Rollover to a Roth?

[mathjak107]

Corrrect ,if your comparing a traditional to a roth you can squeeze more into the roth because your pre-paying the tax outside it.

but comparing a 401k where you can even up the amounts they work out the same at the end.

by the same token you could pay the tax with money on the traditional from outside the ira and get similiar results.

typically everyone compares by paying the taxes on the roth up front with money outside of it but they always subtract the taxes off the bottom line of the traditional rather then figure those too from outside it.

 

[Sarah in SC]

My partner has about $250,000 in her rollover IRA (all wih Vanguard). Should she rconvertl to a Roth? She is 67 on SS & pension, has no debts and her house is aid for.

Blue, this is where some time with a pro who can look at her specific situation might really come in handy, like someone you can get on an hourly basis. Either a CPA with a financial planning bent (look for the PFS designation) or maybe an NAPFA member CFP.

I like the idea that others have suggested of converting some each year, bumping up to the bottom of a bracket, but I guess I'm of the school that would rather see more of her money stay in traditional than in Roth at this age, barring anything really unusual in y'all's financial structure.

I've counseled my own parents through their 60s not to convert, but your situation might be different.

 

[GrayHare]

What you fail to consider is purchasing power of your dollars today vs. purchasing power of those dollars at some future date after the inflation effect.

I left duration out of the example since it makes no difference. The example *does* take purchasing power into account since it inflates all amounts equally. The $2520 higher net worth with Roth is expressed in inflated dollars; you can remove the inflation if you want (divide by 100), but even then the Roth still gives you more net worth than the tIRA.

 

[pb4uski]

the tax free part may not mean anything if rates are the same.

given the same tax rates and gains the roth and the traditional both would equal the same amount assuming you equal the amounts up .

as an example in the 25% bracket 5000.00 in a roth ,plus the taxes you have to prepay is the same as 6650 pretax in your 401k

if both doubled over time they both yield the exact same bottom line after the taxes on the 401k are paid.

folks always figure this wrong because they prepay the taxes upfront on the roth with money outside the roth . they then try to compare by paying the taxes out of the traditional..

they really end up equalling the same thing at the end of the day.

This is true IF the tax rate during the accumulation phase and the tax rate during the withdrawal phase are the same. However, for many people their tax rate in accumulation will be higher than their tax rate during withdrawal, so for these people tax-deferred or tax-free is preferable.

 

[StuartR]

I left duration out of the example since it makes no difference. The example *does* take purchasing power into account since it inflates all amounts equally. The $2520 higher net worth with Roth is expressed in inflated dollars; you can remove the inflation if you want (divide by 100), but even then the Roth still gives you more net worth than the tIRA.

You only address the asset inflation, while completely ignoring consumer inflation and present day buying power vs. future buying power.

As the inflation ratchets up, the decision to forgo the greater real purchasing power today by tax deferment for the ever diminishing purchasing power later, becomes more prevalent over time.

Put another way, that $2,520 you gain at the end may not buy a stick of gum and will ultimately be far less valuable than the value of the money you use today that is not paid to the tax man today.

To neglect the effect of consumer inflation over time due to currency debasement is missing a big piece of the equation in the decision to go Roth or not.

 

[kaneohe]

There actually are 2 cases to consider in comparing Roth vs Traditional

I. Funds are limited to income only ....cash poor..only have 5K income
I.A. TIRA....contribute 5K; TIRA doubles to 10K; cashout and pay 25% tax
of 2.5K leaving you with 7.5K
I.B. Roth....contribute 3.75K; pay 25% tax of 1.25K; Roth doubles to 7.5K
I.Results TIRA = Roth

II. Funds are unlimited...have savings in addition to 5K income
II.B. Roth.....contribute 5K; pay 25% tax of 1.25K on income depleting outside funds by that amount; Roth doubles to 10K
II.A. TIRA....contribute 5K; also have extra 1.25K in outside funds compared to case II.B
TIRA doubles to 10K; extra 1.25K doubles to 2.5K
Cashout TIRA and pay 25% tax of 2.5K; cashout side fund and pay Tax on
appreciation of 1.25K
After tax result is 10K TIRA - 2.5K tax + 2.5K side fund - tax on 1.25K =
10K - tax on 1.25K
II. Results: Roth beats TIRA by amount of tax on 1.25K

........so depending on which assumption you make (I...limited funds)
vs II (unlimited funds), the Roth is either equal to or better than TIRA
if tax rates are the same

Exactly the same math holds for Roth conversions depending if you are paying conversion tax from the TIRA or from outside funds.

