Isn't comparing the difference on an after-tax basis, the only fair way to compare? Even if you are only considering your lifetime, in order to use funds from the TIRA, you have to pay taxes when you withdraw.
401k's, IRA's and RMD's - tax consequences
- Thread starter Ronstar
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Isn't comparing the difference on an after-tax basis, the only fair way to compare? Even if you are only considering your lifetime, in order to use funds from the TIRA, you have to pay taxes when you withdraw.
My model fully comprehends all taxes due during my lifetime, including withdrawals/RMDs from tax-deferred accounts. I do not "accrue" future taxes due after my death, except when my objective is to evaluate Roth conversions as part of a legacy planning strategy. And as I said before, that is a distant secondary objective for us at this early point in retirement.
I'm interested in getting Cobra's take on this issue, since it's far from clear that he's using the right metric to measure the benefit of early Roth conversions, even if restricted just to his own lifetime, but my take is that it's considerably more complicated than just saying "he's doing it right" or "he's doing it wrong". On the one hand, although his spreadsheet appears to be doing the calculations correctly, it seems clear that his methodology is quite suspect. It seems to share with the I-ORP calculator a tendency to produce long term asset allocation shifts as a result of the Roth conversions that bias the result either for or against Roth conversions. I also agree with your point that, with the assumptions he's making, the money remaining in the tax deferred account does him practically no good at all - he can't withdraw it without triggering rather punitive taxes. Contrast this with what is probably hundreds of thousands of dollars in the Roth IRA that would be available to him with a few clicks of a mouse, and with no tax consquences whatsoever. He's definitely sacrificing a lot of "robustness" in his future choices in order to get the numbers to work for him.
On the other hand, it's just not that clear. Even though we don't have a better estimate than a 25% tax rate on RMDs, it strikes me as quite laughable to try to predict with any accuracy the actual taxes that a 53 year old like Cobra will actually pay on his RMDs a couple of decades from now. It all depends on future changes in the tax law, the exact amount of his other income, and whether he can figure out a way to make some of the RMDs tax deductible. It's defintely within the range of possibilities that his RMD tax rate might be lower than 25%, perhaps much lower. And in any case, Cobra and I both agree that he personally won't see the rewards of early Roth conversions in his balance sheet until he is in his eighties. That's a long time to wait for a bet on early Roth conversions to pay off.
In this analysis are you comparing the raw data....i.e. TIRA valued at face value(untaxed) and Roth also at face value (taxed already)? If true and if you were planning on donating all the TIRAs to charity, that might be a fair thing to do but otherwise, it kind of feels lilke apples vs oranges?
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Yes, that's correct. For each year in retirement, I calculated total portfolio value as the sum of Roth IRA + tax deferred + taxable after paying taxes due that year, but without regard to future tax liability. I agree that it has a vague sense of comparing apples to oranges, but it's hardly a radical way to assess one's net worth at any given point in time. I bet the people who just add up the raw numbers greatly outnumber the ones who make adjustments for future tax liability.
Agreed...................including me!
I was just trying to understand because, at least for me, the focus was on Roth conversions and I was trying to understand yours and Cobra's obviously very detailed analyses. Thanks for clarifying.
The only kind of Roth analysis I like is the very simple-minded one of
1) Take 10K TIRA and 2.5K in taxable. Leave it alone and in N yrs it is a 100K TIRA and perhaps 25K taxable (or a bit less).
2) Take 10K TIRA and 2.5K in taxable. Convert it at e.g. 25% using taxable funds leaving you with 10K Roth. In N yrs it is a 100K Roth.
The raw numbers have guy w/ TIRA with 125K and the Roth guy with 100K.
But TIRA guy owes 25K if he cashes out with some tax on taxable account
(3.4K) so Roth guy is a bit ahead if tax rates stay the same.
I might be mistaken but I thought you guys were converting at 15% and taking RMDS at 25% or greater so couldn't understand how TIRA could be ahead unless you were comparing pre-tax data so again, thanks for clarifying. Give you guys credit for having the energy to do all those detailed RMD year by year analyses. I get tired thinking about it.
