Is Roth Conversion Worth It?

[SevenUp]

Convert to ROTH now or not does not make a significant difference...

...if tax rates now and later are the same - yes.

If tax rates now vs. later are 10% different (e.g., 12% vs. 22%) then it makes a 10% difference in the after-tax result. Whether 10% is significant or not may be in the eye of the beholder.

 

[RetiredHappy]

...if tax rates now and later are the same - yes.

If tax rates now vs. later are 10% different (e.g., 12% vs. 22%) then it makes a 10% difference in the after-tax result. Whether 10% is significant or not may be in the eye of the beholder.

We are already at 22% and 24% tax brackets, I won't sweat over future tax rates.

 

[chassis]

@pb4uski when (what age) do you expect to break even on the taxes paid on Roth conversions, to eventually arrive at 7% better net worth at age 100?

@SecondCor521 it looks to me like you don't like the message (McQuarrie's), and are attempting to shoot the messenger (McQuarrie) by casting aspersions on his credentials. Kitces and McQuarrie are both psychologists. Strange....or not strange?

There have been people in the past whose message wasn't well received by the populace. You yourself know of an example.

 

[SevenUp]

...when (what age) do you expect to break even on the taxes paid on Roth conversions...?

Break-even is immediate on any Roth conversion if the tax rate doesn't change.

 

[pb4uski]

+1. Breakeven is immediate if tax rate today is the same or lower than future tax rate when RMDs happen... which it is in my case.

 

[cat4ever]

And... this all assumes that the future tax rate is the same as today's tax rate... if today's tax rate is lower then you come out even further ahead...

THIS!! Even if your models tell you it's break even, this is a BIG reason to do Roth's regardless up to the tax bracket you expect to be in when RMD's and SS start. I guess if taxes go down in the future then conversions probably won't pan out, but i'd be happy to take that loss and have that be the case.

Of course the ultra-cynical might say there's nothing to stop 'them" from taxing Roth's along with other tax increases our friendly government may come up with.

 

[rwdflynavy]

Did the OP ever clarify Medicare vs. Medicaid? Seems like that's an important piece of information.

 

[SecondCor521]

@SecondCor521 it looks to me like you don't like the message (McQuarrie's), and are attempting to shoot the messenger (McQuarrie) by casting aspersions on his credentials. Kitces and McQuarrie are both psychologists. Strange....or not strange?

There have been people in the past whose message wasn't well received by the populace. You yourself know of an example.

You might want to look again.

I never wrote that I disliked the message. I thought the arguments to support the message were poorly constructed, so I disregarded the message.

And I'm not casting aspersions on his credentials - I think I was objectively pointing out the lack of evidence of any relevant credentials.

How something is received by other people in general has little to no bearing on whether I subscribe to an idea or not. There are a lot of things I do and believe that are quite common, and a number of things I do and believe that are uncommon.

Since he was an academic in a business school and his paper was published in some financial publication, I started reading his paper with a positive expectation. As noted in my earlier reply, I read the first several pages of his paper and came across numerous holes in logic.

I then wondered how someone who worked in a business school at what I consider to be a good university could write so poorly on a financial topic, and how a financial publication could have published such stuff. So I investigated his credentials and the characteristics of the publication. Since there was no evidence of relevant credentials, the review standards of the publication were not very high, and his message was poorly argued, I chose to discard it.

I wouldn't characterize either McQuarrie or Kitces as psychologists based on their respective careers and experience.

I think you are quite right to imply that my previous reply on McQuarrie may have focused too much on his lack of credentials and less on his poor logic. Since it has been several months since I wrote that post, I don't recall exactly why. It may have been that I thought the poor logic in the paper was self-evident, or at least more obvious than the credentials issue. It was probably partly that most of what I read in his paper simply didn't apply to me. And it was probably more my fascination with what I saw as people (people in the personal finance area generally, not you specifically, although it seems clear you agree with McQuarrie on this subject) reading and accepting what he had to say without much due diligence. Finally, I think I was just being lazy - pointing out all the flaws in his logic would have taken too much time and energy for me to bother with.

I prioritize the logic and the evidence over the credentials, by the way. But in the case of both McQuarrie and the other person to whom you allude, I haven't seen any need to do so.

HTH, I'll give you the last word if you want it.

 

[chassis]

@SecondCor521 thanks. I don’t want the last word on anything. I want to bring the ground truth to light on Roth conversions. It’s an element of my own retirement financial planning that I don’t think makes sense for me. I don’t understand how it can make sense for as many people as seem to be in support of Roth conversions on this site and bheads. McQuarrie’s work for me is one small piece of information in a large bucket of information. I briefly read some of his work and moved on.

I have used i-orp, RPM and my own spreadsheet and I don’t see the benefit for Roth conversions. To gain a wider perspective, I have asked HNW, UHNW individuals and a family office trustee (UUHNW families) and none of them are doing Roth conversions for themselves or their clients.

You said you are Roth converting with zero tax, correct? How does that work?

 

[pb4uski]

Yup. Math is hard.

