Adding Roth Conversions and Interpreting the Results

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Jump to:

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• Tax Bracket Visualizer
  • Adding Roth Conversions
  • Fine-Tuning the Conversion Amounts
• Projected Taxes
• IRMAA Surcharges
• Portfolio Value
• Portfolio Value Difference
• Portfolio Value by Asset Type
• Required Minimum Distributions (RMDs)
• Assumptions
• Exporting Results

 

To replicate the case study in the videos and the entries in the screenshots below, please use the following "The Joy of Rothing" cheat sheet linked below:

The Joy of Rothing - Case Study Assumptions

 

Tax Bracket Visualizer

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The first graph of the Roth Projection illustrates the amount of taxable ordinary income (e.g., wages, taxable Social Security, taxable interest, IRA distributions - including Roth conversions, etc.) for each year of the projection, as well as the various marginal tax brackets applicable to that taxable ordinary income. 

This graph shows the peaks and  valleys of taxable ordinary income across a client's lifetime, to better spot opportunities where low income years may make Roth conversions more attractive. 

Users can show/hide any bracket by clicking on any of the bracket percentage labels (10%, 12%, 22%, etc.) for either the 'Base Case' or 'Roth Conversion' income labels to  better focus on specific elements of the analysis. For example, the screenshot above "hides" the 32%, 35%, and 37% brackets because they are out of the scope for this client's income.

This particular example highlights a prime potential opportunity for Roth conversions in the years between when someone stops working but doesn't yet have to take Required Minimum Distributions (RMDs) from their Individual Retirement Accounts (IRAs).

Users can further zoom in on particular ages or years to see the amount of ordinary income in the 'Base Case' and 'Roth Conversion' scenarios, along with the ordinary income levels where corresponding tax brackets begin, by hovering over any point on the graph.  





This example starts with $0 of taxable ordinary income. The table suggests that that there is plenty of room until the 12% bracket stops and the 22% bracket starts at $102,850 of taxable ordinary income. Hypothetically, if the goal is to max out the 12% bracket via Roth conversion, a user may wish to illustrate converting upwards of $90-100K (adjusted for inflation) starting at age 64 until RMDs begin at age 75.

Adding Roth Conversions

Adjust the amount and sequencing of the planned Roth conversions for client(s) by navigating to the Roth Conversions section of the Control Panel.

 

Click the pencil/paper icon to open the Roth Conversion screen. Similar to other screens in this tool, click +Add Row to add the row for the first year of conversions, along with the amount and any corresponding inflation adjustment for future years. Be sure to indicate the year when conversions are set to end; otherwise, the system will assume that conversions continue indefinitely.

The example below assumes that conversions to begin at age 64 and continue until Bob's RMDs start at age 75. Notice that those amounts start at age 64, the year after Bob retires, and continue until age 74, the year before Bob's RMDs start.

 Bob's Roth conversions start to fill up the 12% bracket, as seen below. Note, however, that it looks like Bob's converions end at age 71, despite data entry that attempted to model conversions going through age 74, the year before RMDs began at his age 75. Why is that?

The "Warnings" section in the control panel gives us a clue. Even though the projection included conversions continuing until age 74, by age 71, Bob has fully converted all of his tax-deferred assets by age 71. 






That leaves  room to model some conversions for Jane, between Bob's age 71 (Jane's age 69) and when RMDs begin for each at age 75:

The resulting graph below indicates that Bob and Jane have maxed out the 12% bracket. But when Bob turns 70, he starts to receive Social Security income, which pushes taxable ordinary income over the 12% bracket and into the 22% bracket. Then when Bob turns 75, his RMDs push income even higher into the 22% bracket. But this is a good foundation.  

Fine-Tuning the Conversion Amounts

There will be some element of plug and play to fine-tune a Roth conversion strategy, as shown above. After some editing of the amounts, this Roth conversion strategy for Bob and Jane has been optimized to max out the 12% bracket over time.

