The referenced article (above) is not only faulty in its concept, but also the example:
protagonist wrote: Advisers say you generally need to hold the Roth IRA for 15 to 20 years to make it pay off. So they generally don't recommend conversion for anyone over age 60.
"If you're going to hold the IRA for less than 10 years, you definitely don't want to do it," says Tom Wiggins, a Certified Financial Planner at Rehmann, a business consulting and financial advising firm in Farmington Hills, Mich."
Note that this discussion implies that the account owner has more money in the TIRA than he needs to live on (at least for the short term). If he needs it for living expenses, he NEEDS it and conversion is not an option. The question is whether it is worth converting since the "conversion tax" may not be able to be earned back by future growth in the Roth.FAULTY CONCEPT:
Being able to earn back the paid taxes (or not) shouldn't be the issue. The issue should be if the taxes paid at conversion time will be more than saved in future taxes. That means, if all the conversion taxes (from all the years where conversions are done) total $X, will more than $X be saved in future TIRA withdrawal taxes?
1) Money in the TIRA that is not needed for living expenses will compound the same regardless of which account it is in. Conversions will lower future RMDs and let the future compounding shift to the Roth.
2) The longer you wait to withdraw, the more the TIRA value will grow which implies more taxes will be paid in the future (assuming the same tax bracket--or a higher one if the RMDs/conversions push you into a higher bracket).
3) The account value will continue to grow until distributions become greater than the growth. RMDs start at 3.65% of the account value and stock market returns are more often than not, greater than that.
4) Unneeded money can grow for your heirs, which (hopefully) is a long time away. If they are still working when they inherit, their tax bracket may be higher than yours. They need to start taking RMDs in the year after they inherit, not at 70.5, and the RMDs may push them into a higher bracket.
5) If you will be subject to estate taxes, all assets will be considered as to their dollar value, not their spending value. A dollar in Tax-deferred, in Roth, and in taxable will be subject to the same Estate Tax. The more tax-deferred dollars that can be converted to Roth, the less that will be owed in Estate Taxes, due to fewer taxable dollars remaining. (Some were spent on taxes to convert Tax-deferred dollars to Tax free dollars.)
6) Once SS starts, your tax bracket may increase due to having more taxable income. From 0 to 85% of SS will be taxed depending on your other income sources and their value. So conversions should be done before SS starts.
7) Once RMDs start, they will increase your taxable income.
Assuming an annual investment return of 6 percent, it would take someone in the top tax bracket 18 years to break even on the conversion, estimates Richard Rampell, chief executive of Rampell & Rampell accounting firm in Palm Beach, Fla."
This Math does not make sense.
The article was written before 2011 (according to a date reference later in the article) when the top federal rate was 35%. Today it is 39.6%. Let's also assume you live in a high tax state like California, making the highest possible tax rate about 50%. Remember, this is the worst case.
OK, we decide to convert $10,000 and pay the $5,000 in taxes (federal and state).
If we convert $10,000 and pay taxes out of taxable, it will only take 7 years of simple compounded growth of 6% to reach $15,000.
If we convert $10,000 and pay taxes out of the conversion (ouch!), the remaining $5,000 will take 12 years of simple compounded growth of 6% to get back to $10,000.
I can't see any way it takes 18 years to recover the taxes paid. I used their numbers for a worst case that wasn't even as bad tax-wise as it is today.
And most people are nowhere near that tax rate!
Can anyone find anything that makes sense in that article's "Reason 2"?
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.