Author Topic: Monte Carlo or Monte Cristo: Roth Conversion vs. Capital Gains Reset  (Read 1832 times)

JG in Hangzhou

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Hi everyone, hoping to get some advice before I sit down and do some heavy calculations only to find out I missed a key concept. 
Merry Christmas and Happy New Year (in Advance).  It's the year of the Rooster coming and for us Monkeys (1956,1968,1980) that means another good year overall, filled with our usual complex navigation of ups and downs.  Anyhow, here's the situation, I look forward to reading the collective wisdom of this forum.

Life Situation: Married filing jointly, one child age 10. Age 48, semi-retired, living in China.  Own a business in China that pays taxes in China and qualify for US tax exemption as we are non-residents of the USA.  Currently also exempted from obligatory health care/health care penalty.

Gross Salary/Wages: Zero W-2 or other income, except for taxable gains and dividends. 
Pre-tax deductions: None.

Other Ordinary Income: 0

Qualified Dividends: 15,000 & Long Term Capital Gains:10,000       401K Dividends: ~ 12,000. 

Rental Income, Actual Expenses, and Depreciation: Rental income but with depreciation, the net comes out as a 13,000 loss. (probably another issue that I should raise rent, but renters are good and take good care of the place).

Adjusted Gross Income:  25,000

Taxes: 0

Current expenses:  None, all paid in China through China business.

Assets:   Taxable Investments:  650K including current Unrealized Long Term Gains:  230K
               Cash: 250K (from recent house sale and 2016 re-balancing)
          IRA Accounts: 800K
          Roth Accounts:  21K 
          Rental Home:  Market Value   450K;  200K Equity 

Liabilities: Mortgage 250K at 3.5% ARM
Specific Question(s):  Given a current plan for my family and I to stay in China for the next 5 years, what’s the tradeoff between:
a) starting a Roth Conversion Ladder now to move IRA money into Roth Accounts
or
b) cashing out Taxable Unrealized Long Term Gains to avoid paying capital gains tax?

Finally:  Do I need a Monte Carlo model or should I just go to Denny’s and have a Monte Cristo (The quick and easy sandwich with ham, turkey and Swiss slices, dipped in an egg/milk mixture and fried to a golden brown)?

seattlecyclone

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Re: Monte Carlo or Monte Cristo: Roth Conversion vs. Capital Gains Reset
« Reply #1 on: December 27, 2016, 10:21:37 AM »
You're staying in China for five years. What happens next? Do you plan to sell the Chinese business, move back to the US, and fully retire?

The following thoughts consider US taxes only. I have no idea how (or if) this will affect your Chinese taxation.

I think it makes a lot of sense to do a Roth conversion up to the amount of your standard deduction ($12,600) and personal exemption (3 x $4,050), total of $24,750. A 0% tax rate on this money really can't be beat.

Do you "actively participate" in the rental house? If so, that's another $13,000 you could convert tax-free as long as you keep your MAGI below $100k.

Beyond that, there's no real hurry to build up Roth principal since you have a lot of taxable funds to rely on during the beginning of your early retirement. If it were me, I would probably harvest some 0% capital gains next, up to the top of the 15% bracket. You already have $25,000 of qualified dividends and long-term gains, so that leaves another $50,300 you could wipe off the books tax-free.

Repeat this each of the next five years while you live in China and you'll likely be able to wipe out the $230k in long-term gains and build up around $125k of Roth basis, all without paying tax.

Of course this all assumes the tax code won't be radically overhauled with the new Republican administration. Stay tuned for tax law changes and adapt your plans accordingly.

JG in Hangzhou

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Re: Monte Carlo or Monte Cristo: Roth Conversion vs. Capital Gains Reset
« Reply #2 on: December 27, 2016, 10:34:35 AM »
You're staying in China for five years. What happens next? Do you plan to sell the Chinese business, move back to the US, and fully retire?

Not sure, may juggle some time back and forth.  Want to get my daughter into High School in the US.  China high school is work intensive with low personal development, though things are changing here slowly.  Hopefully we can keep the China business running through partners, but in China that's always iffy.  Most like, full retirement in 2031, or half time in China, with my wife doing some part time work if she can't stand being home all day, (I can always easily things to do). 

MDM

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Re: Monte Carlo or Monte Cristo: Roth Conversion vs. Capital Gains Reset
« Reply #3 on: December 27, 2016, 11:40:44 AM »
Qualified Dividends: 15,000 & Long Term Capital Gains:10,000       401K Dividends: ~ 12,000. 

