To Roth or not to Roth

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Would appreciate the Fatwallet "hive mind" opinion for a niche question on IRAs.  I apologize in advance if similar posts have been made, but I can't easily find them.

I have a Rollover IRA from a 401K at a company for which I no longer work, which is a sizable proportion of my overall retirement portfolio.  My financial adviser suggested that I convert this IRA to a Roth, which would entail a very large tax payment, since I am in a high tax bracket.  

Does this make sense?  I'm converting pre-tax into post-tax money, which would grow tax-free for many, many years, but my crystal ball tells me that I will be in a much lower tax bracket in retirement.

I'm mostly in index funds, if it helps to know this...  Thanks everyone!

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Also, take a link at the links I provided.  Congress has done this in the past.  Heck, they'll slap a surtax on anything... (more)

galabar (Sep. 13, 2016 @ 12:56a) |

No but my tax software manages that info and keeps it on a "worksheet" as part of its financial outlook.

junkmail9572 (Sep. 13, 2016 @ 5:39a) |

For that matter they could slap an extra tax on non-Roth IRA's just as easily.

junkmail9572 (Sep. 13, 2016 @ 5:42a) |

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If you're in a high bracket now, it does not make sense to convert now.

It especially does not make sense if you don't have free and clear (after tax) cash to pay the taxes come April 15. If you have to use any portion of the retirement money to pay the taxes, definitely do not convert.

Do you trust that Congress will not alter Roth tax rules in the future? I do not, so I'll take the tax deduction today, thank you. Also, being in a high tax bracket right now is another reason that such a plan may not be in your best interest.

Roth's are over-hyped and have yet to prove that they will deliver decades into the future.

phisher4 said:   ............................................
I have a Rollover IRA from a 401K at a company for which I no longer work, which is a sizable proportion of my overall retirement portfolio.  My financial adviser suggested that I convert this IRA to a Roth, which would entail a very large tax payment, since I am in a high tax bracket.  

............................., but my crystal ball tells me that I will be in a much lower tax bracket in retirement.

..................................

  Is your adviser right for you?   Sounds like you know more....  

What was the advisor's logic behind the conversion?  Sometimes there are situations where conversions make sense from an estate planning standpoint. http://www.marketwatch.com/story/estate-planning-with-a-roth-ira... I suspect that you are younger ("many, many years") and estate planning isn't yet a significant part of your planning at this point.  Converting your IRA also enables you to make backdoor Roth contributions without tax consequences.  In most cases though, what others have said is accurate, it might be best to wait for a dip in income to do a conversion.

 

raringvt said:   it might be best to wait for a dip in income to do a conversion.

 

  And/or a dip in the market, preferably both at the same time.

raringvt said:   What was the advisor's logic behind the conversion?  Sometimes there are situations where conversions make sense from an estate planning standpoint. http://www.marketwatch.com/story/estate-planning-with-a-roth-ira... I suspect that you are younger ("many, many years") and estate planning isn't yet a significant part of your planning at this point.  Converting your IRA also enables you to make backdoor Roth contributions without tax consequences.  In most cases though, what others have said is accurate, it might be best to wait for a dip in income to do a conversion.

 

   

The adviser's logic is that the Roth grows tax-free for 20 years, while a pre-tax IRA does not.  The pre-tax IRA will be taxed as regular income at retirement.  That's the entirety of his argument.  

phisher4 said:   
raringvt said:   What was the advisor's logic behind the conversion?  Sometimes there are situations where conversions make sense from an estate planning standpoint. http://www.marketwatch.com/story/estate-planning-with-a-roth-ira... I suspect that you are younger ("many, many years") and estate planning isn't yet a significant part of your planning at this point.  Converting your IRA also enables you to make backdoor Roth contributions without tax consequences.  In most cases though, what others have said is accurate, it might be best to wait for a dip in income to do a conversion.

 

   

The adviser's logic is that the Roth grows tax-free for 20 years, while an pre-tax IRA does not.  The pre-tax IRA will be taxed as regular income at retirement.  That's the entirety of his argument.  