Yeah, your understanding was correct. All of my Roth conversions assumed a 15% tax bracket and all of my RMDs assumed a 25% tax bracket. Cobra's calculations may have had some of the RMDs taxed at 15% because he included more detail, including using a variety of inflation rates that appear to have had a big impact on the numbers. With my assumptions, it's always beneficial to make the Roth conversions, but whether the benefit is enjoyed by the retiree or by the retiree's heirs depends on how long the retiree lives.
I've always been numbers oriented, so doing the calculations didn't bother me at all. Normally I would have been too lazy to actually set up a spread sheet, but with this thread things were different. I had I-ORP trying to convince me that early Roth conversions were a must, even at a 28% tax rate, whereas Cobra was saying his numbers said Roth conversions would never benefit him at all, even if done at 15%. Although I was aware of the immense complexity of the issue, these results were hard to reconcile, so I decided to model my own situation and see what the numbers said. Assuming there are no major undetected errors in my calculations, my spreadsheet is telling me to Roth convert as much as I can at 15%, but that any conversions at 25% can either wait until later or not happen at all.
Perhaps the key words here are "in his balance sheet"? Seems like you might not be ahead, but you wouldn't be behind either immediately after the conversion if you choose the after-tax metric instead of the balance sheet one.
Ex: have 10K TIRA and 2.5K in taxable.
1) Leave alone and have 10K TIRA and 2.5K in taxable.
2) Convert , paying 2.5K in taxes from taxable and have 10K Roth.
Next day , need funds
1) Must pay 2.5K taxes on TIRA if at 25% tax rate so have 10K left.
2)No taxes due on Roth so have 10K..........same as TIRA after-tax.
Note: some little details ignored such as pre-59.5 early w/d penalty on TIRA, 5 yr or age 59.5 clocks on Roth conversion so might in practice have to wait a bit longer but nowhere near age 84.
My metric is ending portfolio value at death, exact same as described by you in post #80. As I said before, the model includes all taxes due during my lifetime. The baseline model and metric do not include "accrued" taxes due after my death, except when evaluating legacy planning objectives. I've also stated that legacy planning is a distant secondary objective. Our main objective is to maximize amounts available to spend during our lifetime, after tax. Given that objective, I believe this is the appropriate metric for evaluating Roth conversions. But I am certainly open to alternative suggestions if someone can explain why it would be more appropriate.
I am not concerned with minimizing lifetime taxes if the result is a lower ending portfolio value. While I am certainly not looking forward to the tax hit at age 70, my model indicates that the portfolio growth enabled by NOT paying tax on Roth conversions at this early age, exceeds the tax hit due to larger RMDs from age 70 through death. It would appear that you and I are aligned on that conclusion, provided we use the same growth rate assumption in our models.
I need to think more about the rest of your post and respond later.
In my case, all conversions were taxed at 15%. I did some what-if's into the 25% bracket, but the preliminary results were not good at all. After age 70.5, I fall into the 25% bracket under both scenarios (do-nothing or convert). But, as karluk indicated, not all of the RMDs are fully taxed at 25%. Under the conversion scenario, a lower portion of RMDs fall into the 25% bracket. But, the differential RMD between the two scenarios is always taxed at 25%.
Each person's situation will be different and no one can know precisely what the tax code may look like 20-40 years from now. But, if you are evaluating conversions, I still think it is imperative to model future long-term taxes as realistically as possible to not bias the conclusion. It's quite easy to index brackets, std deductions, and exemptions with an assumed inflation rate, and get a fairly realistic picture of exactly how RMDs will be taxed.
Kaneohe, in scenarios where the "TIRA could be ahead," it is not just a function of the metric (i.e. "comparing pre-tax data"). Based on what you've posted, I think you may be under-estimating the portfolio growth impact from prepaying taxes early in retirement. Evaluating Roth conversions only from a differential tax perspective is a trap. I use a relatively conservative growth assumption of 5.4% in a stock-heavy taxable account. And the growth I enjoy on would-be conversion tax at 15% is greater than the 25% tax due to higher RMDs.
Cobra, your comment is sufficiently ambiguous that I hestitate to make a definitive judgment. But it's statements like this that lead me to believe that you are using faulty methodology in your Roth conversions. You seem to believe that you are somehow sacrificing long term growth by making investments in a Roth IRA instead of a taxable account. But it's not illegal to hold equities in a Roth, so you could easily duplicate the holdings that you expect to produce a 5.4% return within the Roth. You could easily find an asset mix that didn't sacrifice any long term growth at all, just make more of that growth tax free. In fact, almost all of the articles one reads about asset location call for holding the investments with the highest expected returns in a Roth. That's why my Roth IRA is heavily invested in stocks, while I hold primarily bonds and fixed income in my tax deferred account.
