Roth IRA doesn’t seem good

[RunningBum]

You still could have done backdoor Roths, for you and your spouse. (Just mentioning this for anyone who may still be in that situation). When doing a backdoor, you're using money that you've already HAD to pay tax on, so at that point the only question is "Do I want this to grow tax-free, or do I want it in a taxable account"? The math is pretty easy on that one. Wish I'd learned about backdoors earlier!

[-]
You'll have to show me the easy math. If I'm in a high tax bracket while working, and expect to be in a lower bracket in retirement, how does the math work out to be better to pay taxes on the conversion at the higher rate?[/-]
Never mind, I was mistaken, see the next 3 posts.

 

[Curmudgeon]

You'll have to show me the easy math. If I'm in a high tax bracket while working, and expect to be in a lower bracket in retirement, how does the math work out to be better to pay taxes on the conversion at the higher rate?

I'm talking about a backdoor contribution.
Say you have a 401K that you're already contributing to, and/or your income is too high to contribute to a tIRA. After paying taxes, you have $5500 left over (actually $5500 per person, or $6500 per person for those over 50 yrs old). If you put that into a taxable account, then every year when it sheds dividends, or interest, or cap gains, you're going to pay taxes on that. If you backdoor that $$ into a Roth, then all of your future earnings (and withdrawals) are tax free.

 

[kaneohe]

You'll have to show me the easy math. If I'm in a high tax bracket while working, and expect to be in a lower bracket in retirement, how does the math work out to be better to pay taxes on the conversion at the higher rate?

I think Curmudgeon was responding to a different situation.....Jerry1 commented that high income prevented him from contributing directly to Roth so Curmudgeon suggested backdoor Roth.....which, if done properly, doesn't cost anything in taxes since basis only is involved. You might be thinking of converting deductible contributions/earnings.

 

[RunningBum]

I was mistakenly thinking that a backdoor Roth was always a deductible IRA which is then converted to a Roth (and taxed on the conversion). You are talking about making a non-deductible IRA contribution, and then converting to the Roth. No tax on the conversion since it was non-deductible. Carry on.

 

[Curmudgeon]

You are talking about making a non-deductible IRA contribution, and then converting to the Roth. No tax on the conversion since it was non-deductible. Carry on.

Yep. Towards the end of my w*rking years, I was stashing away $13K per year in a Roth this way. Wish I'd known about this, or seen the advantage, earlier!

 

[RunningBum]

How long has the backdoor Roth been around?

 

[Cobra9777]

I think what Animorph means might be something like this:
Assume you have 10K in TIRA and 25% tax rate
1) If you convert TIRA and pay 25% tax from TIRA you end up w/ 7.5K in Roth.
After N yrs, it doubles to 15K vs
2) Leave TIRA alone. After N yrs it doubles to 20K. You pay 25% tax and end up after tax with 15K, the same as Roth conversion in 1) above.

However if you pay conversion tax from taxable account instead, it goes like this. Assume you have 10K in TIRA, 2.5K in taxable acct, and 25% tax rate.
3) You convert TIRA and pay 25% tax from taxable account. You end up with 10K in Roth. After N yrs, it doubles to 20K.
4) Leave TIRA and taxable account alone. After N yrs you end up w/ 20K TIRA and 5K taxable. The TIRA after tax is worth 15K. The taxable account has appreciated 2.5K . You pay 15%CG taxes of 0.37K and end up with 4.63K. You have after tax a total 19.63- K so the Roth is larger. The difference is even larger because the taxable account probably had dividends along the way which were taxed (tax drag). The longer the time period the greater the difference will be.

Basically by using the taxable account to pay the conversion taxes, you were able to stuff more into the Roth to gain the advantage.

Thanks. This topic is very important to me as I'm evaluating possible conversions into the 22% bracket where I don't expect much, if any, benefit from tax rate differentials.

Conceptually, I get it. I've seen people describe Roth conversions as a kind of "transfer" from the taxable account into the Roth. In your example, the $10K tIRA is really only worth $7.5K after tax. So by moving all $10K into the Roth and paying tax from the taxable account, in effect, you have transferred $2.5K from your taxable account into the Roth, where it will live a happy, tax-free life from that point on.

