Feeling dumb about Roth

[youbet]

I like the idea that the earnings come out of a Roth tax free. For young people, the concept of putting $5.5k into a Roth today and withdrawing that plus earnings (assume it doubles 3 times over 40 years) of $44k (nominal) must be appealing.

Despite being deep into geezerhood, I'm doing some pre-RMD conversions now. If our plans remain intact, our son will inherit the Roths. If we need to do some withdrawals, they will be tax free avoiding the higher tax bracket we'll be in once RMD's start and the earnings will have gotten a free ride.

[travelover]

I read a suggestion to make grandkids beneficiaries of Roths so that it can grow faster than their RMDs deplete it. Sounds like a good idea.

[Animorph]

Just a couple of late comments that I didn't see mentioned:

#1 Roths are better if the withdrawal tax rate is equal or higher, not just higher. The Roth has more after-tax sheltered value for the same number of dollars in the account than a traditional IRA.

Also keep in mind that even if you are in the "25%" tax bracket in retirement, some of that income comes to you at 10% and 15%, so the average tax rate is lower than 25%. In general your 401k dedecutions will be at your current top rate. That will tend to work against the Roth a little bit. Having both accounts lets you withdraw tIRA money at the lower rates and fill in with Roth withdrawals to avoid the higher rates.

And as has been mentioned, early retirement (before Soc Sec and other income comes on line) may give you access to very low tax rates that will allow you to convert some of your 401k into a Roth.

#2 A Roth account is better than a taxable account. If you are filling your 401k, then fund a regular Roth IRA with any retirement savings left over. Either with regular contributions if your income is low enough, or the "backdoor" method if your income is too high.

[sunsnow]

another benefit I did not see mentioned, is that you get a chance to convert during dips in the market. i did the majority of my conversion in 2010, and saved a lot of $$$. if you guess wrong, you can recharacterize.

[Backpacker]

Just not sure where my tax rate will be down the road. In theory we'll be in lower bracket as we'll be taking less in draws than current income. Lots of unknowns there. I am maxed on 401k and also maxed on roth IRA, can't get any current tax advantage by putting $ into taxable IRA, and like that I will be able to take funds out of Roth prior to 59.5 as I am shooting for 56 at the oldest for FIRE.

[Duke of Sands]

Re-inheriting IRAs, our experience may be unusual but could be relevant for some. Watch out when an aging parent enters a nursing home and thus has huge medical deductions, yielding a zero income tax rate. We should have had her cash out her t-IRA or convert it to a Roth tax-free while she was still alive, instead DW and I are now paying 15% tax on RMDs from her inherited IRA.

[Midpack]

Also late.

Probably a glass half empty view, but one of my reservations about a Roth IRA (conversion in my case) is, if your holdings were to decline in value - you could conceivably be paying taxes (going in) or (much) more than you end up with. Not the case with taxable or TIRAs.

I may have missed it, but I could not find a provision that would allow you use the "loss" later, you eat the loss - unlike in taxable accounts. And of course with a TIRA or Rollover IRA you pay taxes on distributions, so you would not overpay taxes. Hopefully someone will correct this if I'm wrong...

[ejman]

Quote:

Originally Posted by Midpack Also late. Probably a glass half empty view, but one of my reservations about a Roth IRA (conversion in my case) is, if your holdings were to decline in value - you could conceivably be paying taxes (going in) or (much) more than you end up with. I may have missed it, but I could not find a provision that would allow you use the "loss" later, you eat the loss - unlike in taxable accounts. And of course with a TIRA or Rollover IRA you pay taxes on distributions, so you would not overpay taxes. Hopefully someone will correct this if I'm wrong...

Precisely why I have not converted. If we go into an extended decades long low growth period (AKA Japan) I can't see the sense in paying taxes now on a portfolio that doesn't grow or grows very slowly. Plus I happen to live in a very high income tax state and the minimum tax on a conversion for me would be 25% (Fed + State).

