This year has warped my conversion schedule. I went flat in March before the big drop and generated a bunch of cap gains taxes. It’s worked out OK. I have a couple hundred K of short term and long term tax loss harvested which I can apply to the gains reducing my tax bill dramatically. In addition I only Roth converted up to the top of the 12% bracket (a little over 100K) to keep my ordinary income tax bill low. Cap gains raises ordinary income taxes beside the capital gains themselves.
There are several calculators I use to estimate taxes.
Tax Plan Calculator is a quick ordinary income tax calculator
Smartasset is a quick cap gains tax estimator
1040 Calculator is a more comprehensive tax estimator.
If you have LTCL (long term cap loss) and STCL short term cap loss, these can be applied to cap gains. STCL can be applied against STCG on a dollar for dollar basis. Accrued STCL can also be applied against LTCG. To do so is an inefficient use of STCG if you incur much STCG in a year. If you hardly ever accrue STCG the using STCL against LTCG may be an option. If you have both STCL and LTCL these can be added together and used against LTCG to reduce your tax bill. Since the CG taxes are likely the lowest I’ll ever see in my life time, I decided to reset my tax basis as well as protect my money during this time of high volatility. Using the capital loss in a low tax environment makes the write off more robust. If you have a 15% cap gain rate and a $1000 cap gain and a $500 cap loss to apply against the gain you wind up paying 15% on $500 of $75. If cap gains were 20% the tax would be $100, so paying in the lower tax environment in this case saves 25% on taxes.
As of tonight a Biden win is likely. Depending on the Senate outcome there could be change in tax policy coming. The most draconian would be a retroactive tax revision in 2021 if House, Senate and Pres all go blue. If Senate stays red, tax law will likely be static through 2022 and may become in play in 2023 but likely won’t take effect till 2024. If Trump wins tax law won’t change till 2025. AS of 2020 I have 67% of my Roth completed, this year in the 12% bracket. Next year in Jan 2021 I can convert up to the top of the 22% bracket and likely be immune from any tax changes. This would take me up to about 82% of my Roth conversion by Jan 2021. The next year 2022 would also be a 22% bracket conversion, taking my conversion to 92% of completion and would likely be still under the trump tax regimen. 2022 is a mid term year and the Senate would be liable to change from red to blue so 2023 may be the year they decided to raise cap gains, but by then I’m in my final year of conversion with only a small amount to convert and a concominent small tax liability.
In 2021 we start SS and so that adds to the conversion ceiling. 2021 will be a small SS check because my wife will retire at 62 taking her age 62 discount and I will take her spousal benefits which is 50% of her take. In 2022 I will turn 70 take my full SS and she will continue with her age 62 payout and we will continue like that until she reaches FRA when she will switch from her benefit to my spousal benefit 50% of my SS, or 150% of my SS. This maximizes our SS over a lifetime and when I die she gets a bigger survival benefit. Therefore 185K (using standard deduction) is about the top of the 22% and (185K – 0.85 * SS) is the Roth conversion ceiling if I want to stay in the 22% bracket.
I’m definitely be ready for this Roth stuff to be over and I’m definitely ready to start SS. My goal is 1.5M in the Roth for self insurance, 400K in a TIRA to RMD as an annuity, Social Security, and then use he brokerage as a piggy bank to pay the difference between SS + RMD and my monthly expense.
18 Replies to “Roth Conversion Update”
Have you gotten back in the market after your exit in March? Or are you in all cash? If you haven’t gotten back in what are the criteria you are using to determine when to get back in?
I’ve been trading in and out of about $1M of my portfolio in IRA and Roth accounts and the rest is in cash. Right now I have about 565K at risk. From that I’ve made 11 months worth of living expenses plus an additional $170K for the year. I’ve traded in and out of GLD selling high and rebuying low to compound my money and also I’ve traded commodities bonds and QQQ. Except for moving in and out of QQQ, I pretty much left equities alone this year because they are too risky. My best performer is BTC which is up 346% this year. BTC is a long term bullish setup IMHO because it is being adopted as mainline and had undergone what is called the halving which means it’s “hardness” now is better than Gold and the way the algorithm is designed it only gets harder and therefore more valuable from here. This is the 4th year of my retirement so my clock is winding down and at most I have 15 years left probably more like 10, so my risk management window and hence uncertainty is smaller as well. It’s hard to plan 40 years not so hard to plan 10.