The benefit is equal to the tax that would have eventually been paid on the taxable account were it not "transferred" to the Roth. I set up a simple spreadsheet that also shows the benefit is quite small for conversions up to the top of the 12% bracket and for short periods between conversion and RMD, but then increases to a meaningful amount as you convert into higher brackets with longer periods.

The more difficult problem is calculating the real-world tax drag from the taxable account. If I continue managing income and limiting conversions to the top of the 12% bracket over the next 13-14 years, then I owe nothing on QDs and LTCGs until 70 when RMDs and SS start. But my plan is to nearly exhaust the taxable account by then (the result of deferring SS and tax-deferred withdrawals). So I'm struggling to find the benefit if I never actually pay tax on the taxable account.

What's more, if I convert into the 22% bracket, I immediately pay the 27% incremental rate on QDs and LTCGs. So the net cost on conversion is higher than 22%. And I potentially deplete the taxable account even earlier.

 

[PatrickA5]

How long has the backdoor Roth been around?

Since I think 2010. That was the year the $100,000 income limit on conversions to Roths was done away with. That's when I started doing backdoor Roth conversions.

 

[Curmudgeon]

Ah, guess I only missed a few years then.

 

[cathy63]

How long has the backdoor Roth been around?

The income limit for conversions was repealed for the 2010 tax year. We were able to convert DH's IRA at that time, because it had all after-tax contributions and had not yet recovered from the 2008 recession, so the gains and tax owed were relatively small. We continued to do back door conversions for him as long as one of us was working.

I had rolled over some prior 401Ks, so I have a mix of pre-tax and after-tax money in my IRA and it never did make sense to convert it. Back door conversions aren't really an option in that situation.

 

[rollergrrl]

Who is saying the Roth is so much better? Not sure I have heard that before.

Generally the advice is to max out tax deferred space and then max out the Roth space before contributing to a regular tax account.

The general advice might change for lower income households.

My spouse and I have been maxing our tax deferred accounts and not maxing our Roth accounts. It seems that a lot of main stream financial gurus seem to be recommending to get your match on tax deferred and next max out Roth before maxing the tax deferred. To me it seems better to max out tax deferred assuming fees are reasonable before maxing our Roth.

 

[bada bing]

Why are people saying the Roth is so much better? What am I missing?

That isn't the common advice I see for new contributions. What I've seen is advice that for most people, a deductible contribution is preferable and the first destination for new money up to contribution limits. Exceptions to that rule are people who have lower income and expect their tax rate to go up in retirement.

You still could have done backdoor Roths, for you and your spouse. (Just mentioning this for anyone who may still be in that situation). When doing a backdoor, you're using money that you've already HAD to pay tax on, so at that point the only question is "Do I want this to grow tax-free, or do I want it in a taxable account"? The math is pretty easy on that one. Wish I'd learned about backdoors earlier!

+1
I have seen it described as using your potential "Roth space". There are several ways to get money into Roth space that don't involve any additional taxes. The backdoor and mega-backdoor Roth are two excellent tools to get more money into Roth space that have no additional costs over the alternative of taxable accounts. If you are an average or above earner and have money for long term savings beyond max'ing tax deferred accounts, the backdoor and mega-backdoor Roth are fantastic. If only they had been available all along.

 

[RunningBum]

Since I think 2010. That was the year the $100,000 income limit on conversions to Roths was done away with. That's when I started doing backdoor Roth conversions.

Thanks, I feel better. I was part time by then so I could (and did) make Roth contributions thru the front door by then.

 

[Brat]

As I likely posted in another thread there can be an advantage to converting some $ in a tIRA to a Roth. My DH will be 80 this year, MRDs are fast accelerating. I can manage our taxable income so that our taxable income is slightly below $77,400 - the 12% marginal tax rate for the next couple years. We don't anticipate needing the Roth investments but if we do it will be when our RMDs would be well over 7%/yr and in the 22% marginal rate bracket.

