Hi boarder, can you point me to some examples of this? I am sure folks that are FIREd are doing this put would love to see some numbers. Thank you!
Here's an example of how this might look.
Suppose you retire this year, planning to spend $50k annually. If you're following the 4% rule that implies your portfolio is $1.25 million. Suppose $1 million of this is in traditional IRAs, while the last $250k is in VTSAX in a taxable account.
You roll over $50k from your traditional IRA to Roth to get your Roth ladder going. This counts as regular income.
Your $250k of VTSAX pays out a bit less than 2% in dividends, let's call it $5k. You need to sell some shares for the other $45k.
You have some choice about which shares to sell. The oldest ones generally will have lower cost basis, meaning higher taxes when you sell. Let's say you choose to sell some shares you bought in 2014 when the price was about $50 per share. It's a bit under $70 now, meaning you need to sell about 650 shares to get your $45k. With a $20 gain per share, that's a $13,000 capital gain that you need to report on your tax return.
Add it all up and you have $50k of regular income, plus $18k of capital gains/dividend income.
If you're single and claiming the standard deduction of $12,000, that means you're only taxed on $38k of regular income and $18k of capital gains/dividend income.
That $38k number puts you just below the top of the 12% bracket for your regular income. For the Roth conversion you would be paying 10% on the first $9,525 and 12% of the rest, or $4,369.50 in total.
For capital gains, you pay 0% up to the top of the 12% bracket (the first $700 of capital gains income in this example), and 15% after that. So you would pay an additional $2,595 in tax (($18,000 - $700) * 15%) based on your taxable capital gains and dividends.
Your total tax burden on $68k of gross income would then be $4,369.50 + $2,595 = $6,964.50, an effective tax rate a hair over 10%.
With the same income numbers but married filing jointly, you instead have a $24,000 standard deduction, meaning you're only taxed on $26k of the Roth conversion, amounting to $2,739 of tax. Your capital gains and dividends would all be taxed at 0%.
This is of course just an example. You might start retirement with some existing Roth basis that you can withdraw tax-free, reducing the amount you need to take from your taxable account. You might start with a bigger taxable account, allowing you to supplement your Roth withdrawals in years 6+ with some taxable withdrawals, thus reducing the amount you need to convert each year. There are a number of possible variables. It all depends on your particular situation.