Karluk, I fully acknowledge that I can use the same AA in a Roth that I can in my taxable account. However, the growth impact I'm referring to (in my response to Kaneohe, and throughout this thread) is not the result of different AAs. It results from early payment of taxes on Roth conversions. Those funds, once paid, leave my accounts altogether and go into the US Treasury. At that point, they are obviously unavailable to grow in any account that I own... Roth, taxable, or otherwise.
If there is some fault in that thinking, please let me know.
Yes, that thinking is mistaken, or at the very least only makes a case against Roth conversions if there are other factors in play (which I fully admit there may be - this is not a simple issue, as I think we can all agree.)
Take the case of a 53 year old who wants to convert $10,000 tax deferred to a Roth IRA. In order to minimize his tax bill, he cashes in some taxable assets to pay the $1,500 taxes due. Let's assume that he can pay 0% capital gains on the taxable assets, so taking $1,500 from his taxable assets doesn't generate any additional taxes on top of the $1,500 tax due on the conversion. Also, in order to eliminate the drag of no longer having $1,500 earning 5.4% per year, he decides to split the Roth IRA into a $1,500 investment earning 5.4% per year and an $8,500 investment earning 4.4%. How does doing this compare with leaving his tax deferred and taxable accounts untouched until the tax deferred money is withdrawn to pay an RMD at ages 80?
Case 1: Our retiree has skipped the Roth conversion and has $1,500 compounding @5.4% in a taxable account and $10,000 taxed deferred compounding @4.4%. Over the course of 27 years to age 80, the taxable account grows to $6,205, and the taxed deferred account grows to $31,982. After paying 25% tax on the RMD, the retiree has $23,986 from the RMD plus $6,205 already in the taxable account for a total of $30,191. In addition, $4,705 of the $6,205 in the taxable account would be subject to long term capital gains, if it is needed for any reason. That would incur additional taxes of $705, assuming a 15% LTCG tax rate.
Case 2: Our retiree has made the Roth conversion and has a Roth account consisting of two subaccounts - $1,500 @5.4% and $8,500 @4.4%. Over the course of 27 years, the 5.4% subaccount grows to $6,205 and the 4.4% subaccount grows to $27,185. At age 80, he has a total of $27,185 + $6,205 = $33,390. His net worth is about $3,200 higher than if he hadn't made the Roth conversion. In addition, the entire $33,390 is completely tax free if he needs the money, in contrast to Case 1, in which the retiree still has $4,705 in unrealized capital gains.
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A modified version of the simple version given earlier:
You have 10K in TIRA . Leave alone or convert using TIRA funds alone (usually not recommended)
1) 10K TIRA. Pay 25% taxes and have left 7.5K for a Roth conversion. Asssume in N yrs, Roth is 10x for value of 75K.
2) 10K TIRA left alone. In N yrs it is also 10x for value of 100K. However to use it you must take it out of TIRA and be taxed 25% leaving you with 75K , exactly the same as the Roth..............since before and after tax rates were the same.
In this case, you gave up your 25% early and thought the other way was better because you had more working for you. Some people call this Uncle's hand in your pocket..........even tho you thought you owned 100% of the TIRA, Uncle had 25% in his hand all along. Obviously if you had converted early at 15%, but taken RMDs from TIRA later at 25%, the advantage would swing to the Roth. So the model may be simple-minded ( I call it elegant), but the gross features , I believe, still show up.
As karluk noted, many and perhaps most folks do net worth statements using the raw data (uncorrected for tax). This might be good enough for the home loan or ?? where they want to know whether you're a 100K or a 1M type guy.
I would think if you were doing a Roth conversion analysis, you would want to take account that the TIRA money is "show" money since to use it, you'd have to pay taxes .
You have 10K in TIRA . Leave alone or convert using TIRA funds alone (usually not recommended)
1) 10K TIRA. Pay 25% taxes and have left 7.5K for a Roth conversion. Asssume in N yrs, Roth is 10x for value of 75K.