[Animorph]

Quote:

Originally Posted by Midpack Also late. Probably a glass half empty view, but one of my reservations about a Roth IRA (conversion in my case) is, if your holdings were to decline in value - you could conceivably be paying taxes (going in) or (much) more than you end up with. Not the case with taxable or TIRAs. I may have missed it, but I could not find a provision that would allow you use the "loss" later, you eat the loss - unlike in taxable accounts. And of course with a TIRA or Rollover IRA you pay taxes on distributions, so you would not overpay taxes. Hopefully someone will correct this if I'm wrong...

I think the chance of having a net portfolio tax loss over a long retirement is very slim. Why let a small probability worst case drive your decisions? I pretty much go with the most likely outcome, as much as we can ever know, with some insurance for a possible downside.

If you don't withdraw some tIRA early within the lower tax brackets, you may indeed overpay taxes if RMD's kick you into a higher tax bracket. You definitely want to balance those withdrawals to avoid the higher tax brackets. Then, any tIRA withdrawal you make while you still have taxable funds is an opportunity to place that taxable money into a Roth and avoid future taxes.

Or you could just put only fixed-income investments into the Roth. No principal loss, hopefully, and the income is not taxed. More of a sure tax thing than stocks.

[kaneohe]

Quote:

Originally Posted by Midpack Also late. I may have missed it, but I could not find a provision that would allow you use the "loss" later, you eat the loss - unlike in taxable accounts. And of course with a TIRA or Rollover IRA you pay taxes on distributions, so you would not overpay taxes. Hopefully someone will correct this if I'm wrong...

There is a provision that potentially allows you to use the loss later......if you itemize. Unfortunately, since this as a misc deduction, it is subject to a 2% of AGI threshold before anything can be deducted and you would have to deplete all of your Roths to use it.

Agree w/ Animorph's comments. As w/ most investments, a longer term strategy generally is better.

[Midpack]

Quote:

Originally Posted by Animorph I think the chance of having a net portfolio tax loss over a long retirement is very slim. Why let a small probability worst case drive your decisions? I pretty much go with the most likely outcome, as much as we can ever know, with some insurance for a possible downside. If you don't withdraw some tIRA early within the lower tax brackets, you may indeed overpay taxes if RMD's kick you into a higher tax bracket. You definitely want to balance those withdrawals to avoid the higher tax brackets. Then, any tIRA withdrawal you make while you still have taxable funds is an opportunity to place that taxable money into a Roth and avoid future taxes. Or you could just put only fixed-income investments into the Roth. No principal loss, hopefully, and the income is not taxed. More of a sure tax thing than stocks.

Appreciate your perspective (and kaneohe), it's by no means a slam dunk decision. I have not spent enough time thinking through RMDs at age 58, but I need to thanks.

Our TIRAs are entirely bond funds and probably will be for many years, though "principal loss" on bond funds is almost guaranteed in the years ahead as interest rates inevitably increase eventually IMO.

[Animorph]

Here's what I'm planning to do specifically:

2013-2015: Roth convert up to $160k to pick up the $2500 tuition tax credit. Looks like it's better to delay conversions for $2500/year. ACA subsidies and other tax situations may provide similar incentives.

2016-2018: Roth convert up to near the top of the 25% tax bracket. This is our maximum conversion years. Higher tax rate, but getting a lot done early is apparently worth it.

2019-2024: Roth convert to top of 10% bracket, take advantage of some 0% taxed capital gains.

2025-2029: My SS starts. Roth conversions stop. continue to get some 0% taxed capital gains.

2030-?: RMD's hit from DW's tIRA since we don't get it down to zero. We're back into the 25% tax bracket and 15% capital gains.

According to the plan we never actually withdraw anything from the Roth accounts. It just provides us with the highest yearly spending compatible with a specified portfolio ending value.

The basic optimization process I used was to control the tIRA withdrawals, Roth conversion or income or RMD, for each year. It's a process of calculating in which year adding $1000 to the tIRA withdrawal contributes the most to the available spending level. I repeat that until no additions help the spending level. Then I try subtractions, then a subtraction paired with an addition. Then I reduce the amount and run through it again. I keep running until I'm trying changes of less than a penny. Obviously a lot of assumptions about everything, including tax rates, SS, inflation, investment gains, and goals. Clearly not something with an easy answer. And still a work in progress for me.

