Author Topic: Roth Conversion Ladder Questions  (Read 301 times)

yachi

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Roth Conversion Ladder Questions
« on: May 04, 2021, 02:11:22 PM »
Does it matter what time during the year you do your conversion?  Does it count as 5 years if I roll money over December of 2021, and pull it out January of 2026?

Iím 2 years short of having enough cash to live on for the 5 years I would be building the Roth Conversion Ladder, any tips on how to fund the rest?  Is it crazy to start conversions now while I have W2 income I can use to pay the taxes? - I want to keep my income low to maximize ACA subsidies during retirement, and there are probably some deductions I'm not fully able to use because my income is not high enough.  We got almost 4K back in taxes last year despite not paying in.  That's not counting the stimulus payments.

When rolling money over, how do you handle inflation?  Apply last year's inflation to the next 5 years and adjust what you roll over?

MDM

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Re: Roth Conversion Ladder Questions
« Reply #1 on: May 04, 2021, 02:25:35 PM »
Does it matter what time during the year you do your conversion?  Does it count as 5 years if I roll money over December of 2021, and pull it out January of 2026?
Yes.  See A-5(b) in 26 CFR ß 1.408A-6 - Distributions. | CFR | US Law

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Iím 2 years short of having enough cash to live on for the 5 years I would be building the Roth Conversion Ladder, any tips on how to fund the rest?  Is it crazy to start conversions now while I have W2 income I can use to pay the taxes? - I want to keep my income low to maximize ACA subsidies during retirement, and there are probably some deductions I'm not fully able to use because my income is not high enough.  We got almost 4K back in taxes last year despite not paying in.  That's not counting the stimulus payments.
Starting conversions earlier, or paying the 10% penalty on early withdrawals, are two possibilities.   Which of those is better depends on the tax rates you would have to pay now vs. later.  Skipping tax-advantaged investing altogether in favor of loading up taxable accounts for some years is another possibility.

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When rolling money over, how do you handle inflation?  Apply last year's inflation to the next 5 years and adjust what you roll over?
Probably not worth attempting to be that exact.  One possibility would be "convert until you fill the tax bracket you need to reach for your minimum conversion".

secondcor521

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Re: Roth Conversion Ladder Questions
« Reply #2 on: May 04, 2021, 02:38:37 PM »
I'd just add that if you're paid fairly well now, a good strategy to get that extra oomph would be to get a low paying but easy (and possibly fun) job to cover the gap.  I'm not as much of a tax expert as MDM and the others, but it does seem to me that having $10K to $20K a year in earned income is treated really well by the tax code - you might get EITC, you'll probably get some retirement savings contribution credit, you'll probably get good ACA subsidies, and there may be others.

I've been FIREd for about 5 years and although I don't need the income and my Roth ladder is overfunded, I still end up doing Roth conversions each year because I have nonrefundable credits that go to waste otherwise.  A part time job would also sop up those credits for me as well.

You also might find that your spending is lower than you are currently predicting.  I found out that some of my spending right before I retired was stress spending - going to Burger King because it is salty, sugary, fatty, easy deliciousness turned out to be stress relief valve of sorts.  Similarly vacations - I've been a lot of places already, and just hanging around my house and not working is pretty nice - no need to fly somewhere else for a week.  And if I do go I can travel hack in a number of ways to make it very cheap.

To be clear, I can afford both vacations and Burger King whenever I want.  I just don't feel any pressing urge for those things anymore because I don't have the stress of working.

Did you include your Roth contributions in your Roth ladder funding?  Those come out first and are penalty- and tax-free, so arguably should be considered part of your ladder.

Between a part time job, lower spending, Roth contributions, and knowing about the December to January rule, I think you might be better off than you think.

yachi

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Re: Roth Conversion Ladder Questions
« Reply #3 on: May 04, 2021, 03:31:07 PM »
One thing I considered was taking the 10% penalty to cover my spending money years 1 and 2 while also rolling over the first 2 years.  That doubles my reported income for those 2 years, and really messes up my health insurance plans.

The 10% penalty and hit to health insurance costs has to be compared to starting the Roth Conversion Ladder while working.  I wouldn't have to pay the 10% penalty, and it wouldn't affect my health insurance costs, but would bump me up in tax brackets.

I have a number of items that are budgeted by year, but only spent every 5 to 10 years, so that gives me some flexibility.

I may have to give the part time job some serious thought.  It helps that I can save the Roth conversion for the end of the year.  That way I'll know what kind of earnings I got that year.

I did find an interesting option.  It has a high tax cost your last year working, but then it's consistently low while being retired.
Year 1: Rollover 2x spending while working
Year 2: Rollover 1x spending, while spending from savings
Year 3: Rollover 1x spending, while spending from savings
Year 4: Rollover 1x spending, while spending from savings
Year 5: Don't roll anything over.  Spend 1.1x from Traditional IRA with penalty
Year 6: Rollover 1x spending, while spending from Year 1 Rollover
Year 7: Rollover 1x spending, while spending from Year 1 Rollover
Year 8: Rollover 1x spending, while spending from Year 2 Rollover
Year 9: Rollover 1x spending, while spending from Year 3 Rollover
Year 10: Rollover 1x spending, while spending from Year 4 Rollover
Year 11: Rollover 1x spending, while spending from Year 6 Rollover