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Mechanics of doing a Roth conversion in retirement

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  • Mechanics of doing a Roth conversion in retirement

    My question for the group is how does one do a roth conversion in retirement? This is not a question about back door Roth. So, I think I get the notion that you are trying to limit the RMDs (and therefore tax consequences) by pushing 401k/IRA funds to your Roth, but I want to know basically the process of the conversion. Maybe this is a loaded question with lots of variables, so bear with me. Suppose I'm married, no longer working and I have a portfolio of $2.5M made up of 50% 401k and 50% brokerage, and I want to draw $100K annually to live on. How do I perform taking my annual $100K while also converting funds each year to a Roth? Please explain, by example, how I fill up the tax brackets and make the Roth conversion. I understand there are strategies of timing when to convert and how much to convert, but I first want to understand more basically how it is done. Thank You.
    Last edited by Chreeto; 03-18-2022, 11:38 AM.

  • #2
    Age is important too. doing a conversion too close to when you get to medicare can have consequences.

    I think the idea is to convert up to your desired tax bracket. So if you want to fill up the 24% bracket you convert up to 329k. your 100k living expenses can come from selling shares that haven't appreciated from your taxable account.

    I had to fill out a form from my brokerage saying how many shares of which fund I wanted converted.

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    • #3
      Yes there are many variables but given the data you’ve presented, it’s basically a math problem. As a MFJ first decide what tax bracket you are comfortable filling. If it’s say 22% you’ll have $178K + your $26K standard deduction (unless you can itemize more) for $204K total income. From this, subtract your $100K and any dividends generated from your taxable account. Whatever is left is how much you can Roth convert. Taxes on the $178K should be paid from your taxable account. If you are 72 or older, take your RMD or greater first. Then rollover the amount you want to convert directly to your Roth IRA. Essentially two separate transactions to accomplish the task.

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      • #4
        Need your age, when you plan on taking social security (opensocialsecurity.com) and any taxable income to calculate taxable income and any other cash you would plan on using for paying taxes. The basic goal is to convert to minimize taxes prior to RMD's.
        Standard recommendation is minimize tax by withdrawing from your taxable (capital gains) and then the 401k and then the roth. You need to model the amount of Roth conversions that will smooth the effective tax rates by year to avoid higher taxes do to RMD's. That takes software.

        David Graham at FiPhysician dot com would be a contact to provide you some advice and does a good job of running the models for a flat fee.
        You have a lot of assumptions and retirement withdrawal needs are lumpy (credit David for that). You also have IRMAA (medicare surcharges) that come into play at 65 for medicare.



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        • #5
          How do I perform taking my annual $100K while also converting funds each year to a Roth?
          Prepare in advance, a bucket of cash/cash-equivs to draw upon for living expenses during Roth years.
          Another option, start with your target income ($340,000 currently), subtract the desired $100k + miscellaneous income. and then Roth convert the remainder.
          IRMAA premiums add approx. 1% to total tax burden.

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          • #6
            If you are asking about the actual mechanics then when you retire you should roll your 401k into a traditional IRA. The entire balance. Wherever you have that IRA you should open a Roth IRA too. When you have decided how much to convert based on advice above, there is a way online to simply convert the money and you’d be taken to a screen and asked how much to convert. Once you do that you’ll see a balance in the Roth IRA. The following year that institution will send you a 1099-r form for taxes, which is how you’ll report the convertion to the IRS and pay the tax due

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            • #7
              As a single person I cut this in half. I plan to convert $170 k this year. I have no other ordinary income. All other income is taxed as a dividend or capital gain. This will add to my IRMAA burden starting soon. Life is hard to perfectly plan. Vanguard for example has a button that says roth convert on IRA accounts. It is easy to do. I plan SS at 70. I might stop roth converting then or continue until 72. So far I have converted $675k. This has taken me several years.

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              • #8
                The key in the Roth conversion is to have free cash available for the taxes. If you simply pay taxes out of the converted amount, it is difficult to make the early payment of taxes work. That is what makes the math so difficult to model.

