So I physically started Roth conversion this week. I have enough information to know the majority of my post tax distributions for the year, not exactly but close. Should only be about 8K unqualified. The unqualified is taxed as ordinary income and qualified as cap gain. I will pay taxes on unqualified and write off my cap gains against my LT cap loss for zero tax on that aspect of my tax life. So I have about 8K ordinary income to worry about off the top.
My first conversion is my wife’s IRA’s in entirety. It’s about 140K. She has 24K in post tax basis mixed in that money, so by working through the calculations in form 8606 her taxable income is reduced to about 115K, for a 140K conversion. Therefore I’m up to about 123K (115 + 8) in taxable income for 2018. The reason I closed her out first was because of the write off on her account. It gets the maximum amount of money into her Roth to commence compounding. My net tax saving for this move is 5K. This will close out her remaining experience in Roth conversion as all of her money will be tax free in a Roth.
My next conversion will be my own and I will convert something like 125K and I may go a bit higher as my tax picture becomes clearer. I chose $250K as a max conversion instead of the top of the 24% because it avoids the 3.8% medicare surtax on amounts above $250K and avoids higher medicare monthly premiums, and generates 22K less in taxes (88K over 4 years saved), while over 4 years I will converting about 2/3 of our TIRA. The other 1/3 I will leave in bonds and go ahead and RMD that amount at 70 and use that money to buy hamburgers. My conversion factor on 125K is 97.9% taxable because of my post tax money in there So on a 125K conversion only 122,375 will be part of my AGI.
My taxable AGI therefore will be 115K + 122K +8K or 245K with a 5 K safety factor since you can’t re-characterize Roth conversion anymore. My net conversion will be 140K + 125K or 265K into the Roth and I will reinvest the 8K back into my taxable account. My tax bill for that conversion will be $41307 for a 265K conversion for an effective 15.6% tax rate. I’ll send the IRS the 2018 money and we will be cool. Had I converted 341K my effective tax rate would be over 19%. My move in January 2019 will be to convert another 245K AGI. With the conversion factor of 97.9% I will be able to convert $250K actual money from the Roth for a 2 year conversion of $515K, over half of my estimated conversion amount. My tax bill on that $245K is also $41,307 and I will send the IRS the money in January and we will be cool for FY 2019. So by start 2020 @ 4% my 515K investment should be worth almost 536K. I’ll do it again (250K, 245K taxable) in FY 2020 and be up to 814K in the Roth at 4%. Finally in FY 2021 I’ll add the last ($250K, 245K taxable) bringing our Roth’s to 1.1M with a tax bill of 165,228 or a 15% tax bite. I’ll leave the rest of the TIRA to grow ever time as I withdraw and should have about 600K left in TIRA @3% return over 4 years. $600K will RMD $22K the first year and will grow to $28K the 10th year and $32K by the 20th year. The TIRA at my age 90 will still have $340K available in funds just in case. Every withdrawal from the TIRA going forward will use that 97.9% conversion in calculating the AGI, so $22K RMD is only $21.5K in AGI. Every $500 helps. I will supplement my income by selling taxable stocks and using my LT cap loss. As SS grows and RMD grows my “need” to access money from the post tax account to make budget diminishes, or I can slice off a little more from the post tax money roast and buy the ol’ lady a new car. The Roth remains untouched. It will transfer wealth to my kids or be available as insurance in case of medical disaster. At 5% it’s estimated worth will be 3M at my age 90.
So by doing the conversion in this way, my future will cost me $165K up front in taxes. If I converted to 340K/yr (top of 24%) it would be about 256K in upfront taxes on the future. I will leave the $90K or so I save in taxes invested to grow @ say 5% and the interest off that easily pays for the unpaid taxes on the RMD. Since the RMD is small the taxes are small. This is an important point to understand. I maximize my tax free growth by converting my wife’s IRA first. I’ve been analyzing what assets of mine to convert and momentum is going first. Next will be foreign and emerging. Next US and finally alternatives commodities and REIT. I will re-balance my AA across accounts. Since I’m living off a wad of cash my AA presently is about 55/45%. A desirable percent in early retirement adding some SORR protection. As I spend that cash down and pay my taxes my AA will naturally rise to maybe 65%. At that point SS kicks in and the TIRA RMD’s and I’ll be 5 years closer to death and my necessary SWR from taxable drops a lot, so I can afford a little more risk (actually a lot more risk but what’s the point of owning too much risk if you already won the game?)
People write accumulation investment plans. This is my deflation plan. It tells me my need based on my assets. It directly informed my accumulation phase plan. It actually shows I worked too long but I didn’t hate my work life at all. One day I realized every day I went to work all I was earning is more risk since I already made all the money. My accumulation was determined by going to SSA.gov and adding up my lifelong earnings using medicare wages. From that I could easily calculate a reasonable average cost of living as an estimate. I paid medicare wages for 49 years and was always employed in some fashion. From those medicare wages, I paid for 2 adoptions, 2 college educations for my kids, bought 2 houses sold one, bought a dozen cars, started a family. I never had debt except the mortgage which was tax advantaged. I also funded a portfolio over 43 years. My portfolio was almost twice my medicare wages and probably 2/3 of it was accrued interest. This means my portfolio could support about 2 retirements. The earlier you retire and with less, your portfolio’s survival at some point becomes leveraged to a rate of return. The earlier you retire and on lesser money your leverage increases. Thinking of your future in terms of leverage I think is useful when it comes to planning because leverage is what drives you crazy, and your brain is hard wired to be risk averse. It’s also what causes you to fail. It’s hard to live in peace with too much leverage hanging over your head. I never used a 4 x 25 kind of calculation to determine the future probability. Instead I beat the hell out of it with a Math hammer which is my nature. Took over a year to figure this out and optimize it to where I am happy with it. Hopefully some insight can be gained as you make a plan germane to your situation. Deflation has a lot of moving parts, and no W2 protection, but adequately funded retirement with no side gigs and all that hassle is glorious. I took a 2 hour nap in the sun in my sun room today and even though unconscious I enjoyed every minute of the sensation of warm sunshine on me. The I got up, took a leak and wrote this screed. I recommend!
What’s your deflation plan?