Modelling Roth Conversions after FIRE

[geekette]

We've been fired about a decade, and have kept our Traditional to Roth conversions fairly low for the ACA benefits.  In the next 2 years, we'll transition to Medicare and will want to more aggressively convert.

Are there any websites that can model this?

[lhamo]

Not a website, but the Bogleheads Retiree Portfolio Model spreadsheet is pretty good for tinkering with Roth conversion/tax management strategies

Overview:  https://www.bogleheads.org/wiki/Retiree_Portfolio_Model

Link to spreadsheet here:  https://www.bogleheads.org/forum/viewtopic.php?t=97352

Warning:  The spreadsheet is VERY complex and full of red ink warnings until you get most of your data put in. Just plod through it --easier if you stick with the defaults for things like asset allocations at first -- and eventually the red ink should go away.  The Roth conversion section is at the very end. 

[2sk22]

We've been fired about a decade, and have kept our Traditional to Roth conversions fairly low for the ACA benefits.  In the next 2 years, we'll transition to Medicare and will want to more aggressively convert.

Are there any websites that can model this?

My absolute favorite is Pralana Gold which I can recommend without reservation.  You should note that the best tools for Roth conversion planing are not freebecause incorporating tax calculations is not trivial. Pralana costs about $100 per year - its currently sold in the form of an Excel spreadsheet but is in the process of being converted to a web app.

[mistymoney]

Not a website, but the Bogleheads Retiree Portfolio Model spreadsheet is pretty good for tinkering with Roth conversion/tax management strategies

Overview:  https://www.bogleheads.org/wiki/Retiree_Portfolio_Model

Link to spreadsheet here:  https://www.bogleheads.org/forum/viewtopic.php?t=97352

Warning:  The spreadsheet is VERY complex and full of red ink warnings until you get most of your data put in. Just plod through it --easier if you stick with the defaults for things like asset allocations at first -- and eventually the red ink should go away.  The Roth conversion section is at the very end.

that is complex! but thanks for posting about it. Might try to work with it next weekend.

[geekette]

Thanks - I'm going to need a clear head and plenty of time.

[Ron Scott]

I'm going to need a clear head and plenty of time.

The model will do what models do: predict benefits and/or drawbacks. You can review model output when you’re tripping if you want and you’ll be fine.

The problem is thinking through the assumptions the model operates from, and then you’ll need more than a clear head. You’ll need a fortune teller.

[MDM]

You've probably made a good choice not converting while on the ACA.  For your upcoming choice, consider Roth Conversion with Social Security and Medicare IRMAA.

If you want to check your choice while on the ACA, see Roth Conversion and Capital Gains On ACA Health Insurance.

[Turtle]

I have been using Projection Lab to try out various scenarios for my own situation.  There’s a ChooseFI podcast episode with the creator of that program, which includes a coupon if you are interested.  There’s also a free trial period available.

[dhbike01]

You've probably made a good choice not converting while on the ACA.  For your upcoming choice, consider Roth Conversion with Social Security and Medicare IRMAA.

If you want to check your choice while on the ACA, see Roth Conversion and Capital Gains On ACA Health Insurance.

@MDM,

Can you explain the attached chart to me which is based on my numbers for this year?

My realized + projected income for the year, excluding Roth conversions is a follows:

Taxable Interest - $9,474
Long Term Capital Gains - $4,612
State: TX
With Roth conversions, I planned to top off at $36,000 in income.

First year on ACA, Gold Plan: $939.86 PTC: $883

I have already executed some Roth conversions this year, but it's not relevant to my question as it doesn't alter the chart.  I can understand a marginal tax rate of 10% and 12%, but I don't understand what is going on in between 10% and 12%.  I know that the ACA subsidy must be affecting the chart in some way but I expected more of a smooth transition between 10% and 12%.  I came up with this years numbers manually, to the point where the ACA subsidy was acceptable to me and the taxes were minimal.  Next year, I want to be more aggressive, so I plugged this years numbers into your spreadsheet to test it out for next year.

Thanks.  Maybe it's a simple explanation I missing.

[MDM]

The simple explanation is "that's how the ACA law works." ;)

Of course, the tax effects of the ACA law are anything but simple.

Going through Form 8962 while looking at cells Calculations!AC88:AI119 may help.

Without your SLCSP it would be hard to reproduce (I'm assuming "Gold Plan: $939.86 PTC: $883" are your monthly gross premiums and APTC payments respectively for all 12 months), but here are some guesses:
- Up to 150% of FPL you owe no ACA premium, so that covers the 0% and 10% bracket rates, up to ~$15K.
- From ~$15K to ~$33K you are seeing a combination of having to repay some of your APTC, plus a spike when going over one of the repayment caps at 200% or $300% FPL, plus the 27% marginal tax rate anyone incurs when another dollar of ordinary income taxed at 12% also pushes a dollar of LTCG into the 15% LTCG bracket.

Is that enough to get started?

