Another Roth Question

[ERD50]

Originally Posted by Nords

I think a Roth conversion is too complex a multi-variable problem to be treated with phrases like "time has nothing to do with it" and "it's a wash".

Nords, that is true, my simple spreadsheet was not accounting for the tax you would be paying on the growth of the money that would be used to pay the taxes on the conversion (an opportunity cost). So, taking that into account, there is less lost opportunity to subtract from the final Roth total, so it makes the Roth look a bit better when you convert the full amount and pay the taxees outside that account.

- however...

At 15% tax rates, this is really small. For simplicity, I assumed the gains on the money outside the account would be taxed at the same 15%, all at the end (no distribution/dividends). After 30 years, the Roth looks 2.19% better; 0.072% as an annual rate. If those cap gains got a favorable treatment at the 15% marginal tax rate, or there were taxes to be paid along the way, it would look a bit better.

So no, looking at it with the taxes paid outside the conversion it is not a wash, but it is really close. The real benefit is a hedge against future higher marginal tax rates.

Bottom line (IMO) convert to Roth, as long as you feel reasonably certain that your future tax rates will be higher than the rate at which you convert. If they are the same, nothing lost, maybe a little gained if you pay the taxes outside the account.

-ERD50

[FIRE'd@51]

Originally Posted by Peter

One other factor to consider is that capital gains inside a traditional IRA will be taxed as regular income when they are withdrawn. Roth withdrawals are, of course, tax free. So even if tax rates remained the same, there could be an advantage in doing the conversion, if some or all of the assets are likely to show significant capital gains.

This is incorrect with regard to a conversion. It is true for a Roth contribution. Once inside either IRA the money compounds tax-free. As ERD50 has pointed out, the laws of multiplication are commutative, i.e. A x B = B x A

Let

P = the current amount in your traditional IRA

t = tax rate (assumed constant)

R = rate of return on IRA investments (the same in Traditional or Roth)

N = number of years

Case 1 - Leave money in traditional IRA and pay taxes upon withdrawal

Money after tax at withdrawal = P x (1+R)^N x (1-t)

Case 2 - Convert to Roth

Money after tax at withdrawal = [P x (1-t)] x (1+R)^N = same as Case 1

The real problem, as Nords points out, comes with the RMD's associated with the Traditional IRA and how they interact with your other income

[yakers]

Originally Posted by ERD50

Bottom line (IMO) convert to Roth, as long as you feel reasonably certain that your future tax rates will be higher than the rate at which you convert. If they are the same, nothing lost, maybe a little gained if you pay the taxes outside the account.

-ERD50

One other point I consider is it is good to tax diversify; have taxable, tax deferred and tax free funds so I can draw from whatever source works best at the time both tax wise and also from an estate planning point of view.

[ERD50]

Originally Posted by yakers

One other point I consider is it is good to tax diversify; have taxable, tax deferred and tax free funds so I can draw from whatever source works best at the time both tax wise and also from an estate planning point of view.

yakers, that is a good point also - that flexibility might help us in the future if we could benefit by lowering our taxable income in one year vs another.

FIRED'@51 did the math, I'll do an example for the math-o-phobics. When you do a Roth conversion and pay the taxes from the converted amount, time really does have nothing to do with it, it *is* a wash.

Example:

Assume same tax rate at start and end; 25% in this case - could be anything. I used a growth of 10x, could be anything.

A) $10,000 in Trad IRA. Grows 10 times to $100,000 over time. 25% to taxes, you have $75,000 in your pocket.

B) $10,000 converted from Trad IRA to Roth. 25% goes to taxes leaving $7,500 in Roth. Grows 10 times to $75,000 over the same time period. Zero to taxes, you have $75,000 in your pocket.

As stated above, paying the taxes outside and getting the full $10,000 into the Roth has advantages. Slightly higher return overall, and more flexibility with more in the Roth. That is what I am doing.

-ERD50

[teejayevans]

Originally Posted by ERD50

B) $10,000 converted from Trad IRA to Roth. 25% goes to taxes leaving $7,500 in Roth. Grows 10 times to $75,000 over the same time period. Zero to taxes

IIRC, its generally recommended to pay the taxes from funds outside the IRA, there by
maximizing you growth of tax-free money.

As previously stated, and I agree 110%, forgetting the math, it's best to be tax diverse.
Tom

[Gearhead Jim]

Originally Posted by REWahoo!

...
You will see some concerns about the possibility of changes in the tax laws which could cause your ROTH to be taxed twice, but I'm of the opinion the risk of that is reasonably small.
...

Most people, when they talk about future tax changes, speculate about various ways that taxes will likely rise; but i haven't heard anyone talking about double taxation of Roths. Can you elaborate?
Thanks.

[jdw_fire]

Originally Posted by Gearhead Jim

Most people, when they talk about future tax changes, speculate about various ways that taxes will likely rise; but i haven't heard anyone talking about double taxation of Roths. Can you elaborate?
Thanks.

The talk of double taxation of a Roth comes from speculation that in the future the US tax code will be changed so that you are taxed on WDs from Roth IRAs.

[Gearhead Jim]

Wow, that would really be a low blow. I didn't think that even Congress could be that foul, but I've been wrong before.

[uncledrz]

Originally Posted by chinaco

Has anyone identified any good papers on Roth IRA strategies? I am interested in learning more about conversions from Trad IRA and 401ks to Roth with an eye on reduced taxes.

try the fairmark site
http://fairmark.com/rothira/decide.htm

Tio z

[teejayevans]

Originally Posted by Gearhead Jim

Wow, that would really be a low blow. I didn't think that even Congress could be that foul, but I've been wrong before.

I doubt it, can anyone name an instance where the rules were change and existing
investments were not grandfathered in?

Most likely is will be in the form of a catch-all tax like AMT will indirectly tax your roth
income. And there will be plenty of warning, so you will see a massive pull out of roths
if this should ever occur.
Tom

[FIRE'd@51]

Originally Posted by teejayevans

I doubt it, can anyone name an instance where the rules were change and existing
investments were not grandfathered in?

Yep, in 1993 Clinton raised the amount of SS benefits subject to taxation from 50% to 85%, depending upon your income. No one was grandfathered out. Remember, you pay SS taxes with after-tax dollars too.

Originally Posted by teejayevans

Most likely is will be in the form of a catch-all tax like AMT will indirectly tax your roth
income.

I agree it would be more likely to be done this way, but the results could be just as onerous.