Over FPL limit for Roth Conversions

@solowriter ACA subsidies don't end at 150% poverty. For 2025, there's a gentle slope down to no subsidies, but the cliff at 400% is almost certain to come back for 2026.

If your MAGI without Roth Conversions exceeds a limit that you enter in the FPL field, your limit is simply ignored. ACA premium credits continue well above that level, but between 1.5 and 4X FPL, the premium credit phases out in a saw-tooth pattern that averages around a 15% cost on top of your regular tax bracket - so your Roth Conversion cost in this range can be 27%. You probably don't want to stop in that range. Above 4X FPL, the premium credit phases out at 8.5% on top of your ~12% bracket, so 20.5% until there is no credit left. The usual strategy is to either stay as close to the bottom of the steep phase-in range as possible or go well over to use the 22% bracket, depending on how urgent your conversions are. For a first pass, leave all the FPL, IRMAA, etc. limits blank and let the Roth Optimizer do its thing. Even though it only looks at ordinary tax brackets, it's hard to beat by very much when you try to manually tune the case.

Note that the ability to maximize ACA premium credits and do Roth Conversions in low tax space are excellent reasons to put off claiming SS benefits as long as possible.

@solowriter Actually, in this case, "over" means it's over the limit by a fraction of cent due to a rounding issue which will be corrected in the next release. We appreciate your attention to detail here and for bringing it to our attention.

Stuart

@smatthews51 Thanks for addressing that.

Follow up here, how do Roth Conversions (and subsequent difference in ACA MAGI) impact ACA subsidy levels in the tabular projections?

I've noticed that whether I set FLP to 1.5 or 4 in various combinations, it seems to give me about the same total amount of subsidies over an 18 year period, varying by only a few thousand dollars. Total subsidies in three runs have come out at $330k, $334K and $337K.

Also, how does the tool project those subsidy levels? I entered in the second lowest cost silver plan for my zip code and age in my state's marketplace, but the longest out year I could choose to get my estimate was 2025.

Is the tool taking that original 2025 SLCSP price and increasing by inflation, or is there some other math going on behind it?

@ricke thanks for this breakdown and your other posts on this topic, your comments have been extremely helpful for me as I've been learning how to use the tool.

I definitely saw the benefit from setting SS to 70 before converting. But when I set no limits for FPL, the tool seemed to prioritize conversions over ACA, putting me over the limit for subsidies in most years. (As an aside, I want to say how grateful I am the tool has this capability in the first place. I've tried to shoehorn conversions up to the FPL limits in other tools with frustrating results -- after a LOT of work!)

We have about a 50/50 Roth/TIRA split in our portfolio, so my strategy has been to prioritize Roth to pay expenses and keep ACA MAGI down, while using conversions to hit the various FPL limits. In my base scenario, without conversions, I actually don't qualify for ACA since MAGI is below 138 FPL -- another insight that I haven't seen in any other tool.

My question is, how do I know when to stop converting? I'm using Bill Hines' book as a guide and as he says, you don't want to go crazy with conversions so you can still pay long-term care costs with pre-tax money. (Though we also have a fully funded HSA for this purpose, too.)

But my other concern is not wanting to hit my wife, who is eights years younger, with a big widow tax at the end.

What is the best way to use the tool to see when I've converted enough to avoid that?

I will run through some things I do with regards to Roth Conversions.

First, under Build-Management-Effective Tax Rate, set a tax rate to apply to any residual left in the TIRA. If you have heirs you care about, that should be the expected tax bracket they will be in when they have to empty your TIRA in the 10 year span they get. If you intend to give the residual to charity, then the number can be zero. Alternatively, if you do not have heirs you care about and have no particular charitable intentions, then you should be targeting spending all your money by age 100 or so. The only leftover would be due to dying sooner, not for lack of trying to spend it. The Analyze-Spending Strategies-Consumption Smoothing or ABW are the withdrawal strategies those folks use.