[intent]

Great stuff here, and most of it is making sense - even to me

Some of the suggested benefits of a Roth are still confusing me though, as follows:

Quote:

Originally Posted by Khufu Do you expect to leave money after you die either to your wife (especially if she is younger) or to any kids? If so, the only way to leave them money that could earn investment returns tax-free over their lifetimes would be a Roth account. How valuable that is depends on what their tax rates would be and how good the returns on the investments actually turn out to be. It also matters whether the investments were strict buy-and-hold of equities or equity funds, which would therefore pay only a long-term capital gains rate and only once, or would be interest income that would be taxable at income rates every time it was received. An investment account that is tax-free for life could be an enormous advantage, but it depends.

By this do you mean that passing on Roth money is advantageous because it won't force the recipient into a higher tax bracket when they make withdrawals from it? Or is there a different benefit that I'm overlooking?

Quote:

Originally Posted by RetiringAt55 Another advantage is that you can effectively put more money away in a Roth 403b than in a regular 403b because the $17.5K cap applies to it as well but it is after tax.

I've heard this before, but I must admit I don't understand how the after tax contribution of $17.5K is worth more than the pre-tax contribution of the same amount.

Quote:

Originally Posted by Backpacker like that I will be able to take funds out of Roth prior to 59.5 as I am shooting for 56 at the oldest for FIRE.

I was under the impression that early withdrawal penalties apply to Roth accounts same as they do to traditional accounts. Am I misinformed about this?

[kaneohe]

Quote:

Originally Posted by intent Great stuff here, and most of it is making sense - even to me Some of the suggested benefits of a Roth are still confusing me though, as follows: By this do you mean that passing on Roth money is advantageous because it won't force the recipient into a higher tax bracket when they make withdrawals from it? Or is there a different benefit that I'm overlooking? I've heard this before, but I must admit I don't understand how the after tax contribution of $17.5K is worth more than the pre-tax contribution of the same amount. I was under the impression that early withdrawal penalties apply to Roth accounts same as they do to traditional accounts. Am I misinformed about this?

The following comments are about Roth IRAs.......just notice that OP is about Roth 401K/403B which I'm not very
familiar with.

You can withdraw your original Roth contributions at any time w/o penalty.
You can withdraw conversions after 5 yrs w/o penalty.
You have to worry about the earnings but withdrawals from a Roth IRA are considered to be contributions first, then conversions, and earnings last.

An after-tax contribution of a given amount is obviously worth more than a pre-tax contribution of the same amount because the pretax amounts could only be used after paying the tax upon withdrawal. That perhaps though is not a fair comparison............since the Roth owner had to pay the tax on his contribution up front, his taxable account is is worth less than the pre-tax owner.
Effectively the TIRA owner has an extra amount in his taxable account.
Over a period of time tho (assuming all tax rates are the same), the Roth owner will be ahead by some amount
(by the amount of the tax on the gain of that extra amount that the TIRA owner has in the taxable account).

[-Jackson-]

Quote:

Originally Posted by kaneohe You can withdraw your original Roth contributions at any time w/o penalty. You can withdraw conversions after 5 yrs w/o penalty. You have to worry about the earnings but withdrawals from a Roth IRA are considered to be contributions first, then conversions, and earnings last.

This is something I've been wondering about. Could you effectively make early withdrawals from your TIRA/401K without SEPP by transferring to a RIRA and keeping conversions five years ahead of withdraws?

Say you retire at 50 with 5x expenses in contributions to a RIRA and the remainder of your money in a T401K/TIRA. If you begin withdrawing contributions from your RIRA and also begin conversions the same year, and do the same every year, in the 6th year you could withdraw the first year's conversion without penalty? Every year you could withdraw the conversion amount from five years previous and do this for 4.5 years until age 59.5?