2) 10K TIRA left alone. In N yrs it is also 10x for value of 100K. However to use it you must take it out of TIRA and be taxed 25% leaving you with 75K , exactly the same as the Roth..............since before and after tax rates were the same.
In this case, you gave up your 25% early and thought the other way was better because you had more working for you. Some people call this Uncle's hand in your pocket..........even tho you thought you owned 100% of the TIRA, Uncle had 25% in his hand all along. Obviously if you had converted early at 15%, but taken RMDs from TIRA later at 25%, the advantage would swing to the Roth. So the model may be simple-minded ( I call it elegant), but the gross features , I believe, still show up.
As karluk noted, many and perhaps most folks do net worth statements using the raw data (uncorrected for tax). This might be good enough for the home loan or ?? where they want to know whether you're a 100K or a 1M type guy.
I would think if you were doing a Roth conversion analysis, you would want to take account that the TIRA money is "show" money since to use it, you'd have to pay taxes .
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I would tend to agree with Cobra's method of calculating net worth, primarily because of his preference to exclude benefit to his heirs from consideration when making the conversion. If you adjust the numbers based on anticipated future tax liability, you would probably get a better measure of the total benefit of making the conversion, but it wouldn't tell you anything about the proportion of the benefit that goes to the retiree vs. the proportion that goes to the heirs. For me the most illuminating thing about this whole exercise is that there is no net benefit to the retiree's bottom line until rather late in life.
I do agree, however, that having a Roth account gives almost incalculably more flexibility on the spending side. So Cobra's method has the most appeal to extremely affluent retirees who can reasonably expect to never need to make withdrawals from their tax deferred accounts in excess of their RMDs.
Also, with a spreadsheet, it should be a simple matter to add a column or two and track both raw net worth and an adjusted figure based on anticipated future tax liability.
Your example illustrates the futility in trying to construct a simple, 1-conversion, 1-distribution example of this extremely complex dilemma. Too many other assumptions in the background. Why in Case 1 is the entire balance withdrawn as an RMD? Why age 80? I could think of a dozen more why's but I'll stop there. They're all just a function of your assumptions.
To illustrate my point, let's assume your example is the entire financial existence of this 53 old, instead of a subset of some other unspecified set of assumptions. No other balances exist other than those you mentioned and all expenses are covered from other sources. Let's also change the first year of comparison to age 71 instead of 80, so it aligns with the first year that a distribution is required.
Case 2 is unchanged except that the tax-free balance available at age 71 is $22,317, instead of $33,390 at age 80. This consists of $3,866 in the 5.4% subaccount, and $18,451 in 4.4% subaccount.
For Case 1, the balances grow to $25,573 at age 71, consisting of $21,707 in the tax-deferred account and $3,866 in the taxable account. The first RMD is $792 ($21,707/27.4), which drives $198 of taxes at 25%. The rest of the RMD goes back into the taxable account. Net balance $25,375.
At this point, Case 1 (no convert) net worth is ahead by $3,058. But that's only age 71. So, I continued this analysis through age 100 and Case 1 was ahead at every age. Why? The Case 1 portfolio started off $1500 ahead due to no upfront tax on conversion.
Yes, we can all agree this is not a simple issue. But I don't think your example disproves the validity of my statement about the growth impact of tax prepayments early in retirement. Nor does my modification of your example disprove the validity of other conclusions under other sets of circumstances. I was more interested in your earlier point about possible bias created by asset allocation drift, than rehashing the point that different situations result in different conclusions. Maybe I'll get back to that later.
N02L84ER
Thinks s/he gets paid by the post
Cobra9777, I am a newbie, so feel free to disregard if you do not believe this will make a difference or is unlikely to happen. I skimmed through your posts and did not see any mention of testing the ending balance difference if, heaven forbid, one of you passes early and the other has to pay the federal taxes at the much higher "single" taxpayer rate when RMDs are in effect. Full disclosure, I am doing conversions but have no pensions or rental income, so my situation is not the same as yours. Maybe enough pension and SSEC income disappears that it is not a problem?
