Obviously a naive question, what's the logic flaw?

[GoodbyeYellow]

DW is in a funk because we (62, 59) didn't use Roth all these years, mainly as we didn't pay attention but also because for the last 10 years or so, our AGI exceeded the limit. We now have a rather large nest egg, 2/3 of it in a tIRA, roughly evenly split) and the balance in joint brokerage. Our withdrawal rate to support expenses should be under 3%. A small amount has been IRA-invested post-tax, which will be converted to Roth, but it's relatively minor.

While trying to placate her I came up with the following example. Yes it uses some assumptions but calcs of this type usually do. I understand tax rates may rise (is this guaranteed?), one spouse may die, placing the other in a Single (higher) bracket, etc. But these are maybes.

Base assumptions:
- $1M starting amount in either case
- Invest for a period of 10 years, withdraw entire amount at that time, pay any applicable taxes.
- 7.2% growth rate (for easy computation using rule of 72, so that money doubles).
- (Fed+state) tax rate 33.33%, again for easy computation. Stays steady.

Scenarios:

a) tIRA:
Year 0: Invest $1M
Year 10: value doubles to $2M
Pay $666.7K taxes
Take home $1.333M

b) Roth:
Year 0: Invest $666.7K after paying taxes on $1M
Year 10: value doubles to $1.333M, all of it take home

Take-home difference is zero.
Yes I'm sure there's a flaw or three, so please be kind.

 

[clobber]

No flaw. Traditional and Roth are the same if the tax rates are constant.

 

[Sunset]

OP - calculate what your tax rate will be at age 72 (when you add in SS, and RMD's from IRA and 401Ks).
For simplicity I just take my existing tax return, keep what I would have if I was 72 (divs, interest, but no work), and add in today's SS, and the RMD amount.
Everything is in today's dollars, but gives a good idea.

If you have lower tax rates before then, you could do some conversions, or at least do some IRA withdrawals (when past 59.5).

 

[donheff]

I regret not evaluating this more carefully years back. DW and I could probably have benefitted from some Roth conversions over the last 10 years. If one of us dies and the other has to do all of the RMDs as a single taxpayer, the hit will hurt. But, since our AGI over the last decade was relatively high I suspect the advantage of conversions would have been limited.

 

[CRLLS]

DW is in a funk because we (62, 59) didn't use Roth all these years, mainly as we didn't pay attention

[snip]

I understand tax rates may rise (is this guaranteed?), one spouse may die, placing the other in a Single (higher) bracket, etc. But these are maybes.

We too did not contribute to Roth IRA's favoring the tax deduction while working. I should have paid attention back then. We grow too soon old and too late smart. Oh well! We are doing Roth conversions now. Due to the recent Bull Markets, we are getting behind every year, leaving more and more in our tIRAs. But we keep trying.

I think it is a given that tax rates will increase. Even if nothing happens before then, the current low rates will expire on December 31st, 2025 and will revert to previous rates. Guarantee? Nothing in life is guaranteed.

As for one spouse dying, again, pretty much a given that one will predecease the other unless there is an accident where both go at once. the question is more likely when and for how long will the surviving spouse be filing single.

 

[RunningBum]

OP, you are probably better off having contributed to the tIRA while working, and if you are retired now or will soon you have a great opportunity to convert.

Figure out what your tax rate was while working, what it is in early retirement, and what it will be once you start SS and have RMDs at 72. Chances are that they were highest when working, lowest in ER, and in the middle after age 72. Plus those tax rates into your example and you'll see that the tIRA was best while working, so you made the right choice there. Now, you compare ER with post-72, and you see that Roth is better now, so do partial conversions every year to try to even out the tax rate for the rest of your life.

 

[pb4uski]

Your analysis is spot on... if the tax rates are the same and the money to pay the taxes is taken from the conversion/contribution, then there isn't any difference. If the money to pay the taxes comes from taxable funds, then the Roth conversion comes out slightly ahead because you avoid taxes on the growth of the taxable funds... I posted an example of that below.

Where the big benefits for Roth conversions are is where you can convert at lower rate today and avoid paying a higher rate later... especially where one is in the 12% bracket in early retirement and expect to be in the 22% tax bracket once pensions, SS and RMDs are all online.

Your situation of having 2/3 in tax-deferred is very common. The option to invest in a tax-free Roth wasn't available for almost half of my career and once it was available I was earning too much to contribute. We were 44/53/3 taxable/tax-deferred/tax-free when I retired and despite aggressive Roth converting since ER we are 12/60/28 today as our tax-deferred account are growing faster than I can convert at a low tax cost. Since I pay the taxes from taxable it effectively shifts taxable account money to tax-free.

