Tax Planning with TurboTax What-If Worksheet: Roth Conversion

The tax season is over for most people but if you used TurboTax downloaded software, don’t uninstall it just yet.

I showed in previous posts some unwelcoming features in TurboTax that you may want to opt out of — underpayment penalty and estimated tax payment vouchers. Ironically, TurboTax downloaded software also has a very useful feature hidden deep inside. You have to know how to dig it out.

Project Taxes for Current Year

It’s called the What-If Worksheet. After you’re done with your previous year’s taxes, you use the What-If Worksheet to project your taxes for the current year. It also makes it easy to compare different scenarios.

The idea of the What-If Worksheet is that you can create alternative scenarios and see how your taxes will change.

What if you earn more income?

What if your income drops?

What if you take on a mortgage?

What if you sell some investments and realize capital gains?

What if you convert some IRA money to Roth AND you sell some investments with a capital loss?

The What-If Worksheet is only available in TurboTax downloaded software. It’s not in its online software. It’s another reason to use TurboTax downloaded software, not the online software. As far as I know, only TurboTax has it. H&R Block doesn’t have it. Neither does FreeTaxUSA.

Plan for Roth Conversion

I’ll show you how to plan for Roth conversion with this Work-If Worksheet in TurboTax by the same example I used in the previous post Roth Conversion with Social Security and Medicare IRMAA.

A retired couple, both age 66, Florida residents, married filing jointly with no dependents. They live on $60,000 of Social Security benefits, $20,000 of Traditional IRA withdrawals, $5,000 of interest income, and $10,000 of qualified dividends. They have no other income or deductions. Both of them enrolled in Medicare Part B and Part D.

TurboTax shows that this couple with $95,000 of income paid $2,018 in federal income tax. That’s only 2% of their income. They are interested in doing a Roth conversion next year to take advantage of their low tax rate.

Find What-If Worksheet

For some odd reasons, TurboTax doesn’t advertise this vastly useful What-If Worksheet. You’ll have to know that it exists and really look for it.

Click on Forms on the top right in TurboTax downloaded software and then click on the Open Form button.

This opens a pop-up window. Type “what” or “what-if” in the search box. Double-click on the “What-If Worksheet” in the search results to open it.

Create a Baseline

The What-If Worksheet has four columns. Column 1 is auto-populated with data from your tax return. Columns 2 to 4 are used for tax planning.

First, you create a baseline for the current year. Checking the box “Copy column 1 to column 2” under “Copy columns” copies your tax return for last year to Column 2. Checking the box “Check box to use XXXX tax rates” under Column 2 applies the current year’s tax brackets. You can give it a short name such as “Baseline.”

Change the numbers under Column 2 with what you already know will be different this year. For example, you know you will earn more interest because interest rates have gone up, you know you will have less in dividends because you sold some investments last year, your Social Security benefits will go up because of COLA, etc.

Column 2 is your best guess of your current year’s taxes before you take any deliberate actions.

Test Alternatives

After you create a good baseline for the current year, suppose you want to see how converting $20,000 from your Traditional IRA to Roth will affect your taxes.

Copy Column 2 to Column 3 by checking the box under “Copy columns.” Check the box to use the current year’s tax brackets again. Give it a short description such as “Convert $20k.”

Scroll down to the line for taxable IRA distribution and raise the number by $20,000 from the baseline in Column 2 to your alternative scenario in Column 3.

The What-If Worksheet shows this additional income will increase the taxable amount of the Social Security benefits for this couple in the example by $17,000. Together with the $20,000 Roth conversion, the AGI will increase by $37,000.

Scroll down further. The What-If Worksheet shows that converting $20,000 to Roth will increase the total tax from $2,138 in the baseline to $6,565. That’s a difference of $4,427, which translates into $4,427 / $20,000 = 22% average marginal tax rate on converting $20k.

Now you can decide whether paying a 22% tax to convert $20,000 is worth it. Do it if you think your future tax rate will be higher than 22%. Don’t do it if you think your future tax rate will be lower than 22%.

If you’d like to test another alternative, such as converting $50k, repeat the above to copy the baseline in Column 2 to Column 4 and increase the IRA withdrawal by $50k in Column 4. Calculate the difference in total tax and the average marginal tax rate when you convert $50k.

Case Study Spreadsheet

The Case Study Spreadsheet in the previous post shows the same effect for converting $20k in this same example.

The chart from the Case Study Spreadsheet shows that increasing the IRA withdrawal from $20k to $40k produces a 22% marginal tax rate. It also shows that this same marginal tax rate continues before hitting a spike when the IRA withdrawal reaches $45k (converting $25k to Roth on top of a $20k withdrawal).

The What-If Worksheet in TurboTax doesn’t show the marginal tax rate directly. You have to calculate it yourself by dividing the difference in total tax by the conversion amount. Nor does it show the marginal tax rate for different conversion amounts in a chart. You don’t know where it may hit a spike. You’d have to do trial-and-error with different inputs: $20k is OK, what about $30k; $50k is too high, what about $40k, …

It also only shows the difference in federal income tax. It doesn’t include the effect on state income tax or Medicare IRMAA. The Case Study Worksheet includes both the state income tax and Medicare IRMAA.

The What-If Worksheet in TurboTax is easier to use though. TurboTax already has your tax data. You don’t have to find the right places to enter them in a spreadsheet. You don’t need to learn how to use a spreadsheet if that sounds intimidating.

Professional Software

I’ve heard great praise for a professional tax planning software called Holistiplan. Many financial advisors use it to do tax planning for their clients. I watched a demo of Holistiplan on YouTube:

Holistiplan uses the same technique as the What-If Worksheet in TurboTax.

• Copy data from the tax return for the previous year to the current year.
• Make known changes to create a baseline.
• Copy the baseline to an alternative scenario.
• Make changes to the alternative scenario and compare it with the baseline.

It also produces a chart of the marginal tax rate similar to the Case Study Spreadsheet.

If you go to a financial advisor for this type of planning, it may cost you $1,000 or more. After you use TurboTax downloaded software to file your taxes, you already have the What-If Worksheet in TurboTax for tax planning estimates. It doesn’t show a chart or include the effect on state tax or Medicare IRMAA but it gets you 80% there. Use the Case Study Spreadsheet if you want to get close to 100%.