After those fine-tuned adjustments, Bob and Jane's conversion plan is illustrated in the Tax Bracket Visualizer below. Notice now that Bob has converted all of his tax-deferred assets, as has Jane, as indicated by the "Warning" in the control that indicates not all entered Roth conversions for Jane (Client 2) were completed due to those tax-deferred assets being depleted by 2062. Also, because Jane depleted her tax-deferred assets, her planned QCD in 2063 did not happen.

Projected Taxes

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The Projected Taxes graph shows lifetime tax projections of both the base scenario (green) and the Roth conversion scenario (blue). The projection difference indicates the lifetime tax savings anticipated by executing the Roth conversions. In the example above, the multi-year Roth conversion plan this client is projected to result in $815,452 less in taxes compared to the base scenario with no conversions.

To aknowledge the impact of the Time Value of Money, users can display the net present value of the nominal amount of tax savings by clicking the appropriate radio button in the Control Panel, as shown below, along with a desired discount rate. The example below uses a discount rate of 6%, idential to the portfolio return assumption. The tool tip/(?) icon associated with the Discount Rate field contains links to resources that discuss which discount rates are appropriate for this kind of analysis.

Even when discounting the tax savings, there is a respectable amount of tax savings as a result of undertaking this Roth conversion strategy, as seen below.

 

Medicare - Income Related Monthly Adjustment Amount (IRMAA Surcharges)

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While not technically a tax, Income Related Monthly Adjustment Amount (IRMAA) surcharges on Medicare Part B and D Premiums can be a consideration for Roth conversion planning. To enable this additional graph and include IRMAA surcharges in a Projection, toggle on this option in the Control Panel.

The example above indicates a savings of $25,568 in IRMAA surcharges, resulting from reduced income in later years due primarily to lower RMDs in the Roth case compared to the base case.  Similar to the Projected Taxes graph, users can display either the nominal amount of IRMAA differences or the discounted present value.

 

Portfolio Value

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This graph will show the cumulative effect of the Roth conversions on the combined portfolio balance by the end of the plan, which corresponds to the user-entered life expectancy for the longest-lived member of the household.

In the example above, the projected total portfolio balance is $10,717,473 for the Roth Case, compared to $9,778,329 for the base case, resulting in a portfolio value difference of $939,144 for the Roth Case. 

The base case and Roth conversion lines on the graph are sometimes so close that it may be difficult to see the difference. The "Portfolio Value Difference" helps to better indicate that difference in such cases by plotting the total portfolio value of the Roth Case minus the Base Case in each year of the projection. The point at which the curve becomes positive is sometimes referred to as the 'break-even' or 'crossover point,' whenthe Roth Case portfolio value ultimately overcomes the hurdle of the cost of the conversion and any associated opportunity cost of foregone returns on the amount of taxes paid. 

 

Portfolio Value by Asset Type

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This chart breaks out the total portfolio balance across the three asset types (taxable, tax deferred and Roth) for both the Base Case and Roth Case. To see the broken out balances for a given year, hover over the graph area for that year. These two graphs are particularly powerful in illustrating the mix of assets a client will pass on to their beneficiaries if there is a legacy goal in connection with a Roth conversion strategy.

Required Minimum Distributions (RMDs)

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If toggled on in the Control Panel, the Required Minimum Distributions graph will show the projected Required Minimum Distribution (RMD) amounts coming from tax-deferred accounts for both the Base Case and Roth Conversion scenarios. This can be particularly helpful in illustrating the impact of Roth conversions on potentially reducing RMDs in later years, especially for clients who will not need their full RMD to meet spending needs. In the example below, this series of Roth conversions will lower the RMDs these clients would otherwise have to take.

Assumptions

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The bottom of the Roth Projection will include a summary of the assumptions used in the analysis.

Exporting Results

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At the bottom of the Control Panel,  click the "Export" button shown below to view a spreadsheet of the math behind the projections.