[dhbike01]

My SLCSP is $11,980 which is more than the Gold plan but I don't think that's unusual from what I understand.
When I finish my tIRA distributions with $21,914.59 for $36,000 in total income and enter it in B31, form 8962 tells me I have an Excess advance payment of PTC of $11 in AD105.  To me this aligns almost exactly with what I expected from the original sign up with the ACA plan, so that's perfect.

I'm just struggling with the interpretation of the chart with respect to how much a tIRA withdrawal affects my Marginal tax rate.  When I find the point on the chart that aligns with $21,914.59, it's on the first upward slope of the chart somewhere between 20% and 30% marginal tax rate.  When I look at cells O183 - S184, where $21,914.59 falls somewhere between, the marginal tax rate is somewhere between 25.74% and 25.86%, and the cumulative tax rate is 11%.  But, I know with an income of $36,000 that I'm clearly in the 12% marginal tax bucket.  When I look in G17 my 1040 Tax is calculated as $1783 + the $11 Excess APTX tax in G19, which is in the ballpark of where I expected to be except a bit lower because of the fact that you have to think about LTCG for ACA but not federal taxes and I simplified.  The effective tax rate on $36,000 of income is only 4.98% and this is displayed in E63.

I was kind hoping that I could pick a dot on the chart and realize that's the sweet spot.  I guess by referencing all of the various federal tax and PTC cells it's still better than manual, but can you see where I'm struggling with the visual.  Maybe it's just me.  There may be something where I just need to think about it this way or that way?

[secondcor521]

My SLCSP is $11,980 which is more than the Gold plan but I don't think that's unusual from what I understand.
When I finish my tIRA distributions with $21,914.59 for $36,000 in total income and enter it in B31, form 8962 tells me I have an Excess advance payment of PTC of $11 in AD105.  To me this aligns almost exactly with what I expected from the original sign up with the ACA plan, so that's perfect.

I'm just struggling with the interpretation of the chart with respect to how much a tIRA withdrawal affects my Marginal tax rate.  When I find the point on the chart that aligns with $21,914.59, it's on the first upward slope of the chart somewhere between 20% and 30% marginal tax rate.  When I look at cells O183 - S184, where $21,914.59 falls somewhere between, the marginal tax rate is somewhere between 25.74% and 25.86%, and the cumulative tax rate is 11%.  But, I know with an income of $36,000 that I'm clearly in the 12% marginal tax bucket.  When I look in G17 my 1040 Tax is calculated as $1783 + the $11 Excess APTX tax in G19, which is in the ballpark of where I expected to be except a bit lower because of the fact that you have to think about LTCG for ACA but not federal taxes and I simplified.  The effective tax rate on $36,000 of income is only 4.98% and this is displayed in E63.

I was kind hoping that I could pick a dot on the chart and realize that's the sweet spot.  I guess by referencing all of the various federal tax and PTC cells it's still better than manual, but can you see where I'm struggling with the visual.  Maybe it's just me.  There may be something where I just need to think about it this way or that way?

I'm not sure why the disconnect on your tax situation in the first two paragraphs.  MDM can figure it out I'm sure.  But it's possible that since you mention both ordinary income and LTCG that you're encountering what I've heard called the 27% phantom tax bracket and Michael Kitces calls a capital gains bump zone.  He explains the phenomenon here:

"In fact, the interrelationship between ordinary income and long-term capital gains creates a form of “capital gains bump zone” – where the marginal tax rate on ordinary income can end out being substantially higher than the household’s tax bracket alone, because additional income is both subject to ordinary tax brackets and drives up the taxation of long-term capital gains (or qualified dividends) in the process."

https://www.kitces.com/blog/long-term-capital-gains-bump-zone-higher-marginal-tax-rate-phase-in-0-rate/

As for the last paragraph, I actually use the CSS to do my taxes in December and figure out my AGI sweet spot.  I can get it down to an exact dollar.  Sometimes I change the values of $220 and $0 in cells P83:P84 to zoom in on a particular area of the graph.

[MDM]

My SLCSP is $11,980 which is more than the Gold plan but I don't think that's unusual from what I understand.

Yes, your situation is not at all unusual.  What is unusual, or at least different from an "it's only the bracket rates that matter" expectation, is tax law in general and ACA tax law in particular.

When I look at cells O183 - S184, where $21,914.59 falls somewhere between, the marginal tax rate is somewhere between 25.74% and 25.86%, and the cumulative tax rate is 11%.  But, I know with an income of $36,000 that I'm clearly in the 12% marginal tax bucket.

See above, and the marginal tax rate wiki I linked in a previous post.  The chart in that wiki shows exactly the 27% rate 2ndcor521 mentioned.

I'll get to a deeper dive in a little while....

[MDM]

I'll get to a deeper dive in a little while....

Looking at Roth conversion amounts, here's a start.

$0-$5,130: No tax due to standard deduction; full premium tax credit equal to your $11,158 premiums.