I view it this way... when I deferred that income I did so because I thought that our income and tax rate in retirement would be much lower than it was while we were working so we would benefit from lower tax rates in retirement. As it turns out we were much more financially successful than we expected at the time we deferred that income, and the tax rate difference is not near as beneficial as we anticipated. What's the problem with that? It's a nice problem to have.

 

[pb4uski]

From https://www.early-retirement.org/forums/f28/is-roth-conversion-worth-it-110776-2.html#post2659354

... 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?

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!
---------------------------------------------------------------------------------------------------
$19,672 = $10,000*(1+7%)^10
$3,934 = $2,000*(1+7%)^10
$3,449 = $2,000*(1+7%*(1-20%))^10

 

[OldShooter]

A Roth is basically tax rate arbitrage but with a lot of side effects.

 

[sengsational]

The assumptions of ones model will typically drive the action you take. And making a play one way or the other will often not make that much difference on a percentage basis. Given large balances, the differences in dollars can seem significant, though. The more aspects your model considers, the more likely it will match the future (or one would hope to assume). Another way to say that is a simple model might not be that great. This is a long way to suggest using various models, all with the same inputs and assumptions (as best you can) and then select the action you were going to go with before all your research

 

[ivinsfan]

Why are you trying to placate your spouse? In the fog of work, raising kids, maybe helping parents S#$t happens. If your biggest problem at your age is a not having a big Roth you are truly blessed.


I don't like paying taxes either and we messed up some of that along the way but hey who's perfect.. I've got a perfect storm coming in 9 years when interest included we'll have well have at least 6 digits of I bonds maturing, two RMD's, SS payments, and farmland rent to pay taxes on.



We'll be 83 and 79 by then and if we are both still here I'll just write the check without much nail biting. If we're not here our DD's can worry about it.

 

[SnowballCamper]

I know the Roth account is popular here and in the press, and there are generally some marginal gains when you are on a long timeline. But they rely on getting your assumptions about the future right (tax rates, living long enough...), and in that way it's a bit of a gamble.

FWIW, with the current low rates on investment income when you're making ~80k or so, I wonder why I bothered with the deductible IRA for all those years in order to have to pay regular income rates on all the gains. This topic doesn't get as much attention as the Roth for some reason... I think because it's behind us, and there is not much to do about it.

I'd try to shift the conversation toward the future. You've got about ten years to get that tIRA balance down before RMDs kick in. Take more of it out now (do conversions if you want/can)... or you might be having a similar conversation about "why we didn't spend the tIRA down before RMDs put us in this ridiculous tax bracket."

Good Luck!

 

[finnski1]

Your analysis is spot on... if the tax rates are the same and the money to pay the taxes is taken from the conversion/contribution, then there isn't any difference. If the money to pay the taxes comes from taxable funds, then the Roth conversion comes out slightly ahead because you avoid taxes on the growth of the taxable funds... I posted an example of that below.

Where the big benefits for Roth conversions are is where you can convert at lower rate today and avoid paying a higher rate later... especially where one is in the 12% bracket in early retirement and expect to be in the 22% tax bracket once pensions, SS and RMDs are all online.

Your situation of having 2/3 in tax-deferred is very common. The option to invest in a tax-free Roth wasn't available for almost half of my career and once it was available I was earning too much to contribute. We were 44/53/3 taxable/tax-deferred/tax-free when I retired and despite aggressive Roth converting since ER we are 12/60/28 today as our tax-deferred account are growing faster than I can convert at a low tax cost. Since I pay the taxes from taxable it effectively shifts taxable account money to tax-free.

I view it this way... when I deferred that income I did so because I thought that our income and tax rate in retirement would be much lower than it was while we were working so we would benefit from lower tax rates in retirement. As it turns out we were much more financially successful than we expected at the time we deferred that income, and the tax rate difference is not near as beneficial as we anticipated. What's the problem with that? It's a nice problem to have.

This all makes perfect sense to me and I think what happened to a lot of us who are in our 60's

 

[jazz4cash]

Why are you trying to placate your spouse?

Are you married??

 

[RetiredHappy]

We don't have any ROTH and are happily retired. We also have no intention of doing any ROTH conversions in the future. We have equal amounts in tax deferred and taxable accounts. There is no right or wrong answer.