  Counter advisor with what you told us:
You will pay a higher marginal tax rate (when you the conversion) now as compared to your rate during retirement.

If that is indeed what your crystal ball says, you should not do the conversion. Of course there are a few unknowns: What will taxes look like in general when it comes tome for your retirement? What will YOUR tax look like at the time of your retirement.

In most cases, it will make little sense to convert a large chunk of IRA into a Roth at one time --- it will likely push you into higher brackets. Rather consider waiting for a "lean year" when your income dips (voluntarily or involuntarily --- e.g., job loss for you or spouse). Convert portions of your IRA during those yours when your marginal rate is lower.

ETA: I would seriously consider ditching the advisor if that is how he/she thinks/knows about taxes. 


ETA: I would seriously consider ditching the advisor if that is how he/she thinks/knows about taxes. 

  
Thanks -- that's what I was thinking too.  Finding good financial advice is near impossible where I live.  

Then again, logic dictates that if a financial adviser was stellar, they wouldn't need a job.

If you believe that your marginal tax rate in retirement will be higher, do the conversion now.

If you believe that your marginal tax rate in retirement will be lower, do not do the conversion.

If you believe that your marginal tax rate in retirement will be the same, it matters not what you decide.

BigTR said:   
If you believe that your marginal tax rate in retirement will be the same, it matters not what you decide.

  It still matters.  If tax rate stays constant, timing the conversion is important.

Right, it's mostly about marginal tax rate expectations. Roth also has some additional penalty-free access before retirement age (which may also be adjusted in the future). It sounds like your adviser isn't considering tax rate differences at all, and may even have an extremely naive understanding of math.

I think finding financial advice that's worth paying for is near impossible where everyone lives.

One other aspect to think about regarding Roth vs Traditional is that the Roth doesn't have a Required Minimum Distribution. Don't know if that will matter to you when you're 70, but you'll have a little more control over your financial situation if you're in a Roth.

 

A Roth is really just another hedge and *might* benefit you in retirement. Who knows that the brackets will be or if it will truly remain tax free. Can't say I'd roll over a big IRA myself due to the taxes, but I don't think it's a bad place to put $5.5K a year you were gonna save anyway.  One nice is you can always take out the principal that you put in without penalty.

For me I hold high dividend and REIT in my Roth IRA so I don't have to pay taxes on dividends every year. Hopefully never.

phisher4 said:   

   

The adviser's logic is that the Roth grows tax-free for 20 years, while a pre-tax IRA does not.  The pre-tax IRA will be taxed as regular income at retirement.  That's the entirety of his argument.  

  
I'm not sure why it's worth paying a financial adviser who isn't good at math, or at applying math to everyday financial issues.

I have $100 in taxable IRA. I expect it to grow 5x before I spend it, or $500. If I pay 30% taxes, I get to spend $350.
I don't convert my taxable IRA, so I don't spend $30 in taxes today, and put that $30 in a Roth. It grows 5X and I get to spend another $150 at retirement, or $500 total after taxes.

I pay $30 in taxes to convert my $100 IRA to Roth. It grows to 5x its current size, and I get $500 to spend tax-free at retirement. Clearly this after tax $500 is better than the after tax $500 above, because, well, it grew tax free.

As you can see, it matters not when you pay the xx% of tax, it only matters if today's marginal tax rate is higher than your marginal rate when you take your IRA distributions.
Due to variable taxation of Social Security benefits, your effective tax rate on the traditional IRA might be higher than you'd think. If a $10 traditional IRA distribution causes $5 in SS to be added to taxable income, your 30% rate might act more like a 45% rate.

I like to have both Roth and Traditional retirement accounts, giving me some flexibility in being able to generate cash flow from the Roth without increasing my taxable income. For instance, I might keep my traditional distributions at some inflection point on the marginal tax curve every year and live on that, but in years when I buy a new car I might take $25k from the Roth.

