Those Who don't/didn't do Roth Conversions

[SevenUp]

In our case, if we didn't do aggressive Roth conversions, our RMDs alone would be ridiculously large, especially on top of Soc Sec and "passive income" from dividends, interest, STCGs.

Then doing some amount of Roth conversion will have been of great value to you - very good!

 

[LateToFIRE]

I think he means, you are paying the taxes today, that's 'spending' and cashflow.

-ERD50

If you create 2 options: Option 1 convert, Option 2 don't convert. The net cashflow difference is 0 until the year you spend the money. There is no present value difference to calculate

Yours is an odd situation. Perhaps it fits for some. Most here assume the tax rate is the same thru work and retirement. For me, I'll be in a higher rate as soon as RMDs hit. I may be wrong, but here is my analysis. If correct,it shows with all other things equal, the growth of investments in the Roth is far worth the conversion.

						tIRA No Conv		tIRA w/ Conv
Year	tIRA No Conv	tIRA w/Conv	Roth Acct	Combined Total	benefit of conversion by yr	RMD W/D (age 73)	annual tax paid on RMD	RMD W/D (age73)	annual tax paid on RMD	Tax w/o conv If died	Tax w/conv If died
	(A)	(B)	(C)	(B+C)	(E-A)	A x RMD FACTOR	E x 0.22	B x RMD Factor	G x 0.22	(A*.22)	(b*.22
-	1,000,000	900,000	100,000	1,000,000	0					220000	198000
1	1,050,000	945,000	105,000	1,050,000	0					231000	207900
2	1,102,500	992,250	110,250	1,102,500	0					242550	218295
3	1,157,625	1,041,863	115,763	1,157,625	0					254678	229210
4	1,215,506	1,093,956	121,551	1,215,506	0					267411	240670
5	1,276,282	1,148,653	127,628	1,276,282	0					280782	252704
6	1,340,096	1,206,086	134,010	1,340,096	0					294821	265339
7	1,407,100	1,266,390	140,710	1,407,100	0					309562	278606
8	1,477,455	1,329,710	147,746	1,477,455	0					325040	292536
9	1,551,328	1,396,195	155,133	1,551,328	0					341292	307163
10	1,628,895	1,466,005	162,889	1,628,895	0	65947	14508	59352	13058	358357	322521
11	1,644,392	1,479,953	171,034	1,650,987	6,595	69092	15200	62183	13680	361766	325590
12	1,657,520	1,491,768	179,586	1,671,353	13,834	72381	15924	65143	14331	364654	328189
13	1,668,015	1,501,213	188,565	1,689,778	21,763	75819	16680	68237	15012	366963	330267
14	1,675,597	1,508,037	197,993	1,706,030	30,433	79038	17388	71134	15649	368631	331768
15	1,680,339	1,512,305	207,893	1,720,198	39,859	82775	18211	74498	16390	369675	332707
16	1,681,581	1,513,423	218,287	1,731,710	50,129	86235	18972	77611	17075	369948	332953
17	1,679,425	1,511,482	229,202	1,740,684	61,259	89809	19758	80828	17782	369473	332526
18	1,673,587	1,506,229	240,662	1,746,890	73,303	93496	20569	84147	18512	368189	331370
19	1,663,770	1,497,393	252,695	1,750,088	86,318	97296	21405	87567	19265	366029	329426
20	1,649,662	1,484,696	265,330	1,750,026	100,364	101206	22265	91086	20039	362926	326633
21	1,630,939	1,467,845	278,596	1,746,441	115,502	105222	23149	94700	20834	358807	322926
22	1,607,264	1,446,538	292,526	1,739,064	131,800	108599	23892	97739	21503	353598	318238
23	1,579,028	1,421,125	307,152	1,728,278	149,250	111988	24637	100789	22174	347386	312648
24	1,545,992	1,391,393	322,510	1,713,903	167,911	115373	25382	103835	22844	340118	306106
25	1,507,919	1,357,127	338,635	1,695,763	187,844	118734	26121	106860	23509	331742	298568
26	1,464,581	1,318,123	355,567	1,673,690	209,109	122048	26851	109844	24166	322208	289987
27	1,415,762	1,274,186	373,346	1,647,531	231,769	124190	27322	111771	24590	311468	280321
28	1,362,360	1,226,124	392,013	1,618,137	255,777	126144	27752	113530	24977	299719	269747
29	1,304,334	1,173,900	411,614	1,585,514	281,180	127876	28133	115088	25319	286953	258258
30	1,241,675	1,117,507	432,194	1,549,701	308,027	129341	28455	116407	25610	273168	245852
						total tax paidup (H14:H46	462574		416317
				308,027		remaining tax to be paid	273168		245852
						total tax paid+due	735742		662168
							Delta tax saved	73574