Next, I minimize the need for Roth Conversions by preferentially putting bonds/CDs in the TIRA. That will slow the TIRA growth and is the tax efficient way to hold assets as then the taxation of the investment returns (bonds dividends are ordinary income) are taxed the same as the account. That maximizes space in taxable/Roth space for your stocks, where the growth is taxed at lower rates. In Pralana, you select Advanced Portfolio Modeling and then select Mode 2. Mode 2 keeps your overall portfolio allocation constant while allowing you to preferentially hold your bonds in tax deferred. You select the order of which account should have the most stocks - I select taxable, then Roth, then tax deferred. I tell the program that taxable and Roth should be 100% stocks and tax deferred 100% bonds and let the program figure out what allocation each account should have based on my overall priorities.

If you want to test whether getting ACA subsidies beats doing Roth Conversions, then after you've run the Roth Optimizer, you can manually test by entering an FPL limit that is just above what your ACA MAGI is (ACA MAGI adds back in tax free interest and the non-taxable portion of SS). Note that if you reduce conversions in the early years, you have to increase them in later years to catch back up.

After running the Roth Optimizer, I also check for places where the optimizer is paying an IRMAA surcharge - there are a couple of places where the tax bracket jumps up in the middle of the IRMAA tier, so you may not want to fill that bracket. The Optimizer will chase any positive return, but what I find is there is a broad, flattish zone where you can do lots of conversions for very little improvment. My non-scientific rule of thumb is that if the conversion doesn't improve the final estate value by 10% of the converted amount, I don't do it.

I also use the Analysis - Historical Analysis to tune my assumed rate of return. I shoot for about the 20-30th percentile (meaning 70-80% of historical outcomes were better). The reason is that the top 30% or so of market results all occurred following severe bear markets. That ain't us, so I exclude those exceptional return periods from my thinking. It's important to be at least somewhat conservative as Roth Conversions can lose you money if the market does really poorly. To prove that to yourself and see why I like to be a little conservative with conversions, click the "Activate Historical Sequence" button near the top of the Historical Analysis page and select 1965 as the starting point. The program then shows you the gut wrenching year by year results of what you would have gone through then. Then look at your final portfolio value with Roth Conversions Enabled and then again with them Disabled.

The question about long term care is difficult. Most people don't actually use much, if any, long term care, but it's very expensive so. you need to plan for it. You can test the potential benefit by entering a long term care expense, inflation rate and year to start under Build-Expenses - Long Term Care. Then test extra TIRA withdrawals in those years the Build-Financial Assets -Scheduled Withdrawal Table. In general, it looked like I would want to ensure that I withdraw enough to use up the medical deduction.

I also do cases where I look at what would happen if I passed early. No doubt the wife would be in a higher tax bracket and grateful for any conversions that had already been done, but it's hard to know what to do with that, statistically, men and women have only a couple years difference in life expectancy, so other than existing age and health differences between you, it's hard to know how many years of widowhood to test.

@ricke Thank you so much for this roadmap, you've given me plenty to think about and put into practice here. I'll circle back once I've had time to implement this.

One quick question in the meantime, which is the ABW spending strategy? Is that the same as Actuarial?

I'll just add a tip that the PlanVision tax guru shared with me for early retirees. (PlanVision is for-fee advisory service for DIY types.) The advice is to go year-by-year prioritizing either Roth Conversions or ACA subsidies. It's not very feasible to balance in a single year. I have an age difference with my spouse, so while we're both on ACA, we might prioritize that. When the first reaches Medicare age, that subsidy for 1 might look less attractive. I can model approaches like this in Pralana and compare it to something more aggressive in Roth Conversions. I will also add, that the more conservative your plan, the less attractive Roth Conversions look. So they are subject to the "fatal flaw" of all planning software... the assumptions you enter dramatically alter the results. I tend to ensure doom and gloom (but not total apocalypse) works OK, and then anything beyond that is gravy for my charitable beneficiaries.

@solowriter

Yes, ABW is Actuarial Based Withdrawal.

@jlee Good point, I was actually wondering about the cumulative totals of ACA vs Roth over time.

We have the same situation regarding age difference, which means we effectively would be on ACA for 18 years until we're both on Medicare. In one scenario, it is telling me that I would receive about $440k in subsidies, which is about the same amount I'd save in taxes from Roth over the same period. I'd love to get both, but I'm not sure I trust the math.

Banking on the cumulative totals makes a lot of assumptions I'm not sure I'm comfortable making, including tax rates and ACA subsidies (even beyond 2025 sunsets) remaining where they are over time.