The way I’m positioned once Roth conversion is over is I will live on SS + my wife’s SS plus the RMD from a 400K TIRA risked at 3% growth above inflation, which I will treat as an annuity and emergency medical money since you can use TIRA tax free for medical expense so it has a catastrophic insurance aspect. SS is tax advantaged and since I’m aiming to live in the second tax bracket in terms of ordinary income and not exceed that, the 15% tax advantage of SS basically pays for the yearly taxes on SS + RMD. If SS is 66K/yr SS taxable is 56K meaning I have 10K of built in tax money in my SS check. If RMD is 20K my taxable income is 56k + 20k = 76K and taxes on $76K under present code is $5703. The top of the second bracket MFJ both over 65 is about $103K, so my RMD + SS can inflate by 26% over the years until I inflate into the next tax bracket. I figure that should give me 15 to 20 years to live in the second bracket until I inflate my way out and by then I’ll be dead, and my wife will have the unmolested Roth to fall back on to pay for her future. The key to this plan is to try and look as middle class (2nd tax bracket) as possible in terms of ordinary income and capital gains. If you look rich to the IRS you will be treated as rich, and third tier is when the tax laws says you are rich. There are a WHOLE lot of votes in the first 2 tiers so the congress probably won’t screw with folks the first 2 tiers. Regardless of the narrative tax law is written to soak the rich.
My biggest account is a large brokerage account which I now own capital gains free, so I can use money from that to supplement my ordinary income tax free going forward. Eventually I will reinvest a good portion of the brokerage to return about 4% + inflation, which gives that aspect of the portfolio a low level of risk. Small risk means small draw downs, desirable when you’re old. My WR on the brokerage is slightly over 1%. So the majority of my portfolio will be around a 4% + inflation level of risk. At Roth conversion completion, I will have about 1.2M in that account. The Roth is disaster insurance and legacy money and I will risk that money most aggressively since it also is cap gain free and have no need to touch it. If we move to deflation I will move to a lower risk aka move to more cash gold or BTC. Bonds will be a terrible investment in deflation because the debt is so high. I read a recent study that says in order for new debt to increase economic performance it has to be about 1/2 of the old debt, in other words for the FED to have any effect it will have to expand the balance sheet 150% which will drive bonds underwater.
The key to the future is to NOT have any leverage on your future IMHO. You need to retire with enough money to pay your expenses till you and your wife die, plus inflation. If you have less than that amount of money your future is leveraged and a leveraged future in a hyper leveraged world means you are going down when the governments go down.
So those are my criteria. I’m approaching my life from a retired risk management perspective not a working man max accumulation perspective. My goal is to not run out of money, not maximize my return. I already made all the money, now it’s about spending all the money without running out. My focus has switched from the mean to the tails on the bell curve. I use VIX (S&P vol) VXN (NAS vol) OVX (oil vol a proxy for commodities) and GVZ (gold vol) as clues when to invest and I want those vols down around 22. VIX is 27, VNN 33, OVX 52 and GVZ is 21 so right now I’m in GLD and BTC and my portfolio is up 27K today. If I had the same amount invested in the much more risky QQQ I’d be up 14K.
No matter where you reside, anticipating tax legislation is a tricky call. FWIW, IMO – irrespective of who finally wins – tax increases somewhere sometime seem likely.
Best of luck with pulling it all off.
OOI, is it feasible/worthwhile going up a tax bracket to accelerate the conversion process?
