Interesting peek into the future.... Roth vs RMDs

[Perryinva]

@old medic We don’t do QCDs currently either, and our accounts are not that big either, under $2M. We might need it. But I can also see doing them if the heirs are undeserving or abusive. Unless things change, our heirs would waste every cent they get..

 

[junkanoo]

That you keep saying this does not make it true. I will run through your case with actual numbers. We must consider total taxes paid in the two cases: (A) parent converts, (B) parent does not convert.

Let's put the parent at the bottom of the 22% bracket and have the heir $50000 into the 32% bracket. (I chose those because think that makes your case as strong as possible, but I actually think it doesn't matter.) I am using 2025 tax tables.

Case A
Parent pays $11157+0.22*$10,000 = $13,157.
Heir pays =$80398+(50000+0)*0.32 = $96,398.
Total taxes paid: $109,755


Case B
Parent pays $11157+0.22*0 = $11,157.
Heir pays =$80398+(50000+10000)*0.32 = $99,598
Total taxes paid: $110,755

The only thing that changed was whether the parent converted or not. As a direct consequence of this one action or inaction, the difference in taxes paid was $110,755 - $109,755 = $1,000.

Hmm, why the even number? Because [$110,755 - $109,755]/$10,000 = 0.1 which also = 0.32 - 0.22.

So, I could easily be missing some issues but these are the issues I see.

1. "We must consider total taxes paid in the two cases: (A) parent converts, (B) parent does not convert."

No, we must not. In the situation when the parents converts, that's totally on them. No one forced them to pay those taxes. So, every dollar of that decision is taxed at their marginal rate. The way you are doing it (effective tax rate) undermines that reality.

2. You are showing that if the Parents converts they are converting $10k and if they don't convert, the heir is paying $10k. Where is the growth on the investment? Missing that growth does not help your case. I had the T-IRA gift being $1 million for each child, thus a tax consequence of (ballpark) $100k each year. That only led to the heir's effective tax rate moving from 16 to 19%. Which is still below the parent's 22% marginal tax rate.

3. I didn't have to consider it because in my analysis, the parents did no conversions. But, if you're going down the conversion route, it brings more things to consider, such as whether the taxes are being paid out of their taxable or tax-deferred accounts. Then ... what is the missed opportunity on those dollars?

 

[old medic]

@old medic We don’t do QCDs currently either, and our accounts are not that big either, under $2M. We might need it. But I can also see doing them if the heirs are undeserving or abusive. Unless things change, our heirs would waste every cent they get..

Our Son is the one we worry about, If we left anything for his Son He would do his best to get his hands on it to blow it. He already tried talking him into taking money out of savings account to to buy a racing motorcycle.

 

[old medic]

Anyone ever factor in normal contingencies like dying earlier than expected?
I get it that someone on the hairy edge of 1X FI might be trying to optimize a percent here or ther
Back to the Roth vs RMD, I really feel that the RMD and IRMMA problem is a privilege.
Do you want to trade places with them?

Yes and also if we split up. After 42 years and what we already have been through I highly doubt its in the cards.
I guess we are not FI but have a good income stream from pension and SS with a small nest egg that we could stretch out a good way.
IMRRA problem is about nonexistent for us, especially converting everything.....guess its good to be poor.
If you find someone to trade We'll try it... Our Taxable Income has never been 6 digits....

 

[Ronstar]

I turn 71 this year. DW turns 72. RMDs start next year. We did a Roth conversion last year. May do one this year, but it will be our last one if we do decide to do one. I can't see Roth conversions making any sense in our RMD years.

 

[Out-to-Lunch]

So, I could easily be missing some issues but these are the issues I see.

1. "We must consider total taxes paid in the two cases: (A) parent converts, (B) parent does not convert."

No, we must not. In the situation when the parents converts, that's totally on them. No one forced them to pay those taxes. So, every dollar of that decision is taxed at their marginal rate. The way you are doing it (effective tax rate) undermines that reality.

"Must consider" does not mean "Must convert." We "must consider" taxes in order to determine the best course of action.

2. You are showing that if the Parents converts they are converting $10k and if they don't convert, the heir is paying $10k. Where is the growth on the investment? Missing that growth does not help your case. I had the T-IRA gift being $1 million for each child, thus a tax consequence of (ballpark) $100k each year. That only led to the heir's effective tax rate moving from 16 to 19%. Which is still below the parent's 22% marginal tax rate.

If the marginal rate does not change, growth (or loss) is not relevant in the analysis due to the commutative property of multiplication. That is, for principal P, tax rate t, and growth g, [ P*(1+g)] * (1-t) = [ P*(1-t)] * (1+g). We could go through the numerical example with growth involved if you were open to it.

By the way, are you saying that your analysis is not NOT able to capture a case where there is no growth?

3. I didn't have to consider it because in my analysis, the parents did no conversions. But, if you're going down the conversion route, it brings more things to consider, such as whether the taxes are being paid out of their taxable or tax-deferred accounts. Then ... what is the missed opportunity on those dollars?

