Is Roth Conversion Worth It?

Still Learning said:
pb4uski -sorry for the typo. Will be in the 22% bracket at 72
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Ive got maybe a stupid question as it relates to Roth conversions. What if, for whatever reasons, you're income puts you in the highest tax bracket? I keep reading that it makes sense up to 22% brackets, but what if a persons is still working or has structured deferred income that puts them well over 22% for the net 10 years. That is my case and I don't see where a Roth Conversion would help. Am i missing something?
 
chassis said:
@StillLearning Roth conversions offer no benefit, or a very small benefit very late in life, for most people. ...
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OP, I don't agree with chassis that Roth conversions offer no benefit.

In your case they are beneficial,be because you can take advantage of your current 12% tax rate 22% later on. In other cases, if you were already in 22% with no conversions vs 24% later, then the benefits are negligible.
 
RetiredHappy said:
https://www.elderlawanswers.com/can-an-ira-affect-medicaid-eligibility-14544
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Thanks for the link to the article. I was able to find a number of others that said essentially the same thing.

If you're concerned about LTC costs and are relying on this plan to go on Medicaid, why have you not just bought an LTC insurance policy? It might be expensive, but it would presumably preserve your assets for your daughter and have the hopefully added bonus of not being on Medicaid.

I'm not really trying to advocate for any particular path here. Mostly just curious about your thought process.
 
drums said:
Ive got maybe a stupid question as it relates to Roth conversions. What if, for whatever reasons, you're income puts you in the highest tax bracket? I keep reading that it makes sense up to 22% brackets, but what if a persons is still working or has structured deferred income that puts them well over 22% for the net 10 years. That is my case and I don't see where a Roth Conversion would help. Am i missing something?
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The main benefit to Roth conversions is to pay a lower rate to convert than you'd be paying when you withdraw later, whether forced due to RMDs or just withdrawing for living expenses. So if you are working or have other income that puts you in a higher bracket now than what you expect later, you almost certainly don't want to convert.

And there's not a generic rule that says it makes sense to convert up to 22%. For some it will be to the top of 12% or to the point where qualified dividends would be taxed. Or not at all, especially if you are getting ACA subsidies. In fact my thought is that if you are converting to the top of 22%, you might want to go to 24%. This helps you make real headway on reducing your tIRA, and the 22% rate is scheduled to return to 25% in 2026.

Bottomline, everyone's case is different, and you shouldn't apply advice given for one situation to yours, without really understanding if that makes sense. Plus not everything stated in these threads is good advice at all.
 
Still Learning said:
What got me into this question of LTC exposure was learning that ROTH IRA funds are just as exposed as savings, SS, pension, stocks and other income producing sources........I am still learning........... that retirement IRA funds are not, beyond withdrawals and RMDs. So just started investigating trusts again and still find them to be a bit complicated and only partially successful based on legal websites pending our first consultation with an elderly care legal firm. We should be able to self fund what we eventually need.

Believe the overall concept of converting to Roth IRAs makes sense for us. Currently in the 12% tax bracket vs 35% when working and 22% in a few years time as our income stream from current and new investments continue to increase.
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Note you must already be taking distributions from them for traditional retirement accounts not to be counted as an asset:

"Medicaid will count your IRA or 401k as an available source of funds to pay for your care, unless it is in payout status. 'Payout status' means that you are taking at least the required distribution out of your plan on a monthly basis. If your IRA account is in payout status, the monthly payment will be counted as income, thereby impacting the Medicaid income limits."

https://www.kobricklaw.com/can-medicaid-take-your-ira/

Medicaid will come after your estate to recover LTC costs so be sure those accounts have a named beneficiary other than your estate.

EDIT: NY does not go after anything other than the probate estate after a Medicaid recipient dies.

So assets held jointly with right of survivorship or held in a living trust are not subject to Medicaid recovery after death.

