Roth conversions or taxable step up?

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CnC
Posts: 208
Joined: Thu May 11, 2017 12:41 pm

Roth conversions or taxable step up?

Post by CnC » Fri Oct 27, 2017 12:09 pm

Edit: perhaps this should be in personal finance? I am not sure which section this rests in.


Hey guys I was reading on here and found two interesting tax tips for retirement. I'm not sure if they will be there when I retire, but they seem like either one will be an extreamly useful tool for retirement.

I would like to know more about them, which one is "better" and or which one should be focused on. I would also like to know if I am off the mark and don't understand something.

1) Roth conversions taking my 401k rolling into a regular IRA then converting X % of it into a Roth paying taxes on that amount. The idea is to get as much rolled over before my pension/our social security kick in so that
We can withdraw Roth money to supply our SS and pension income without bumping up the tax bracket.

2) Step up taxable accounts. The idea here is to sell as much stock/ECT as possible yet stay under the income limit right now if you make under 89,000± including write-offs you pay no capital gains. Then buy as much stock as you can at the new higher price. Lowering your capital gains in the future.

Assuming you have both 1 mil in 401k and 1mil in a taxable brokerage account which would be the best?

In our case we require around 60,000 for expenses which would allow us ±30,000 for taxable conversions.

I can add as much detail as is needed if more is needed. We are hoping for an early 50's retirement with a cola pension starting at 55 that will cover 60-70% of mandatory experience and at 67 social security + cola pension will cover 100-110% of mandatory expenses.
Last edited by CnC on Mon Oct 30, 2017 10:25 am, edited 1 time in total.

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FiveK
Posts: 3125
Joined: Sun Mar 16, 2014 2:43 pm

Re: Roth conversions or taxable step up?

Post by FiveK » Fri Oct 27, 2017 4:09 pm

CnC wrote:
Fri Oct 27, 2017 12:09 pm
Hey guys I was reading on here and found two interesting tax tips for retirement. I'm not sure if they will be there when I retire, but they seem like either one will be an extreamly useful tool for retirement.

I would like to know more about them, which one is "better" and or which one should be focused on. I would also like to know if I am off the mark and don't understand something.

1) Roth conversions taking my 401k rolling into a regular IRA then converting X % of it into a Roth paying taxes on that amount. The idea is to get as much rolled over before my pension/our social security kick in so that
We can withdraw Roth money to supply our SS and pension income without bumping up the tax bracket.

2) Step up taxable accounts. The idea here is to sell as much stock/ECT as possible yet stay under the income limit right now if you make under 89,000± including write-offs you pay no capital gains. Then buy as much stock as you can at the new higher price. Lowering your capital gains in the future.

Assuming you have both 1 mil in 401k and 1mil in a taxable brokerage account which would be the best?

In our case we require around 60,000 for expenses which would allow us ±30,000 for taxable conversions.

I can add as much detail as is needed if more is needed. We are hoping for an early 50's retirement with a cola pension starting at 55 that will cover 60-70% of mandatory experience and at 67 social security + cola pension will cover 100-110% of mandatory expenses.
Don't recall this being conclusively answered one way or the other. By "conclusively" I mean an equation or at least "proof by spreadsheet." If it has, no doubt someone will post. ;)

What I do recall is something along the lines of "short term, saving 15% on LTCG is better than, for example, saving (25% - 15% = 10%) on Roth conversions, but the more years of compounding ahead, the better Roth conversions look."

Either is a good thing to do. :)

CnC
Posts: 208
Joined: Thu May 11, 2017 12:41 pm

Re: Roth conversions or taxable step up?

Post by CnC » Mon Oct 30, 2017 10:05 am

FiveK wrote:
Fri Oct 27, 2017 4:09 pm

Don't recall this being conclusively answered one way or the other. By "conclusively" I mean an equation or at least "proof by spreadsheet." If it has, no doubt someone will post. ;)

What I do recall is something along the lines of "short term, saving 15% on LTCG is better than, for example, saving (25% - 15% = 10%) on Roth conversions, but the more years of compounding ahead, the better Roth conversions look."

Either is a good thing to do. :)
Yea luckily I looked into it and noticed it. Conventional wisdom is that your tax rate goes down in retirement, but for dedicated investors that isn't the case. A married couple who had good jobs for 30+ taking Social security and a pension as well as 401k savings will have substantially more income in retirement than while working with none of the write offs.

36k a year for 401ks really drops your marginal rate.

Learning about this has already changed my Outlook on social security withdrawal age.


Also just looking for clarification, Roth IRA money is 100% government free money correct? Meaning the government ignores it for all calculations, if I took $250,000 out of my Roth one year (after 60) it wouldn't affect any of my taxes or Medicare costs or anything at all right?


Looking for anyone else who might have knowledge of these systems.

smitcat
Posts: 648
Joined: Mon Nov 07, 2016 10:51 am

Re: Roth conversions or taxable step up?