 

[REWahoo]

Yup. Math is hard.

Yes, I heard somewhere that numbers is difficult.

 

[SecondCor521]

@SecondCor521 thanks. I don’t want the last word on anything. I want to bring the ground truth to light on Roth conversions. It’s an element of my own retirement financial planning that I don’t think makes sense for me. I don’t understand how it can make sense for as many people as seem to be in support of Roth conversions on this site and bheads. McQuarrie’s work for me is one small piece of information in a large bucket of information. I briefly read some of his work and moved on.

I have used i-orp, RPM and my own spreadsheet and I don’t see the benefit for Roth conversions. To gain a wider perspective, I have asked HNW, UHNW individuals and a family office trustee (UUHNW families) and none of them are doing Roth conversions for themselves or their clients.

You said you are Roth converting with zero tax, correct? How does that work?

What gets less mention than it should is that whether a Roth conversion makes sense depends a lot of factors - marital status, number of children, life expectancy, relative percentage of assets in traditional IRA, opinion on future tax changes, estate planning approach, the rest of one's tax picture, etc. This is really what you might consider the "ground truth" on Roth conversions: It depends.

People often assume that others' factors are the same and arrive at the conclusion that since Roth conversions make sense (or don't make sense, or are a wash) for them, then this must be true for others. This is a fallacious conclusion based on a faulty assumption.

Roth conversions clearly make a lot of sense for me, given my particular set of factors. I fully accept that they may not make sense for you given your factors. I assume your factors differ, which explains the difference in our conclusions. Fine by me.

I suppose what you see as broad support for Roth conversions here is really a combination of two things: (1) the people here may have similar sets of factors - there are probably a number of us who are in our 50s/60s who are early retired with large traditional IRAs, and (2) there are a few posters who are pretty positive towards Roth conversions who post frequently on the topic (myself and @pb4uski are probably in this group).

And as for me - and I presume @pb4uski as well - I think we're generally saying that Roth conversions make sense for us. We often omit or leave unwritten the part about it may not make sense for others who may be in different situations.

Whether *HNW individuals or their offices are doing Roth conversions or not is perhaps only partially applicable to you or me anyway. Yes, they may be smart, capable people with money, but if their circumstances or goals differ too much from yours or mine, what makes sense for them to do may not make sense for us to do.

And yes, last year I did a low-five figure Roth conversion and had a total tax in the single digits on my Form 1040 line 24.(*) This happened because I had nonrefundable tax credits that almost equaled my tax liability (line 21 was just a little bit less than line 16). My nonrefundable credits included a dependent tax credit, the AOTC, and a residential energy tax credit.

It was that way by design. Every year I do volunteer tax preparation, which gives me access in December to a tax preparation program. I go in there, put in all my numbers, and then do a Roth conversion at the end of December to dial in my income exactly where I want it. The only reason I couldn't get my 1040 line 24 to exactly $0 has to do with the fact that the tax tables are in $50 increments.

Of course, federal income tax isn't the whole story. In my case, state income tax, ACA subsidy effects, and FAFSA EFC effects are part of the strategy as well.

(*) Which, I just realized, means I didn't actually pay zero federal income tax. I paid 0.012% federal income tax. Perhaps I rounded in my other post - rounding 1.2 basis points to zero seems OK in the larger context - I didn't want the forest to get lost for the trees.

 

[captain3d]

Similar here. $25k negative income on rental property. Convert $50k to create $25k positive income for max ACA subsidy but effectively zero tax

 

[pb4uski]

That is how I look at it. Convert to ROTH now or not does not make a significant difference. So instead of messing with it now, I will worry about IRA taxes when they hit me. For estate planning, I plan to use disclaiming part of IRA inheritance to pass a part of the IRA to other beneficiary(ies) who maybe in a lower tax bracket. Problem solved!

It's very situational.

Where it does make a significant difference is where with SS, pensions and taxable account income you are near the top of the 12% tax bracket so RMDs push you into the 22% tax bracket so RMDs are taxed at 22% where you could have earlier converted at 0%, 10% or 12% or combinations thereof and you failed to do so because you stupidly thought that it doesn't make a significant difference.

Now if before RMDs you are near the top of the 22% tax bracket and RMDs push you into the 24% tax bracket and are taxed at 24% then you're right.

But there are a lot of people in the first category where it does make a significant difference.

 

[CardsFan]

A few random thoughts on the topic:

- pb4uski has provided a mountain of evidence on the benefits of conversions. His post years ago are what started me on the path.

- conversions are NOT a game changer. I can't think of any way conversions will help if your portfolio does not currently support your spending

- while conversions may not ultimately be very beneficial to some, there are very few downsides. I guess the biggest would be if you converted at market highs, the market dropped a lot, and then never recovered. You can make up your own minds on the probability of that possibility.

- Roth IRA's are one of the most tax efficient ways to pass an inheritance.