Putting the net value of the RMD into your taxable account without making any adjustments to the Roth IRA in case 2 is the second error you made in your conversion calculations. It resulted in your assuming a much higher growth rate for the do nothing option than the Roth conversion option once RMDs begin. Instead of being a drag on performance because of the 25% tax, the net long term result of RMDs is positive for the do nothing option, because more and more money is being taken out of an account with 4.4% growth and put into an account with a 5.4% assumed growth rate. If you do this and leave most of the Roth languishing at 4.4% growth, why naturally the Roth can never catch up. The problem is not upfront taxes paid, but an apples to oranges assumption you are making about asset allocation and growth.
No so. If you adjust the asset allocation in the Roth to match the asset allocation in Case 1 after the RMD, the Roth conversion option catches up easily and with accelerating margins as you get older. My calculations indicate that the break even point is age 85, and that's assuming you never pay a dime in taxes on interest, dividends or capital gains generated from the taxable account. Obviously that's completely unrealistic to expect in a taxable account held from age 53-85. With more realistic assumptions on the taxes generated by the taxable account, the break even point would undoubtedly be close to age 80, just as it was for me.
Yes, please do. Asset allocation drift is undoubtedly the primary reason, and perhaps the sole reason, that your spreadsheet has convinced you that Roth IRA conversions will never pay off, even at a favorable tax rate.
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I didn't make any assumption about asset allocation and growth. You established the parameters of the example and the two cases, with a completely unspecified set of background circumstances. I simply clarified the background circumstances, which changed the conclusion entirely. With that clarified, it seems you want to change the original parameters. OK... Yes, when all the growth assumptions are aligned, there is a breakeven point at age 87 (not 85). Either way, I'm sure that sends a warm and fuzzy message to Roth converters everywhere.
On to more interesting things...
You are quite presumptuous for a person who has never actually peeked under the hood of my spreadsheets.
First, I have not studied i-orp to the degree that you have, so I cannot comment on its tendencies at that level of granularity. My own spreadsheet model assumes a static AA and associated growth rate for each account class: taxable, tax-deferred, Roth. The spreadsheet also calculates AA at the total portfolio level at every age to ensure there is no unintended drift resulting from these static assumptions. Ordinarily, with such a static model, one would expect some drift toward higher equities in the overall AA since the taxable account (mostly equities) has a higher growth assumption than tax-deferred (50/50). But, in my base case, this drift effect is almost perfectly compensated by withdrawals from the taxable account prior to age 70. After 70, the overall AA drifts modestly heavier toward equities. I have purposefully not compensated for that, as SS would join the mix at around the same time, which, as a fixed-income equivalent, balances the overall AA picture back to my target.
In any case, that's the base case, and I'm comfortable with it. Your question is... What happens when I make Roth conversions? You suggest my methodology is suspect because Roth conversions produce long-term AA shifts that bias the conclusion. It has always been my assumption that Roth conversions would come out of the stock allocation in the tax-deferred accounts, and go into stock in the Roth account. Thus the Roth would be 100% stock while tax-deferred would gradually drift heavier toward fixed income during the conversion period. The taxable account would remain all equities, so again, the overall portfolio AA would be unchanged throughout the conversion process. Just a shift of stock holdings from tax-deferred to Roth.
Now, as Roth conversions occur, the static growth assumptions for taxable and Roth are not an issue, since they don't change with conversions (all equity). However, the model cannot dynamically change AA and associated growth rate each year for the tax-deferred account, which is the only account that changes AA during the conversion period. So, for the conversion scenario, my solution was to assign a growth rate to the tax-deferred account based on the average AA over the course of these periods, as follows:
41/59 average AA from 53-70 (starts at 50/50, ends at 33/67)
33/67 AA from age 70 onward
37/63 overall average
Using the average AA from 53-70 seemed reasonable since the conversions occur in a fairly linear profile. Using the average of that period (41/59) plus 33/67 for the period after 70 is accurate for death at 87. Since I had to make an assumption, that sounded as good as any. For death prior to 87, that average is slightly understated, and for death after 87, it's slightly overstated. I also tested the model's sensitivity to this assumption. In order to change the conclusion in favor of converting, the tax-deferred AA would need to be higher than 42% equity, which seems unreasonable, given the profile above, which is fixed at 33% from age 70 on.
Sorry for the long explanation. But I made every attempt possible within the constraints of the model to avoid bias one way or the other. The overall AA is constant across time in both scenarios, and it's consistent between the two scenarios. I welcome suggestions to improve this.
