A Simple ROTH Conversion Quiz

[Franz Kafka]

Without using your financial calculator, if Joe's current tax bracket is 28% and will remain the same after he retires, about how much will he be able to save in taxes by converting to ROTH now?

There's too much subtle BS going on with these conversion webinars ...

 

[alphawave2k]

I'm no financial whiz, but here is my take on this. If the tax rate is the same, then basically they are paying their taxes now vs in the future...a wash. However, the real benefit is from the future gains and tax avoidance they will have in their portfolio if it grows nicely over the time after the conversion is made.

So simple example: Convert a $100K, pay $28K in taxes now, and investing the $72K in the ROTH. That's assuming someone has the $28K just sitting there with nothing better to do with it.
Now, you have to figure the future rate of return and number of years that $72K has to work to make up for the $28K.
So in order to recoup the $28K, the remaining portion needs to return 38% to breakeven, and any returns after that is tax free gravy.

If someone thinks they can invest to get a return of 38% over a reasonable time and continue to keep their money growing, then it's worth it to do a conversion. The sticking point for a lot of people will still be the $28K they'll have to pay up-front, which not too many average folks have in these tight economic times.
This is a strategy suited for the well-to-do IMHO.

 

[Franz Kafka]

I'm no financial whiz, but here is my take on this. If the tax rate is the same, then basically they are paying their taxes now vs in the future...a wash.

Yes, one doesn't need any financial calculator to know this. There's absolutely no savings.

However, the real benefit is from the future gains and tax avoidance they will have in their portfolio if it grows nicely over the time after the conversion is made.

That's the kind of Red Herring I've been hearing from these webinars. How much they can earn on their converted ROTH is a complete non-issue. Wherever they can recoup the tax paid through the gain they can do exactly the same with their traditional rollover IRA.

On the other hand, it's always a good idea to have a portion of your retirement fund in a taxable account because you can plan your distribution so you won't have to pay any taxes at lower bracket. This WILL save taxes instead of having 100% of your fund in tax-exempt accounts.

 

[BNTRS]

Or I could just keep it in the traditional IRA and see what tax rates I'm dealing with at retirement. If they are lower, good for me. If they are higher, I'll just put it in a CRT and take the massive deduction....Oh wait, I could do that even if they are lower.


I love the people who tell me that some people just don't have a charitable sense about them. If it meant my saving thousands in tax dollars, I'd find something to be charitable about.

 

[scagnt83]

Its a wash; as already stated.

If the money is earmarked to pass on to loved ones the conversion makes more sense.

 

[padthaiforlunch]

Not a total wash.

If they convert $100k today (and pay the taxes from non-qual money) then the tax bill is $28k.

Say the account grows to $200k, whether they convert or not. If they spend the full $200k while living, they must pay tax on it. Either the $28k from today's conversion, or $56k as the money is pulled out. Looks like tax savings to me.

Say they plan to pull money from IRA in retirement. If they take Roth money, they may lower their tax bracket.

You also need to consider that distribution from a traditional IRA may trigger the taxation of some SS benefits. Worst case scenario where 85% of SS income is taxed can create an effective tax rate of over 50%.

If they don't spend the money and it's passed on....

Traditional IRA: kids pay tax on $200k.
Roth: kids pay tax only on gain while it's stretched.

Cliff Notes: Roth IRA can provide tax savings even if bracket is still the same in retirement.
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On the other hand, it's always a good idea to have a portion of your retirement fund in a taxable account because you can plan your distribution so you won't have to pay any taxes at lower bracket. This WILL save taxes instead of having 100% of your fund in tax-exempt accounts.

What? Did you get this switched around?

 

[Franz Kafka]

FWIW I'm NOT against ROTH or people converting their traditional IRAs to ROTH. What I'm against is the kind of BS that's used to exaggerate the benefits of doing so of which I think below is a perfect example.

Not a total wash.

If they convert $100k today (and pay the taxes from non-qual money) then the tax bill is $28k.