- you don't need to convert everything. Going into high tax brackets may not make sense

- conversely, going into higher brackets might make sense if you can stay below the IRMAA brackets, if only for a few years, when RMD's start (ultimately they will bite any one with a large tIRA, unless you die before they kick in)

Finally, there is no one size fits all answer. As pb4uski said, "It's very situational."

 

[pb4uski]

Thanks, CardsFan. I'm less concerned about the:

... if you converted at market highs, the market dropped a lot, and then never recovered. You can make up your own minds on the probability of that possibility. ...

When I convert I usually sell ticker XXX in my tIRA and buy ticker XXX in my Roth so it is as if I held ticker XXX the whole time.... I do this because I don't want the conversion to change my AA.

The taxes are paid by increased withholdings from my pension since I can do those over the year despite the bulk of my Roth conversions being done in January with a top-up in December.

 

[cat4ever]

Something else that Roth gives you is flexibility. Say you have/want to make a large purchase in the future, either for health problems, that perfect vacation house, that dream car or other BTDs. With Roth money you'll have the ability to do so without going into the next tax bracket, say from 22/24 to 34 (or whatever they happen to be in the future). All other things being equal, why not give yourself that flexibility in the future?

 

[Winemaker]

Thanks, CardsFan. I'm less concerned about the:


When I convert I usually sell ticker XXX in my tIRA and buy ticker XXX in my Roth so it is as if I held ticker XXX the whole time.... I do this because I don't want the conversion to change my AA.

The taxes are paid by increased withholdings from my pension since I can do those over the year despite the bulk of my Roth conversions being done in January with a top-up in December.

Fidelity allows me to do in kind transfers for not only conversions, but also for RMDs. We did a conversion this year because of a rental sale, and my mom does the RMDs.

 

[cat4ever]

The taxes are paid by increased withholdings from my pension since I can do those over the year despite the bulk of my Roth conversions being done in January with a top-up in December.

Interesting. And yet another reason to take a pension instead of a lump sum. This kind of math can get very hard

 

[pb4uski]

Fidelity allows me to do in kind transfers for not only conversions, but also for RMDs. We did a conversion this year because of a rental sale, and my mom does the RMDs.

I could do an in kind transfer of the same ticker but I can do the exchange with just a few clicks and I don't have to call, so it's actually easier.

 

[meleana]

I may have asked this here before- I really can't remember.



But why not just withdraw money from your Traditional IRA's while you are waiting to collect SS at age 70 instead of doing the Roth conversions? Doesn't it attain the same result- lowering your balances in Traditional IRA's and therefore lowering your RMDs?

 

[N02L84ER]

I may have asked this here before- I really can't remember.

But why not just withdraw money from your Traditional IRA's while you are waiting to collect SS at age 70 instead of doing the Roth conversions? Doesn't it attain the same result- lowering your balances in Traditional IRA's and therefore lowering your RMDs?

Before age 59.5, there can be a 10% tax penalty for withdrawing from an T-IRA but not for doing a Roth Conversion.
After age 59.5, if you have enough money in a taxable account to live on and pay the taxes on the withdrawal or Roth conversion, then the Roth conversion has a slight advantage. By paying the taxes from the taxable account, you are basically moving the taxes on the IRA into a Roth that will never be taxed again under the current rules. By spending the taxable instead of the IRA, you are reducing future distributions from the taxable account. Distributions from taxable accounts add to one's AGI whereas Roth earnings do not add to AGI. If these taxable distributions push you above (or if you are already above) the 12% tax bracket you will owe more taxes on the larger taxable distributions so the Roth conversion and spending from taxable saves you some tax money.

 

[meleana]

Before age 59.5, there can be a 10% tax penalty for withdrawing from an T-IRA but not for doing a Roth Conversion.
After age 59.5, if you have enough money in a taxable account to live on and pay the taxes on the withdrawal or Roth conversion, then the Roth conversion has a slight advantage. By paying the taxes from the taxable account, you are basically moving the taxes on the IRA into a Roth that will never be taxed again under the current rules. By spending the taxable instead of the IRA, you are reducing future distributions from the taxable account. Distributions from taxable accounts add to one's AGI whereas Roth earnings do not add to AGI. If these taxable distributions push you above (or if you are already above) the 12% tax bracket you will owe more taxes on the larger taxable distributions so the Roth conversion and spending from taxable saves you some tax money.

Thanks.


Right now we are 65 and 67 and living off cash in bank accounts. We do also have a brokerage account with mostly tax efficient bond funds and 2 stock funds (dividend and value).

 

[pb4uski]

Good answer by N02L84ER above. We are in similar situation to meleana... lots of taxable account money to use for spending and paying Roth conversion taxes... so I prefer Roth conversions over spending tIRA withdrawals... I want to get as much as possible into tax-free Roth at a reasonable tax cost.

 

[RunningBum]

But why not just withdraw money from your Traditional IRA's while you are waiting to collect SS at age 70 instead of doing the Roth conversions? Doesn't it attain the same result- lowering your balances in Traditional IRA's and therefore lowering your RMDs?

Capital gains and dividends in a Roth are not taxable, but are in your taxable account where it would go if you withdrew.