Yes, paying taxes from other sources brings in additional considerations. An important one whether the overall risk profile of the portfolio changes. My analysis paid the taxes from the conversion to keep the risk profile the same, so as to isolate as best as possible the implications of the decision of whether to convert or not.

But I gather that you have already made up your mind, and are not open to considering mathematical or numerical examples that disconfirm your predetermined beliefs.

 

[junkanoo]

"Must consider" does not mean "Must convert." We "must consider" taxes in order to determine the best course of action.

.... snip

That's not what you wrote. You wrote:

"We must consider total taxes paid in the two cases: (A) parent converts, (B) parent does not convert."

And this is not some word-smithing difference. Your math is based on the Parent's total taxes. So you wrote total taxes and your math is based on total taxes.

I challenge you to find a recognized expert in wealth management that says that the person who is considering a Roth Conversion should use their total taxes versus using their marginal bracket in their analysis. Said another way, taking a Roth Conversion is completely discretionary and as such should be analyzed at one's marginal tax bracket (or in the case of the Conversion starting at the 22% bracket and ending in the 24% brackets - multiple brackets) NOT at their effective tax rate.

That's why your math is wrong.

Now, you can either acknowledge that or not.

 

[TheWizard]

...QCDs..... I don't quite understand the concept. I understand supporting a cause and we do give to several charities locally. But I don't get giving away our hard earned and saved money we didn't pay tax on just so we don't have to pay tax on it.... I guess it would be different if we had millions.....

QCDs are simple, once you are age 70.5 and older. Your tIRA custodian makes out a check for $100 to your qualified charity and no income tax is due on that $100, either from you or from the charity.

Conversely, in my case, if I take $100 from my tIRA as either a normal withdrawal or a Roth conversion, I pay tax of 24% + 5% leaving me a net amount of $71.

----> QCDs are a more efficient way to do charitable donations...

 

[old medic]

QCDs are a more efficient way to do charitable donations...

I might owe you a beer... Or the local kids will.... Our biggest cause is our county toy run. Now thinking about leaving a few $K to pass along later.

 

[junkanoo]

I might owe you a beer... Or the local kids will.... Our biggest cause is our county toy run. Now thinking about leaving a few $K to pass along later.

If "leaving" means keeping some money in your tax-deferred accounts to distribute when you're 71 1/2+ ... sure.

 

[old medic]

Not sure, but "leaving" implies as part of your estate.

I meant leaving it in the IRA instead of converting it. Not that it would matter that much, our effective tax rate is around 11%. At $500 a year that's a bottle of good bourbon.

 

[Out-to-Lunch]

That's not what you wrote. You wrote:

"We must consider total taxes paid in the two cases: (A) parent converts, (B) parent does not convert."

And this is not some word-smithing difference. Your math is based on the Parent's total taxes. So you wrote total taxes and your math is based on total taxes.

I challenge you to find a recognized expert in wealth management that says that the person who is considering a Roth Conversion should use their total taxes versus using their marginal bracket in their analysis. Said another way, taking a Roth Conversion is completely discretionary and as such should be analyzed at one's marginal tax bracket (or in the case of the Conversion starting at the 22% bracket and ending in the 24% brackets - multiple brackets) NOT at their effective tax rate.

Where to begin?

Do you know how one goes about computing a marginal rate? How would you describe it in words? Hint: You might use the words "compute total taxes" twice (i.e., under two different conditions).

As for your argument from authority regarding expert opinion on Roth conversions: Yes, experts recommend considering the marginal rate at conversion. But that one piece of information is not enough. You must compare it to something to make the decision. What do experts recommend comparing it to? They recommend comparing it to the marginal rate at which the tax-deferred money will eventually be taxed. (https://www.bogleheads.org/wiki/Roth_conversion). Which is what I have been saying to you for a long time.

That's why your math is wrong.

Now, you can either acknowledge that or not.

Perhaps you could help me by pointing out precisely where the math in my example is wrong.

 

[Al18]

Your marginal bracket is typically 0%, 10%, 12%, 22%, 24% etc. It should be displayed in your tax program, and you can also determine it by online tax calculator such as 1040 Tax Calculator

 

[Time2]

Are you sure you have the right handle on what matters?

I'd be quite pleased if my tax-deferred balance, 99% in stock funds, grew from around $1M now to $3M in two years.
And if it somehow grew to $5M, I'd be ecstatic!

Try to focus more on the primary goal of investing, if you can...

Ya, sarcasm is hard using text. It's a dichotomy, I want my money to grow as fast as possible, I also want to reduce my Tax deferred accounts so I have no concerns about RMDs, or at least my wife will have no concerns.

 

[Out-to-Lunch]

Your marginal bracket is typically 0%, 10%, 12%, 22%, 24% etc. It should be displayed in your tax program, and you can also determine it by online tax calculator such as 1040 Tax Calculator

I am thinking of cases like phaseout of subsidies, the SS tax torpedo, etc. The resultant marginal rates do not typically fall into the standard tax-table rates.

Moreover, if we are contemplating a largish conversion, spanning brackets is quite possible. Sometimes is useful to know what the "marginal" rate is on, say, the last $10,000 instead of the last $1.