However, when applying for Medicaid in NY there are limits on how much you & your spouse can retain (including jointly held assets & those in a revocable trust) plus income limits:

https://www.medicaidplanningassistance.org/medicaid-eligibility-new-york/

Unless there's specific NY law that protects revocable trusts, an irrevocable trust would normally be needed to protect assets above those limits, but those are not cheap to setup & maintain...e.g. an independent trustee, not you or your spouse, controls distributions via the terms of the trust & the trustee usually is compensated for that trouble.

Final thought:

If you've already taken steps to self-fund 5 years of LTC (each?) I doubt you'll have to worry about any of the above.
 
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@StillLearning

I see posts on this thread supporting Roth conversions generally. And the posters explain how they work, in other words the mechanics and the theory.

But what you don’t see, and you should ask for, is for the precise benefit received by people who have executed Roth conversions. How many dollars of benefit, by what date (age) did the Roth conversions provide? And what percentage of net worth were the benefits? This information is absent from posts I see on this site.

Supporters of Roth conversions generally post, “Do it, this is how it works.” Rather than posting, “This is how many dollars Roth conversions have benefited me, and it was material to my net worth by xyz%”.
 
chassis said:
@StillLearning

I see posts on this thread supporting Roth conversions generally. And the posters explain how they work, in other words the mechanics and the theory.

But what you don’t see, and you should ask for, is for the precise benefit received by people who have executed Roth conversions. How many dollars of benefit, by what date (age) did the Roth conversions provide? And what percentage of net worth were the benefits? This information is absent from posts I see on this site.

Supporters of Roth conversions generally post, “Do it, this is how it works.” Rather than posting, “This is how many dollars Roth conversions have benefited me, and it was material to my net worth by xyz%”.
Click to expand...

Apparently you're overlooking my reply to your similar request on another thread:

https://www.early-retirement.org/fo...doing-a-roth-rollover-110106.html#post2637108

As for age, I turned 52 and expect to do Roth conversions every year until I am 72, so one can take the numbers in the above reply and multiply by 20. Oh, and I've already been doing Roth conversions for 5 years, so it's probably more fair to multiply by 25.

As far as percentage of net worth, my policy is to never disclose absolute net worth or income figures for privacy reasons. But if I mention that my net WR% is about 1% of my FIRE stash, you or anyone can probably do some math to get a rough idea of the size of the tax benefit relative to my FIRE stash, which is not my net worth but is in the same ballpark magnitude-wise. My math shows it'll probably be about 8.3% of my net worth (4 months savings / 12 months per year times 1% net WR * 25 years).

I suppose you can argue technicalities with me on whether my post meets your criteria here. Go ahead if you like, but I won't engage with you in that manner.
 
My Roth conversion value proposition is pretty simple. We've been living off of taxable account money since I retired at the end of 2011 so absent Roth conversions, our income would be less than the standard deduction so our tax without Roth conversions is $0.

When I am subject to RMDs at 72, between SS, pension, taxable account income and RMDs we'll be in the 22% tax bracket and if I hadn't done any Roth conversions then we would have been even deeper in the 22% bracket. Over the past 10 years, I've converted almost 1/2 million and paid about 9% on average... a mix of 0% (covered by unutilized standard deduction), 10% and 12%.

So let's say if I hadn't done any Roth conversions that I would have paid 20% on RMDs (part 15% and part 25% assuming that tax brackets sunset as in current statute)... I'm paying 9% now to save 20% or more later... I'm ahead by ~11%.

The math is so simple even a caveman can do it and I don't need a complex model through age 90 to prove the obvious.

But actually, I do have a model through age 100 and if I compare my age 100 projected net worth with Roth conversions vs with none, my net worth is 7% higher with Roth conversions. But that is only counting Roth conversions for 2020 onwards. If I adjust for the Roth conversions that I did prior to 2021, Roth conversions will increase my net worth by almost 20%. I concede that the 20% is a broad brush estimate, but even just the 7% makes it worthwhile.