 

[haha]

they really end up equalling the same thing at the end of the day.

Mathjak, always certain, sometimes right.

The guy who did a balance sheet example above showed that it is foolish to pay the tax with the converted money, but he did account for the tax.

Ha

 

[kaneohe]

I could understand a big argument about whether to save or spend during a period of high inflation. I don't see what role inflation plays when you are comparing TIRA vs Roth. It's not like you're going to be spending out of either in the interim and even if you were, you would spend equal amounts (adjusted for taxes) out of both.

 

[mathjak107]

This is true IF the tax rate during the accumulation phase and the tax rate during the withdrawal phase are the same. However, for many people their tax rate in accumulation will be higher than their tax rate during withdrawal, so for these people tax-deferred or tax-free is preferable.

yep we agree there, thats why im not in favor of anyone shooting recommendations from the hip out to folks to just do a roth.

not a heck of alot of americans are going to be in a higher bracket when not only one but 2 paychecks stop.

even if rates are the same the fact that more income passes through at lower tax rates each year still puts the traditional ahead.

i said it right that time lol....

 

[mathjak107]

Mathjak, always certain, sometimes right.

The guy who did a balance sheet example above showed that it is foolish to pay the tax with the converted money, but he did account for the tax.

Ha

well heres my numbers

putting 6675 pretax in a 401k is the same as 5k in a roth with 1675 going for taxes upfront, in the 25% bracket.

if things double the roth has 10k , the 401k has 13,350

13350 less 25% for taxes is 10k after tax.


if taxes stayed the same the 401k would be ahead since more of it over the years would go through at lower tax rates.


if you compare putting 5k in a traditional vs 5k in a roth then you would have to take the extra 1675 used for prepayment of taxes

in the roth and invest it outside the traditional. you would need to find something tax advantaged but even so there will be some taxes so that case would favor the roth but 401k vs roth doesnt have that problem

 

[packrat44]

I could understand a big argument about whether to save or spend during a period of high inflation. I don't see what role inflation plays when you are comparing TIRA vs Roth. It's not like you're going to be spending out of either in the interim and even if you were, you would spend equal amounts (adjusted for taxes) out of both.

Congress-critters can effectively raise the tax rate by not adjusting the tax brackets for inflation. This way they can say they are not raising taxes, but people will gradually (or not so gradually) will be moved into a higher tax bracket.

Not adjusting for inflation the income level when SS benefits become 50% or 85% taxable is an example how inflation can lead to higher taxes.

 

[mathjak107]

they could do alot of things but if i had to guess ,with 80 million of us any political party would have to be nuts .

dont forget we arent just 80 million people ,we are 80 million old crotchety people.

 

[packrat44]

they could do alot of things but if i had to guess ,with 80 million of us any political party would have to be nuts .

dont forget we arent just 80 million people ,we are 80 million old crotchety people.

They have not adjusted the brackets for inflation for when SS benefits become taxed. Therefore, they must figure those 80 million are asleep at the wheel or too stupid to realize what is taking place. ATM also comes to mind when thinking what damages can be caused by inflation.

 

[haha]

No doubt we can both do arithmetic, but for someone with more than hand to mouth means, he would put $5000 in either the Roth or a 401K or TIRA, and pay the tax on that $5000 from his taxable accounts. The same arithmentic holds for a conversion which is what was being discussed. Then to make the comparison we must go down the road a bit, and look at what remains of that money in each case. In the Roth case, we start with $5000 in the Roth, and nothing in our bank account. In the TIRA, we start with $5000 in the TIRA, and $1250 in our bank account. Assume a return, which of course will be higher in both the Roth and the TIRA than it is on the bank account because we won't have the drag of taxes each quarter, then go out a few years, tax what is in the TIRA and compare the balances of each strategy.

You do it if you are interested. I usually do these things once, and then go on to to other things. If I am right or wrong, this issue is settled for me, barring law changes.

