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Re: Is this a good strategy
Old 04-05-2006, 07:38 PM   #21
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Re: Is this a good strategy

FYI, Here is a quote form the www.i-orp.com webpage that is in agreement with what I've found from my spreadsheets. Basically the only reason to do a rollover to a ROTH after ER, assuming your tax rate is a costant in retirement, is to give you more control over your funds and to avoid issues with large min distributions.

www.i-opr.com summarizes this like this:

"Analytically, there is little difference between a regular IRA and a Roth IRA, all other things being equal:

V = b(1+r^y) (1-t) is the distribution value of a regular IRA at year y, earning at rate r, starting with before-tax balance b and paying tax rate t.

R = (1-T)b(1+r^y) is the value of a Roth IRA at year y, earning at rate r, starting with before-tax balance b and paying tax rate T at the time of the contribution.

There are 3 cases:

If t = T then V = R and whole thing is a wash. This case occurs when the distribution tax rate (t) is the same as the pre retirement personal income tax rate (T).

If t < T then V > R the Tax-deferred Account provides more retirement funds than does the Roth IRA. This case occurs when income tax rate during retirement (t) is less than during the working years (T). This is the normal retirement situation.

If t > T then V<R and the Roth IRA is a better deal. This case occurs when the distribution tax rate (t) is larger than the tax rate before retirement (T). This is the situation for very young wage earners, graduate students, and the like. Roth IRA savings during this period in a persons working life can have a big payoff."
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Re: Is this a good strategy
Old 04-05-2006, 08:12 PM   #22
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Re: Is this a good strategy

Quote:
Originally Posted by nun
FYI, Here is a quote form the www.i-orp.com webpage that is in agreement with what I've found from my spreadsheets. Basically the only reason to do a rollover to a ROTH after ER, assuming your tax rate is a costant in retirement,* is to give you more control over your funds and to avoid issues with large min distributions.
Well, if someone can whip out a more complicated formula that agrees with our spreadsheets then we must be right.

Tax brackets are just one part of the issue. I think the "math" completely glosses over the issues of Social Security taxation and making an effective additional Roth contribution during the conversion by paying the taxes with funds outside of the IRA. The reason that i-orp.com doesn't bring them up is because it's darn hard to turn into a spreadsheet sound-bite.

That math doesn't even begin to consider the issues of starting a deductible traditional IRA in your teens & 20s (low-income years for most) and then converting it to a Roth before age 70½ ... for example after retirement but before drawing SS. It also doesn't offer any speculation on the direction of tax rates, which are arguably as low as they're gonna get for the next few deficitcades.

It's not a simple issue, and there are not simple answers.
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Re: Is this a good strategy
Old 04-05-2006, 09:04 PM   #23
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Re: Is this a good strategy

Quote:
Originally Posted by Nords
Well, if someone can whip out a more complicated formula that agrees with our spreadsheets then we must be right.

Tax brackets are just one part of the issue. I think the "math" completely glosses over the issues of Social Security taxation and making an effective additional Roth contribution during the conversion by paying the taxes with funds outside of the IRA. The reason that i-orp.com doesn't bring them up is because it's darn hard to turn into a spreadsheet sound-bite.

That math doesn't even begin to consider the issues of starting a deductible traditional IRA in your teens & 20s (low-income years for most) and then converting it to a Roth before age 70½ ... for example after retirement but before drawing SS. It also doesn't offer any speculation on the direction of tax rates, which are arguably as low as they're gonna get for the next few deficitcades.

It's not a simple issue, and there are not simple answers.
I agree that there is more to consider than the simple calcs as all the caveats and particular circumstances will change the results. One thing though if you pay the tax on the rollovers from other after tax funds the ROTH rollover does win if the tax rate is the same going in as coming out

As my situation will be that I'll drop from the net 25% tax to 15% tax bracket at ER I'll just do ROTH conversions that take me up to the 15% income limit and pay the tax from my after tax account. I should end up a bit ahead financially, but way ahead in financial flexibility by the time I'm 60.
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Re: Is this a good strategy
Old 04-05-2006, 10:16 PM   #24
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Re: Is this a good strategy

Nun,
I think your last post hits the nail on the head. The use of taxable funds to pay the tax on the Roth conversions, done up to the limits of your 15% bracket in ER, makes the Roth come out way ahead, especially when you factor in possible RMDs and the overall sense that we are unlikely to pay for baby boomers' retirements with lower taxes in the future!
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Re: Is this a good strategy
Old 04-06-2006, 01:11 AM   #25
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Re: Is this a good strategy

Nun and ERBob--
Paying the (15%) taxes with after-tax funds is equivalent to contributing an additional 15% (of the rollover amount) to your Roth IRA. So no wonder this scenario comes out ahead in the end! You're able to roll $100K (eventually) from your TIRA, which is subject to taxes upon withdrawal, directly into your Roth IRA, which is not subject to taxes. Really, though, what you have done is taken an after-tax $15K and indirectly add it to the Roth IRA to make up for the taxed portion.

