Roth IRA conversion and RMDs

[villagetinker]

Here is a question/situation that I have not seen discussed. There are a lot of very knowledgeable people, so I am looking for thoughts, insights, concerns on the following:

Person is approaching 70 and will need to make RMDs in the next year or so.
A back of the envelope shows $XXX thousands of dollars in additional taxes if the government suggested RMD is followed to the expected lifespan. On the other hand if the ENTIRE amount of the qualified funds are converted in 1 year, the tax is well below 50% of the total for the 25 or 30 years of yearly RMDs.
So here are may thoughts:
1. Making the conversion all at once results in one very big tax bill (not sure if this can be spread over 2 or 3 years??), but after that NO taxes on the Roth withdrawals.
2. Not sure how long it will take to make up the large tax bill from the remaining investments. I need to do more modeling on this.
3. Still working on yearly cash-flow cases, normal RMD versus baying all at once.

I would love to hear others ideas on doing this (good/bad idea), other possible gotchas with this approach.

I will, of course, be discussing with my financial advisor, my tax advisor, etc. I think this will be an interesting discussions as I am sure that I am missing something. Thanks for your comments in advance.

[Villageswimmer]

Keep in mind that as income increases above defined thresholds, the amount you pay for Part B increases significantly, if that’s important to you.

[retiredguy123]

I think there are just too many unknowns and variables on this to make a definitive decision. Some of these are your life span, the rate of return on future investments, and future tax rates. But, one thing to consider is that doing a Roth conversion will allow you to leave tax free money to your heirs. However, another thing is that, if you ever need assisted living, nursing care, or other long term care, the tax deferred money can be used on a tax free basis because it is tax deductible. For example, if you are spending $90K per year in a nursing home, the entire amount is tax deductible and that is the time to spend tax deferred money, if you have it. Personally, I do not plan to do any Roth conversions and to delay taxes for as long as possible. It may feel good and make life simple, but I don't think you will come out ahead if you convert all of your tax deferred money to a Roth.

[jojo]

retired guy, I was not aware that nursing home costs were entirely deductible with tax deferred money. Did this provision remain in the new tax bill?

[retiredguy123]

retired guy, I was not aware that nursing home costs were entirely deductible with tax deferred money. Did this provision remain in the new tax bill?
It is my understanding that the new tax law maintains the medical expense deduction for 2 years for expenses in excess of 7.5 percent of income and in excess of 10 percent of income after 2 years. I believe that nursing home costs are considered medical expenses. Also, a large part of assisted living costs are also deductible, but not at 100 percent.

[jojo]

It is my understanding that the new tax law maintains the medical expense deduction for 2 years for expenses in excess of 7.5 percent of income and in excess of 10 percent of income after 2 years. I believe that nursing home costs are considered medical expenses. Also, a large part of assisted living costs are also deductible, but not at 100 percent.

Thanks for your input. IMHO that would appear to greatly influence the Roth conversion decision.

[champion6]

I think there are just too many unknowns and variables on this to make a definitive decision. Some of these are your life span, the rate of return on future investments, and future tax rates. But, one thing to consider is that doing a Roth conversion will allow you to leave tax free money to your heirs. However, another thing is that, if you ever need assisted living, nursing care, or other long term care, the tax deferred money can be used on a tax free basis because it is tax deductible. For example, if you are spending $90K per year in a nursing home, the entire amount is tax deductible and that is the time to spend tax deferred money, if you have it. Personally, I do not plan to do any Roth conversions and to delay taxes for as long as possible. It may feel good and make life simple, but I don't think you will come out ahead if you convert all of your tax deferred money to a Roth.This post is confusing. It seems to imply that the RMD is tax-free if used for specific medical care.

This is not true. Maybe jojo and I have misunderstood.

The only time the RMD is tax-free is if it is donated to a qualified charity. Here is what Vanguard has to say: Taxation of required minimum distributions | Vanguard (https://investor.vanguard.com/investing/taxes/required-minimum-distributions)

[retiredguy123]

This post is confusing. It seems to imply that the RMD is tax-free if used for specific medical care.

This is not true. Maybe jojo and I have misunderstood.

The only time the RMD is tax-free is if it is donated to a qualified charity. Here is what Vanguard has to say: Taxation of required minimum distributions | Vanguard (https://investor.vanguard.com/investing/taxes/required-minimum-distributions)
My point is that, if you have money in a tax deferred account, and you incur large medical expenses during the year, you can withdraw as much money as you want and take a tax deduction for medical expenses. So, if your taxable income is $60,000, but you have $90,000 of deductible medical expenses, you can withdraw $30,000 from a traditional IRA in the same year and owe no income tax for the year. The amount you withdraw can be larger than the RMD to take full advantage of a medical deduction. The idea is to time your IRA withdrawals to take advantage of the itemized medical deductions.