So, is the bottom line the $73,574 overall taxes saved? Am I missing something else? Would also note that the $$$ used to pay the initial 12% conversion tax would have compounded to $52K over 30 years, so should probably be netted against the $74K tax savings.

 

[SevenUp]

So, is the bottom line the $73,574 overall taxes saved? Am I missing something else?

The spendable amount remaining after tax is - or at least should be - the bottom line of interest.

 

[LateToFIRE]

The spendable amount remaining after tax is - or at least should be - the bottom line of interest.

After-Tax Spendable Totals (22% tax rate)
No Conv	tIRA	1,092,674
	RMD's	1,850,296
		2,942,970
Conv	tIRA + Roth	1,415,600
	RMD's	1,665,267
		3,080,867
Dif		-137,897

So, this is what I'm getting for the spendable amounts remaining after tax, taking into consideration that the RMD's should be accounted for to give an apples to apples comparison. I still think the initial tax payment, which would have compounded to $52K should be netted against the conversion scenario totals, so looks to me like the benefit is ~$86K after 30 years.

[And if I apply PV, that amount is $35K in today's dollars]

 

[ncbill]

this is an odd example in that tax rates are lower in future. . I'm converting because my tax rate today is 12% and in 20 years it will be 22%.

yep, so don't convert while still working.

retire early, convert up to the top of the 12% bracket (MFJ) because once SS starts and/or one member dies the marginal tax rate will be much higher.

it's more of a hedge than a deterministic model.

 

[pb4uski]

I think y'all are making the analysis more confusing by including the $900k that stays in the IRA... since that $900k is common to both alternatives it doesn't matter and can be excluded from each alternative.

To simplify, say one has $100,000 in an IRA and $12,000 in taxable funds, is currently in the 12% tax bracket and expects to be in the 22% bracket in 30 years. 5% growth.

If you convert then you end up with $100,000 in a Roth and $0 in taxable. The Roth grows at 5% for 30 years to $432,194 ($100,000 * (1+5%)^30) that can be spent tax-free.

If you don't convert then the $100,000 in the IRA grows to $432,194 in 30 years and when withdrawn you end up with $337,111 (($100,000 * (1+5%)^30)*(1-22%)). Meanwhile, the $12,000 in taxable grows to $43,671 ($12,000*(1+5%*(1-12%))^30). So in total at the end of 30 years you have $380,782 that has been taxed and can be spent.

The Roth conversion is $51,412 better ($432,194 - $380,782).

Most of the benefit is from the tax savings... with the IRA you pay $95,083 in tax when you withdraw the $432,194... whereas the $12,000 paid in taxes with the Roth conversion is valued at $51,863 after 30 years ($12,000*(1+5%)^30) for a difference of $43,220.

The other $8,191 is tax savings by shifting $12,000 in taxable to the tax-free Roth for 30 years. The $12,000 in the Roth grows to $51,863 ($12,000*(1+5%)^30), $8,191 more than the growth of the $12,000 in the taxable account to $43,671 ($12,000*(1+5%*(1-12%))^30).

 

[SevenUp]

After-Tax Spendable Totals (22% tax rate)
No Conv	tIRA	1,092,674
	RMD's	1,850,296
		2,942,970
Conv	tIRA + Roth	1,415,600
	RMD's	1,665,267
		3,080,867
Dif		-137,897

So, this is what I'm getting for the spendable amounts remaining after tax, taking into consideration that the RMD's should be accounted for to give an apples to apples comparison. I still think the initial tax payment, which would have compounded to $52K should be netted against the conversion scenario totals, so looks to me like the benefit is ~$86K after 30 years.