Rental Income, Actual Expenses, and Depreciation: Rental income but with depreciation, the net comes out as a 13,000 loss. (probably another issue that I should raise rent, but renters are good and take good care of the place).
Adjusted Gross Income:  25,000
Assets:   Taxable Investments:  650K including current Unrealized Long Term Gains:  230K
               Cash: 250K (from recent house sale and 2016 re-balancing)
          IRA Accounts: 800K
          Roth Accounts:  21K 
Specific Question(s):  Given a current plan for my family and I to stay in China for the next 5 years, what’s the tradeoff between:
a) starting a Roth Conversion Ladder now to move IRA money into Roth Accounts
or
b) cashing out Taxable Unrealized Long Term Gains to avoid paying capital gains tax?
It depends on what maximum marginal rate you are willing to pay.

Conceptually, the first step in LTCG taxation is 15%, which is larger than the first step in ordinary income taxation of 10%.  That tends to support maximizing LTCG amounts taxed at 0%.

You could use the Excel Solver with the case study spreadsheet to investigate some options.  See below for a one year look that maximizes after-tax income, subject to keeping the marginal rates for both tIRA distributions and LTCG below 15%.  The spreadsheet calculates marginal rates by using a $10 increment, so using 12.5% as the solver upper limit gives an answer $5 below the start of the 15% rate.

In other words, $56,750 of LTCG and $43,300 of tIRA->Roth conversions (using 2016 tax rates) would keep your marginal rate at 10% and maximize your after-tax result. This assumes no rental income or loss.



JG in Hangzhou

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Re: Monte Carlo or Monte Cristo: Roth Conversion vs. Capital Gains Reset
« Reply #4 on: December 27, 2016, 06:43:32 PM »

You could use the Excel Solver with the case study spreadsheet to investigate some options.


Thanks for the reply and the example MDM.  Unfortunately I can't connect to google drive from China. I'll get my dad to download it and send it to me via email.  Seems like that's one tool I need, to run scenarios each year we are here.

JG in Hangzhou

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Re: Monte Carlo or Monte Cristo: Roth Conversion vs. Capital Gains Reset
« Reply #5 on: March 28, 2017, 12:04:23 PM »
Help!  Now it's almost April 2017. 
I sold one house but somehow got more favorable tax treatment than I expected due to carryover losses from renting. 
I didn't convert any tIRA to Roth, but I did cash out about 50K in gains from my taxable account selling an S&P Index fund and other stocks and reinvesting in VTI. 
Good news, 0 federal tax for 2017 and only about 2K tax to NJ for the sale of the house.

What else happened?  My unrealized gains are now higher than before.  Of course, new gains rolling in every year, New LTG for taxable account = 253K.
So it seems I need to burn this down by converting more than 50K in gains each year, but I'm still worried about the long term consequence if I don't convert the tIRA money to ROTH because of the 5 year baking period.
Is there a way to look at the 15 to 20 year consequence of these actions instead of just maximizing tax treatment over the next year?

Catbert

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Re: Monte Carlo or Monte Cristo: Roth Conversion vs. Capital Gains Reset
« Reply #6 on: March 28, 2017, 02:31:49 PM »
I wish I had a definite answer for you regarding whether to do Roth conversions to avoid huge RMDs or selling stocks and paying LTCG rather them accumulate.  Here are a few things to think about:

*Make charitable contributions by donating appreciated stock through a Donor Directed Fund.  Fidelity and Vanguard both have them as well as others, I assume.
*For capital gains and dividends generated within your mutual funds have them pay out rather than be reinvested. 
*Someone will always owe income tax on those IRAs.  The basic of your taxable accounts will reset when one of you dies. 

MDM

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Re: Monte Carlo or Monte Cristo: Roth Conversion vs. Capital Gains Reset
« Reply #7 on: March 28, 2017, 02:47:41 PM »
I didn't convert any tIRA to Roth, but I did cash out about 50K in gains from my taxable account selling an S&P Index fund and other stocks and reinvesting in VTI. 
Good news, 0 federal tax for 2017 and only about 2K tax to NJ for the sale of the house.
...
Is there a way to look at the 15 to 20 year consequence of these actions instead of just maximizing tax treatment over the next year?
AFAIK there is no program that combines complete tax calculation with year-by-year optimization of optional income streams (e.g., IRA conversions, capital gains, start dates for SS and pension, etc.).

Have you tried the one year look using the spreadsheet noted previously?

JG in Hangzhou

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Re: Monte Carlo or Monte Cristo: Roth Conversion vs. Capital Gains Reset
« Reply #8 on: March 28, 2017, 06:44:09 PM »
MDM,   Regretfully, I have not as I cannot access Google drive from China.  I don't use a VPN but this summer when I return to the US I will download it and add it to my useful tools. 

Mary w  "*Someone will always owe income tax on those IRAs.  The basic of your taxable accounts will reset when one of you dies. "  - Sorry guess I haven't paid much attention to the 'what happens after I'm gone' scenerio.  What's the tax reference for this wisdom so I can read and drive it deeper into my collective understanding?