DTASFAB said:   
BigTR said:   
If you believe that your marginal tax rate in retirement will be the same, it matters not what you decide.

  It still matters.  If tax rate stays constant, timing the conversion is important.

  Plus if it's "the same" and you are maxing out the yearly limit(s), then the Roth offers the advantage of a higher annual effective limit on contributions.  (Since it's post-tax, it's equivalent to a higher pre-tax amount).

phisher4 said:   
raringvt said:   What was the advisor's logic behind the conversion?  Sometimes there are situations where conversions make sense from an estate planning standpoint. http://www.marketwatch.com/story/estate-planning-with-a-roth-ira... I suspect that you are younger ("many, many years") and estate planning isn't yet a significant part of your planning at this point.  Converting your IRA also enables you to make backdoor Roth contributions without tax consequences.  In most cases though, what others have said is accurate, it might be best to wait for a dip in income to do a conversion.

 

   

The adviser's logic is that the Roth grows tax-free for 20 years, while a pre-tax IRA does not.  The pre-tax IRA will be taxed as regular income at retirement.  That's the entirety of his argument.  

_____________________________________________________________________________________
Adviser is guilty of qualitative thinking when he should be thinking quantitatively.

  

SlimTim said:   may even have an extremely naive understanding of math.
  
It probably has more to do with that misleading example that the likes of Suze Orman used. They'd start with $2000 in an IRA and a Roth, and then show that at the end you had all this money tax free, but completely ignored that in that year, you either had an extra $500 in tax savings that could be invested (IRA) or that you had to pay $500 in extra tax. I couldn't believe how many people didn't see the flaw in that example. Then there's the lack of understanding of the distributive property of multiplication that I learned in 6th grade. I guess most people missed that day in math class.

BigTR said:   If you believe that your marginal tax rate in retirement will be higher, do the conversion now.

If you believe that your marginal tax rate in retirement will be lower, do not do the conversion.

If you believe that your marginal tax rate in retirement will be the same, it matters not what you decide.

  
Except that any growth will be taxed if the conversion is taxed later but not if the conversion is done now.  If OP has substantial income in retirement, the taxes on that untapped growth could be significant.

Bend3r said:   
DTASFAB said:   
BigTR said:   
If you believe that your marginal tax rate in retirement will be the same, it matters not what you decide.

  It still matters.  If tax rate stays constant, timing the conversion is important.

  Plus if it's "the same" and you are maxing out the yearly limit(s), then the Roth offers the advantage of a higher annual effective limit on contributions.  (Since it's post-tax, it's equivalent to a higher pre-tax amount).

Absolutely, but this is just another way of saying you're paying the taxes now instead of later with the Roth.

If OP has available cash on hand to pay extra taxes this year AND the market dips considerably between now and the end of the year, it wouldn't be a terrible idea to convert.  Think of it this way.  If you had $1M in a traditional IRA in 2005, 100% invested, and in 2008 it was worth $450K, 2008 would have been a great time to convert, because that $450K in the Roth would now be worth what, about $1.4M?  Something like that.  So you would have paid income taxes on $450K, and there would be no taxes due ever on the $900K in capital appreciation.

The biggest piece of advice for OP has nothing directly to do with the question of conversion.  Looking at the bigger picture, OP has to grill the FA to find out exactly why this recommendation was made, and inquire in more detail than has already been described above.  If the answer is not satisfactory, OP should not be using that FA for anything, period.

Chyvan said:   
SlimTim said:   may even have an extremely naive understanding of math.
  
It probably has more to do with that misleading example that the likes of Suze Orman used. They'd start with $2000 in an IRA and a Roth, and then show that at the end you had all this money tax free, but completely ignored that in that year, you either had an extra $500 in tax savings that could be invested (IRA) or that you had to pay $500 in extra tax. I couldn't believe how many people didn't see the flaw in that example. Then there's the lack of understanding of the distributive property of multiplication that I learned in 6th grade. I guess most people missed that day in math class.

  Very few people have the ability to apply the math they learned in school.  