Ha

 

[steelyman]

My employer (academic) first offered Roth 403(b) accounts in 2008. Since 1994, I had contributed the maximum to a traditional (tax-deferred) 403(b) plan. When the Roth became available, I jumped immediately and went all-in with the Roth from then until I left work in 2011. The split between the two accounts presently is about 2:1 (trad/Roth).

I'm ambivalent about embarking on any conversions between the two, and I think it is relevant that I do not have any kids - it's quite possible whatever happens to be left ends up going to charity. I can see the points being made here and in many other similar threads about conversion strategies, so no problems there. But I think for me, I'll just sit pat and use the resources (when they are available, which is a few years away) to retain some flexibility with taxes.

 

[JoeWras]

I'm ambivalent about embarking on any conversions between the two, and I think it is relevant that I do not have any kids - it's quite possible whatever happens to be left ends up going to charity. I can see the points being made here and in many other similar threads about conversion strategies, so no problems there. But I think for me, I'll just sit pat and use the resources (when they are available, which is a few years away) to retain some flexibility with taxes.

Similar for me. I do not have a Roth yet. I'm still w*rking.

I looked at backdooring, but the conversion of my tIRA would be slammed at 28 or 33%. I also would have had to roll over my roIRA from an old 401k back into my current 401k to make backdooring possible. Blah. Not sure I want all the eggs in that basket. I like the flexibility of a variety of accounts.

This discussion has been good though, because it has opened up my eyes to doing some conversions once I FIRE. Didn't consider that previously. I'll have that period before 59.5 to generate income from these deferred accounts. I could do conversions while still tapping a taxable account to live. Don't need the IRA money, but would like to draw down the account so RMDs don't kill me later.

At least I kind of like the idea of converting during that pre 59.5 period instead of the 72(t) which is very restrictive.

 

[ronocnikral]

Similar for me. I do not have a Roth yet. I'm still w*rking.

I looked at backdooring, but the conversion of my tIRA would be slammed at 28 or 33%. I also would have had to roll over my roIRA from an old 401k back into my current 401k to make backdooring possible. Blah. Not sure I want all the eggs in that basket. I like the flexibility of a variety of accounts.

This discussion has been good though, because it has opened up my eyes to doing some conversions once I FIRE. Didn't consider that previously. I'll have that period before 59.5 to generate income from these deferred accounts. I could do conversions while still tapping a taxable account to live. Don't need the IRA money, but would like to draw down the account so RMDs don't kill me later.

At least I kind of like the idea of converting during that pre 59.5 period instead of the 72(t) which is very restrictive.

It should be pointed out that many people above the thresholds for contributing to a deductible IRA and wanting to "Save" some money face a decision of leaving in a taxable account, contributing to a non-deductible IRA or investing in a Roth, neither will change the amount of taxes due. If one is able to invest directly to the Roth (or can go backdoor without bringing any other taxes due on other IRA's), the contributions are always "available" tax and penalty free (5yr wait if you convert). To me, this is the best of both worlds, tax "free" growth and preserving some flexibility. The decision is almost made for you.

Some years we are over the direct Roth contributions, and only my wife will will convert a non-deductible IRA since she has no other traditional/rollover IRA's and "my" contribution gets stuffed into our taxable account. Other years we can contribute directly and we both do so.

And just to be clear, if you plan to convert pre 59.5, you'll have to do so 5 yrs in advance to avoid making an IRS auditor's day.

 

[JoeWras]

And just to be clear, if you plan to convert pre 59.5, you'll have to do so 5 yrs in advance to avoid making an IRS auditor's day.

We're already contributing to non-deductible IRA. I've been filing that paperwork for something like 15 years, so once I did it, I've continued. So, there's a lot there to backdoor. Problem is the gains and earlier deductible contributions, along with a roll-over IRA, would have to be proportionally declared on the backdoor, so I'm holding off on that. So, the idea is to push it off until j*b income goes away.

As for your 5 yr comment... I'm a bit confused. I'm not planning on withdrawing from the roth until much later, past age 70 or so. Your comment about "IRS auditor's day" would be if I was withdrawing from Roth at 59.5, right? In other words, I'm going to keep that 5 year buffer well beyond 59.5 for the Roth.