Now keep in mind, I think it is beneficial in our situation because I'm trading paying tax at 0%, 10% and 12% today to avoid paying 15% or 25% tomorrow. If we were already solidly in the 22% tax bracket and it was a 22% now vs 28% later tradeoff then I think it would still be beneficial, just substantially less so.

From what the OP wrote, they are in the same sweet spot that we are... 12% now vs 25% later.
 
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pb4uski said:
My Roth conversion value proposition is pretty simple. We've been living off of taxable account money since I retired at the end of 2011 so absent Roth conversions, our income would be less than the standard deduction so our tax without Roth conversions is $0.

When I am subject to RMDs at 72, between SS, pension, taxable account income and RMDs we'll be in the 22% tax bracket and if I hadn't done any Roth conversions then we would have been even deeper in the 22% bracket. Over the past 10 years, I've converted almost 1/2 million and paid about 9% on average... a mix of 0% (covered by unutilized standard deduction), 10% and 12%.

So let's say if I hadn't done any Roth conversions that I would have paid 20% on RMDs (part 15% and part 25% assuming that tax brackets sunset as in current statute)... I'm paying 9% now to save 20% or more later... I'm ahead by ~11%.
The math is so simple even a caveman can do it and I don't need a complex model through age 90 to prove the obvious.
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@Chassis - you now have a real life math example. The actual work involved in the process is also simple. Only ACA subsidies are preventing me currently from Roth converting.
 
chassis said:
McQuarrie is one author on this topic.
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An author with dubious credentials on the topic of Roth conversions. See my post:

https://www.early-retirement.org/fo...ng-roth-conversions-109662-2.html#post2625341

Kitces, an author with better credentials on the topic of Roth conversions (see https://www.linkedin.com/in/michaelkitces), appears to disagree with McQuarrie. See for example:

https://www.kitces.com/blog/tax-rat...taxable-income-liquidations-roth-conversions/
 
@pb4uski I don't see that you are accounting for the growth of that money you have given up to pay taxes. The growth of that money that you no longer have, could account of the $ difference in the tax rate of now vs. later.
 
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SecondCor521 said:
Apparently you're overlooking my reply to your similar request on another thread:

https://www.early-retirement.org/fo...doing-a-roth-rollover-110106.html#post2637108

As for age, I turned 52 and expect to do Roth conversions every year until I am 72, so one can take the numbers in the above reply and multiply by 20. Oh, and I've already been doing Roth conversions for 5 years, so it's probably more fair to multiply by 25.

As far as percentage of net worth, my policy is to never disclose absolute net worth or income figures for privacy reasons. But if I mention that my net WR% is about 1% of my FIRE stash, you or anyone can probably do some math to get a rough idea of the size of the tax benefit relative to my FIRE stash, which is not my net worth but is in the same ballpark magnitude-wise. My math shows it'll probably be about 8.3% of my net worth (4 months savings / 12 months per year times 1% net WR * 25 years).

I suppose you can argue technicalities with me on whether my post meets your criteria here. Go ahead if you like, but I won't engage with you in that manner.
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I realized I made two mistakes in the above.

First, I rounded down from 4.11 months to 4 months.

Second, I used net WR% instead of gross WR%. My gross WR% is currently 1.96%.

So the actual FIRE stash benefit is 4.11 / 12 * 1.96 * 25 ~= 16.8%.
 
I’m specifically looking at a mega back door. We both contribute the max to our 401k /roth 401k (50/50 split to max dollar amount) and our earned income is too high for a traditional Roth (although we both have them, and contributed before our incomes caught up with us).

Honestly, I’d even be open to “just” a back door Roth if I could keep taxes below our max income tax rate.
 
turbo89 said:
I’m specifically looking at a mega back door. We both contribute the max to our 401k /roth 401k (50/50 split to max dollar amount) and our earned income is too high for a traditional Roth (although we both have them, and contributed before our incomes caught up with us).

Honestly, I’d even be open to “just” a back door Roth if I could keep taxes below our max income tax rate.
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Neither the backdoor nor the mega-backdoor will affect your taxes (for better or worse) in the current year.

