Am I doing the Math Right? (Roth IRA Q)

[Chan_va]

Folks, need some help here

I currently have 200K in a traditional IRA (funded with pre tax $) in Vanguard, and currently cannot contribute to a Roth IRA due to income limits. The 200K in the traditional IRA also prevents me from doing a backdoor Roth contribution.

I have a 401k with a my current employer and could roll over the Vanguard IRA to the 401k, and thus contribute to a Roth IRA via the backdoor Traditional-Roth conversion.

The expense ratio in Vanguard for my IRA (total bond market index) is 0.1%, the equivalent expense ratio in my 401k is 0.43%. So, it will cost me an additional $660/yr in fees to move my IRA out of Vanguard. (For asset allocation reasons, the IRA has to be 100% bonds)

My paper napkin math (assuming 25+ years to retirement, 15% long term capital gains tax, 4% long term return on bonds) indicates that $5k in a Roth today, would be worth ~15K in 25 years. The tax savings of a Roth (compared to investing the same 5K in a taxable account) is ~$1500.

So, it would seem that I would take a $660/yr hit on expenses, but it would be worth $1500/yr to me to perform the roll over from my IRA to my 401k.

The proposition becomes more attractive if taxes rise in the future, less attractive if bonds perform worse than average in the future.

Am I doing the math right?

[kaneohe]

Isn't that 1500, $1500 over the 25 yr lifetime (not annually) of that 1st Roth (5K---->15K in taxable, 10K gain, 1.5K CG tax)?
so each succeeding Roth saves somewhat less since it's 24 yrs, 23 yrs, etc?

[Chan_va]

Good point. The point at which the CG gain = expense ratio loss ($660) will roughly be 15 years by the math.

[Epsilon Delta]

15% long term capital gains tax

Why does capital gains tax rate come into play? You're talking bonds and IRAs, surely the ordinary income tax rates are all that matter. Or did you mean a 15% ordinary income tax rate?

[Epsilon Delta]

Since you are investing in bonds you should also consider leaving the funds in the low expense IRA and making non-deductible contributions. By my calculations after 25 years you would end up with $739k in the IRA with a basis of $125k. If you roll over to the 401(k) and do backdoor Roths you would end up with $481k in the 401(k) and $218k in the Roth. So compare $218k in a Roth to an IRA with a value $258k and $125k of basis. Is the ordinary income tax on $133k more than $40k or not, i.e. is your retirement tax rate likely to be more than 30%?

[Chan_va]

Epsilon - I am comparing 5k in a taxable account vs. 5k in a Roth. Both funded with after tax $. Hence the long term CG rate.

I cannot contribute pre tax to an IRA since I am maxing out 401k and am above income limits

[Epsilon Delta]

Epsilon - I am comparing 5k in a taxable account vs. 5k in a Roth. Both funded with after tax $. Hence the long term CG rate.

I cannot contribute pre tax to an IRA since I am maxing out 401k and am above income limits

Yes, but I think you said you would be investing in bonds. Bonds generate interest and are expected to give only minimal capital gains, so the ordinary income tax rate is more important.

I suggest you compare a non-deductible (i.e post tax) IRA contribution. There is no upper income limit for this. A non-deductible IRA is better than a taxable account for bonds for any tax and interest rates. A non deductable IRA might be better than a Roth if the Roth costs $660 per year (it depends on the rates and time period of the investment.