[Villageswimmer]

The RMD, as well as traditional IRA withdrawals, are treated as ordinary income. I think Rg is referring to the fact that certain medical expenses are deductible within defined limits (if/when you itemize deductions). So, if you are able to itemize medical deductions, you may, in effect, recoup some of the tax you would otherwise pay on such withdrawals.

It’s a bit of a long shot, particularly with the new higher standard deduction, but it might make a case for tax diversification, i.e., some $ in traditional and some $ in Roth.

Unfortunately, we can’t predict the future.

[Villageswimmer]

Sorry, I think we were typing at the same time.

[It's Hot There]

I would suggest getting professional advice on the nursing home cost deductibility .......... not seeing facts so far.

[Villageswimmer]

I would suggest getting professional advice on the nursing home cost deductibility .......... not seeing facts so far.


It is. See IRS Pub. 502 @ irs dot gov

[It's Hot There]

It is. See IRS Pub. 502 @ irs dot gov


If medical reasons, not personal reasons and the adjustment relating to AGI.

Hate when facts get in the way.

[Villageswimmer]

If medical reasons, not personal reasons and the adjustment relating to AGI.

Hate when facts get in the way.

Does anyone go to a nursing home if not for a medical reason? They won’t take you if not medically qualified. Sorry, I don’t understand.

[villagetinker]

Back to my original question(s). I am looking for potential gotchas with doing the conversion in one year versus taking RMDs over 25 years or so. I agree the impact on Social Security (medicare) payments was not something I had thought about, a BIG thank you. So looking for any others.
Lets keep up the discussion as I am sure there will be others interested. As I mentioned before, all of this discussion will become questions for the tax and financial planning advisors.

[It's Hot There]

If I don't convert, I earn on 100% of my invested portfolio. If I convert, I earn on 75%, 70%, 65%, etc., on my portfolio. After 10 years, if I don't convert I have, what, 40% larger portfolio.

[villagetinker]

If I don't convert, I earn on 100% of my invested portfolio. If I convert, I earn on 75%, 70%, 65%, etc., on my portfolio. After 10 years, if I don't convert I have, what, 40% larger portfolio.

Yes, BUT, you get into RMDs at age 70, which is what started this thread. So you cannot keep all of your investments in the original tax sheltered investments. So I am looking at alternatives, ALL now or use the government required RMD schedule.

[It's Hot There]

Of course RMD is coming........so is death.

My point is I would rather have 40% more in my pocket and let RMD runs its course than "prepay" taxes.

[villagetinker]

Of course RMD is coming........so is death.

My point is I would rather have 40% more in my pocket and let RMD runs its course than "prepay" taxes.

AH! you are getting to the crux of the matter, I am trying to determine if "prepaying" the taxes as you put it is better than paying the additional taxes for 25 years or more. I am hoping for more interesting discussion on this.

[Jkenworthy1325]

Money that is put in tax free and is coming directly to you will be taxable.


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[Boomer]

VT, I do not think the RMD itself can be converted to Roth, but after the RMD is taken, additional IRA funds may be converted to Roth — of course the additional amount would be taxable income, too. But at least some of the money from the RMD might go toward paying the taxes on the Roth conversion if you choose to follow up with one.

As someone mentioned earlier in this thread, the RMD as a QCD (Qualified Charitable Contribution) is a way to avoid paying income tax on the RMD.

The QCD, of course, means giving away money, but it can be worth looking into. (Options include giving more money to the government or giving it to a qualified charity.)

The RMD as a QCD has to be done exactly according to the rules. Careful records must be kept, showing the money went from the IRA directly to the charity. Also, donor-advised funds do not qualify.

For those who donate to charity anyway, the QCD might be a better way to do that (instead of itemizing the contribution) when it comes to the RMD and tax time. If the intention is to do a Roth conversion with additional IRA funds after the RMD is taken, that obviously can mean even more taxes so a QCD might help to keep those taxes down and also could be a way to keep the AGI from crossing the threshold that increases the cost of Medicare that is deducted from SS each month.

You have brought up an interesting question. I am just trying to give you a few things to learn more about. Like you said, VT, you will be getting professional advice. Please keep in mind that I am not a tax accountant or financial advisor or any such thing so I might not even know anything about what I just wrote in this post. :)

PS: I am not sure about this either but I think the new tax law took away the ability to recharacterize a Roth conversion.

[retiredguy123]

To answer your question, you need a crystal ball. How much return will you make in the future, what changes will be made to tax laws and rates, how long will you live? Over the years, most articles by "experts" that I have read say that you should delay paying taxes for as long as possible. That is what I plan to do. But, it is not an all or nothing decision. You can convert some money to a Roth and leave some in a tax deferred account. Diversification.