 

[ivinsfan]

Yes I'm married and female,perhaps it's the word choice combined with the word funk. What's done is done. Have an honest discussion with spouse about conversations and then leave her to get over it.

 

[Montecfo]

Best choices can often be determined in retrospect.

We did a Roth conversion while still working years ago when in a low tax bracket one year. We were rarely able to contribute otherwise. We are close to 2/3 tax deferred and I think we made the right choices.

I think it is easy to wish you had more in Roth, while not recognizing the cost of doing so.

With tax deferred, you get a shot at Roth conversions. But you can't convert a Roth back. It's a one-shot deal.

 

[GoodbyeYellow]

Are you married??

OP here...This is the best answer!

OK I jest, because the analyses and responses from all of you are very useful and thought-provoking.

I have considered, deeply, the conversion to Roth upon retirement. For those so inclined, in my other recent posts I refer to a plan for using ACA for the next 6 years. This obviously puts a glitch in that plan, as it is either have a high-ish MAGI or avail of ACA, but can't do both. As a result this has become my main sleep thief lately. BTW we have to decide in about a month, both due to open enroll as well as some personal things going on.

An FP (from Fido) we talked to said we should say 'bugger all' to ACA and live high off the hog, paying full market prices. But here's how I look at it (in general terms, trying to avoid too many references to dollar figures for brevity).

We can already support our current standard of living on an ACA-friendly MAGI IF we play the other cards right - harvesting tax losses, using cash on hand, and... wait for it... cashing in much of that smallish Roth balance we do have.

For us, living high off the hog would mean some $40K more spending per year. I'm not even sure we can do that unless we get into capital expenditures, like a new car, new systems for the house, etc. Decent vacations are already in the budget, and we could up it to First Class but...

So a $40K spend would (separately) increase health care spending by up to $25K (maybe more?), making the need = $65K. Pre-tax we are looking at $85-90K additional withdrawals (very rough math for now) per year, additional. Add Roth conversions to this and it goes up accordingly, but of course that's goodness in general.

Doable? Yes. Desirable? I don't have an answer yet. Frugality is what got us here (to a comfortable nest egg) and I think most, if not all, of you will identify with that. Some of my friends from work... not so much. I know a guy who's 64, has had financial stress for at least 30 years now, got laid off about 3 years ago (planned to work till 75 but can't find well-paying work, surprise), has negative net worth in the mid-six figures, and still doesn't get frugality. Probably never will. I have tried to help him, including lending him money (which I got back after some effort and much time), and with advice, but it doesn't take.

I digress, back to the $40K. The view I am taking is this: go in for the ACA-level earnings, and if life throws a curve ball in any given year or years, just dip into the nest egg and go on with life, ACA be damned.

Also - and I hesitate to add a question this late in the thread - the plan is for 6 years (till she turns 65), and funding has been calculated for that period. However, I would go on Medicare in 3 years, and we may need to reassess at that point. It may be that subsidies are not enough incentive to continue ACA, maybe we've blown through more cash than I expected, maybe, maybe. At least we would have gotten the 3 years of low health care spending. Is this wacky thinking?

I appreciate also those who chimed in with similar "Rothless" stories, it really helped. As I told my kids years ago, whatever you are experiencing, it is certain that someone, somewhere, sometime, has been through the same thing. The internet, for all its evils, has made learning about this so much more possible.

 

[GoodbyeYellow]

Yes I'm married and female,perhaps it's the word choice combined with the word funk. What's done is done. Have an honest discussion with spouse about conversations and then leave her to get over it.

No offense intended, perhaps could have used a better word.

She carries a lot of financial insecurity from her childhood, having been dad-orphaned and raised by her mom in a time and place not at all friendly to working women, to put it mildly.

 

[ivinsfan]

No offense intended, perhaps could have used a better word.

She carries a lot of financial insecurity from her childhood, having been dad-orphaned and raised by her mom in a time and place not at all friendly to working women, to put it mildly.

I get it, I grew up in a poor enlisted man military family. I wouldn't trade it as it gave me many good things, but childhood was pretty much Mom and Dad squeezing every penny. I would let your wife adjust on her terms as that's the way it has to happen for me, I have to think it through on my own.


In fact my DH is pretty analytical like you and if he waves something in front of my face and says, Look, it just makes things worse.



Your ACA issues aren't helping with any of this either. You know ACA income is one year at a time, if you look at that way it's much easier to stress less about the decision.

 

[Time2]

I'm in the same boat as several above, I had many years in low tax brackets and still used tIRAs. I just didn't know at the time.