$5,131-$16,730: 10% bracket; still $11,158 PTC

$16,731-$17,327: 12% bracket; still $11,158 PTC

>$17,328: still 12% bracket; but now your PTC starts dropping, causing your actual marginal tax rate to increase, because a lower PTC means less net PTC (line 9 on https://www.irs.gov/pub/irs-pdf/f1040s3.pdf).

Have other things to do now, but will get back to this if you are finding it helpful.

Oh, and if you think the chart you see is weird, change cell Calculations!R80 from Y to N to see the real tax code (e.g., using the Tax Table instead of tax formulas) in operation. :)

[dhbike01]

>$17,328: still 12% bracket; but now your PTC starts dropping, causing your actual marginal tax rate to increase, because a lower PTC means less net PTC (line 9 on https://www.irs.gov/pub/irs-pdf/f1040s3.pdf).

Ok.  I knew this but I don't think I was thinking about this correctly.  I've been paying $56.86 per month in ACA premiums, which I was not thinking about as a tax but as an expense.  I was focusing on getting the monthly premium to something that I was comfortable with.  But $56.86 x 12 + $11 excess advance = $693.32 additional tax.  If I add this to the $1783 1040 Tax, then it's $2476.32 total tax on $36,000 income or a 6.9% effective tax.  But, I could see where it starts escalating quickly on the marginal because when I decided on $56.86 per month I was actually comparing other numbers and had noticed that the percentage of income on the ACA premium went up sharply if I went any further.  I guess this means the optimal is where there is a $0 ACA premium or very close to it.

In your opinion, is it best to look at the chart data and pick the point where the marginal rate is 10% or maybe the first bit of 12%?

On another note, the point where the data drops back down to 12% marginal rate, is that just where there are no more ACA subsidies, so in that case if you want insurance you really are just paying the entire premium and the chart no longer reflects the ACA premium as a tax, but as an expense on your own?

This is making me rethink if I want to be more aggressive next year.  One thing I could do is drop to a bronze and perhaps create a little more room.

A few years down the line, when I start Medicare, that's basically a fixed expense, but I guess that could also be thought of as a tax but maybe an unavoidable one.

[MDM]

OK, here's all of it (and the ranges may be off by a few dollars, but close enough....):

$0-$5,130: No tax due to standard deduction; full premium tax credit equal to your $11,158 premiums.

$5,131-$16,730: 10% bracket; still $11,158 PTC

$16,731-$17,327: 12% bracket; still $11,158 PTC

$17,328-$28,000: still 12% bracket; but now your PTC starts dropping, causing your actual marginal tax rate to increase, because a lower PTC means less net PTC (line 9 on https://www.irs.gov/pub/irs-pdf/f1040s3.pdf).  The marginal rate has a slope instead of being flat because both line 3 (your ACA MAGI) and line 7 (the fraction by which you multiply the MAGI to determine how much of your premium you have to pay) on https://www.irs.gov/pub/irs-pdf/f8962.pdf are increasing at the same time.

$28,001-$29,654: still 12% bracket; at $28,000 you would have to repay $950 of excess APTC.  Because you are under 300% FPL, your repayment is capped at $950 so you would pay only the 12% bracket rate.

$29,655: you exceed 300% FPL so the whole $1,241 excess APTC is due instead of only $950.  $1 more income costs $291 in tax.

$29,656-$32,055: similar to the zone that started at $17,328, your excess APTC repayment increases until it hits the $1,575 cap for being <400% FPL.

$32,056-$44,233: similar to the zone that started at $28,001, your APTC repayment stays constant so it's just the 12% bracket rate.

$44,234: you exceed 400% FPL so the whole $3,573 excess APTC is due instead of only $1,575.  $1 more income costs $1,998 in tax.

$44,235-$47,540: Now the MAGI multiplier (aka "applicable figure") is constant at 8.5% so your marginal rate is constant at 12%+8.5%=20.5%.

$47,541-$52,151: The 27% rate due to 12% ordinary plus 15% LTCGs mentioned previously, plus the 8.5% ACA claw-back = 35.5% marginal rate.

$52,152-$52,276: Back to 20.5% because all the LTCGs have been taxed.

>$52,277: You pay the 22% and 24% bracket rates when in those brackets, plus the 8.5% ACA premium claw-back rate, until at $126,850 the total MAGI = $126,850 + $9,474 + $4,612 = $140,936.  At that amount you would owe back the entire APTC $10,596 received.

Interesting trip down the tax law rabbit hole, but back to your main question: how much to convert?  As discussed in Whether, when, and how much to convert, that depends on the marginal tax rates you expect to pay in the future, for example after taking SS and RMDs.

Converting that first $17,327 for 12% or less seems a reasonable bet unless you expect to pay no tax when taking SS and RMDs.  Assuming you decide to do at least that much, you might ask "should I convert more?"  To answer that question, you have to look at the cumulative marginal rate for dollars above that $17,327, as shown here:



That long stretch at 12%, ending at $44,233, brings the cost of converting the $44,233 - $17,327 = $26,996 down to ~20%, and might also be a good bet.

OK, that's enough of a dump: back to you....