I was doing some thinking today (a dangerous activity).

I was marveling at the amount of income that can be realized tax-free, a-la Go-Curry-Cracker.

It is well known that investments (long term capital gains (LTCG) + dividends) are taxed preferentially: https://www.nerdwallet.com/blog/taxes/capital-gains-tax-rates/

So let’s go through a few scenarios here given 2019 tax parameters after accounting for the $2k child tax credit for any child <= 16 years old.

- Married w/ no kids:
- $24.4k of tax-free Roth conversions (up to std deduction)
- + $78,750 of LTCG
- = $103,150 of tax-free income.

- Married w/ 1 small child:
- $24.4k of tax-free Roth conversions (up to std deduction)
- + $92,083 of LTCG =($78,750 + $2k/0.15, since the tax rate on LTCG in excess of $78,750 is 15%)
- = $116,483 of tax-free income.

- Married w/ 2 small children:
- $24.4k of tax-free Roth conversions (up to std deduction)
- + $105,417 of LTCG =($78,750 + $4k/0.15, since the tax rate on LTCG in excess of $78,750 is 15%)
- = $129,817 of tax-free income.

- Married w/ 3 small children:
- $24.4k of tax-free Roth conversions (up to std deduction)
- + $118,750 of LTCG =($78,750 + $6k/0.15, since the tax rate on LTCG in excess of $78,750 is 15%)
- = $143,150 of tax-free income.

- Married w/ 4 small children:
- $24.4k of tax-free Roth conversions (up to std deduction)
- + $132,083 of LTCG =($78,750 + $8k/0.15, since the tax rate on LTCG in excess of $78,750 is 15%)
- = $156,483 of tax-free income.

- Married w/ 5 small children:
- $24.4k of tax-free Roth conversions (up to std deduction)
- + $145,417 of LTCG =($78,750 + $10k/0.15, since the tax rate on LTCG in excess of $78,750 is 15%)
- = $169,817 of tax-free income.

You can validate any of the above scenarios using TaxAct’s recently updated (for 2019) tax estimator tool: https://www.taxact.com/tools/tax-calculator.

I’m not claiming to have uncovered anything new here; I am just calculating explicitly what Jeremy at GCC has been doing for a decade now using updated 2019 parameters.

The above thought experiment has reiterated to me that my taxable account should easily be viewed as a tax-exempt account, albeit one with an annoying dividend tax drag of 0.44% until retirement (=2% dividend yield on VTSAX * (15% federal tax on dividends + 7% state tax on dividends)). Thanks to future tax-free Roth conversions, my pre-tax accounts (totaling $455k) can likewise be considered to be tax-exempt accounts. At $24.4k/year (which will admittedly grow slowly over time), that’s 19 years of tax-free conversions, ignoring any interest growth.

Given the above, our entire balance sheet is essentially tax-exempt. Woot. You need a lot less to live on when >30% of each dollar is not siphoned off to taxes.

If the above hasn’t swayed you on the merits of strategically optimizing your lifetime tax burden, I don’t know what will. Check out this post for more inspiration: https://www.gocurrycracker.com/never-pay-taxes-again/

For the scenario with 5 kids, if I didn’t have any LTCG to realize, here’s what it looks like:

- Married w/ 5 small children:
- $107,504 Roth conversion
- – $24,400 standard deduction
- =$83,104 taxable income
- Taxes owed:
- 10%*($19,400)
- + 12%*($78,950-$19,400)
- + 22%*($83,104-$78,950)
- =$10,000 federal tax liability pre CTC
- – $2k child tax credit * 5
- = $0 federal tax liability post CTC

$107,504 of tax-free Roth conversions is less impressive than the headline figure of $169,817 because the $169,817 fully exploits the 0% taxation on LTCG for $78,750 and 15% taxation on anything in excess, whereas the Roth conversion approach begins to accrue pre-CTC tax liability for any conversion in excess of $24.4k.

What a bizarre tax system we have, eh?

Good post and it helps to see actual numbers.

Would you sacrifice trad to Roth conversions in favor of keeping income low and getting ACA subsidies?

Also, think you have a type on the Married w/ 4 small children tax-free income amount.

Thanks for catching the typo! It’s fixed now.

I haven’t studied ACA subsidies very well, but I know that if you are $1 above 400% FPL, you can lose something like $18k of subsidies. The implicit tax rate on that $1 of income is therefore 18,000,000%.

If I were taking advantage of ACA subsidies, I’d certainly avoid that $1 of excess income in which you face a 18,000,000% tax rate and a $18k penalty.

Are you facing this same Roth Conversion vs ACA subsidy decision yourself?

Since I’m married with 5 kids, FPL is $39,010. 400% of FPL is therefore $156,040. The $107,504 Roth conversion discussed at the end of the post would therefore not push me over the ACA subsidy cliff. The 169,817 of Roth Conversions + LTCG, however, would. If I were to implement this strategy, I’d realize only enough LTCG to keep me below the 400% FPL cutoff.