 

[ronocnikral]

I apologize if I wasn't clear and misread your statement. I thought when you were talking about converting and not doing a 72t, you meant you wanted to convert to roth and then use that money pre 59.5. You can do so, usually if you wait 5 yrs. Once you reach the magic age and you have at least one Roth IRA account established for 5 yrs or more, you can convert one day and withdraw the next (which would make me question why one would do such a thing, but it is in the cards).

i'm in the same boat due to a rather large rollover ira which would mean I would have to do the conversion pro-rata. That is why I just put the money in a taxable account if I am over the Roth contribution limits. I find the taxes paid along the way are worth the flexibility over the non-deductible IRA (which without the ability to convert directly to a Roth, turns me off).

 

[JoeWras]

No worries, ronocnikral.

Really, what is comes down to for me is leveling out that deferred income from FIRE until the end. I'm going to have this pre-59.5 time in which I can bring some of that income back at reduced tax rates from what I have today.

Like you, I have a variety of accounts, both taxable and deferred to play with. I'm fortunate that I can do conversions without tapping any of that converted money.

The joys of optimizing many variables at one time.

 

[Sirka]

conversion once I FIRE

This discussion has been good though, because it has opened up my eyes to doing some conversions once I FIRE. Didn't consider that previously. I'll have that period before 59.5 to generate income from these deferred accounts. I could do conversions while still tapping a taxable account to live. Don't need the IRA money, but would like to draw down the account so RMDs don't kill me later.

+1
this is my view exactly. It does not make sense to me, to convert to Roth and pay higher tax before FIRE, assuming lower taxable income and lower taxes then.

 

[devans0]

You can do so, usually if you wait 5 yrs. Once you reach the magic age and you have at least one Roth IRA account established for 5 yrs or more, you can convert one day and withdraw the next

As I have understood IRS rules, there are two 5 year rules.

First 5 year rule is that a Roth IRA has to be started 4 years plus the partial year of the first Roth's implementation. Other Roths started go back to this date so if you are working and not sure, start a beginning Roth to get the clock ticking down.

The second 5 year rule deals with conversions. Each conversion starts a new 5 year clock. If you convert starting at 59.5 years old, you have to be 64.5 years to be able to get the gains tax free. If you also convert at 60.5, then you have a third clock running to 65.5 ticking concurrently. I have read conflicting things about the partial year being rounded up for this rule!

I am planning do the bucket approach to Roth conversions. YMMV.

 

[ejw93]

I think staying within the 15% bracket with the conversions is a good idea, ESPECIALLY if your partner has family/heirs to pass unused Roth funds to from the estate.

 

[kaneohe]

As I have understood IRS rules, there are two 5 year rules.

First 5 year rule is that a Roth IRA has to be started 4 years plus the partial year of the first Roth's implementation. Other Roths started go back to this date so if you are working and not sure, start a beginning Roth to get the clock ticking down.

The second 5 year rule deals with conversions. Each conversion starts a new 5 year clock. If you convert starting at 59.5 years old, you have to be 64.5 years to be able to get the gains tax free. If you also convert at 60.5, then you have a third clock running to 65.5 ticking concurrently.

I am planning do the bucket approach to Roth conversions. YMMV.

see the flow chart on p. 63 http://www.irs.gov/pub/irs-pdf/p590.pdf

Once you turn 59.5 y.o., the only clock that matters is the 5 yr clock of the oldest Roth. If you have a pre-existing older Roth (>= 5 yr old), the conversion clocks don't matter unless, of course, they are the oldest Roth.

 

[ronocnikral]

As I have understood IRS rules, there are two 5 year rules.

First 5 year rule is that a Roth IRA has to be started 4 years plus the partial year of the first Roth's implementation. Other Roths started go back to this date so if you are working and not sure, start a beginning Roth to get the clock ticking down.

The second 5 year rule deals with conversions. Each conversion starts a new 5 year clock. If you convert starting at 59.5 years old, you have to be 64.5 years to be able to get the gains tax free. If you also convert at 60.5, then you have a third clock running to 65.5 ticking concurrently. I have read conflicting things about the partial year being rounded up for this rule!

I am planning do the bucket approach to Roth conversions. YMMV.

as kaneohe points out, this is not correct. There are qualified distributions and non-qualified. It is important to note the rules pertaining to each of these distributions. Generally speaking, non-qualified is any distribution taken before age 59.5 (with some exceptions of course).

These rules are often muddled in the world wide web. Another example is people often think direct Roth contributions cannot be withdrawn for 5 years. This is not true either.