Would this be a way to avoid 72T SEPP? You would be able to choose the amount to convert, and start or stop at will, so long as you kept track of conversions, contributions, and earnings? Or am I way off on how this works?

[Alan]

Good information over at Bogleheads on inherited Roths.

Inheriting a Roth IRA - Bogleheads

It is quite complicated but I think, in general, a non-spouse beneficiary cannot co-mingle the inherited Roth with their own, and if they do RMD's over their lifetime, or cash out the IRA over a 5 year period they pay no tax or penalties.

[kaneohe]

Quote:

Originally Posted by -Jackson- This is something I've been wondering about. Could you effectively make early withdrawals from your TIRA/401K without SEPP by transferring to a RIRA and keeping conversions five years ahead of withdraws? Say you retire at 50 with 5x expenses in contributions to a RIRA and the remainder of your money in a T401K/TIRA. If you begin withdrawing contributions from your RIRA and also begin conversions the same year, and do the same every year, in the 6th year you could withdraw the first year's conversion without penalty? Every year you could withdraw the conversion amount from five years previous and do this for 4.5 years until age 59.5? Would this be a way to avoid 72T SEPP? You would be able to choose the amount to convert, and start or stop at will, so long as you kept track of conversions, contributions, and earnings? Or am I way off on how this works?

Sounds like you should apply for a US patent for this creative idea
I can't poke a hole in your idea but you might feel better if you got it blessed by Alan S. on the fairmark.com forum (retirement sub-forum) or the bogleheads.org forum.

[-Jackson-]

Quote:

Originally Posted by kaneohe Sounds like you should apply for a US patent for this creative idea I can't poke a hole in your idea but you might feel better if you got it blessed by Alan S. on the fairmark.com forum (retirement sub-forum) or the bogleheads.org forum.

I'm not sure I'm the first to think of it. I did search around a little and I couldn't find anything written about doing something like this. So I thought maybe there was a rule or regulation that made it impossible. I am 30 and probably 15 or 20 years from accumulating enough to retire (unless there is a significant pay increase in there somewhere). I am sure the rules will change significantly in that time. I was just curious if anyone had thought of this, or if it was possible. There are often threads about bridging the time between early retirement and age 59.5 when IRA withdrawals can begin. I thought maybe this would be an option?

Thanks for the input. I may go ask on those other forums and see what kind of answer I get.

[seabourne]

Quote:

Originally Posted by -Jackson- This is something I've been wondering about. Could you effectively make early withdrawals from your TIRA/401K without SEPP by transferring to a RIRA and keeping conversions five years ahead of withdraws? Say you retire at 50 with 5x expenses in contributions to a RIRA and the remainder of your money in a T401K/TIRA. If you begin withdrawing contributions from your RIRA and also begin conversions the same year, and do the same every year, in the 6th year you could withdraw the first year's conversion without penalty? Every year you could withdraw the conversion amount from five years previous and do this for 4.5 years until age 59.5? Would this be a way to avoid 72T SEPP? You would be able to choose the amount to convert, and start or stop at will, so long as you kept track of conversions, contributions, and earnings? Or am I way off on how this works?

This is roughly what I'm intending to do, beginning in the next few years. For someone like me (age 34), 72t withdrawals in a low interest rate environment would lock me into a low percentage withdrawal for the next 25 years - well below a SWR, and would thus require me to build up a larger savings base (or spend down taxable accounts over that period, potentially hurting tax efficiency).

Right now, I fully fund my RothIRA, split my annual max between 401k, Roth401k and a company ESOP, fully fund an HSA account, and put savings into taxable investments last. being able to roll my Roth401k money into a RothIRA as a contribution, and then slowly convert the 401k and ESOP into RothIRA in a manner that lets me control my taxable income carefully should effectively increase the value of the accounts. Flexibility in having control over accounts with varying tax rules will be worth a good deal over the next 30 years, and let me adapt if I have significant other income in that time as well. None of that is nearly as viable with a 72t plan at my age.

[-Jackson-]

When you roll a roth 401k to an RIRA it counts as one big contribution? I did not know that.