Sure you can go up but then you pay significantly more taxes and fees and penalties. If you have a cap gain hit, the amount of cap gain you pay is a function of your ordinary income. More income higher cap gain in percent terms. It’s not linear but metered out in terms of a threshold income triggers a higher tax aka soak the rich. Cap gains at 12% is zero. Cap gains at 22% is 15%. Also higher income increases Medicare with a 3.4% surcharge which kicks in I think around 24%. In addition how much you pay for Medicare is a function of how much you make. Someone in the 24% ballpark pays 3 to 4 times the monthly Medicare fee of someone around the 12% bracket. It gets MUCH worse if you go from married filing jointly to single (as in if a spouse dies), then you get royally soaked and it’s important to include those married goes to single cliffs in the plan or upon your death your wife will get killed with taxes. Top of the 12% bracket (about 102K) married filing jointly one spouse over 65 is 8823. Top of the 22% bracket for MFJ one spouse over 65 (188K) is 27,673 in taxes plus a 1.5 to 2 times Medicare increase. So increasing the ordinary income by 86K (84%) increases taxes 18850 or 313%. This is why anything over the 12% bracket is soak the rich. At 103K/yr the government calls you rich. Top of the 24% 64179 plus the 3.4% surcharge plus a multiple Medicare monthly increase.
The presidency is going to Biden and the Senate with the runoff in GA is still up for grabs. It could wind up 50/50 with Harris as tie breaker and people like Mitt Romney causing trouble, so increased taxes are still in play.
Thanks for the detailed and thoughtful reply. I can see why you may feel anything over 12% begins to look/feel like “soak the rich”. However, to my eyes , the US personal tax regime seems pretty generous! Income tax in the UK jumps from 20% to 40% at around £50k PA with no intermediate steps – and you can forget any idea of MFJ!
I’m not so much aghast at paying taxes as being aware how the system is designed. In blackjack the house edge is 0.5% if the odds are played perfectly by player. 0.5% is the asymptote of a large number of hands played. The betting strategy makes a difference also. If you bet wrongly the houses advantage increases. If you bet rightly and then walk away a winner, you’re a winner. When you play with the government you always lose because they have the guns. My goal is to try and strategize a methodology that makes you legally the least of all losers.
The government sets up chutes like cattle chutes. They admix their money with your money (tax deferred accounts) and then set up criteria whereby their appreciated proportion of their money is extracted from your account on an ever increasing basis. The extracted money is called ordinary income and subject to taxation. An increasing rate of extraction PLUS a progressive tax policy causes a yearly increase in the compounded amount of money to be extracted from your account. So while your account is shrinking the government is increasing their lawful take. Your solution is to get out at as low a tax as possible, while you can limiting their future compounded “take” on your accounts. It’s pay me now or pay me a compounded amount later. If you pay me now you suffer a change in cost basis, but over time the rate of return on the already taxed money overtakes the compounded increase in taxes on the untaxed money.
If you die young your heirs will lose the resetting of the cost basis. If you die old you will outlive the trap of compounding and increased taxation. Of course if you die young, you’ll be dead and avoid the trap anyway, so what you are doing is assuring a larger portfolio in the future when you are old and unable to make decisions because the decisions take a decade or two to payoff, and the progressivity of the tax law precludes making any changes.
If you understand the dynamics 10 years before retirement there is still time to position yourself to a higher probability of never running out of money if times go south. Retirement is not about dying rich, it’s about not dying poor. Dying rich is an accumulation strategy and focuses on growing the mean of your portfolio. Accumulation strategies typically rely on excess risk to generate excess return with the idea income from work and length of work can offset the excess volatility. Not dying poor is a tail risk strategy that tries to minimize “badness” in your portfolio when you are least likely to be able to defend yourself because you no longer have a job.
I hear you.
The graphic in the article you linked to below clearly drives home some of this too.
However, it is worth noting that, so-called, progressive taxation is not unique to the US and, as I said at the outset, the US system seems to my eyes (at least) less punitive than others.
The apparent flat lining at the richest levels is also IMO not unique to the US!
Lastly, I think you are completely correct that if you educate yourself sufficiently ahead of time you may be able to side step some of this – but I stress the may – as the rules of the game are not set in stone – whereas they are in a casino, provided, of course, that you use the correct strategy!
