Roth Conversions - Much Ado About Little?

[GrayHare]

Quote:

Originally Posted by Animorph So a wash for immediate after-tax net worth, $172 either way. But now you have the $15 after-tax value you moved from the tIRA to the Roth, and you have "moved" $5 of your taxable account into your tax-free Roth account. The benefit is that you avoid all taxes on that $5 in the future, capital gains or dividends or interest. But you only see that over time.

It's mathematically commutative: in your example your after-tax NW remains the same with or without conversion to Roth no matter how much time passes.

[rayvt]

Quote:

Originally Posted by GrayHare It's mathematically commutative: in your example your after-tax NW remains the same with or without conversion to Roth no matter how much time passes.

Correct.

What this really is, is a way of putting more money into a Roth than you could otherwise. As was pointed out above, $10K in a regular IRA is only 85% yours (depending on your tax bracket), so it's only $8500, but $10K in a Roth is 100% yours.

I *think* that with the commutativeness, it all cancels out -- but it's very confusing.

Financially, in your working years the financially best thing to do is put your money into a taxable S&P500 fund, rather than an IRA or a Roth.
One way or another, you pay ordinary income tax on IRA/Roth money, but only LTCG on taxable S&P500 money.

But this ONLY works if you keep your grubby hands off the S&P fund and buy-and-hold until you retire. That's the hard part for most people. Due to mental accounting, people generally won't touch the IRA/Roth until retirement, but in their mind the S&P fund isn't "retirement fund" so it'll get spent on car/house/boat/RV somewhere before they retire.

The other main reason for doing Roth conversion is to reduce the IRA balance so that you aren't forced to take a larger RMD than you want. Taxwise, as you say, there is no difference overall between IRA and Roth.

[gofan316]

Roth conversion will also impact ACA subsidy, if you intend to use it. For example if your AGI is 45k, and you fill up 17K with Roth conversion, to the ACA cliff $62k, your annual silver plan cost will be 62000*9.56%=$5927; without Roth, the same plan will cost $4200 for the original 45k income.

That will be additional 10% "tax rate" there: (5900-4200)/17000

Not sure if the ORP calculator takes that into considerations.

[Chuckanut]

Quote:

Originally Posted by gofan316 Roth conversion will also impact ACA subsidy, if you intend to use it. For example if your AGI is 45k, and you fill up 17K with Roth conversion, to the ACA cliff $62k, your annual silver plan cost will be 62000*9.56%=$5927; without Roth, the same plan will cost $4200 for the original 45k income. That will be additional 10% "tax rate" there: (5900-4200)/17000 Not sure if the ORP calculator takes that into considerations.

Good points. Of course, the Roth conversion may also prevent a similar thing from happening regarding the taxation of social security benefits when one hits the age of required distributions. A Roth conversion might save the day when those required distributions push a person into higher tax brackets where some advantages are lost.

It's confusing to say the least.

[kaneohe]

Quote:

Originally Posted by GrayHare It's mathematically commutative: in your example your after-tax NW remains the same with or without conversion to Roth no matter how much time passes.

I've only seen that "c" word used in connection w/ IRA contributions:
e.g. contribute 10K to TIRA (if you could) vs 7.5K to Roth (if you could).
This is for the 25% tax bracket. Then if each doubles
TIRA = 20 K but after 25% tax , after tax is worth 15K
Roth doubles and is worth 15K. same same as you say and the same thing
and calculations apply if you do the Roth conversion using TIRA funds to pay the tax (if you could w/o penalty such as being old).

The difference comes if you use outside funds to pay the tax so that the Roth
starts bigger.
TIRA= 10 K plus 2.5K side fund; if each doubles TIRA= 20K; side fund 5K-
After tax of 25%, TIRA=15K, side fund = 5K-- with total of 20K --
the -- is due to the tax drag during the compounding period and the CG tax
of the side fund upon sale.

Roth=10K with 0 in side fund since the 2.5K was used to pay the conversion.
Roth doubles like the TIRA did to 20K so the Roth is somewhat ahead by the
-- since no taxes were due. The longer time/larger gains will make the delta even larger. This is why the common advice is to pay the tax w/ outside funds (plus if
<59.5 y.o.,you avoid the early withdrawal penalty).

Now if you are in 15% bracket with 0% rate on QDIV/LTCG , the -- might
shrink to 0.

[Rothman]

Quote:

Originally Posted by Chuckanut Good points. Of course, the Roth conversion may also prevent a similar thing from happening regarding the taxation of social security benefits when one hits the age of required distributions. A Roth conversion might save the day when those required distributions push a person into higher tax brackets where some advantages.

I think Chuckanut is on to something, a Roth conversion might save the day.....

Mr. Taxman never hangs around,
When he hears this Mighty sound,

Here I come to save the day!
That means the Mighty Roth is on the way!

Yes sir, when there is a tax to make right,
Mighty Roth will join the fight!

Excess RMDs or higher future taxes in the land,
He's got the situation well in hand!

We know that when there's tax danger, we'll never despair;
Because we know that when there's tax danger he is there...
On RMDs, on higher brackets, in staying below ACA.

We're not worrying at all
We just listen for his call
"Here I come to save the day!"
That means that Mighty Roth is on the way.

When there is a tax to make right,
Mighty Roth will join the fight
"Here I come to save the day!"
That means that Mighty Roth is on the way!


I thought that was catchier than a post about commutative laws don't apply with non-linearities in the tax situation.


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[GTFan]

Quote:

Originally Posted by gofan316 Roth conversion will also impact ACA subsidy, if you intend to use it. For example if your AGI is 45k, and you fill up 17K with Roth conversion, to the ACA cliff $62k, your annual silver plan cost will be 62000*9.56%=$5927; without Roth, the same plan will cost $4200 for the original 45k income. That will be additional 10% "tax rate" there: (5900-4200)/17000 Not sure if the ORP calculator takes that into considerations.

Exactly, and since we are trying to limit income from WDs etc. to stay below 250% of FPL (to maximize the Silver cost-sharing benefits) I won't be doing Roth conversions. It's a much better subsidy at those levels that you're forgoing if you go past 250% (around $39k income for a family of 2). We're actually going to try to stay below 200% FPL if we can because the Silvers are way better at those levels, both for subsidies and cost-sharing.

http://www.healthpocket.com/obamacar...on-silver-plan

Add that to the lost investment growth of converted Roth money (i.e. the money lost to taxes and foregone subsidies) and it's really a wash at best in these scenarios IMO.