 

[Curmudgeon]

In the end, everyone's financial situation and goals vary; and Roths, TIRAs, and taxable accounts are just 3 different tools that can be used. Cases where Roths may be a useful tool include:
1) When you can't make a deductible contribution but want to shelter future earnings, making backdoor contributions will enable this,
2) When the possibility of future RMDs and/or other income streams in retirement will put you into a higher marginal tax bracket than you're in now, converting or contributing to a Roth will net you tax savings.

But to say that 'Roth is better than TIRA', or vice versa, just doesn't make sense. Use the right tool for the right job.

 

[43210]

Let’s say you have 1 million in a tax deferred account and withdrawal the recommended 4%. That would be $40,000 a year. Taxes on that $40,000 would be very small after you subtract $24,000 for the married standard deduction. So you would only be taxed on $16,000 at 10%.

Why would you rather be taxed now and put the money in a Roth when you are in the 22% or higher tax bracket? Why are people saying the Roth is so much better? What am I missing?

You definitely have the right idea. It's all about choosing paying tax now versus paying tax later, and figuring how to get the better rate.

You just need to be aware (see some examples in thread) that there are a whole bunch of things that make it more complicated, but the basic idea is correct.

My spouse and I have been maxing our tax deferred accounts and not maxing our Roth accounts. It seems that a lot of main stream financial gurus seem to be recommending to get your match on tax deferred and next max out Roth before maxing the tax deferred. To me it seems better to max out tax deferred assuming fees are reasonable before maxing our Roth.

I agree that this advice is common. I've seen it a lot. It is "cookie-cutter" advice, and these so-called "gurus" are doing a disservice by giving it. Actually, getting any employer match is almost certainly the right choice, but what to do next depends on many things, and for a lot of people, going to Roth is not the best choice. It all depends on a bunch of stuff.

 

[karen1972]

As pb4uski said, all things being equal its exactly the same.

Its all a game
1. how much big is your tax deductions (itemization) now vs later (kids, college, mortgage)?
2. how much extra income do you have (current job/bonus/stock options vs. SS and RMDs)?
3. will you retire early and have years you can convert to ROTH at little or no tax?
4. whats your finger wag at what tax brackets will be when you retire.. same, more, less?

In my working years I was always in the 33% plus category, so the likelihood of falling back into the 25% category was very high for me so other than backdoor IRAs just no point until I hit FIRE and now in 15% tax bracket...everything seems like a deal.

 

[Senator]

Let’s say you have 1 million in a tax deferred account and withdrawal the recommended 4%. That would be $40,000 a year. Taxes on that $40,000 would be very small after you subtract $24,000 for the married standard deduction. So you would only be taxed on $16,000 at 10%.

Why would you rather be taxed now and put the money in a Roth when you are in the 22% or higher tax bracket? Why are people saying the Roth is so much better? What am I missing?

Do not count on the low tax brackets of today being there tomorrow. The low bracket could be well over 50% at some point.

 

[exnavynuke]

Let’s say you have 1 million in a tax deferred account and withdrawal the recommended 4%. That would be $40,000 a year. Taxes on that $40,000 would be very small after you subtract $24,000 for the married standard deduction. So you would only be taxed on $16,000 at 10%.

Why would you rather be taxed now and put the money in a Roth when you are in the 22% or higher tax bracket? Why are people saying the Roth is so much better? What am I missing?

Median household income in this country is still in the $5x,xxx/year. Right there in the 15% tax bracket, but likely with a lot more deductions/credits than that same couple would have in retirement (when they no longer get the child tax credits or mortgage deduction etc etc). For people making a "median" income, it's quite conceivable that their tax rate in retirement (especially if they retire at a median retirement age with SS etc) will be at or above their tax rate during the most of their higher earning working years.

That's one reason that many people "should" choose a Roth over traditional (all other things equal).

 

[MrLoco]

Another reason Roth IRA's make sense if one wants to leave money to heirs.
Both Inherited Trad. and Roth IRA's require RMD's by Dec. 31 the year following the original account owner's death using the IRS single life expectancy table.