That may or may not address your question "I’m not sure I quite follow how I avoid paying addition income tax on this?"

If it doesn't help - can you be more specific about your concern(s)?
 
RetiredHappy said:
@pb4uski I don't see that you are accounting for the growth of that money you have given up to pay taxes. The growth of that money that you no longer have, could account of the $ difference in the tax rate of now vs. later.
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It doesn't matter... you are falling into a common trap/popular misconception.

Say you have $10,000 in an tIRA and $2,000 in taxable accounts and your tax rate is 20% and your investments grow at 7% annually.

One choice is to Roth convert where you end up with $10,000 in a Roth and the taxable account is used to pay the $2,000 tax bill. After 10 years at 7% the $10,000 Roth has grown to be a $19,672 Roth that can be spent.

Alternatively, you don't convert. Over the 10 years, the $10,000 tIRA grows to $19,672. Meanwhile, the $2,000 taxable account grows to $3,449 (growth is less because each year's 7% get's taxed at 20% so the after-tax growth is 5.6%). If you withdraw the $19,672 tIRA to spend, pay the 20%/$3,934 in tax, at the end you only have $19,187 to spend ($19,672+$3,449-$3,934).

You actually come out ahead with the Roth because you avoid tax on the taxable account earnings... so where is this alleged growth that you are so concerned about? :D

Let's say that there isn't tax on the taxable account earnings, so over the 10 years it grows to be $3,934.... after you withdraw the $19,762 tIRA and pay the 20%/$3,934 in tax you have $19,672 left to spend... the exact same as the Roth.

So the Roth comes out better for the tax avoided on the taxable account growth if you don't convert.

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... run the numbers for yourself and see.

So this simple example proves that you come out ahead even if the tax rate is the same then its pretty easy to see that if the tax rate is lower today that you come out further ahead... no complex models needed!
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$19,672 = $10,000*(1+7%)^10
$3,934 = $2,000*(1+7%)^10
$3,449 = $2,000*(1+7%*(1-20%))^10
 
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SevenUp said:
Neither the backdoor nor the mega-backdoor will affect your taxes (for better or worse) in the current year.

That may or may not address your question "I’m not sure I quite follow how I avoid paying addition income tax on this?"

If it doesn't help - can you be more specific about your concern(s)?
Click to expand...



Yea, I guess I’m just a bit confused and need to read a bit more on back door conversions. I got the impression that a back door conversion was taking money from a tax advantaged account (e.g. 401k) and placing it in a Roth account (tax free growth), without penalty /fees.

This article seems to imply I can do that conversion “and then some”, up to $58k. It seems like this would increase my out of pocket tax amount by the excess amount I converted?

I think I’m mostly confused about how I would convert “extra money” (beyond my 401k contribution limit),
 
I don't think we have enough information about OP's overall financial picture to make informed guesses. OP needs to define the goals - the reason for Roth Conversions is tax arbitrage, trying to convert at low rates to avoid high rates later. Converting huge chunks all at once seems the opposite of that.

Chassis mentioned the Bogleheads Retiree Portfolio Model, that is an excellent tool, (though the input is a bit quirky, you have to be patient and read the instructions). If you go to the Bogleheads site their wiki has a link to the regular version and with search for a thread by BigFoot48, you will find the link to the latest Beta version which has a unique feature that allows you to vary the stock/bond asset allocation in each type of account.

I find that putting your bonds preferentially in your t-IRA greatly reduces the optimum amount of Roth Conversions you should do. As no tool is perfect, I also approximated the same situation in Pralana Gold (it includes has more of the tax code in some respects, but requires manual approximation of the asset allocation optimization) and get the same trend.

If your advisor is not talking to you about your goals - maximizing your security?, maximizing your spouse's security if you die early? maximizing after tax bequests to heirs? maximizing charitable gifts? etc. and then helping you set up a strategy to reach your goal, they are useless.
 
turbo89 said:
I got the impression that a back door conversion was taking money from a tax advantaged account (e.g. 401k) and placing it in a Roth account (tax free growth), without penalty /fees.
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Uh, nope.

