Good time for Roth conversions?

[cypher1]

Been awhile for following up on forum but I've been meaning to ask for opinions on when to do Roth conversions, or if it makes sense for me to go down this path in the near future. I'm 44, single, in MN (not sure if state matters yet), with marginal tax rate 22% and effective tax rate 15%. I have a Vanguard Rollover IRA with 70K between three funds that I've been debating when to apply conversions. I'm not trying to market time given the recent current global economic events. But with that balance I have the money to pay the taxes to do so, which I'm not in a hurry to do all at once this year.

My plan was moving about 30K this year to my existing Roth IRA, and then the following four years convert another 10K each time. I figured since I plan to work another 11-16 years, which who knows if my tax brackets will be above or below where I'm at now, but I'd prefer to deal with the tax implications now or near future. If I end up working for another 16+ years and growth is tax-free I'd be very content do it now, along with one less IRA in my account for simplifying in the long run.

Let me know what I've missed for considerations and concerns.

[kork13]

I'm a big fan of tax-free growth, even if for no other reason than simplicity. But in general terms, doing a Roth conversion during a period with down markets (such as when the markets are down 14% YTD) is generally in your favor -- the absolute dollar amount of your conversion is lower, so you pay less taxes getting the conversion done.

Biggest consideration is your income & tax bracket. Is there any chance that your income (including the converted amount) will be low enough to be in the 12% bracket? Or high enough to bump you into the 24% bracket? If the answer to both is "no", then I'd err toward just taking advantage of the low market & covering as much of it as you can afford to pay taxes on next year.

Important Note: DO NOT use converted funds to pay the estimated taxes as a withholding!!! The brokerage will likely older that option, but doing so makes the conversion largely pointless. By paying the taxes with separate, external funds, you're able to make the money "more dense" by effectively packing those tax dollars into your new Roth IRA. It's gonna be worth more as $70k in tax free dollars because the taxes are already paid. But if you pay taxes as a withholding, your $70k becomes only $55k.

[cypher1]

Thanks kork for all that information! The answer is a "no" for both brackets (unless I get laid off and/or decide to change gears in career) in the near future. Great point about not allocating converted funds for paying any estimated taxes. That idea didn't cross my mind, but I could see how others would lean that direction for withholding.

I'm not saying this is a need or urgent, but given the timing of events I see this as an opportunity while budgeting for tax implications for the next year(s).

[srblanco7]

I'm a big fan of tax-free growth, even if for no other reason than simplicity. But in general terms, doing a Roth conversion during a period with down markets (such as when the markets are down 14% YTD) is generally in your favor -- the absolute dollar amount of your conversion is lower, so you pay less taxes getting the conversion done.

Biggest consideration is your income & tax bracket. Is there any chance that your income (including the converted amount) will be low enough to be in the 12% bracket? Or high enough to bump you into the 24% bracket? If the answer to both is "no", then I'd err toward just taking advantage of the low market & covering as much of it as you can afford to pay taxes on next year.

Important Note: DO NOT use converted funds to pay the estimated taxes as a withholding!!! The brokerage will likely older that option, but doing so makes the conversion largely pointless. By paying the taxes with separate, external funds, you're able to make the money "more dense" by effectively packing those tax dollars into your new Roth IRA. It's gonna be worth more as $70k in tax free dollars because the taxes are already paid. But if you pay taxes as a withholding, your $70k becomes only $55k.

Only other consideration that I could come up with was to verify that you don't have other (traditional) IRAs, in which case the pro rata rule may apply.

As Kork noted, Roth conversions are about marginal tax rates - comparing the conversion rate against a future taxable withdrawal rate if you left the investment in the IRA (recognizing that we don't know what future tax rates will be and that our current tax rates would likely be considered historically low).

[Like2Plan]

In addition to Kork's point about being able to convert more by using money outside the IRA for taxes..... If you use money inside the IRA to pay taxes--the tax money taken out of the IRA will be considered an early distribution and you pay an additional 10% penalty (on the $$ that is considered a distribution) because you are not yet 59.5.

Now the question--should you do it? It is hard to say without knowing your entire financial picture. For all we know you could have a 401K with several million in it (and RMDs might trigger higher taxes and also Medicare Income-Related Monthly Adjustment Amount-IRMAA) and you are just asking about a miscellaneous IRA because you are trying to streamline your portfolio. I have been --trying to figure out a general rule, but it turns out it is a very complex question.

Under the current tax law and income levels staying the same over retirement, it might seem like a good idea (because tax rates are supposed to go back to what they were before TCJA and you might be in a higher bracket). BUT, this goes to the old saying--Nobody knows nothing... It sounds like the current tax rates might get extended (how long?) ... But, there could be changes to IRAs.

The thing is you might not pay any taxes when you take distributions at retirement. Currently, you can make charitable donations using pretax IRAs at age 70.5. Medical expenses that exceed 7.5% of your AGI can be used to offset IRA income. You receive a slightly higher deduction/exemption for being over 65. On the other hand, if you are taking social security--your IRA distributions could make your social security taxable.

Srblanco7 made a good point. If you have made non-deductible contributions to your traditional IRA the pro rata rule applies. Folks who have made contributions to a traditional IRA but their income exceeded the amount that allowed them to take the deduction on their taxes would fall into this category. (Another reason is if you were covered by another retirement plan at work and couldn't take the deduction for the IRA contribution). Anyway, even if you have IRAs accounts at different financial institutions, the IRS considers you to only have 1 traditional IRA. More info here: https://www.irs.gov/instructions/i8606

What is your goal? When are you planning to use the money-early retirement before social security or late retirement post social security/medicare? Are you trying to maximize tax efficiency (and maximize the amount of money you will have to spend)? Are you trying to minimize the impact RMDs might have on your income?

I also agree with Kork and Srblanco7 that when the market is down, it is a great time to convert to Roth. It makes lemonade out of lemons.