Say the account grows to $200k, whether they convert or not. If they spend the full $200k while living, they must pay tax on it. Either the $28k from today's conversion, or $56k as the money is pulled out. Looks like tax savings to me.

Is that the kind of mathematical deception you use to lure people into transferring their accounts with you? What if they go home and figure the math out and confront you with it, what do you do then? Should I take the pains to point out the deception?

If they take Roth money, they may lower their tax bracket.

You see that statement "requires" presence of taxable retirement accounts. Hence why I said "it's always a good idea to have a portion of your retirement fund in a taxable account because you can plan your distribution so you won't have to pay any taxes at lower bracket. This WILL save taxes instead of having 100% of your fund in tax-exempt accounts." As a side note, ROTH is NOT the only tax-exempt retirement fund available out there.

You also need to consider that distribution from a traditional IRA may trigger the taxation of some SS benefits.

Again I'm NOT for having 100% of your retirement fund in fully taxable accounts. See above.

If they don't spend the money and it's passed on....

Traditional IRA: kids pay tax on $200k.
Roth: kids pay tax only on gain while it's stretched.

I must be a complete moron because I keep thinking ROTH is double-taxed under the above scenario. Please enlighten.

Maybe I misunderstood what you were trying to say (I sure hope so). Maybe you tell your clients that all they have to do to convert their traditional IRA is to sign the one page app that says ROTH Conversion on top and send it to their existing carrier or investment company. Maybe I'm just too dang sarcastic.

 

[padthaiforlunch]

I'm not getting you.

How is paying tax on 200k the equivalent of paying tax on 100k? What's the deception?

And why are taxable accounts "required?"
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So not paying taxes on growth is deceptive?

 

[Franz Kafka]

How is paying tax on 200k the equivalent of paying tax on 100k? What's the deception?

"Mr. Client, I can show you how you can save as much as $56,000 in federal income tax!!"

"Huh? I'm all ears! Please tell me how I can save that much money in taxes!"

"Mr. Client, if you start this tax-deferred qualified plan and it grows to $200,000 by the time you retire, you're going to owe the IRS whopping $56,000 at 28% bracket! You can easily save this $56,000 of income tax by not starting this plan at all!!"

"HUH????!!!!! Why didn't I ever think of that???!!!!!"

And why are taxable accounts "required?"

How is Mr. Client going to "lower" his income tax bracket if he has NO taxable income?

So not paying taxes on growth is deceptive?

No but telling Mr. Client he's not paying any taxes on the growth while he's actually paying taxes on the growth IS deceptive.

When Mr. Client pays $28,000 tax on his $100,000 of tax-deferred account to convert to ROTH and it grows to $200,000, he IS actually paying $56,000 in tax. So when you tell Mr. Client you're saving him $28,000 of tax, you ARE being deceptive.

 

[padthaiforlunch]

"Mr. Client, I can show you how you can save as much as $56,000 in federal income tax!!"

"Huh? I'm all ears! Please tell me how I can save that much money in taxes!"

"Mr. Client, if you start this tax-deferred qualified plan and it grows to $200,000 by the time you retire, you're going to owe the IRS whopping $56,000 at 28% bracket! You can easily save this $56,000 of income tax by not starting this plan at all!!"

"HUH????!!!!! Why didn't I ever think of that???!!!!!"

Nice straw man. Of course the client wouldn't save the full $56k.

How is Mr. Client going to "lower" his income tax bracket if he has NO taxable income?

Are you high? If he has no taxable income, he'll be in a lower tax bracket than someone with $50k in income. You know: less income, less taxes.

No but telling Mr. Client he's not paying any taxes on the growth while he's actually paying taxes on the growth IS deceptive.

When Mr. Client pays $28,000 tax on his $100,000 of tax-deferred account to convert to ROTH and it grows to $200,000, he IS actually paying $56,000 in tax. So when you tell Mr. Client you're saving him $28,000 of tax, you ARE being deceptive.

Methinks you're having us on. You do know that the growth in a Roth is non-taxable, right? You fund with after-tax dollars and it grows tax-free. That's why people have them.

So just how is the client paying $56k in taxes?