Traditional to Roth Conversion - Best Approach & Advice?

[iluvzbeach]

This is the first year that DH & I are both completely FIRE.  In previous years we had too much income to consider doing Roth conversions but this year we have room to do about 15K in Roth conversions, while still maximizing our ACA subsidies for the Silver Cost-Sharing level.  I'd appreciate any input you can offer as to whether we should do this and, if so, what approach makes the best sense.  Below are some details:

~DH (age 63) has only had Traditional IRAs (formerly 401Ks) to this point.  He does not have a Roth.
~I am 53 and had approximately 30K in a Roth 401K that I rolled into a Roth IRA in late 2022 after leaving my employer.
~We both have Traditional IRAs.  RMDs will push us into IRMAA territory if we do not get started on Roth conversions and get quite a bit converted between now and when RMDs kick in.
~We are intentionally trying to keep income low in order to maximize ACA subsidies and keep health insurance premiums and deductibles as low as possible (or as makes sense) until we're both on Medicare.  DH will go on Medicare in 2025 and I'll follow behind in 2035.
~We have sufficient cash on hand to not require any IRA distributions for the next 6+ years.

Questions:
~Should we bother doing any sort of Roth conversion now, even if it's just 15K per year for the next few years?  If we don't do Roth conversions, we'll simply do Traditional IRA distributions from DH's IRA to inflate our income to the level we need for ACA and help replenish our cash funds.
~If you recommend we do Roth conversions, should they come from DH's IRA or should we do them from mine?
~Does the 5-year rule for Roth conversions start from the time the Roth IRA was opened (late 2022 in my case) apply for all future conversions into the Roth, or does each conversion restart the 5-year clock for that grouping of funds?
~My initial thoughts are to do small Roth conversions until DH is on Medicare.  Then, beginning in 2026 when I'll be the only one on ACA, we could realize more income each year and do larger conversions (staying under IRMAA).  While ACA premiums for me would be higher, at least it would only be for one person and not both of us.  I do have an HSA that could support higher OOP expenses/deductibles for myself if large medical expenses were to arise.

I would really appreciate any advice you can offer about the best way to proceed.  Thank you!

[secondcor521]

First, Silver CSRs are not reconciled.  They are based on your estimated AGI.  So if you estimate 249% of FPL for your AGI, then you will get Silver CSR73 even if your AGI ends up being 251% of FPL on your tax return.

The ACA subsidies (APTC) are reconciled on your tax return on Form 8962.  I think the proper way to look at this is as a parallel tax system.  The marginal rates are higher (sometimes much higher) than indicated by the Applicable Percentage in the 8962 instructions.  See here to understand why:  https://seattlecyclone.com/aca-premium-tax-credits-2021-edition/

I tend to favor Roth conversions over traditional IRA distributions.  Taxwise it's the same thing, but if you end up not spending some of it, what is unspent ends up in a tax-free Roth rather than a taxable account.

As for your actual three questions:

A1.  I would do Roth conversions up to where the marginal tax rate on the last dollar is about the same or a bit less than your estimated marginal tax rate when you're in your late 70s.  Your late 70s rate will be based on RMDs, SS, other income, tax rates then, and IRMAA, so it's a bit of a guess, but you can at least make an estimate.  This may be only $15K; it may be more or less depending on what you learn about your ACA marginal rate (see above).

A2.  Probably his, simply because he's older and will hit RMDs first.  But if either of you had a small IRA and wanted to simplify by emptying out that account, there can be value in that.  This assumes no concerns about divorce or blended families where what you have individually might matter more than the old fashioned "all in one pot" approach.

A3.  Each conversion has it's own 5 year clock which starts on January 1st of the year in which the conversion was made, regardless of when during the year it was made.  So a Roth conversion today would have a five year clock starting on 1/1/2023 and being accessible on 1/1/2028.

As an aside, don't forget to report your Roth conversions on Form 8606 part II.  If you do his and hers conversions, then you will complete two Form 8606s, one for each person.  Submit the Form 8606(s) with your tax return.

HTH.

[MDM]

Roth Conversion and Capital Gains On ACA Health Insurance
and
Roth Conversion with Social Security and Medicare IRMAA
could help you.

If you try what those suggest, is it helpful?

[iluvzbeach]

First, Silver CSRs are not reconciled.  They are based on your estimated AGI.  So if you estimate 249% of FPL for your AGI, then you will get Silver CSR73 even if your AGI ends up being 251% of FPL on your tax return.

The ACA subsidies (APTC) are reconciled on your tax return on Form 8962.  I think the proper way to look at this is as a parallel tax system.  The marginal rates are higher (sometimes much higher) than indicated by the Applicable Percentage in the 8962 instructions.  See here to understand why:  https://seattlecyclone.com/aca-premium-tax-credits-2021-edition/

I tend to favor Roth conversions over traditional IRA distributions.  Taxwise it's the same thing, but if you end up not spending some of it, what is unspent ends up in a tax-free Roth rather than a taxable account.

As for your actual three questions:

A1.  I would do Roth conversions up to where the marginal tax rate on the last dollar is about the same or a bit less than your estimated marginal tax rate when you're in your late 70s.  Your late 70s rate will be based on RMDs, SS, other income, tax rates then, and IRMAA, so it's a bit of a guess, but you can at least make an estimate.  This may be only $15K; it may be more or less depending on what you learn about your ACA marginal rate (see above).