This last point is where judgement comes into play – ie is it worth paying [even] more taxation today (by, say going up another tax band) in the hope that you can avoid future changes to the rules – that may cost you even more taxation.
I suspect – although I do not know this to be a fact – that the relative plethora of US tax bands gives you more opportunities to consider – which of course just adds to the complexity too!
A tricky call indeed!
These are by far the most well-thought out retirement plans I’ve read anywhere, and they serve as a playbook for folks like me (late 40s, earning less as I cut back) to plan out the next decade with Roth conversions.
Thanks for the template, the in-depth Q and A in the comments and the consideration of the tax bomb that is so often missing from the standard spiel.
Risk management can be a beautifully choreographed process when done well.
Thankyou. That’s why I publish them, because successful retirement is a very different strategy than successful accumulation and I want my Fellows not so much to have a blueprint but to understand something about the complexity. The system is what the system is. The system is designed to separate you from your money in your retirement, especially if you were a successful upper middle class to low end upper class accumulator. For the insanely wealthy, there is the top tax rate and they just pay a fixed proportion so all the dosey-doe stuff is not relevant, else they figure some tax shelter and pay nothing. Here is an article I wrote with a graphic of how the first 4 tax brackets treat different income earners. The slopes on the top lines of the polygons tell the story. Blue is 10%, green 12%, red 22%, and black 24%. This graph screams at you who the government considers to be rich. It also tells you where it’s safe to swim and where it’s not.
Maybe it is just me, but did you intend for us to have to login to WordPress to read your linked taxation article?
Thanks Al I put in the wrong link
Glad to see your Roth conversion update. A lot of worldwide craziness since the last time. Your ability to keep your conversions in the lowest 2 tax brackets is great planning. It seems like your overall portfolio is taxable>tIRA>Roth, at least at the start. I think a lot of wealthy savers may not have the same flexibility especially if their 401k/tIRA is their largest asset. I suspect many docs will have tIRAs>$2M which will make it necessary to take multiple Roth conversion chunks significantly larger than $100K. Whether they have enough taxable assets to pay the conversion tax could be another issue. In my own case, I really need that 22% and 24% space to effectively reduce my pre-tax account since I still have a part-time gig and am not fully retired. While you’re goal may be “not dying poor” it appears you’re winning the game.
In principal it’s the same calculation if you have 1M or 10M and no way to shelter. In fact the situation is worse the richer you are. The problem is the way the government controls disbursement and taxation. THE GOVERNMENT OWNS PART OF YOUR 2M. Let’s say 400K. If you double that 2M in 10 years the government now owns 800K of that 4M. RMD is how the government annuitizes their money and the more you make the more they make and the more you make the more gets taxed.
RMD starts at 3.7% in the first year rises to about 6% in the tenth year, 10+% in the 20th year and 20% in the 30th year. This means your ordinary income steadily rises and is compounded by increasing RMD and any positive return on your investment tending to push you into higher brackets. Social Security is inflation adjusted and so generally rises, pushing you further into higher brackets. So a 2M IRA RMD’s at 79K plus lets say SS provides 65K. So your mandatory income is 144K the first year in the 22% bracket. 66K SS at 2% inflation for 10 years becomes 80K/yr and RMD on the 2M @ 5% return is 118K total 198K pushing you into 24%. In 20 years your mandatory income will be 256K and the marginal rate will be 27.4%.
In my case my wife is younger than me and she has family history of age 90+ in women, so when I RMD she might expect 30 years. If I die at 82 (198K income) her tax rate would immediately shoot from the 27.4% bracket into the 38.4% bracket PLUS her SS would drop from a 2 income SS to a single survivor benefit and she would have to pay at that rate for 15 years if she lived to 92 (25% chance). If you pulled out 1.5M from the IRA over say 7 years and put it into a Roth, and left 500K in the IRA, you would get taxed on 214K/yr ordinary income each year, your tax bill would be about 34K x 7 or 238K to convert 1.5M or 16 cents on the dollar. I calculate the payoff for a 1.5M conversion is about 15 years. After 15 years you (or your wife and heirs) are money ahead.