As commented in a previous post, you can do much better than $0 taxes by keeping your refundable Child Tax Credit, EITC, and the kids’ eligibility for CHIP. The additional Roth conversion or realizing capital gains will blow all those away. Within 400% FPL, doing Roth conversion or realizing capital gains will still reduce your refundable premium tax credit. The actual ceiling for true “no cost” Roth conversion or capital gains harvesting is much lower.

Thanks for stopping by! Great feedback!

The problem I attempted to solve in this post was, if one wanted to pay $0 in federal taxes, how much income could they earn (ans what types of income could they earn) as a function of family size.

I agree that it gets much more complex of a problem to solve when (appropriately) recognizing the fact that you could get refundable tax credits, so you can do much better than owing $0. My 7 years in grad school are a testament to that fact.

The problem with optimizing on this dimension in retirement, as I understand it, is that to get the EITC or CTC (as I understand it) the income has to be earned. Therefore, neither Roth conversions or LTCG, which constitute one’s primary source of income in early retirement, would help a household get a refundable tax credit.

Despite my relatively reasonable understanding of the US tax code, I only have begun to understand recently the complexities of the updated CTC (which frankly acts much more like the EITC than I had realized prior to MDM’s correcting my spreadsheet mistakes).

I agree that CHIP / Medicaid / food stamps / Section 8 housing subsidies would add further complexity to the optimal decision, which I admittedly don’t attempt to tackle in this post.

Not only will LTCG not *help* you qualify for EITC, having even $3,600 or more in investment income of *any* type (including realized long or short term gains, dividends whether qualified or not, interest whether tax-exempt or not, will totally disqualify you for EITC.

Agreed entirely!

Yes, I am facing the same decision for next year due to me leaving traditional employment at the end of this year.

Since I’m married with 2 kids (i.e. tax credits), 400% of FPL is $103K. Given this and the helpful info in your post, my 2020 strategy is to maximize ACA subsidies. Assuming my math is correct, we’ll save around $5K/year by not doing Roth conversions up to the $103K abyss.

Here is the breakdown:

~$30k of ordinary income. Will pay tax on $6K of income that is over the standard deduction ¯\_(ツ)_/¯

~$20K of LTCG to pay for expenses. (Cost basis in taxable account is low so LTCG is unfortunately high)

If I stop there, we’ll pay $1,100/year for a bronze plan in my state based on $50K income ($30K ordinary income + $20K LTCG).

If I take Roth Conversions of $53K up to the $103K ACA subsidy cliff, we’ll pay $6,724/year in bronze premiums but will have $53K of tax free investments in the future courtesy of Roth Conversion (if we make income above $156K). We are probably never going to make over $156K again so the tax free investments don’t come into play?

I think the way of succinctly summarizing your problem is this. What is the marginal tax rate on the $53k of Roth conversions?

Marginal tax rate = (difference in premiums + difference in taxes) / amount converted.

Marginal tax rate = ((6724-1100) + 10%*(19400-6000 since you’ve already earned 6k more than standard deduction) + 12%*(53000-(19400-6000))) / 53000

Marginal tax rate = 22%.

At 22%, I wouldn’t convert the additional $53k to Roth.

If you ignore the incremental taxes, which you shouldn’t, and only consider the marginal cost of healthcare, it’d only cost you: (6724-1100)/5300 = 11%. At that rate, I’d convert. But again this is incorrect b/c it ignores the incremental tax effects.

To see why the full $103k isn’t tax-free, reread the part of the article following “if I didn’t have any LTCG to realize, here’s what it looks like”.

Does this change your thoughts on your “hierarchy of savings” (one of my favorite all-time blog posts!) at all? I’ve been considering using sheltering accounts to push my taxable income down to the 12% bracket, but then putting any additional savings within that into taxable. Does that seem like a good option, given the flexibility having a taxable account offers? Or would you continue to prioritize sheltering first?

Good question.

I think the point of this post is that a taxable account looks a lot like a Roth IRA, with the exception of the dividend-tax drag negatively influencing long-term returns in the taxable account.

In contrast, much of what I discuss on the blog is the optimal decision between Trad and Roth. I’m of the strong opinion that Trad is way better than Roth for most people who are still working.

I think that using Trad to get down to the 12% bracket, then putting any remaining savings into Roth (until full) or table (when Roth fills) is a great strategy. It’s the exact strategy I’d implement if I weren’t constrained by contribution limits.

I love these calculations, it reminds me of the “Free Money” posts (I think that was Millionaire Educator?). I’ve run different scenarios for our family (married with one small kid) and am curious how the reality will look in 2020 when we actually start selling investments.

I’m several years from implementing any of these strategies myself, but I think it’s great to be informed of the downstream tax implications that can influence optimal decision making today.

I’m confused. Is it 107k or 170k for five kids?

107k if you don’t have LTCG. 170k if you do.

Thanks. Reread the post again! Very informative

Frugalprofessor:

You don’t seem to have employment income?

Thanks

In these scenarios, I assumed one was retired (like go curry cracker). I’m currently employed, so the post was not intended to reflect my current situation. Just a hypothetical if I stopped working tomorrow.