I’ve written a lot about Roth conversion especially partial Roth conversion. I’m in the middle of Roth conversion which is why its on my mind. I was playing with a simple FV calc to look at conversion over time. This is a non-spreadsheet method of analysis that is pretty good.
My previous analysis says that something like a 500K TIRA is OK to own when RMD happens. It’s payout is small enough to keep you in the 12% bracket for a long time. So lets’ say you’re age 65, the SECURE act passes, have a 1.5M TIRA and 7 year to convert it (post SECURE act RMD won’t start till age 72). You want to clean out the TIRA such that 500K is left in the IRA after 7 years of conversion. Do you just divide 1M by 7? That would be the crudest estimate but wouldn’t get the job done. The TIRA will continue to grow over the course of the 7 years (presumably) so you will have to transfer more than 1/7 per year (142,000/yr). Lets look at a FV calculation
This calculation says at 4% return (return above inflation) you would want to convert 185K/yr not 142K /yr. Taxes on 185K would be $36,538 and $ 25,106 on 142K MFJ standard deduction one spouse over 65. So now you know how much to transfer and what it’s going to cost. What’s the end value of the Roth?
So at the end of conversion you would have 1.461M in the Roth (nearly as much as you had in the TIRA, and 512K left in the TIRA for a nearly 2M total. Your taxes would be 7 x 36,538 or $255,766 or a cost of conversion of .13 cents on the dollar, a pretty good deal IMHO. Well below 22% or 24% marginal costs.
I pay my taxes not from the Roth conversion but from cash I free up from my brokerage account mixed with long term cap loss, so my taxes money comes out tax free. A good reason to consider learning how to tax loss harvest.
The results may not be perfect since they represent averages but a rational estimate of both conversion amount and cost. As you convert you can adjust the rate of conversion if the market happens o hit a home run or has a crash. My goal is to wind up with 500K in the TIRA and more than 1M in the Roth prior to RMD. Simple quick no muss no fuss, no Monte Carlo.
This analysis presumes you are living on cash for the conversion period for max conversion efficiency, but even if you’re living on side gig income or dividends this is how to do the analysis, you would just have higher taxes if not living on cash, but you would be paying taxes anyway.
A word on how assets come out of the TIRA. My goal is to store my blonds in my TIRA. Your best placement of bonds is in a pretax or Roth account. My asset transfer is to get the highest return asset out first and into the Roth. Second highest next. The idea is to get the growth into the Roth to avoid paying more taxes on the appreciation. Moving growth first may change the calculus slightly but it’s a trivial matter to adjust every year now that you have a method to judge. Simply place the assets on the efficient frontier plane and read off which one pays the most. Alternatively you can move the riskiest first but depends on your goal. My goal is to have the bonds in the IRA and enough stock to own a “tangent portfolio” which is the AA which pays the most return for the least risk. If you owned BND and VTI the AA of the tangent would be 12% VTI and 88% BND. You may want higher growth but higher growth brings more taxes and moving out of 12% bracket sooner since this account RMD’s, so I’ll get my growth in the Roth which grows tax free. You get the tangent portfolio from the efficient frontier curve of the assets
The really good news is $185K/yr avoids all the tax cliffs and surcharges built into the tax code. If you convert to the top of the 24% you go off the cliff and pay more taxes than need be, but that’s a subject for another discussion.
My brokerage (FIDO) allows transfer of assets whole or pratial between Roth and TIRA so I don’t even need to convert to money, just transfer and pay the taxes.