Chyvan said:   
SlimTim said:   may even have an extremely naive understanding of math.
  
It probably has more to do with that misleading example that the likes of Suze Orman used. They'd start with $2000 in an IRA and a Roth, and then show that at the end you had all this money tax free, but completely ignored that in that year, you either had an extra $500 in tax savings that could be invested (IRA) or that you had to pay $500 in extra tax.
 

  

How long ago did Orman say that?
When the Roth IRA was introduced, the IRA limit was $2000, and you could choose between maxing out a $2000 traditional or maxing out a $2000 Roth contribution.
In that case, your $2000 post tax limit was higher than your $2000 pre tax limit, just like I can have a bigger retirement investment with a $6500 Roth contribution today.

wizwor said:   
BigTR said:   If you believe that your marginal tax rate in retirement will be higher, do the conversion now.

If you believe that your marginal tax rate in retirement will be lower, do not do the conversion.

If you believe that your marginal tax rate in retirement will be the same, it matters not what you decide.

  
Except that any growth will be taxed if the conversion is taxed later but not if the conversion is done now.  If OP has substantial income in retirement, the taxes on that untapped growth could be significant.

  No, that's specifically the part that does not matter.  If the marginal tax rate is the same, which was what the statement you highlighted says.....

Example (investing $100k 25%/25% marginal rates at contribution and retirement):
Roth: $75k contribution, $25k tax
Traditional: $100k contribution

+100% gain:
Roth: $150k end value
Traditional: $200k end value

withdrawal:
Roth: $150k withdrawn, no additional taxes
Tradtiional: $200k withdrawn, $50k to taxes (25%), net withdrawn value of $150k.

You pay $50k tax in the traditional vs $25k when contributing in the Roth, but the time value of money is different in the two cases, and the tax amount is exactly equal when the marginal rate is the same at contribution as at withdrawal.

Some years ago had a stretch of low income years and over those years converted every IRA to Roth. Every year we contribute the max to our Roth IRAs and to any retirement options we have at our employers. As many have noted, two factors in play. Marginal tax rate today vs. when OP retires and gain that the funds make prior to being cashed out. If the OP is young, that usually points towards Roth.

EradicateSpam said:    two factors in play. Marginal tax rate today vs. when OP retires and gain that the funds make prior to being cashed out. If the OP is young, that usually points towards Roth.
 

  

Gain is not a factor.
What favors the Roth are possible higher future tax rates, and the ability to contribute more than the traditional IRA limit by contributing the taxes in advance.

I think we've had this discussion on FWF many times, whenever a Roth IRA is discussed.

Others in this thread have tried to make this point, let me give it a try, see if it helps:  If the marginal tax rate is the same now and after retirement, the net gain from a Roth is exactly the same, to the penny, as the net gain from a regular IRA. There is no difference whatsoever.

UncaMikey said:   I think we've had this discussion on FWF many times, whenever a Roth IRA is discussed.

Others in this thread have tried to make this point, let me give it a try, see if it helps:  If the marginal tax rate is the same now and after retirement, the net gain from a Roth is exactly the same, to the penny, as the net gain from a regular IRA. There is no difference whatsoever.

A benefit to the backdoor Roth is the added ability to time the conversion.  If you contribute to a Traditional IRA and invest it, you can take the deduction for the full amount of the contribution.  Then if/when the market goes down, you convert to Roth at that time.  If the market is down 15% when you convert, you only have to pay tax on 85% of the amount you originally deducted.

I'm only seeing discussion of the marginal tax rate now vs. retirement. The marginal tax rate is what's important now, because that's what you're paying if you invest in a Roth or saving now if you invest in a traditional IRA. However, at retirement, the whole tax bracket comes into play assuming all of your income is from your Roth/traditional IRA.