[And if I apply PV, that amount is $35K in today's dollars]

Appears a 12% rate was applied to the final tIRA balances: 1,092,674/1,241,675 = 88%. Is that what you intended?

 

[CRLLS]

So, is the bottom line the $73,574 overall taxes saved? Am I missing something else? Would also note that the $$$ used to pay the initial 12% conversion tax would have compounded to $52K over 30 years, so should probably be netted against the $74K tax savings.

Yes. you are missing a big part. The difference in the 2 scenarios after 30 years. there is >$300k difference in favor of the conversion.

 

[LateToFIRE]

Yes. you are missing a big part. The difference in the 2 scenarios after 30 years. there is >$300k difference in favor of the conversion.

Not if you count the difference in RMD amounts between the convert vs non-convert scenarios.

 

[LateToFIRE]

I think y'all are making the analysis more confusing by including the $900k that stays in the IRA... since that $900k is common to both alternatives it doesn't matter and can be excluded from each alternative.

To simplify, say one has $100,000 in an IRA and $12,000 in taxable funds, is currently in the 12% tax bracket and expects to be in the 22% bracket in 30 years. 5% growth.

If you convert then you end up with $100,000 in a Roth and $0 in taxable. The Roth grows at 5% for 30 years to $432,194 ($100,000 * (1+5%)^30) that can be spent tax-free.

If you don't convert then the $100,000 in the IRA grows to $432,194 in 30 years and when withdrawn you end up with $337,111 (($100,000 * (1+5%)^30)*(1-22%)). Meanwhile, the $12,000 in taxable grows to $43,671 ($12,000*(1+5%*(1-12%))^30). So in total at the end of 30 years you have $380,782 that has been taxed and can be spent.

The Roth conversion is $51,412 better ($432,194 - $380,782).

Most of the benefit is from the tax savings... with the IRA you pay $95,083 in tax when you withdraw the $432,194... whereas the $12,000 paid in taxes with the Roth conversion is valued at $51,863 after 30 years ($12,000*(1+5%)^30) for a difference of $43,220.

The other $8,191 is tax savings by shifting $12,000 in taxable to the tax-free Roth for 30 years. The $12,000 in the Roth grows to $51,863 ($12,000*(1+5%)^30), $8,191 more than the growth of the $12,000 in the taxable account to $43,671 ($12,000*(1+5%*(1-12%))^30).

Agree with this simpler approach - this is about where I came out - just took a longer way there. So, I got the $43K difference. What I'm not quite getting why you're saying the $12K is shifted to the Roth.

 

[pb4uski]

Agree with this simpler approach - this is about where I came out - just took a longer way there. So, I got the $43K difference. What I'm not quite getting why you're saying the $12K is shifted to the Roth.

The difference between the $43k that you calculated and the $51k that I calculate relates to the last paragraph of my post... if you convert then you don't have to pay 12% tax on the 5% interest earnings on the $12k in taxable over the next 30 years like you do if you don't convert because the $12k in taxable ends up in the Roth in a backwards way. If you didn't have the $12k in taxable then you would only have $88k in the Roth after the conversion but because you have $12k in taxable after conversion you end up with $100k in the Roth.

 

[target2019]

The fly in the conversion ointment is that your future returns for 25-30 years won't be 5% on a straight line.

 

[LateToFIRE]

The difference between the $43k that you calculated and the $51k that I calculate relates to the last paragraph of my post... if you convert then you don't have to pay 12% tax on the 5% interest earnings on the $12k in taxable over the next 30 years like you do if you don't convert because the $12k in taxable ends up in the Roth in a backwards way. If you didn't have the $12k in taxable then you would only have $88k in the Roth after the conversion but because you have $12k in taxable after conversion you end up with $100k in the Roth.

Ah, ok I see now. That's a few added wrinkles to the scenario. I was thinking of the 5% more broadly as a LTCG, but of course that might still be taxable. I had also assumed the $12K was netted from the $100K and paid to the IRS (i.e. only $88K got converted).

One more thing, not to sound like a broken record, but I do believe thinking about the savings on a PV basis makes sense for those of us trying to decide if conversion might be worth it or not.

