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When Does it Make Sense to Do a Roth Conversion?

A reader writes in, asking:

“I have read that a Roth conversion is a good idea if I am currently in a lower tax bracket than the tax bracket I will be in during retirement. But real life appears to be more complicated than that, as we will be in differing tax brackets from one year to another during retirement. And I don’t think our situation is particularly unusual.

I expect to retire about 4-5 years from now, which will cause us to move into a lower tax bracket. My wife anticipates retiring a few years after that, which may cause us to move into an even lower tax bracket, where we will be for a few years, until we start taking Social Security and move back up into a higher tax bracket. At what point(s) would Roth conversions be favorable?”

Firstly, just to be clear on one point, we are more concerned with how your marginal tax rate will change over time, rather than how your tax bracket will change over time. (While they are often the same, they can differ due to things such as the way Social Security is taxed or due to ACA subsidies — or other tax breaks — phasing out over certain income ranges.)

With Roth conversions — and tax planning in general — the goal is often to “smooth out” your marginal tax rate, to the extent possible.

Overall, the planning process typically looks something like this:

  1. Forecast your future income on a year-by-year basis using a simple “dummy” scenario, in which you do no particular tax planning. (For example, no Roth conversions at any point, and each year’s spending in retirement comes proportionately from each type of account — Roth, tax-deferred, and taxable.)
  2. Calculate your marginal tax rate in each year going forward under the dummy strategy.
  3. Look for years in which your marginal tax rate is projected to be at its lowest point.
  4. Attempt to shift income from high-marginal-tax-rate years to low-marginal-tax-rate years (e.g., by spending more from tax-deferred accounts or doing Roth conversions in a given year in order to increase taxable income in that year and reduce it in future years).
  5. Repeat steps 3 and 4 until a) your marginal tax rate is projected to be fairly steady going forward (such that you would not benefit from further shifting income from one year to another) or b) you are out of options for income-shifting.

So, for example, in the case of our reader above, his marginal tax rate will likely be at its lowest point in the years after his wife retires and before they start receiving Social Security. So it would likely be advantageous to increase taxable income in those low-tax-rate years (by spending from tax-deferred accounts and likely doing Roth conversions) in order to reduce taxable income in laters years in which they would otherwise have a higher marginal tax rate.

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Can I Retire Cover

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Topics Covered in the Book:
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  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
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Investing Blog Roundup: So Long, “File and Suspend”

After today, the world of Social Security will be slightly less complicated, as there will be one less strategy for retirees to consider. (Also, just FYI, I will be traveling today, so if you are looking for last-minute guidance about whether you should file and suspend before today is over, I am not the person to ask!)

Investing Articles

Other Money-Related Articles

Thanks for reading!

Social Security Planning Questionnaire/Checklist

One thing I see over and over (both in emails from readers and in discussions on the Bogleheads forum) is that people don’t know what information they need to provide in order to get assistance with their Social Security claiming decision. In some cases, that simply means that the person providing the assistance has to request additional information. In other cases, however, it can mean that an important fact is not considered in the analysis and a poor decision is made as a result.

What follows are the pieces of information that are necessary in order to make an informed decision about when to claim Social Security.

The Basics

If you’re getting help with your Social Security decision (whether from a financial planner, the Bogleheads, or elsewhere), you will, at the very least, need to provide the following pieces of information:

  • An estimate of your primary insurance amount,
  • Your month and year of birth,
  • Whether you have filed yet for benefits of any kind, and
  • Whether you have any reason to think that your life expectancy is significantly longer or shorter than average for a person your age.

And, if you are married, you will need to provide those same pieces of information regarding your spouse.

Other Potentially Important Points

In addition to the above, there are several other pieces of information that are important to mention, if they apply to you:

  • Do you have any children under age 18, adult disabled children, or dependent parents?
  • Do you (and/or your spouse) qualify for a pension from work you did that wasn’t covered by Social Security? And if so, what is the monthly amount of that pension?
  • Will you (and/or your spouse) be working between the ages of 62 and your full retirement age? (Or between the ages of 60 and your full retirement age, if you are a widow/widower.) And if so, how much do you expect to earn per year?
  • Have you had a marriage that ended? And if so, how long did it last, did it end as a result of divorce or death, and what is the PIA of that prior spouse?
  • If you are a widow(er) and have remarried, at what age did you remarry?

One important thing to note about the above situations is that they are often overlooked by the online Social Security planning calculators. If one of the above situations applies to you and the calculator you’re using doesn’t ask about that information, then the recommendation from the calculator is likely to be very flawed.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Investing Blog Roundup: Feedburner Acting Up

Again, I apologize for the erratic behavior of my article-to-email delivery system (Google’s Feedburner) this week. After nearly 8 years of working without problems, it has decided to start behaving strangely — delivering the wrong article on Monday, delivering multiple articles (along with the correct article) on Wednesday, and delivering an extraneous email on Thursday.

I’ve been working on finding a solution, but unfortunately the nature of the beast is that I can only try 1 thing per day (i..e, change a setting and hope that on the following day Feedburner does what it is supposed to do).

If things aren’t fixed within the near future, I’ll be switching services.

Investing Articles

Other Money-Related Articles

Thanks for reading!

Social Security: Should I File and Suspend Before 4/30/2016?

I’ve been getting a lot of questions from readers this month about the upcoming “file and suspend” deadline. So let’s go through this one final time, as succinctly and clearly as possible.

First, let’s make sure we’re clear on the deadline itself, as there has been a lot of misinformation on that topic. If you request suspension of benefits by 4/29/16 or earlier, the old rules will apply to your request. If the SSA receives your request to suspend benefits on 4/30/16 or later, the new rules will apply.

If you meet all of the following requirements, it likely makes sense for you to file and suspend (i.e., file for your own retirement benefit and ask to have it suspended) prior to 4/30/2016.

One: You attain* full retirement age prior to the deadline. (You cannot request suspension of benefits until you have reached full retirement age.)

Two: You plan to delay your own retirement benefit beyond full retirement age. (If you want to actually receive your retirement benefit, suspending it obviously isn’t a good idea.)

Three: You want somebody else (e.g., your spouse) to be able to receive a benefit based on your work record prior to the point at which you actually start receiving your retirement benefit. Or you want to preserve the ability to retroactively unsuspend later as a “change your mind” strategy.

Four: You do not intend to receive spousal benefits on your spouse’s work record between your FRA and age 70. (If you want your own retirement benefit to continue growing while you collect spousal benefits, you have to file a “restricted application” for just spousal benefits. But if you file and suspend, you are by definition filing for your own retirement benefit — rather than filing for spousal-only — and that will really mess up your plan.)

*In the world of Social Security, you “attain” an age on the day before your birthday.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Investing Blog Roundup: Exploring RMD Rules

Natalie Choate is one of the leading experts (possibly the leading expert) on the rules regarding distributions from IRAs and other retirement plans. I was excited to learn this week that she’s writing a monthly column for Morningstar. For instance, in the following articles she does a great job explaining various aspects of RMD rules.

Other Investing Articles

Thanks for reading!

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