[villagetinker]

You have brought up an interesting question. I am just trying to give you a few things to learn more about. Like you said, VT, you will be getting professional advice. Please keep in mind that I am not a tax accountant or financial advisor or any such thing so I might not even know anything about what I just wrote in this post. :)

PS: I am not sure about this either but I think the new tax law took away the ability to recharacterize a Roth conversion.

I believe you are correct, about the returning a roth to non roth.
While I did not put any specific dollar amounts in my original post, the back of the envelope calculations show well in excess of $250,000 difference in taxes paid over a 25 year period. The difference was almost 3 to 1, in other words, paying the tax all at once the bill was about 1/3 of the 25 year total. As another poster noted, yes I need a crystal ball, but in a simplified view, if you were to convert the entire qualified account to roth account in one year, you take a large hit on taxes, then the remaining monies grow tax free. I am going to try and calculate the "breakeven" period using an assumed rate of return. Show be an interesting (no pun intended) calculation. None of this takes into account inflation, etc.
So lets keep up the discussion, as i stated before, I am looking for the gotchas that could occur with the eralry payment option.

[petsetc]

I think the answer is, it depends mainly on the effective (not marginal) tax rate you are in. About 10 years ago I started to convert to Roth. My method was to use my prior years copy of turbotax, mock-up my current year in December, and decide what % of tax I was willing to pay on the conversion. I then converted that amount. Even if I was off either way, it was in my "acceptable" level.

And yes, the new tax law has eliminated the "recharacterization", thus once converted, it's over.

Final thought, I cannot image it would ever be advantageous to convert all in one tax year since it would probably greatly increase your marginal and effective tax rate.

FWIW,

Andy

[Boomer]

Good morning, VT,

I saw your response to the last part of my post #21, but my follow-up here is in reference to the first part of that post where I said I thought the RMD could not be converted to Roth -- though additional IRA funds may be.

It looks like I was right according to the following link from a Q&A on Marketwatch.

(And, hey, the guy in the picture has to be right because he has a blackboard and is pointing with a ruler so I think we better pay attention to him. I am just a woman sitting here typing, waiting for my laundry to finish.) Here's the guy:

Can I convert my RMD to a Roth IRA? - MarketWatch (https://www.marketwatch.com/story/can-i-convert-my-rmd-to-a-roth-ira-2017-07-26)

Btw, the link to Vanguard, provided by Champion6 in post #7, has excellent overall information. Thanks, champion6. I have spent a little time pointing and clicking around in your link and learned a few things. Vanguard sure does present info in a clear manner.

Also, adding to the discussion, petsetc, post #24, wrote about converting along the way in years when it is practical tax-wise to do so -- thus reducing the amount of the RMD required annually after 70 and 1/2.

I am glad you started this discussion, VT. I like to learn things about taxes. (Weird. I know.)

[BillPoche]

Another consideration is the possibility that you may relocate to an income-taxing state in future years, either by choice or because your caregivers (children for example) need you closer to them and they live in a higher tax state. That could help support a decision to make a Roth conversion while you live in a zero or lower tax state.

[villagetinker]

This is GREAT discussion and ideas,lets keep this up.

[jimbomaybe]

Check with a professional money manage , I believe there is a 5 year ageing provision on a traditional to roth account, meaning you have to wait 5 years tom take it out

[eweissenbach]

This is an interesting discussion for the most part. The biggest variable in my mind is the growth of the investment in the future. If you convert and get outstanding growth going forward, that growth will be realized tax-free. On the other hand the money you paid in taxes would also be growing at a high rate. Several years ago there was a one or two year opportunity to convert to a roth and pay the taxes over three tax years. That was in a time when the market was low, and I considered jumping on the opportunity because the taxes would not have been onerous, and spread over three years would have been affordable. As the market has come back I think I would have enjoyed a considerable advantage, however I vacillated and ultimately did not pull the trigger. Now with the market back, and having to pay all the taxes in the year of the conversion, I feel it would be too painful. Not that paying the taxes on the RMDs isn't but I guess it's a "pick your poison" question.

[l2ridehd]

Couple of points. Remember that the money in an IRA has never been taxed. So withdrawals are now taxed at your post retirement income. A lot depends on your pre RMD income and how much is in IRA accounts. How much income do you get from pensions and SS and other investments. And the second big factor is your spouses age. When they figure out the RMD amount it is based on 70 & 1/2 (your age) plus your spouses age. If you married a younger women you will be shocked at how small the RMD is.

There are lots of variables and moving parts that you need to consider before doing this. I looked at this in depth and for me it didn't make sense. It may in another 3 years. I had the ability to defer income into a Jacobs trust when I was working which is paid out in annual installments after I retired. I got another 3 years of those payments. After that I will look at it again.

