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Old 01-06-2012, 10:20 AM   #21
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Interesting post. I am so far away from RMDs that I haven't given much thought to the economics of the alternatives once one is in RMDs. I agree a bit with LOL that the assumptions for the taxable account and the IRA should be different and you probably need to modify your analysis to reflect that likelihood. It seems that a full conversion is advantageous once you get to RMD age if you are in a high tax bracket, but probably less advantageous than your analysis suggests. I'll have to make a note to look at this for my Mom when I do her tax return this year.
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Old 01-07-2012, 11:14 PM   #22
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Join Date: Dec 2011
Posts: 21
Originally Posted by pb4uski View Post
Let's compare two extremes where you have 100 in an IRA today. Your tax rate now and later is 30% and you expect that you can invest and earn 5% annually.

In the first case you leave it in the IRA, let it grow at 5% for 10 years to 163. 163= 100* (1+5%)^10. Then you withdraw it and spend it. Assuming a 30% tax rate you would have 114 to spend. 114 = 163*(1-30%).

On the other extreme, you convert the entire amount today, pay the 30 of tax and invest 70 in a Roth IRA that earns 5%. In 10 years the 70 would grow to 114 and you could then spend the 114. 114 = 70 *(1=5%)^10

If the tax rate and rate of return are the same, it shouldn't make a difference.
Hi, thanks for the comment. (Somehow it showed up under my profile, rather than on the board, so I'm quoting it here.)

Your underlying math is, of course, correct but you are overlooking a key component of the strategy I propose, which makes all the difference to the ROTH's advantage.

Simply: You pay the taxes with OUTSIDE money, NOT with funds from the IRA. I really think this is a key point many overlook when evaluating the ROTH conversion options.

Therefore, in your formula above, instead of 70*(1+.05)^10, the correct formula would be 100*(1.05)^10.

Now of course you will immediately observe that we have to pay the taxes from SOMEWHERE. The mathematically fair way to compare an IRA vs ROTH is to have the same $100 IRA, but also have an assumed outside "tax payment fund" of say 30% of the IRA or $30. Now what happens, is that in the regular IRA, you don't prepay anything and you wait for RMDs. You use that tax payment fund to make the small annual tax payments on those RMDs. Meanwhile, of course, your remaining tax payment fund is growing each year. In the case of the ROTH conversion, the tax payment fund immediately goes to zero. However, the ROTH account remains full at $100, and can grow for as long as you can afford to live on outside assets. At a certain point, the tax free growth of 100% of the original value of the IRA will exceed the total sum of a)the tax-deferred growth of the IRA plus b)the remaining tax payment fund that has been growing.

So, one has to make assumptions for the growth of the ROTH, the growth of the IRA, the growth of the Tax Fund, the tax rate for a conversion, the tax rates for RMDs, the tax rate on the growth of the tax payment fund, etc. It gets complicated, but I've worked through it all, including working in higher tax rates for the upfront conversion vs lower bracket annual taxes on RMDs, etc. etc.

The end result is that even on a pretax basis, growing at 4% a year, the ROTH will equal the regular IRA+taxfund after 20 years. Now of course, at that point the ROTH would be available totally tax free, while the regular IRA would be subject to tax rates that could be very high if a large withdrawal was required in any one year. Also, the regular IRA would require those RMDs throughout the period, while the ROTH does not require RMDs either for the participant or for a spousal beneficiary.

After more like 13-16 years, depending on the growth assumptions, the "aftertax" value of the ROTH if withdrawn suddenly will exceed the "aftertax" value of the regular IRA+taxfund if also withdrawn.

In summary, my proposal for this kind of scenario is that IF you can live off outside assets for 15 years or so, EVEN AFTER paying the conversion tax on up front FROM OUTSIDE ASSETS, then the conversion will pay for itself after that 15 years, and moreover, if you are able to leave a bequest, the bequest delivered as a ROTH can lead to extraordinarily higher lifetime value for your beneficiaries if they optimize the stretch opportunities. Just as an illustration, on a current $5-$6MM portfolio, assuming parents never touch the IRA, the conversion will provide in excess of $1MM extra dollars to inheritors over their lifespans.

I'd be happy to share my spreadsheet with anybody who is interested in my process, if that is allowed on this forum. If so, perhaps moderators can educate me on the accepted method of sharing spreadsheet files.
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conversion, ira, roth, tax

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