (not 7.5 percentage points). You may decide you want to blow through the 22.2% rate and go up to the top of the 2nd 12% rate.
While it is true that your strategy will ultimately produce the results you describe as you grow your taxable account, you will also be generating an increase in taxable dividends. Over the last 9 years all of my RMDs have gone into my taxable account. Even with he majority of these dollars going into equity index funds, dividend income is up significantly. So, that is one thing you need to add to your analysis if you haven’t yet done so.
Thanks for commenting. I would utilize an ETF to minimize dividends, and thus the resultant taxes.
I took a look at etf VT, Vanguard Total World Stock fund. Over the last four quarters it paid a total of $2.2747 per share of dividends. At the current price this represents a yield of 1.75%. While this is not like a MMF, as you ramp up the investment amount, the dividends will grow. And depending on where you are within the 12% bracket potentially thwart the strategy.
One more thing you might consider is to change the type of investments within her Trad IRA from equities to bond funds. This would reduce the amount of growth within the account.
OOPS, you’re right 😳
I know an ETF’s tax structure can minimize capital gains, but I didn’t know it can minimize dividends. Would you be willing to explain?