I've been making RMD's from an IRA I inherited from my dad for the last several years. It's not so tough. You make a spreadsheet one time for the annual % withdrawal for the next XX years and then just paste in your year-end balance each January 1. Or have Vanguard/Fidelity calculate it for you. The difficult part for me is paying the 30+% tax on the RMD that I don't need anyway.
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Re: Is this a good strategy
Old 04-06-2006, 07:26 AM   #26
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Re: Is this a good strategy

Quote:
Originally Posted by scrinch
Nun and ERBob--
Paying the (15%) taxes with after-tax funds is equivalent to contributing an additional 15% (of the rollover amount) to your Roth IRA. So no wonder this scenario comes out ahead in the end! You're able to roll $100K (eventually) from your TIRA, which is subject to taxes upon withdrawal, directly into your Roth IRA, which is not subject to taxes. Really, though, what you have done is taken an after-tax $15K and indirectly add it to the Roth IRA to make up for the taxed portion.

I've been making RMD's from an IRA I inherited from my dad for the last several years. It's not so tough. You make a spreadsheet one time for the annual % withdrawal for the next XX years and then just paste in your year-end balance each January 1. Or have Vanguard/Fidelity calculate it for you. The difficult part for me is paying the 30+% tax on the RMD that I don't need anyway.
Thanks for the comments. When I have to pay a large tax bill I usually remind myself that I'm lucky to be making enough money to pay a big bill, it helps a bit ;-)

Given a 3% indexing of the 15% tax bracket level and my need to tap the IRA at 60, if I did no ROTH conversions I don't think my eventual IRA RMD and SS payments would push me over the 15% level.

The winning parts of the annual ROTH conversion are paying for it with after tax $$$ and keeping it at a level where you only have to pay 15% tax, if you're really frugal and have a few deductions maybe even 10%.

As an aside, as I'm going to be living in the UK I'll be able to exclude $80k per year of foreign income and get tax credits making my US income 0. So I should be able to convert an amount upto the full 15% level plus any standard US deductions each year. I'm still not sure if the ROTH conversion will be taxable in the UK, although I imagine I'll get a credit there for the 15% tax I pay in the US. This is where I really need a CPA
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Re: Is this a good strategy
Old 04-06-2006, 08:02 AM   #27
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Re: Is this a good strategy

Quote:
Originally Posted by scrinch
I've been making RMD's from an IRA I inherited from my dad for the last several years. It's not so tough.
Welcome to the board, scrinch.

I agree that many things are "not so hard", but RMDs are such a burden to my FIL that he's an ideal candidate for a Roth conversion just to simplify his life.

His traditional rollover IRA is a three-decade mishmash of employer contributions, employee before-tax contributions, employee after-tax contributions, and a lump-sum incentive to quit. His son is a CPA who has copies of the piles of paperwork needed to calculate the various bases on these different classes of money, but he's a guy who doesn't even have Excel on his computer. Even when he can read the spreadsheet, he can't follow through the RMD calculations without the discussion degenerating to a series of four-letter words about "those bahstids".

I suspect that there are a lot or RMD-required senior citizens who wish they didn't have to do this, no matter how hard it is or isn't.

Quote:
Originally Posted by scrinch
Or have Vanguard/Fidelity calculate it for you.
I wonder who pays the penalty if Vanguard/Fidelity come up with the wrong RMD...
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Re: Is this a good strategy
Old 04-06-2006, 09:49 AM   #28
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Re: Is this a good strategy

Quote:
Originally Posted by Nords
Welcome to the board, scrinch.


I wonder who pays the penalty if Vanguard/Fidelity come up with the wrong RMD...
Nords: Unless you have the bad luck of being the 1% or so each year that is subject to an audit, it would be a non-event. (Under-drawing your RMD).

Your RMD carriers do not send out anything to the IRS regarding what you are required to take out. Their only obligation to the IRS is to report what you have received.

Hell, odds are, your FIL could play "audit roulette" and let you guys sort it out later when you inherited it.

All in all, not a big deal at all.

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Re: Is this a good strategy
Old 04-06-2006, 10:41 AM   #29
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Re: Is this a good strategy

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Hell, odds are, your FIL could play "audit roulette" and let you guys sort it out later when you inherited it.
He probably is!

If he hasn't already disinherited us in favor of his much-more-spoiledfavored granddaughter, we should ask him to put a disclaimer clause in his will so that we can ensure that it becomes her problem...
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Re: Is this a good strategy
Old 04-06-2006, 05:45 PM   #30
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Re: Is this a good strategy

One other point on Roths -- may not apply to everybody but if you are in a position where you may never actually need to draw down your principal (ie you can let your Norwegian Widow strategy crank out divvies and interest for you year after year) then you could plan to die with your IRA intact, if it is a Roth, and never have to pay the taxes in your lifetime. Being forced into any withdrawal scenario in your IRA could be not only a pain, but unecessary. Again, if you're going to need the IRA moneys for living expenses this isn't such an issue, but if you can leave them in place, Roth wins again.

Nords, good point on the inheritance -- people are living so long that it may become the norm to give funds to grandchildren and skip children, who could be in their 80s before the first generation dies.
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