Roth Conversion Ladder Question

[frugalfoothills]

Might be a dumb question, but let's say you reach FIRE and want to take advantage of the Roth Conversion Ladder to access your retirement funds. Most everything I've read says to move your annual expenses over in a year-over-year schedule once you are in a low enough tax bracket.

Is there a limit to what you can roll over in a given year? If not, what's to stop someone from saving an entire year's worth of annual expenses somewhere like a basic bank account, use that to live on for the year, collect zero income and pay 0% income taxes, and then roll over their entire chunk of early retirement cash at once instead of spread out over multiple years? Couldn't you roll over hundreds of thousands of dollars into a Roth at 0% that way?

[boarder42]

no you could not

rolling money from a trad to roth account creates a taxable event and the money is taxed as ordinary income. 

[frugalfoothills]

no you could not

rolling money from a trad to roth account creates a taxable event and the money is taxed as ordinary income.

Right, I understand that, but the point of my question is that if you chose to do the conversion in a year where you collected zero income and therefore paid 0% in income taxes, would the conversion not also be taxed at 0%?

[frugalfoothills]

What's to stop someone from saving an entire year's worth of annual expenses somewhere like a basic bank account, use that to live on for the year, collect zero income...

And where would you be getting this money for your entire year's worth of annual expenses?  In order to get amass the money in the first place (and keep it liquid), you're paying taxes up front.  So it's kind of like you're paying taxes in an effort to avoid paying taxes.  Right? :)

Ha, touche'. I suppose I was thinking that since many people around here seem to keep a decent portion of their stache liquid (I've seen people saying close to $100k in cash! Not I) that it wouldn't be unrealistic to expect you could have one year's worth of expenses available, especially if your expenses were relatively low ($25k or below.) In that case you could live for a year off that nest egg and roll the entire amount over at 0%, no?

Was just curious if that was a strategy for anyone since I'd never seen it discussed.

[boarder42]

no you could not

rolling money from a trad to roth account creates a taxable event and the money is taxed as ordinary income.

Right, I understand that, but the point of my question is that if you chose to do the conversion in a year where you collected zero income and therefore paid 0% in income taxes, would the conversion not also be taxed at 0%?

it depends on how much you're converting - if you're MFJ and no kids and converting under 24k then yes to answer your question you could pay 0 in income tax.  if you convert 24001 dollars and are living off of cash you had in the bank you now owe taxes on that 1 dollar.  whatever you convert is taxed as regular income.

There are other ways to pay 0 in income tax and if you're living a very frugal mustachian life then to answer your question - yes you can do this.  but i wouldnt do it personally b/c you'd need 5 years of expenses + inflation sitting in the bank account - i'll gladly pay a small bit of tax to keep that money invested - b/c then i'm only taxed on the gains. 

[boarder42]

here is a post by go curry cracker showing how its possible to pay almost no tax in FIRE under the old tax code

https://www.gocurrycracker.com/never-pay-taxes-again/

personally we'd never get to no taxes as we plan to spend up to the top of the 12% bracket most of our lives. 

[dandarc]

Don't try advanced tax maneuvers until you've got at least a basic understanding of how taxes work.

There is a very basic misunderstanding about how income taxes work in the United States underpinning the question.  Suggested reading:

https://evergreensmallbusiness.com/income-tax-buckets-not-income-tax-brackets/

The article was written before the latest tax-reforms, but still the basic point - you have a standard deduction bucket that is taxed at 0%.  If you have more income than that, then you fill up the 10% bucket, then the 12% bucket and so on until you've put all of your income into a bucket.

And the Roth conversion - the entire amount - is taxable income.  So unless you're "whole amount" conversion is quite small, you will pay more than 0% on the conversion, even absent any other income of any kind.

[boarder42]

Don't try advanced tax maneuvers until you've got at least a basic understanding of how taxes work.

There is a very basic misunderstanding about how income taxes work in the United States underpinning the question.  Suggested reading:

https://evergreensmallbusiness.com/income-tax-buckets-not-income-tax-brackets/

The article was written before the latest tax-reforms, but still the basic point - you have a standard deduction bucket that is taxed at 0%.  If you have more income than that, then you fill up the 10% bucket, then the 12% bucket and so on until you've put all of your income into a bucket.

And the Roth conversion - the entire amount - is taxable income.  So unless you're "whole amount" conversion is quite small, you will pay more than 0% on the conversion, even absent any other income of any kind.

good point it did seem like the OP was missing this part of what regular income tax is and how it works.  Didnt think i needed to go to that level but it seems like it was probably the point being overlooked.

basically OP if you convert 500k this year you have 500k in new income - it doesnt matter what money you used to live off of that year you converting 500k from roth to trad is taxed and will be taxed as follows for MFJ

24k - 0 tax
19050 - 10% tax
58350 - 12% tax
87600 - 22% tax
150000 - 24% tax
85000 - 32% tax
76000 - 34% tax

[frugalnacho]

no you could not

rolling money from a trad to roth account creates a taxable event and the money is taxed as ordinary income.

Right, I understand that, but the point of my question is that if you chose to do the conversion in a year where you collected zero income and therefore paid 0% in income taxes, would the conversion not also be taxed at 0%?

Only up to the point that the conversion amount is in the 0% bracket. If you convert $200k from traditional into Roth then you have $200k worth of income because of that.

[frugalfoothills]

Don't try advanced tax maneuvers until you've got at least a basic understanding of how taxes work.

There is a very basic misunderstanding about how income taxes work in the United States underpinning the question.  Suggested reading:

https://evergreensmallbusiness.com/income-tax-buckets-not-income-tax-brackets/

The article was written before the latest tax-reforms, but still the basic point - you have a standard deduction bucket that is taxed at 0%.  If you have more income than that, then you fill up the 10% bucket, then the 12% bucket and so on until you've put all of your income into a bucket.

And the Roth conversion - the entire amount - is taxable income.  So unless you're "whole amount" conversion is quite small, you will pay more than 0% on the conversion, even absent any other income of any kind.

good point it did seem like the OP was missing this part of what regular income tax is and how it works.  Didnt think i needed to go to that level but it seems like it was probably the point being overlooked.

basically OP if you convert 500k this year you have 500k in new income - it doesnt matter what money you used to live off of that year you converting 500k from roth to trad is taxed and will be taxed as follows for MFJ

24k - 0 tax
19050 - 10% tax
58350 - 12% tax
87600 - 22% tax
150000 - 24% tax
85000 - 32% tax
76000 - 34% tax

I am new to this (as in, the past few months) and am still learning the ropes, hence my "this might be a dumb question" caveat in the beginning. The FI world can be difficult to navigate for a newbie as a lot of these concepts are considered common knowledge but for someone trying to unscramble it all, things like that aren't always obvious.

Thanks for the reply.

[dandarc]

No worries.  The tax code is about as clear as mud.  A lot of people think that "I'm in the 22% bracket" means "I pay 22% on ALL of my income, therefore CRAP that raise is hurting me!"

[DreamFIRE]

For single filers, tax brackets after $12,000 deduction for income over:

10%    $0
12%    $9,525
22%    $38,700
24%    $82,500
32%    $157,500
35%    $200,000
37%    $500,000

[ooeei]

OP, to put it simply, the amount you convert IS your income. If you make $0 and convert $60k, your taxable income is $60k.

If you keep the conversion amount low you will pay little/no taxes, therefore it usually makes sense to spread it out over as many years as you can to stay in the lower brackets.