But, my final take-away is that there are no clear answers unless the conversion can be done on a zero tax rate basis - that is a pure no-brainer. Otherwise, one is making a whole bunch of assumptions about future taxes. Someone made a previous comment that conversion is like a hedge (against future tax) - I like that way of thinking about it - a hedge protects some amount of future downside risk (for a price) and may or may not be needed.

 

[LateToFIRE]

The fly in the conversion ointment is that your future returns for 25-30 years won't be 5% on a straight line.

Why does that matter?

 

[CRLLS]

Not if you count the difference in RMD amounts between the convert vs non-convert scenarios.

I did account for them. Check out columns 7-10. I calculated the RMDs and the tax on those RMDs independently.

Then look at columns 2 and 5. Column 2 shows the non-converted IRA account balance at every year. Column 5 shows the combined IRA and Roth balances. At 30 years, there is a $308k difference between them.

The last 2 columns is what taxes would be paid by your heirs in the event you pass in any given year.


Granted, my assumption is that the only money coming out of the Ira is for RMD's and the tax rate is 22%.

If somehow my math is wrong or I am missing something, let me know. It sure looks like a win to convert even when the tax rates stay the same.

 

[LateToFIRE]

I think y'all are making the analysis more confusing by including the $900k that stays in the IRA... since that $900k is common to both alternatives it doesn't matter and can be excluded from each alternative.

To simplify, say one has $100,000 in an IRA and $12,000 in taxable funds, is currently in the 12% tax bracket and expects to be in the 22% bracket in 30 years. 5% growth.

If you convert then you end up with $100,000 in a Roth and $0 in taxable. The Roth grows at 5% for 30 years to $432,194 ($100,000 * (1+5%)^30) that can be spent tax-free.

If you don't convert then the $100,000 in the IRA grows to $432,194 in 30 years and when withdrawn you end up with $337,111 (($100,000 * (1+5%)^30)*(1-22%)). Meanwhile, the $12,000 in taxable grows to $43,671 ($12,000*(1+5%*(1-12%))^30). So in total at the end of 30 years you have $380,782 that has been taxed and can be spent.

The Roth conversion is $51,412 better ($432,194 - $380,782).

Most of the benefit is from the tax savings... with the IRA you pay $95,083 in tax when you withdraw the $432,194... whereas the $12,000 paid in taxes with the Roth conversion is valued at $51,863 after 30 years ($12,000*(1+5%)^30) for a difference of $43,220.

The other $8,191 is tax savings by shifting $12,000 in taxable to the tax-free Roth for 30 years. The $12,000 in the Roth grows to $51,863 ($12,000*(1+5%)^30), $8,191 more than the growth of the $12,000 in the taxable account to $43,671 ($12,000*(1+5%*(1-12%))^30).

I did account for them. Check out columns 7-10. I calculated the RMDs and the tax on those RMDs independently.

Then look at columns 2 and 5. Column 2 shows the non-converted IRA account balance at every year. Column 5 shows the combined IRA and Roth balances. At 30 years, there is a $308k difference between them.

The last 2 columns is what taxes would be paid by your heirs in the event you pass in any given year.


Granted, my assumption is that the only money coming out of the Ira is for RMD's and the tax rate is 22%.

If somehow my math is wrong or I am missing something, let me know. It sure looks like a win to convert even when the tax rates stay the same.

How do you reconcile with the above pb4uski approach?

To be clear, I am saying that you have to add up the RMD's and include them and tax-effect them otherwise you're not comparing apples to apples.

 

[target2019]

Why does that matter?

It's not going to be a straight line of 5% returns. So an analysis that plugs in that neat number looks very safe, but the actual sequence of returns in the future will be much different. Your return will have standard deviation, for example.

Another significant factor is inflation. Yes, you can ignore these things, but they happen to have significant influence in the outcome.

You do have to start somewhere, as with your original spreadsheet.

I played with your numbers in Flexible Retirement Planner. One thing that surprised me was the impact of paying 22% tax on the conversions in the 1st ten years, and assuming the tax comes from the investment.

I haven't read this entire thread, but it's mildly interesting. I don't have the credentials to analyze this, so YMMV.

