Young professionals in CA - $80K Roth conversion?

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boglehat
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Young professionals in CA - $80K Roth conversion?

Post by boglehat » Wed Dec 05, 2018 11:41 am

Wife and I currently thinking of converting $80K of traditional funds (from my past employer's 401K) into Roth and we'd love a sounding board.

Status: Married
Ages: 27, 27
State: California
Assets: $545K
-> 160K of this is in pre-tax (traditional) accounts
-> 140K of this is in post-tax (Roth) accounts
Asset allocation: 10% bonds (all domestic), 90% stock (70% domestic, 30% international). No illiquid assets.

We currently save somewhere around ~65% of our post tax income, but our expenses may increase significantly once we have kids. We also want to have some cushion available to help parents in their retirement just in case. We're currently in the Bay Area and there's a chance we'll want to buy a home here, though the ideal plan is to move to SoCal.

Annual income:
- Spouse: $225K (stable)
- Me: $75K (currently, venture-funded early stage entrepreneur. Plan is to go back to big tech, making ~$200K+, if startup fails)

Annually, we're maxing all our tax-advantaged accounts:
- $67K pre-tax through wife
- $11K backdoor Roths through both of us
- $6.9K HSA
- (Should I go back to big tech, we'd have access to more)

Marginal tax bracket: 31% (22% federal, 9% CA)

Reasons to convert $80K to Roth:
- Our marginal tax bracket is likely to go up
- We both plan to work for a long time (as opposed to early retire) and...
- ...we are contributing a lot of money to pre-tax accounts from very early. We are slightly concerned that this may time-bomb into a huge tax bill in retirement
- Politically, we guess that federal taxes are at a local low due to republican governance
- By converting $80K to a Roth, we'll have the ability to withdraw the $80K with no tax penalty in 5 years. This is not the plan, but it's helpful to have accessible cash in case of emergency

Reasons not to convert:
- We'd pay our 31% marginal tax rate for the entire conversion. If we, for example, took a sabbatical and converted money then, we'd benefit from the tiered tax system and we'd be paying significantly less
- We currently have to pay CA taxes. There is a slight chance that we may live abroad for a few years in the future. That may be an opportune time to do the conversion then - when we'd only be liable for federal, but not state
- While we expect we'll retire in CA, it's too many years from now. There's a slight chance we may be in a state with lower taxes.

Given the above pros and cons, we are considering moving forward with the conversion. Anything we are overlooking or any other thoughts/advice?
Last edited by boglehat on Wed Dec 05, 2018 1:15 pm, edited 3 times in total.

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FiveK
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Re: Young professionals in CA - $80K Roth conversion?

Post by FiveK » Wed Dec 05, 2018 12:02 pm

Depending on your startup income, much of that $80K will be hit with 24% federal. Not a huge difference from 22%, but if it makes a difference to you....

In the overall picture of your finances, it probably doesn't matter much. Given that traditional is "safer" (because if that choice is incorrect, it will be because you have "too much money"), and you don't have all that large of a traditional balance now, I'd vote "no". But my crystal ball is cloudy right now, so that could be wrong. ;)

mervinj7
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Re: Young professionals in CA - $80K Roth conversion?

Post by mervinj7 » Wed Dec 05, 2018 12:03 pm

I wouldn't do the conversion. Even if your marginal rate goes up in the near future, it's not necessary true that it will be higher in retirement. 31% is a huge tax hit. Don't overthink it.

bloom2708
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Re: Young professionals in CA - $80K Roth conversion?

Post by bloom2708 » Wed Dec 05, 2018 12:04 pm

Once you pay a tax dollar, it can never be unpaid.

A lot can happen over the next 30-40 years. I would not convert or be in a hurry to pay 31% tax.

With the current tax brackets it takes $2,000,000 pre-tax to get to the 24% bracket using 4% withdrawal.

People will scrimp and save .1% or .2% on expense ratios and happily pay 30% in tax on purpose. I don't like it.

I'm sure others will add their ideas.
"We are not here to please, but to provoke thoughtfulness." --Unknown Boglehead

niceguy7376
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Re: Young professionals in CA - $80K Roth conversion?

Post by niceguy7376 » Wed Dec 05, 2018 12:17 pm

Curious as to how 67K is being contributed for spouse 401k.

Self employed?

boglehat
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Re: Young professionals in CA - $80K Roth conversion?

Post by boglehat » Wed Dec 05, 2018 12:24 pm

niceguy7376 wrote:
Wed Dec 05, 2018 12:17 pm
Curious as to how 67K is being contributed for spouse 401k.

Self employed?
Not 401K; combination of maxing 403b, 407, add'l employee contributions and matching.

boglehat
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Re: Young professionals in CA - $80K Roth conversion?

Post by boglehat » Wed Dec 05, 2018 12:37 pm

FiveK wrote:
Wed Dec 05, 2018 12:02 pm
Given that traditional is "safer" (because if that choice is incorrect, it will be because you have "too much money")
I like that perspective. Essentially a form of insurance - if we're less well off, we'll make more money by keeping in the traditional. If we're well off, we may pay more in taxes than we would've otherwise; but it won't really matter because that only happens if everything has gone well and we retire rich.

I'm coming around to keeping as much as possible in pre-tax while we're in a 31%+ bracket. What about the argument about being able to access the converted-cash in 5 years vs. being forced to wait until 60 to withdraw tax penalty free? Am I being too unnecessarily cautious about having cash on hand given we already have enough in non-retirement accounts to sustain us for a couple of years in case of emergency?

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FiveK
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Re: Young professionals in CA - $80K Roth conversion?

Post by FiveK » Wed Dec 05, 2018 12:52 pm

boglehat wrote:
Wed Dec 05, 2018 12:37 pm
Am I being too unnecessarily cautious about having cash on hand given we already have enough in non-retirement accounts to sustain us for a couple of years in case of emergency?
Probably.

