Roth Conversion?

[phildonnia]

FIRED for a year and a half now, and no regrets.  (Except maybe that my wife is still working.) 

For the first time in two decades, I'm out of the 22% federal tax bracket.  Or regular income (wife's wages, non-qualified dividends, ST cap gain) leaves about $20k left at the top of the 12% bracket.  Seems an attractive time to do a Roth conversion, both for the tax rate, and for getting the tax done while the values are down.

But.  We have $67k in Long-term Cap Gains and Qualified Dividends.  As things stand, $20k of that is in the zero-tax bracket.  Taking more regular income would push that into the 15% zone.

Obviously, doing the conversion results in higher tax this year, both from the conversion itself, and from the increased cap gains tax.  Is it worth it in the long run? 

In future years (when wife joins the Dark Side) I expect even less regular income.   Also, I have plenty of unrealized capital loss I could draw on if that would help.

What do y'all think?

[seattlecyclone]

It's really just a comparison of your current marginal rate against what you expect the marginal rate to be in whatever other year you might choose to realize that income. Right now you'll pay 12% regular rate + 15% capital gains + any reduction in ACA subsidies or other tax credits. So, 27% or maybe more. When else might you realize that income? Would you pay more or less than this?

[MDM]

Obviously, doing the conversion results in higher tax this year, both from the conversion itself, and from the increased cap gains tax.  Is it worth it in the long run? 

How does a graph of your marginal rate vs. conversion amount look?  See Worth pushing through the Social Security hump and/or IRMAA cliffs? for a discussion of things analogous to what seattlecyclone mentions.

[phildonnia]

Obviously, doing the conversion results in higher tax this year, both from the conversion itself, and from the increased cap gains tax.  Is it worth it in the long run? 

How does a graph of your marginal rate vs. conversion amount look?  See Worth pushing through the Social Security hump and/or IRMAA cliffs? for a discussion of things analogous to what seattlecyclone mentions.

Yeah, that's the big question.  Taking the Roth Conversion is a "double" hit, because it is taxable by itself, and it also pushes my capital gains over the 0% threshold. 

I took some time to make a spreadsheet that calculates my taxes for 2022, just so I could wrap my head around all the moving parts.  Ultimately, I ended up converting to Roth enough to take me to the top of the 12% bracket, and then cancelled out all my capital gains.  The idea is that when the investments come back in the future, I can take the gain at 0%.  And meanwhile, I have some more tax-free money in a Roth. 

I hope it all works out.

[joe7886]

I did a traditional IRA to Roth last year for the 1st time. I got the 1099-R from TD ameritrade.  Box 1 gross distributions is my contribution + 2 cents of interest, i did not invest. Box 2a taxable amount is the same number as box 1. Box 2b is an x for taxable amount not determined. From what i gathered and discussed the taxable amount is determined when doing the tax return and only the 2 cents is the actual taxable income, does that sound correct? I'm just worried i messed something up.

[seattlecyclone]

I did a traditional IRA to Roth last year for the 1st time. I got the 1099-R from TD ameritrade.  Box 1 gross distributions is my contribution + 2 cents of interest, i did not invest. Box 2a taxable amount is the same number as box 1. Box 2b is an x for taxable amount not determined. From what i gathered and discussed the taxable amount is determined when doing the tax return and only the 2 cents is the actual taxable income, does that sound correct? I'm just worried i messed something up.

Did you convert pre-tax funds or after-tax funds? If it was pre-tax funds the whole conversion is taxable, while if it's after-tax funds only the growth (2¢) is taxable. The box 2a will always show the full amount as taxable because your brokerage doesn't know how much after-tax basis is in your account; that's between you and the IRS on Form 8606.

[joe7886]

Thanks, it was after tax. I forgot to mention that

[phildonnia]

FOLLOW UP:

I ended up converting $10k from my pre-tax IRA to a Roth.  And harvested $60k in capital losses to try to offset the gains a little. 

Capital gains distributions were higher than expected (and I never know this until I get my 1099).  So I ended up with a capital gain anyway.  And it turned out that about $9k of regular income ended up in the 22% bracket, so the Roth conversion didn't help.  At least I paid the tax when the market was down. 

I had some issues with Wash Sales since my IRA has re-invested dividends.  As I calculate it, I lost the deduction on about $900 in losses due to this.  (I couldn't claim another $200 due to reinvestments in taxable accounts, but at least those keep the higher basis).  With all the recent hype about tax-loss harvesting, watch out for this if you are reinvesting the same things in your IRA.  I think my financial advisor should have said something.

The bright side is: I'm getting a huge tax refund this year; and I'm paying much lower estimated taxes this year. 

[TravelJunkyQC]

Live in a state with income tax and I just did a Roth conversion (pre-tax funds, thus taxable) early in the year. I am now moving to a no-income-tax state later this year. I will then be a part-term resident in both states for the year. Since the forms 1099 and 5498 (from the investment company where the funds are) do not have a date when the conversion took place, how does one report these conversion distributions for the state with income tax? I see three choices. Either the distributions are considered received by year-end, therefore they are 0 for the state with income tax. Either the distributions are all in that state because 'received' before moving out of the state. Either they are pro-rated by the number of days of residence in that state.
Any hard documentation on the answer would be appreciated.

[secondcor521]

Live in a state with income tax and I just did a Roth conversion (pre-tax funds, thus taxable) early in the year. I am now moving to a no-income-tax state later this year. I will then be a part-term resident in both states for the year. Since the forms 1099 and 5498 (from the investment company where the funds are) do not have a date when the conversion took place, how does one report these conversion distributions for the state with income tax? I see three choices. Either the distributions are considered received by year-end, therefore they are 0 for the state with income tax. Either the distributions are all in that state because 'received' before moving out of the state. Either they are pro-rated by the number of days of residence in that state.
Any hard documentation on the answer would be appreciated.

It depends on the states in question and their tax laws.

The best thing to do is to read the state tax instruction booklets to see how they treat part year residents' income.

The short answer is that individual states treat things differently.