 

[LateToFIRE]

It's not going to be a straight line of 5% returns. So an analysis that plugs in that neat number looks very safe, but the actual sequence of returns in the future will be much different. Your return will have standard deviation, for example.

Another significant factor is inflation. Yes, you can ignore these things, but they happen to have significant influence in the outcome.

You do have to start somewhere, as with your original spreadsheet.

I played with your numbers in Flexible Retirement Planner. One thing that surprised me was the impact of paying 22% tax on the conversions in the 1st ten years, and assuming the tax comes from the investment.

I haven't read this entire thread, but it's mildly interesting. I don't have the credentials to analyze this, so YMMV.

OMG, yet more variables to consider! But, thanks for the clarification - I get your points - seems relevant. This is quite the rabbit hole - no wonder it inspires so much debate.

 

[target2019]

OMG, yet more variables to consider! But, thanks for the clarification - I get your points - seems relevant. This is quite the rabbit hole - no wonder it inspires so much debate.

It also inpires software development. There are many calculators and apps that cover this.

Your approach is good. You get to ingest points others are making, ask questions, hear other opinions.

 

[Out-to-Lunch]

It's not going to be a straight line of 5% returns. So an analysis that plugs in that neat number looks very safe, but the actual sequence of returns in the future will be much different. Your return will have standard deviation, for example.

But these vagaries equally affect monies in a tax-deferred account. I am not seeing the relevance of sequence of returns in this decision.

 

[all4j]

If somehow my math is wrong or I am missing something, let me know. It sure looks like a win to convert even when the tax rates stay the same.

I'm not sure if this is a math thing or not, as I'm having some trouble eyeballing this. It would help me if you took a year -- say year 10 -- & show the 2 equations with specific numbers to get to the 2 RMDs. I started looking out at age 100 & somehow I'm not getting it.

Re: including RMDs...I won't speak for other poster, but part of what is missing for me is the impact on rest of portfolio -- specifically the taxable account portion. The tax in year 0 on the conversion would be $22k. That $22k should be invested for 40 years to go against the final numbers. Then, look at 1st year of RMD. "No Conv" scenario would net $51439 in taxable account. The other would net $46294 (if I did math right!), or ~$5k less. That $5k should be invested for 30 years, etc. I suppose you could always reduce the roth by that amount, but you get the idea

 

[all4j]

But these vagaries equally affect monies in a tax-deferred account. I am not seeing the relevance of sequence of returns in this decision.

Are you considering the entire 40 year span? Once RMDs begin for one but not the other, it would seem that whether the good years were before or after that would have a bearing. Especially since the taxable accounts aren't being considered in most of the discussions.

I think it goes past that one though. I don't expect the tax rate to stay static. 10 years ago someone modeling this wouldn't have had RMD start at 73, etc

 

[INTJ10]

We haven't done conversions to date because of the ACA tax credits. It seems to be a no brainer to delay SS and do some conversions up to the 12% limit now that we are on Medicare.

 

[qwerty3656]

People are making this way too complicated. It's all difference in tax rates. It doesn't matter if you converted 20 years ago or convert 20 years from now. If the rate you convert at is say 10% difference (e.g. 22% to 12%) the difference in the amount of money you can spend is 10% of the TIRA money at that time. So if TIRA would grow to $2 Million (at the time you SPEND IT), then if you didn't convert then the taxes would be 22% ($440k) and you would have $2M - $440k = $1,560,000. If you did convert (at 12%) the Roth IRA balance would be $200k higher.

All this future value/present value stuff would affect both the TIRA and the Roth IRA and the relationship would be maintained.

 

[CRLLS]

How do you reconcile with the above pb4uski approach?

To be clear, I am saying that you have to add up the RMD's and include them and tax-affect them otherwise you're not comparing apples to apples.

Of course he is correct. I was looking at the IRA's and Roth IRA conversions not as an entire retirement plan but simply as a comparison of the 2. When I take all of the RMD's that were not used to pay taxes and put them into an after-tax account, then it doesn't look so rosey as I showed. The unstated assumption in that is that the invested excess RMDs are never touched but left to grow. I guess using that for spending would be unfair unless I compared it to taking a similar $$ from the unconverted IRA.