The regular Roth back door just allows you to contribute to a Roth IRA via an indirect method when your income is high enough to preclude a direct contribution.

The mega back door Roth just allows you, under certain circumstances, to contribute a lot more to a Roth IRA than the $6K or $7K regular limit by contributing to an after-tax 401(k) account (or Roth 401(k) - not sure which) and then rolling over those contributions to a Roth IRA.

Neither of these two methods allow you to get pre-tax money into a Roth without taxes.

You may be confused because in certain situations a mega back door Roth involves contributing to a 401(k) account. But those contributions are after-tax, not pre-tax because they're made to either an after-tax 401(k) account or a Roth 401(k) account (I'm not honestly sure which - the mega back door Roth came about after I had FIREd - but you could google it).

A regular Roth conversion can be done without penalties or fees, but generates taxable income of the converted amount (which usually results in income taxes).
 
turbo89 said:
Yea, I guess I’m just a bit confused and need to read a bit more on back door conversions. I got the impression that a back door conversion was taking money from a tax advantaged account (e.g. 401k) and placing it in a Roth account (tax free growth), without penalty /fees.
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Taking an amount of money that hasn't been taxed (e.g., what has been in your traditional 401k account for years) and moving that to a Roth account (either Roth 401k or Roth IRA) makes that amount taxable in the year you move it. See the "Roth IRA conversion" article linked previously.

The backdoor (involving IRAs) and mega-backdoor (involving 401ks) processes are indirect but legal ways to contribute new, already-taxed, money into Roth accounts. See those two articles linked previously.

This article seems to imply I can do that conversion “and then some”, up to $58k. It seems like this would increase my out of pocket tax amount by the excess amount I converted?
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Because you haven't taken and won't take any tax deduction for the amounts contributed in either backdoor process, you won't be liable for tax when you convert those amounts.
 
pb4uski said:
It doesn't matter... you are falling into a common trap/popular misconception.

Say you have $10,000 in an tIRA and $2,000 in taxable accounts and your tax rate is 20% and your investments grow at 7% annually.

One choice is to Roth convert where you end up with $10,000 in a Roth and the taxable account is used to pay the $2,000 tax bill. After 10 years at 7% the $10,000 Roth has grown to be a $19,672 Roth that can be spent.

Alternatively, you don't convert. Over the 10 years, the $10,000 tIRA grows to $19,672. Meanwhile, the $2,000 taxable account grows to $3,449 (growth is less because each year's 7% get's taxed at 20% so the after-tax growth is 5.6%). If you withdraw the $19,672 tIRA to spend, pay the 20%/$3,934 in tax, at the end you only have $19,187 to spend ($19,672+$3,449-$3,934).

You actually come out ahead with the Roth because you avoid tax on the taxable account earnings... so where is this alleged growth that you are so concerned about? :D

Let's say that there isn't tax on the taxable account earnings, so over the 10 years it grows to be $3,934.... after you withdraw the $19,762 tIRA and pay the 20%/$3,934 in tax you have $19,672 left to spend... the exact same as the Roth.

So the Roth comes out better for the tax avoided on the taxable account growth if you don't convert.

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... run the numbers for yourself and see.

So this simple example proves that you come out ahead even if the tax rate is the same then its pretty easy to see that if the tax rate is lower today that you come out further ahead... no complex models needed!
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$19,672 = $10,000*(1+7%)^10
$3,934 = $2,000*(1+7%)^10
$3,449 = $2,000*(1+7%*(1-20%))^10
Click to expand...
:) 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!
 
Doing nothing is often the best course, when it comes to money and investing. Since I don’t anticipate being in a higher bracket later in life, I see no advantage to Roth conversions now. YMMV.
 
Thank you Seven / second, that clarifies it quite a bit! I’ll go back and re-read through those links.
 
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