By my calculation 500K RMD plus SS has enough headroom to keep you in the 12% bracket for about 15 years. Taxes on 80K @12% MFJ the first year would be 6.1K Taxes on 144K (SS + RMD on 2M) the first year would be 17,993. In 10 years taxes on SS + RMD would be about 8400. On 198K (SS + @M RMD) 29,715. If somebody croaks taxes on 198K is 40K. So how much do you want to pay and when do you want to pay it? If ordinary income rates go up the tax bite will be worse. Above 12% is clearly considered rich by IRS so the likelihood of tax rates going down on 22% and above is pretty much zero IMHO. The national debt is 27T I don’t think taxes are going down on the rich.
This analysis is based on an age 65 retirement. To convert this I would convert up to the 249K ordinary income point from ages 65 to 70, and split the remaining lower conversion at 70 and 71 when you start to take SS. So lets say you are 65 in Jan 2020 and retire. 249K that year and at 66 67 68 69 for a total of 1.245M. This leaves 255K to convert. Convert 124K at age 70 and age 71. This would allow you a lot of room for taking SS at age 70 and still keep you under the 250K SS cliff and allow you to convert the most for the least taxes. You will need to have an investment of 7 x living expense plus conversion tax saved to pay your living expense during conversion. You make that money by socking some away starting about age 50.
So if you start investing at 30, you go balls to the wall maxing out pretax until 50 and then split your pretax into pretax and post tax which gives you time to accumulate the nest egg you live on during conversion. Retire at 65, live on the nest egg, take SS at 70 finish conversion by the end of age 71 and start RMD at 72. You are correct about my order. It was brokerage > TIRA > Roth at the end of accumulation became brokerage > TIRA > cash pile > Roth during conversion and will be brokerage > Roth > TIRA > Cash pile at age 72. This is why “max out your pretax” is stupid advice IMHO unless max out pretax means max out a Roth. A brokerage is tax advantaged in the present regimen. You pay ordinary tax going in, leaving only cap gains when you sell and I’d much rather pay 15 cents of cap gains on the buck than 25 cents of ordinary income especially when I’m old and can no longer work.
FWIW, I agree.
I settled on an essentially similar de-accumulation approach, albeit attuned to UK tax.
I concluded that [bar any significant tax-smoothing (along lines laid out above)] tax deferred a/c’s are probably viewed as a good investment [for them] by the tax authorities.
That is, on average, in real terms the tax initially foregone [on the way in] is re-paid plus plus on the way out, provided there is growth, you stay in the scheme for long enough, and you draw down the investment.
Hence, very limited early access and – in the US – RMD’s.
Thus, your strategy is possibly even more optimal if you are trying to minimise the tax you pay as opposed to maximise your after tax.
BTW, these are often not the same goal.
As was pointed out tax law is a black box with an ever changing content and hence an unrecognized and not insignificant source of volatility in planning future return. Tax law is political, meaning it is designed to allocate power and keep in power among those that make the law. In the US the vote does matter and the median income kind of defines the population of voters you don’t want to piss off, so like a school of fish a good place to hide is deep in the middle of the school, not out on the perimeter when dealing with a predator that lives in a black box. My perspective is we have likely seen the nadir in taxes for a while meaning the only way is up from here. In 1992 when Clinton was elected taxes went to the moon resulting in the creation of Newt Gingrich as speaker and Clinton was bound to be a one term president. Clinton postponed soak the rich (Hillary’s position) made a tax deal with Gingrich and managed to live to fight another day. Thus is the nature of the black box and the volatility it introduces into portfolios. Especially with the election of Biden and the release of the vaccine, which will roll out during Biden and whose economic effects will be attributed to Biden, soak the rich will be back in play with a vengeance but will first start at the policy level with the canceling of everything the Orange Man did.