[Boomer]

Couple of points. Remember that the money in an IRA has never been taxed. So withdrawals are now taxed at your post retirement income. A lot depends on your pre RMD income and how much is in IRA accounts. How much income do you get from pensions and SS and other investments. And the second big factor is your spouses age. When they figure out the RMD amount it is based on 70 & 1/2 (your age) plus your spouses age. If you married a younger women you will be shocked at how small the RMD is.

There are lots of variables and moving parts that you need to consider before doing this. I looked at this in depth and for me it didn't make sense. It may in another 3 years. I had the ability to defer income into a Jacobs trust when I was working which is paid out in annual installments after I retired. I got another 3 years of those payments. After that I will look at it again.

Good morning, l2ridehd,

Jacobs trust is a new term to me. I gave it a quick Google but I have not found it yet. I like learning stuff about taxes. (I have no idea why I do.)

For others who are reading this thread:

For those of you who are approaching the RMD age — or where both spouses will be there — you could be in for an aggravating, obnoxious surprise, maybe.

If you have been a good saver, in the market through all these good years, have other sources of income, and/or you have been a two-careers-couple whose IRAs combined are rather significant, your RMD could increase your income enough to throw you across the threshold where more is taken from your Social Security for Medicare premiums.

If you look up “Medicare Premium Rules for Higher-Income” you should find the official Social Security publication that explains this — actually pretty clearly even.

The premium increases are not based on taxable income but on MAGI. (Modified Adjusted Gross Income) If it looks like you are going to get hit, you might want to take a look at the RMD as a QCD. (Qualified Charitable Distribution) which can help with tax-planning. Your SS premium deduction for Medicare is based on your MAGI from 2 years ago.

Avoiding the increased Medicare premiums could be another reason to take a hard look at whether doing some Roth conversion (in addition to the RMD) makes sense — or not. You might have to watch that income line closely. Even though it seems like a lot, it looks like even a dollar over the line could cost you a big jump in your Medicare premium — two years later.

The QCD has been around for years, but was not made permanent (?) in tax law until the end of 2015. When that happened, tax planning became a little easier because people who could be affected used to have to wait to see if Congress would say it was OK each year. If a QCD can help your situation, make sure you understand the rules completely.

Even though this might not affect a lot of people, you might be surprised. It could be worth doing a little homework on this one.


(And, yeah, I know. I already wrote about this stuff in this thread a while back. Oh, well. Gimme a break. I have not had any coffee yet.)

[tagjr1]

BINGO! We have a winner!

[l2ridehd]

Good morning, l2ridehd,

Jacobs trust is a new term to me. I gave it a quick Google but I have not found it yet. I like learning stuff about taxes. (I have no idea why I do.)

Hi Boomer. A jacob's trust is a slightly modified version of a Rabbi trust. Very much like a 401K but can be used in addition to a 401K but you must make decisions at least a year in advance of what you will contribute and what and when you will take the distributions. So much more controlled then a 401K. And once you make the decisions they are cast in stone and cannot be changed.

[Boomer]

Hi Boomer. A jacob's trust is a slightly modified version of a Rabbi trust. Very much like a 401K but can be used in addition to a 401K but you must make decisions at least a year in advance of what you will contribute and what and when you will take the distributions. So much more controlled then a 401K. And once you make the decisions they are cast in stone and cannot be changed.


Thank you, ride,

I just looked up Rabbi Trust, now that you have told me that it is similar. Interesting and a little historic in its origin, too.

In spite of the Rabbi Trust's somewhat possible potential for complications, I can see where it could be a good thing to have the opportunity to be able to use with a solid employer.

I learned something today on TOTV. :)

[Boomer]

Speaking of taxes:

Along with our 2017 tax preparation, our accountant included a "Tax Reform Impact Summary."

This shows what our taxes would have been for 2017 had the new tax "cuts" been in effect and applied to the 2017 same, exact numbers. (simply an academic dry run -- just an "as if" with clear disclaimers in the intro) It cannot be an actual forecast. It can apply only what is known currently.

You might want to ask your accountant if the program used can run a "Tax Reform Impact Summary" to see if taxes would have been lower or higher for your 2017 return had the tax "cuts" been in effect -- or you might not want to know.

[l2ridehd]

Mine did the same thing. You lose deductions but get a lower bracket. Total impact showed mine went up just a few $$. He also included some suggestions to help minimize the impact.

Probably for most folks they will be the same or slightly lower. Mine went up because of the limit on property tax deduction and the way rental property deprecation is handled. But I already plan to sell one of them next month anyway.

[tcxr750]

What about just converting a portion of your account to a Roth? If your talking six figure dollar amounts or more I’d seek out an investment advisor and accountant dealing with high net worth individuals. Not to say that if you devoted enough time and research that you could come up with an answer and save money.