A2.  Probably his, simply because he's older and will hit RMDs first.  But if either of you had a small IRA and wanted to simplify by emptying out that account, there can be value in that.  This assumes no concerns about divorce or blended families where what you have individually might matter more than the old fashioned "all in one pot" approach.

A3.  Each conversion has it's own 5 year clock which starts on January 1st of the year in which the conversion was made, regardless of when during the year it was made.  So a Roth conversion today would have a five year clock starting on 1/1/2023 and being accessible on 1/1/2028.

As an aside, don't forget to report your Roth conversions on Form 8606 part II.  If you do his and hers conversions, then you will complete two Form 8606s, one for each person.  Submit the Form 8606(s) with your tax return.

HTH.

@secondcor521 Thank you for taking the time to provide a detailed response.  I always appreciate reading the information you provide to others on the forums.

I have read through and will take a further look at the blogpost by SeattleCyclone.  Thanks for providing the link.

In regard to A2 above, you suggest doing the conversions to a Roth for DH because he'll be in RMD land first.  I was contemplating doing the conversions on my IRA first, simply because I've got more time for growth which will undoubtedly result in larger RMDs when I hit that age.  If I convert as much as possible between now and RMD age (using taxable accounts to pay the taxes), I can avoid the monstrous RMDs that would otherwise occur.  One thing where I get hung up is that I'm thinking "all or nothing" in terms of whose IRA we do conversions on, when it can actually be on both our IRAs.  We both have approximately the same amount in our IRAs, give or take 50K, and we don't have any children.  We are not looking to leave money to anyone, just to have enough to get us through our lifetimes.

Thanks again.  I'll continue to do more research and analysis around the best approach.

[iluvzbeach]

Roth Conversion and Capital Gains On ACA Health Insurance
and
Roth Conversion with Social Security and Medicare IRMAA
could help you.

If you try what those suggest, is it helpful?

@MDM Thank you so much for the links to these blogposts by The Finance Buff.  I am familiar with the Case Study Spreadsheet and have even used it before, but not religiously and not (obviously) in great detail.  The crazy thing is I do follow the Case Study Spreadsheet Updates forum thread, so it looks like I need to get serious now about using it consistently.  Your work on the spreadsheet is astounding and I know it's a terrific tool.  I'm going to spend more time digesting all of this over the next few weeks, playing with the numbers, etc.  I may reach out if I have additional questions.

Again, thank you!

[secondcor521]

In regard to A2 above, you suggest doing the conversions to a Roth for DH because he'll be in RMD land first.  I was contemplating doing the conversions on my IRA first, simply because I've got more time for growth which will undoubtedly result in larger RMDs when I hit that age.  If I convert as much as possible between now and RMD age (using taxable accounts to pay the taxes), I can avoid the monstrous RMDs that would otherwise occur.  One thing where I get hung up is that I'm thinking "all or nothing" in terms of whose IRA we do conversions on, when it can actually be on both our IRAs.  We both have approximately the same amount in our IRAs, give or take 50K, and we don't have any children.  We are not looking to leave money to anyone, just to have enough to get us through our lifetimes.

If you plan to stay married and don't have a blended family, then I don't think it matters much.  If you convert $20K from yours, then his IRA and RMD grows.  If you convert $20K from his, then your IRA and RMD grows.

I suppose if your IRAs are invested differently, then you'd probably want to convert from whichever IRA is expected to grow the most so that your Roth conversions are getting the biggest bang for the buck in terms of reducing RMDs.

You probably understand that the amount of RMD as a percentage of the IRA balance grows with each passing year.  So when you're both taking RMDs, his will always be a larger chunk of his IRA since he's older.  I suppose this may matter if you end up in the situation where your RMDs and other income (SS, pensions) provide more than what you want to spend - him being older with approximately the same size IRA means his RMD will create more of a "forced income" problem than yours.

[iluvzbeach]

Thanks for the additional thoughts, secondcor521.

We plan to stay married and there is no blended family. Additionally, I am an only child and he has one brother who he is not in contact with.

I am aware of how the RMD amount escalates over the years, but my math has shown that since he’s ten years older and our balances are roughly the same (mine is 40K-50K higher) when it comes time for RMDs mine will be approximately double what his will be due to the continued growth over that ten year period. This is why I was questioning whether it would make more sense to do the conversions from my IRA. That said, if things play out in regard to normal life expectancy, he will likely die before me and his IRA funds would transfer to me at that time leaving me in the same high RMD dilemma. I think I’ve just talked myself into determining that it doesn’t matter whose IRA we begin working to convert to Roth.

Thanks again for your time & input.

Now off to focus on filling in info on the case study spreadsheet to see what I come up with.

[seattlecyclone]

The dollar amount of your RMDs may be higher than his because your account is larger, but because he's older the percentage he's taking out in any given year will be higher.

For example when you start taking out RMDs at 75 he'll be 85. Your RMD will be 4.07% while his will be 6.25%. If you do an extra $10,000 Roth conversion out of your account when you're 74 that will reduce your age-75 RMD by $407. If you do that same $10,000 Roth conversion out of his account in the same year it will reduce his age-85 RMD by $625. You get more bang for your buck in terms of RMD reduction by draining his account first.