The second black box of retirement is inflation. On a relatively fixed income (aka not working) inflation is the kiss of death. Inflation will take a 30 year portfolio and cut its longevity to 15 years or less in a heart beat. It is the preferred method for governments to deal with their over spending. Spend dearly borrowed dollars now pay them off with cheap inflated dollars then. and a dollar denominated portfolio follows suite as the value of the stored wealth erodes and is not replaced by work.
Another black box is globalization which drains GDP from the haves to the have nots. Jobs and the wealth work produces exits stage right to cheaper pastures decreasing GDP over all.
A final black box is financial engineering which is the creation of mirages. If your company isn’t doing well borrow a ton of money at artificially (FED produced) low interest rates buy back shares and inflate price. The actual value of the company is less because of sky rocketing debt but the PRICE per share is greater, so the “market” goes up. If your stock is part of an index all the better because indexes just buy and sell independent of price signal. Price is low, indexes buy if there is a buy order. Price is high, indexes buy if there is a buy order. In a financially engineered market price is always going up until volatility forces failure so indexes continuously buy high indiscriminately. This is why there is noncorrelated diversity on the way up, but diversity completely fails on the way down. A mirage is a mirage and so the “diversity” is also a mirage. When the system fails, volatility forces the truth to be known. If you own volatility you can’t hide from volatility, and volatility (risk) is what you buy when you purchase an asset.
Yup, there are indeed significant risks around us – most of which are totally outside our control – and IMO difficult/impossible to hedge. So, again IMO, reserves are required. But it is anybody’s guess as to how much is really necessary and in what form they should be held.
Was it not always thus? Perhaps we have just become more aware of this as we age. Furthermore, there is no guarantee that wages will keep pace – as quite a lot of folks could attest – so maybe retirees (as a group) are not really uniquely vulnerable; especially those with some form of [even partially] inflation linked income.
It would take around 15 years of 5%PA inflation to half the purchasing power of a Pot – so perhaps not quite a heartbeat! Of course, we are both just about old enough to remember periods of rampant inflation.
Pedant Alert; Pedant Alert: I understand you are using black box as an analogy however, by definition, the content of such a box is unknown – so we can never know if it is changing.
Having said that, I cannot think of a better analogy for “stuff” that is totally beyond our control and probably also well beyond our influence too!
Perhaps, we just need to accept that really knowledge is not power!
Knowledge IS power narrative is not. In the “olden days” judgements were made off valuation which was highly correlated with price. Today price is largely uncorrelated with value and instead strongly correlated with flow and or momentum which is the first derivative rate of change. The AI that trades the market today looks at 1 month momentum and looks at the second derivative inflection, and the AI doesn’t care a whit about going long or short. It only cares about end of month profit. The now delisted Hertz (HTZ/HTZGQ) which is bankrupt traded yesterday. It closed at 1.32 UP 17 cents or 15%. The company is bankrupt meaning its assets are going to be sold to pay it’s debt. The equity value is virtually zero yet someone made 17 cents, meaning someone lost 17 cents so trading Hertz has turned from buying value to trading futures on something with no value. How many other still listed companies represent a risk like this? If Risk total = R1 + R2 + R3 + R4 and you control only R4 and your goal is to minimize risk with some kind of fixed return (say 4%), well the conclusion is obvious. The very last thing you want to do is concede and let entropy eat your lunch.
I agree 100% with you that: narrative is not power.
Sticking with the physics analogies, I happen to think knowledge is more akin to potential power – that is, without the motivation or ability to apply it – for whatever reason – knowledge is pretty useless! In that sense, things that are beyond your control and/or influence will get away from you and IMO there is little point in losing too much sleep over them. It may however be prudent to hold some contingency.
According to the 2nd law of TD the total entropy of an isolated system can never decrease over time, and is constant if and only if all processes are reversible. Given that the latter is rarely, if ever, true, IMO, it may be best to prepare a large lunch – as you might have to share some of it!
I might try this line the next time I see my physician and he gives me a hard time about my weight.