Calling me presumptuous is indicative of someone who has gone into a defensive crouch and refuses to examine the shortcomings of his spreadsheet dispassionately. All I can say is that I have made a spreadsheet that I have reason to believe closely parallels yours. It shows that Roth conversions at age 53 wins in the long run, with the break even point at age 85 with no taxes assessed on the taxable account, and a break even at age 81 with what I consider to be more reasonable assumptions about the taxes on the taxable account.
I'm afraid I consider this discussion to be at an impasse. I have given you my input as to what I consider would be an unbiased analysis of early Roth conversions vs. do nothing until RMDs begin for someone who expects to convert at 15% and take RMDs at 25%. If you prefer your methods, so be it. I would only caution those people who have asked you to post your spreadsheet to be aware of what I consider a clear bias in your methodology and to examine the underlying assumptions very carefully before they use your methods to decide whether to make a Roth conversion. In this case the math supports the conventional wisdom that Roth conversions are a win if your tax rate in retirement is higher than the tax rate on your conversion.
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I thought the smiley face might soften the blow, but apparently not. Agree on the impasse, although I don't really think our spreadsheets and modeling logic are that far apart. My model concludes that the conventional wisdom about Roth conversions does not hold up under certain, not-so-uncommon circumstances for early retirees. You argue that the conventional wisdom should hold under these circumstances, and the different conclusion results from modeling bias. Fair enough. We'll just have to leave it there.
But more importantly, I greatly appreciate the in-depth discussion. This is the one decision since I've retired that I quickly realized is far too complicated for simple, cookie-cutter solutions. And it's rare that anyone will engage me to this level of detail on the finer points. Thank you for that. I've learned a lot.
I'm glad a few people are working to clear this up a bit. I haven't followed the thread closely enough to give any detailed arguments. But here's my thinking:
I think of a 401k/IRA as having two virtual accounts, each allocated identically. The first is my tax-free money. The second is the government's/IRS's money. If you end up paying 15% taxes on all your IRA withdrawals, then the government has owned 15% of you IRA account all along, at any point in time. As far as the value of your portion of the account, if you withdraw at a 15% tax rate it doesn't matter when you take your withdrawals. You still get your 85% of the account, the government still gets its 15%.
Roth converting your 85% of the IRA and withdrawing the remaining 15% to pay 15% taxes leaves you with your 85% tax free amount in a tax free Roth account. A totally neutral transaction. You took your money and gave the government their money, your money is still available and growing tax free. You can do it at any time, as a single conversion or in many smaller conversions, as long as you can do it within the 15% tax rate. You always end up with your same 85%, growing tax free.
You can have the same result if you are in the 15% tax bracket as you make contributions to a Roth 401k/Roth IRA. The government still gets its 15%, you still end up with 85% tax free.
But, the Roth has an advantage over the traditional IRA in that the government's 15% doesn't count against your contribution limits for the Roth. So you can contribute more tax-free value to a Roth account than you can to a traditional IRA account. In the case of a Roth conversion, this means that in addition to converting your 85% into a Roth account, you can also add to your Roth the amount of the 15% withdrawal you made to pay taxes. You do this by paying taxes from a taxable account and converting 100% of the IRA. The net effect is that you have made a neutral IRA to Roth conversion, but you have also in effect moved 15% of the value of the old IRA from your taxable account into the Roth account. No more capital gains or dividend taxes on that previously taxable money. Other than tax timing considerations, that avoidance of taxes on previously taxable money is the benefit of Roth converting. More tax-free value. For you, not your heirs. And since the effect is a reduction of future taxes, the earlier you can convert and let the extra value grow in the Roth, the better. Roth converting just before a Roth withdrawal won't buy you a whole lot.
Added on top of that is the possibility of varying tax rates as you contribute, convert, or withdraw, and of course forced withdrawals due to RMD's. If you can withdraw some of your IRA at 10% instead of 15%, you can take some of the government's money and add it to your tax-free money. Regardless of timing. So you want to minimize your withdrawal taxes from the traditional IRA, whatever the timing. If you can take some out at 0%, do it! If you don't need the money, do it as a Roth conversion. If you can avoid the possibility of 25% taxes on RMD's by withdrawing at 25% taxes or lower now, do it! You just want to minimize the average tax rate and move your taxable account into a Roth as soon as possible.