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                • #9
                  Originally posted by GasFIRE View Post
                  Yes there are many variables but given the data you’ve presented, it’s basically a math problem. As a MFJ first decide what tax bracket you are comfortable filling. If it’s say 22% you’ll have $178K + your $26K standard deduction (unless you can itemize more) for $204K total income. From this, subtract your $100K and any dividends generated from your taxable account. Whatever is left is how much you can Roth convert. Taxes on the $178K should be paid from your taxable account. If you are 72 or older, take your RMD or greater first. Then rollover the amount you want to convert directly to your Roth IRA. Essentially two separate transactions to accomplish the task.
                  Does this mean the estimated taxes on the conversion portion would be based on the 22% bracket (including IRMAA surcharges if relevant)? Or is there some other cost I need to recognize? Great input from everyone and I hear you loud and clear about the importance of age, social security and medicare as critical variables.

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                  • #10
                    Originally posted by Chreeto View Post

                    Does this mean the estimated taxes on the conversion portion would be based on the 22% bracket (including IRMAA surcharges if relevant)? Or is there some other cost I need to recognize? Great input from everyone and I hear you loud and clear about the importance of age, social security and medicare as critical variables.
                    Assuming you took out $100K pre-tax for personal use, the tax burden on the conversion would be 22%. If you converted even more, the tax burden would be a blend of the 22% bracket and the next higher one, 24%. MC premiums are based on your income from your tax return two years prior so any IRMAA surcharge if applicable would be in the future.

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                    • #11
                      Originally posted by GasFIRE View Post
                      Yes there are many variables but given the data you’ve presented, it’s basically a math problem. As a MFJ first decide what tax bracket you are comfortable filling. If it’s say 22% you’ll have $178K + your $26K standard deduction (unless you can itemize more) for $204K total income. From this, subtract your $100K and any dividends generated from your taxable account. Whatever is left is how much you can Roth convert. Taxes on the $178K should be paid from your taxable account. If you are 72 or older, take your RMD or greater first. Then rollover the amount you want to convert directly to your Roth IRA. Essentially two separate transactions to accomplish the task.
                      not 100k, just the capital gains. suppose he has bond funds that haven't appreciated, he sells 100k in bonds, no tax due.

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                      • #12
                        Originally posted by Tim View Post
                        The key in the Roth conversion is to have free cash available for the taxes. If you simply pay taxes out of the converted amount, it is difficult to make the early payment of taxes work. That is what makes the math so difficult to model.
                        Good point. Keep my eye on the ball.

                        To clarify with the above example:
                        * I am taking out from my taxable account the 100K plus additional amount to pay taxes on the conversion
                        * the remainder amount is from my pre-tax IRA (in this case, say, to the top of 22% bracket) which is converted to Roth in the same year

                        Is this correct? The glide path can change, I know, but I want to solidify in my brain how the basic rules work.

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                        • #13
                          Originally posted by triad View Post

                          not 100k, just the capital gains. suppose he has bond funds that haven't appreciated, he sells 100k in bonds, no tax due.
                          I assumed the $100K was from the 401k/tIRA. If taken from taxable then less tax due, potentially much less. Just another one of the variables to consider depending on personal goals/plans in deaccumulation.

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                          • #14
                            Originally posted by GasFIRE View Post
                            I assumed the $100K was from the 401k/tIRA. If taken from taxable then less tax due, potentially much less. Just another one of the variables to consider depending on personal goals/plans in deaccumulation.
                            wouldn't it make sense to withdraw from taxable first and to delay taxes as long as possible?

                            Also I think it makes sense to make sure you aren't over converting. no reason to convert up to the 24% bracket when your RMDs leave you in a lower bracket. If you had 1.25M in your 401k your RMD at 75 years old would put you in the 12% bracket, I believe.

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                            • #15
                              Originally posted by triad View Post

                              wouldn't it make sense to withdraw from taxable first and to delay taxes as long as possible?

                              Also I think it makes sense to make sure you aren't over converting. no reason to convert up to the 24% bracket when your RMDs leave you in a lower bracket. If you had 1.25M in your 401k your RMD at 75 years old would put you in the 12% bracket, I believe.
                              this is the general mantra, but if you have a $2-$3+ million tax-deferred account by age 50 and plan to retire early, you should be converting some of that because you can see that if you leave it alone, when RMDs come at age 72 your tax-deferred balances could be $8-$12m and you easily could have seen it from a mile(years) away and yet did nothing about it.

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