Roth IRA distributions to heirs will be tax free. Trad. IRA distributions will be taxed at the recipient's current tax rate which can be quite high assuming the person is still working.

Also, the Govt. tried to do away with the "stretch IRA" format allowing a beneficiary to take the distributions from an inherited IRA over their lifetime.
If this option no longer is available, a beneficiary would then be forced to take the distributions over 5 years or as a lump sum.
Now imagine a beneficiary inherits a Trad. IRA valued at $2M and must liquidate the entire amount over 5 years. One heck of a tax bite!
Whereas the entire amount of the ROTH IRA would not be taxed.

 

[EastWest Gal]

Another reason Roth IRA's make sense if one wants to leave money to heirs.
Both Inherited Trad. and Roth IRA's require RMD's by Dec. 31 the year following the original account owner's death using the IRS single life expectancy table.

Roth IRA distributions to heirs will be tax free. Trad. IRA distributions will be taxed at the recipient's current tax rate which can be quite high assuming the person is still working.

Also, the Govt. tried to do away with the "stretch IRA" format allowing a beneficiary to take the distributions from an inherited IRA over their lifetime.
If this option no longer is available, a beneficiary would then be forced to take the distributions over 5 years or as a lump sum.
Now imagine a beneficiary inherits a Trad. IRA valued at $2M and must liquidate the entire amount over 5 years. One heck of a tax bite!
Whereas the entire amount of the ROTH IRA would not be taxed.

You don't have to pull everything out of an inherited IRA over 5 years. There is a calculator to figure out how much you have to pull out each year.

https://www.irs.gov/retirement-plans/required-minimum-distributions-for-ira-beneficiaries

Another cool use of a ROTH IRA: A way to leave money to heirs is to start gifting early, avoiding a 5 year lookback. When your kids start working, they aren't always making much money and they are in a low tax bracket. Help them open a ROTH, then gift them the max amount they can put in it. It helps them build their own retirement and learn about investing, while they are on a low tax bracket, and while they're making too little to put much in investments. This only works if your kids aren't spendthrifts, drug addicts, etc.

 

[Sunset]

Another reason Roth IRA's make sense if one wants to leave money to heirs.
Both Inherited Trad. and Roth IRA's require RMD's by Dec. 31 the year following the original account owner's death using the IRS single life expectancy table.

Roth IRA distributions to heirs will be tax free. Trad. IRA distributions will be taxed at the recipient's current tax rate which can be quite high assuming the person is still working.

Also, the Govt. tried to do away with the "stretch IRA" format allowing a beneficiary to take the distributions from an inherited IRA over their lifetime.
If this option no longer is available, a beneficiary would then be forced to take the distributions over 5 years or as a lump sum.
Now imagine a beneficiary inherits a Trad. IRA valued at $2M and must liquidate the entire amount over 5 years. One heck of a tax bite!
Whereas the entire amount of the ROTH IRA would not be taxed.

Regular stock brokerage accounts are also inherited tax free due to the step up in basis upon death of the owner.

 

[Montecfo]

So the Roth vs tIRA is simple: it depends on alternatives such as matched 401k, tax rate now, and tax rate when you withdraw (if you ever do).

Hard to know future tax rates or tax position as a young person. And single folks get into higher brackets pretty fast. So it is not clear that folks early in their careers should fund a Roth over tIRA. Again, it depends.

Roth conversions as retiree or near retiree are easier to get right, since tax brackets become clearer.

Advantage of a tIRA: it's possible to convert to a Roth. But they do not give you your tax back and let you convert Roth to tIRA.

Calculate well my friends!

 

[dallas27]

Some of us fund our roths with distributions from our companies, and these avoid payroll taxes.

 

[Brat]

My brain is twisting in the wind thinking about Roth IRA vs 529 accounts. At a certain level I wished I had increased my conversions to the IRAs with the intent of using them like a 529- but then when WA had the program where we could buy credit hours now for the future that was a good deal. Ah well, what is done is done. I can still take $ out of our Roth to help with their college expenses when the time comes.