Post by smitcat » Mon Oct 30, 2017 10:27 am

CnC wrote:
Fri Oct 27, 2017 12:09 pm
Hey guys I was reading on here and found two interesting tax tips for retirement. I'm not sure if they will be there when I retire, but they seem like either one will be an extreamly useful tool for retirement.

I would like to know more about them, which one is "better" and or which one should be focused on. I would also like to know if I am off the mark and don't understand something.

1) Roth conversions taking my 401k rolling into a regular IRA then converting X % of it into a Roth paying taxes on that amount. The idea is to get as much rolled over before my pension/our social security kick in so that
We can withdraw Roth money to supply our SS and pension income without bumping up the tax bracket.

2) Step up taxable accounts. The idea here is to sell as much stock/ECT as possible yet stay under the income limit right now if you make under 89,000± including write-offs you pay no capital gains. Then buy as much stock as you can at the new higher price. Lowering your capital gains in the future.

Assuming you have both 1 mil in 401k and 1mil in a taxable brokerage account which would be the best?

In our case we require around 60,000 for expenses which would allow us ±30,000 for taxable conversions.

I can add as much detail as is needed if more is needed. We are hoping for an early 50's retirement with a cola pension starting at 55 that will cover 60-70% of mandatory experience and at 67 social security + cola pension will cover 100-110% of mandatory expenses.
We have modeled both of your options with both the IORP and the RPM spreadsheet calculator and plan to do some of each at various times in the future. Roth conversions will be a primary method for us after simulating many possibilities within the calculators.
Both calculators are free but it does require some time and effort to populate them correctly for your comparisons. Well worth the efforts in our case as it opened up a bunch of options for us similar to what you have posted.
As you posted - it is what you keep not what you collect that counts.

ThriftyPhD
Posts: 163
Joined: Mon Jul 31, 2017 10:43 am

Re: Roth conversions or taxable step up?

Post by ThriftyPhD » Mon Oct 30, 2017 10:43 am

The big benefit of Roth conversions is by depleting your pretax money, you reduce or eliminate your RMDs. If you're getting enough from pension and SS, RMDs may raise your taxes for money you didn't need to withdraw. This is even worse for a surviving spouse who would be filing as a single taxpayer.

randomguy
Posts: 4871
Joined: Wed Sep 17, 2014 9:00 am

Re: Roth conversions or taxable step up?

Post by randomguy » Mon Oct 30, 2017 11:02 am

FiveK wrote:
Fri Oct 27, 2017 4:09 pm
Don't recall this being conclusively answered one way or the other. By "conclusively" I mean an equation or at least "proof by spreadsheet." If it has, no doubt someone will post. ;)

What I do recall is something along the lines of "short term, saving 15% on LTCG is better than, for example, saving (25% - 15% = 10%) on Roth conversions, but the more years of compounding ahead, the better Roth conversions look."

Either is a good thing to do. :)

It really depends a lot on the future taxation of either your LTGC or your traditional RMDs. Given that the OP has an excessive of money (i.e. 2 million + 50% COLA pension + SS to meet 60k in spending needs), it seems likely that taxable will largely never get spend. To some extent it matters what will happen to that money (go to charity or heirs) but I think that tends to favor doing ROTH conversions to avoid RMDs and count on stepped up cost basis to avoid the taxes on taxable account. Note the taxable account will still be throwing off 10-20k+ in dividends per year which can fill up a lot of tax space.

CnC
Posts: 208
Joined: Thu May 11, 2017 12:41 pm

Re: Roth conversions or taxable step up?

Post by CnC » Mon Oct 30, 2017 1:55 pm

randomguy wrote:
Mon Oct 30, 2017 11:02 am
FiveK wrote:
Fri Oct 27, 2017 4:09 pm
Don't recall this being conclusively answered one way or the other. By "conclusively" I mean an equation or at least "proof by spreadsheet." If it has, no doubt someone will post. ;)

What I do recall is something along the lines of "short term, saving 15% on LTCG is better than, for example, saving (25% - 15% = 10%) on Roth conversions, but the more years of compounding ahead, the better Roth conversions look."

Either is a good thing to do. :)

It really depends a lot on the future taxation of either your LTGC or your traditional RMDs. Given that the OP has an excessive of money (i.e. 2 million + 50% COLA pension + SS to meet 60k in spending needs), it seems likely that taxable will largely never get spend. To some extent it matters what will happen to that money (go to charity or heirs) but I think that tends to favor doing ROTH conversions to avoid RMDs and count on stepped up cost basis to avoid the taxes on taxable account. Note the taxable account will still be throwing off 10-20k+ in dividends per year which can fill up a lot of tax space.

Granted I am forcasting a bit into the future I don't have the 2 million yet, currently 500k and a paid off home at 32 so I think getting to the +2 million point in 20 years will be well within reason even in some pessimistic markets.

I'm just running some charts out there to try to see what is going to be a reasonable solution rather than see +40% of what I worked and saved for vanish.

Thanks for your input.

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