If you contribute 100% to Roth accounts, you pay all tax now. Let's assume your marginal tax rate is 25% for all contributed dollars. If we assume the amount of your withdrawals at retirement would put you in the hypothetical 30% tax bracket at that point, based on what's being said in this thread, you "came out ahead" based on your accurate prediction of being in a lower bracket now. However, some of the withdrawals, had they been taxable, would have been taxed at say 10%, 15%, and 25%, and some of them would have essentially not been taxable at all due to deductions/exemptions.

In other words, you have to consider any income you might have during retirement. If your analysis is that you will be in a higher tax bracket in retirement, and therefore decide to put all your money in Roth accounts, you need to consider the fact that you actually want some money in pre-tax accounts as well to fill up those 0% / 10% / 15% brackets at withdrawal.

BingBlangBlaow said:   In other words, you have to consider any income you might have during retirement. If your analysis is that you will be in a higher tax bracket in retirement, and therefore decide to put all your money in Roth accounts, you need to consider the fact that you actually want some money in pre-tax accounts as well to fill up those 0% / 10% / 15% brackets at withdrawal.
  That's somewhat glossed over, but it's already implied.  In order for you to expect the marginal tax rate at retirement to be equal or higher, this requires you have filled up the lower brackets either by more w2 income during retirement, traditional account withdrawals/conversions, social security, taxable capital gains, etc.  If you weren't already counting on filling up those lower brackets, then the marginal rate being expected at retirement would be lower.

SummerSoFar said:   Do you trust that Congress will not alter Roth tax rules in the future? I do not, so I'll take the tax deduction today, thank you. Also, being in a high tax bracket right now is another reason that such a plan may not be in your best interest.

Roth's are over-hyped and have yet to prove that they will deliver decades into the future.

  If you believe Roth tax rules could change in the future (which is a totally valid concern), what leads you to believe that Traditional IRA tax rules won't change as well, where you might get taxed twice (now and in the future)?

I took the Roth one-time deal many years ago, back when it was permitted to split the tax impact over four years.  I've been rolling with my Roth ever since.  Here's what I'm liking these days:

People are living longer today than once was the case.  I like that I've not been placed into a forced liquidation situation, an advantage I expect to continue with my Roth.  Funds removed from any IRA cannot continue to accrue tax-protected income.  The longer you live, the larger this Roth advantage looms.  

Course Roth conversions now do not enjoy the help with immediate tax impact I had; today it's all on the margin.  One solution might be to save up some money and then schedule some time off during the year when the conversion is done.  Else use whatever other artifice works for you to get that marginal rate down for just one tax year. 

Bend3r said:   
BingBlangBlaow said:   In other words, you have to consider any income you might have during retirement. If your analysis is that you will be in a higher tax bracket in retirement, and therefore decide to put all your money in Roth accounts, you need to consider the fact that you actually want some money in pre-tax accounts as well to fill up those 0% / 10% / 15% brackets at withdrawal.
  That's somewhat glossed over, but it's already implied.  In order for you to expect the marginal tax rate at retirement to be equal or higher, this requires you have filled up the lower brackets either by more w2 income during retirement, traditional account withdrawals/conversions, social security, taxable capital gains, etc.  If you weren't already counting on filling up those lower brackets, then the marginal rate being expected at retirement would be lower.

  Good point. I just wanted to point out that it's something to consider when trying to magically predict one's future tax situation. You also don't want to decide that you'll definitely be in a higher tax bracket when you retire and then just throw all your contributions into a Roth ignoring this. Regardless, I think it's important to put some funds towards each type of account, which most people will do through their 401k/Roth IRA contributions.

The other thing to think about if you go the traditional route over the Roth route - what are you doing with the tax savings you're netting right now?

If you're just going to spend it, and not invest it, then all things being equal (i.e., if your tax rate would be the same now and in retirement), you will have more money with the Roth option come retirement. If you invest/save the money, and your tax bracket will be lower, then by all means go the traditional route.