I think of a 401k/IRA as having two virtual accounts, each allocated identically. The first is my tax-free money. The second is the government's/IRS's money. If you end up paying 15% taxes on all your IRA withdrawals, then the government has owned 15% of you IRA account all along, at any point in time. As far as the value of your portion of the account, if you withdraw at a 15% tax rate it doesn't matter when you take your withdrawals. You still get your 85% of the account, the government still gets its 15%.
Roth converting your 85% of the IRA and withdrawing the remaining 15% to pay 15% taxes leaves you with your 85% tax free amount in a tax free Roth account. A totally neutral transaction. You took your money and gave the government their money, your money is still available and growing tax free. You can do it at any time, as a single conversion or in many smaller conversions, as long as you can do it within the 15% tax rate. You always end up with your same 85%, growing tax free.
You can have the same result if you are in the 15% tax bracket as you make contributions to a Roth 401k/Roth IRA. The government still gets its 15%, you still end up with 85% tax free.
But, the Roth has an advantage over the traditional IRA in that the government's 15% doesn't count against your contribution limits for the Roth. So you can contribute more tax-free value to a Roth account than you can to a traditional IRA account. In the case of a Roth conversion, this means that in addition to converting your 85% into a Roth account, you can also add to your Roth the amount of the 15% withdrawal you made to pay taxes. You do this by paying taxes from a taxable account and converting 100% of the IRA. The net effect is that you have made a neutral IRA to Roth conversion, but you have also in effect moved 15% of the value of the old IRA from your taxable account into the Roth account. No more capital gains or dividend taxes on that previously taxable money. Other than tax timing considerations, that avoidance of taxes on previously taxable money is the benefit of Roth converting. More tax-free value. For you, not your heirs. And since the effect is a reduction of future taxes, the earlier you can convert and let the extra value grow in the Roth, the better. Roth converting just before a Roth withdrawal won't buy you a whole lot.
Added on top of that is the possibility of varying tax rates as you contribute, convert, or withdraw, and of course forced withdrawals due to RMD's. If you can withdraw some of your IRA at 10% instead of 15%, you can take some of the government's money and add it to your tax-free money. Regardless of timing. So you want to minimize your withdrawal taxes from the traditional IRA, whatever the timing. If you can take some out at 0%, do it! If you don't need the money, do it as a Roth conversion. If you can avoid the possibility of 25% taxes on RMD's by withdrawing at 25% taxes or lower now, do it! You just want to minimize the average tax rate and move your taxable account into a Roth as soon as possible.
Could you list what those circumstances are? I'm afraid that I missed them among all that other detail. I have to give both you and karluk credit for a remarkably civil discussion.
+1 on that. Before this discussion, I had never thought of evaluating Roth conversions based on their effect on a retiree's bottom line, as opposed to the long term tax benefits after the tax deferred account is exhausted. This metric is not for everyone, but it is possible to make a good case for using it in certain circumstances, and it shows that Roth vs. do nothing is "Much Ado About Nothing" for those who prefer it. The RMD withdrawal schedule makes it almost impossible for the Roth conversion to show a net profit until the retiree is in his 80s, which has to make it more or less a wash as to whether said retiree will live long enough to see a payoff. For the heirs, of course, it's a different story.
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Sunset
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
I have enjoyed this thread, and have tried to follow the bouncing ball.
As this thread concentrated on RMD issues, it made me wonder about the usefulness of capital gain harvesting.
Basically, I'm thinking that capital gain harvesting (CGH) at 0% if possible is priority number one prior to roth conversion.
The ability to CGH is limited by existing income (pension, dividends, filing status)
If a person fails to CGH they have less opportunity once SS starts, and once RMD's start, they will pay 15% on capital gains, assuming a large IRA/401K savings.
Comments ?
As this thread concentrated on RMD issues, it made me wonder about the usefulness of capital gain harvesting.
Basically, I'm thinking that capital gain harvesting (CGH) at 0% if possible is priority number one prior to roth conversion.
The ability to CGH is limited by existing income (pension, dividends, filing status)
If a person fails to CGH they have less opportunity once SS starts, and once RMD's start, they will pay 15% on capital gains, assuming a large IRA/401K savings.
Comments ?