I chose the roth option for three reasons, despite being in the 28% bracket right now. First, I believe we will see tax increases across the board in the next 30 years... there will be an expansion of the welfare state and "the rich" will need to pay their "fair share". I feel comfortable paying my taxes now. Second, we live in an income tax-free state right now. So, we are "paying" a 0% state income tax on this money. This gives us flexibility in retirement to potentially move to a state with lower sales tax/property tax/etc in favor of a higher income tax. Third, my wife contributes to a traditional 457, has a 401(a) which will be taxable, and will get a pension. These will all be considered taxable in retirement. My roth provides tax diversity in case tax rates don't end up increasing.

I have considered that the government would come back and try to double tax roth accounts... but I think that would be subject to ex post facto conditions and a violation of due process, and so I don't see that as likely. The more worrisome outcome would be that they would institute a national sales tax.

General rule of politics, you tax the people who have income or assets. Promises made in the past are meaningless and meant to be broken.

Lugs said:     If you believe Roth tax rules could change in the future (which is a totally valid concern), what leads you to believe that Traditional IRA tax rules won't change as well, where you might get taxed twice (now and in the future)?
  
Coin toss, I know. Just a gut feeling that Roth would be on the hatchet list before the tIRA.

sullim4 said:   I think that would be subject to ex post facto conditions and a violation of due process,
  
Tell that to the people in MI when the income tax increased in the middle of the year. They paid the new, higher rate on all their income for the year, not just the money earned during the second half the year.

Then there was Clinton's retro active tax increase in 1993 that the Supreme Court blessed

http://articles.latimes.com/1994-06-14/news/mn-3963_1_retroactiv... and has done so in the past.

taxmantoo said:   How long ago did Orman say that?
When the Roth IRA was introduced, the IRA limit was $2000, and you could choose between maxing out a $2000 traditional or maxing out a $2000 Roth contribution.
In that case, your $2000 post tax limit was higher than your $2000 pre tax limit, just like I can have a bigger retirement investment with a $6500 Roth contribution today.


Sometime in 1998 to 1999 during one of her PBS money-begging shows. I remember it because she said, "I like this guy," in reference to the Roth.
  

Chyvan said:   
Sometime in 1998 to 1999 during one of her PBS money-begging shows. I remember it because she said, "I like this guy," in reference to the Roth.
  

  

Sounds about right.
IRA limits were $2k every year through 2001, then in 2002 they went to $3000 with a $500 catchup for over 50.
If she was like me and just assumed the way to go in the late 90s was to contribute the full $2000, then $2k in a Roth pays more at retirement than $2k in a traditional IRA unless you're in the 0% tax bracket.

taxmantoo said:   then $2k in a Roth pays more at retirement than $2k in a traditional IRA unless you're in the 0% tax bracket.
  

Are you missing the point that at a 25% marginal tax rate to put $2000 in a Roth means that I have to earn $2,500 to do it? Or in the case of an IRA, if I put in $2000 I get $500 back that can then be invested in hopefully a good growth/dividend stock(s) where I might get very favorable long-term capital gains treatment or qualified dividends?

That was the math that she was ignoring in her example.

In the simple example she used, of course, the Roth was going to look like a huge winner, but it's much more complex than that.

Skipping 76 Messages...
galabar said:   
SummerSoFar said:   
prozario said:   ... And once you have benefit (tax free) - even if it changes, i would think it would be illegal to tax it differently for existing money in the account. It may happen to new money contributed after a new law has been passed.
  
Oh yea? Tell me about how that scenario is fundamentally different than how the ACA increased the HSA non-qual withdrawal penalty from 10% to 20% for existing funds.

I agree that such a notion is unlikely. But I firmly believe it is more likely than most folks like to acknowledge.

  Also, take a link at the links I provided.  Congress has done this in the past.  Heck, they'll slap a surtax on anything.

It is absolutely within the power of Congress to place any tax that it wants to on Roth IRA dispersal, targeting any combination of principal and gains.  Whether such a law is passed will be based on the current inhabitants of Congress and the White House.  Just as with the "success tax", minimum distributions, the medicare surtax, and others, the government simply needs to demonize those with assets in order to take them.
   

  For that matter they could slap an extra tax on non-Roth IRA's just as easily.



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