Opinions vary on the "correct" size of a cash-like emergency fund, but "3 to 6" months of basic expenses covers most of those opinions.

boglesthemind
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Re: Young professionals in CA - $80K Roth conversion?

Post by boglesthemind » Wed Dec 05, 2018 12:55 pm

bloom2708 wrote:
Wed Dec 05, 2018 12:04 pm
Once you pay a tax dollar, it can never be unpaid.

A lot can happen over the next 30-40 years. I would not convert or be in a hurry to pay 31% tax.

With the current tax brackets it takes $2,000,000 pre-tax to get to the 24% bracket using 4% withdrawal.

People will scrimp and save .1% or .2% on expense ratios and happily pay 30% in tax on purpose. I don't like it.

I'm sure others will add their ideas.
Sorry to sort of thread hijack but I’m in a very similar situation. If you account for the OP’s age and current savings, they are on tract for a retirement nest egg of more than $2 million. If that is mostly in tax deferred or taxable accounts and with RMD, they will be looking at at least a 24% federal tax bracket if hypothetically nothing happens to the tax laws (improbable). Is it really cut and dry that it’s a bad move to lock in the 22-24% rate now knowing the long term gains are tax-free (at age 27, the investment will continue for a long time)? You also have more tax diversification in your retirement accounts so you can tap into the tax-free Roth IRA pool during retirement if necessary instead of drawing from the tax-deferred accounts that can raise your tax bracket higher in retirement. I’m asking because I’m in a similar situation in a 22% tax bracket and have the option at my work to put to tax-deferred accounts or contribute post-tax funds and do in-service Roth IRA conversions. I have a long ways to go from retiring and I have been electing to do the latter to build up my Roth IRA pool because I am finishing training soon and may not have the option of this mega Roth in the future when I start working a real job.

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Tamarind
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Re: Young professionals in CA - $80K Roth conversion?

Post by Tamarind » Wed Dec 05, 2018 12:58 pm

boglehat wrote:
Wed Dec 05, 2018 12:37 pm
FiveK wrote:
Wed Dec 05, 2018 12:02 pm
Given that traditional is "safer" (because if that choice is incorrect, it will be because you have "too much money")
I like that perspective. Essentially a form of insurance - if we're less well off, we'll make more money by keeping in the traditional. If we're well off, we may pay more in taxes than we would've otherwise; but it won't really matter because that only happens if everything has gone well and we retire rich.

I'm coming around to keeping as much as possible in pre-tax while we're in a 31%+ bracket. What about the argument about being able to access the converted-cash in 5 years vs. being forced to wait until 60 to withdraw tax penalty free? Am I being too unnecessarily cautious about having cash on hand given we already have enough in non-retirement accounts to sustain us for a couple of years in case of emergency?
You should retain a solid emergency fund in non-retirement accounts, but I think paying a big tax bill to add more Roth money to your extended "emergency fund" would be a mistake. Given the numbers you cite, you also have a sizable and growing taxable account that you haven't called out.

There's no good reason to withdraw from Roth in even a prolonged catastrophe unless you'd already depleted your taxable account. Remember that in a scenario where you lose most of your income for long enough to spend your whole emergency fund, you are going to be cutting expenses like crazy and your tax rate will also be much lower. That makes pulling from taxable and sparing the Roth even more attractive.

Where is your emergency fund? Is it synonymous with your taxable account and invested? If so you might get more peace of mind from establishing a formal e-fund that is only in MM or CDs.

megabad
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Re: Young professionals in CA - $80K Roth conversion?

Post by megabad » Wed Dec 05, 2018 1:07 pm

I'm not sure I understand. Don't you have to convert if you want to keep doing backdoor Roth? You said you have a tIRA. Or do you have a new 401k that you can roll the tIRA into?

boglehat
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Re: Young professionals in CA - $80K Roth conversion?

Post by boglehat » Wed Dec 05, 2018 1:17 pm

megabad wrote:
Wed Dec 05, 2018 1:07 pm
I'm not sure I understand. Don't you have to convert if you want to keep doing backdoor Roth? You said you have a tIRA. Or do you have a new 401k that you can roll the tIRA into?
Sorry, the $80K is in my past employer's 401k, not a tIRA. I edited the post to clarify.
We're converting $11K a year for backdoor Roth no matter what, the question is whether to convert an additional $80K this year.

libralibra
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Re: Young professionals in CA - $80K Roth conversion?

Post by libralibra » Wed Dec 05, 2018 1:29 pm

boglehat wrote:
Wed Dec 05, 2018 12:24 pm
niceguy7376 wrote:
Wed Dec 05, 2018 12:17 pm
Curious as to how 67K is being contributed for spouse 401k.

Self employed?
Not 401K; combination of maxing 403b, 407, add'l employee contributions and matching.
So about 20k is after-tax contributions? Maybe check if you can do a mega backdoor roth with these funds first.

boglehat
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Re: Young professionals in CA - $80K Roth conversion?

Post by boglehat » Wed Dec 05, 2018 1:33 pm

Tamarind wrote:
Wed Dec 05, 2018 12:58 pm
Where is your emergency fund? Is it synonymous with your taxable account and invested? If so you might get more peace of mind from establishing a formal e-fund that is only in MM or CDs.
We have a year+ of living expenses in cash (3 months) + MM/bonds (9+ months). MM/Bonds are technically part of the asset allocation I listed above, so our portfolio stock allocation if you take out emergency fund is closer to 100%, but I'm OK with this given our age and low expense/income ratio. Wife and I are also in different industries so theres a bit less likelihood that we'd both lose jobs at the same time.
Tamarind wrote:
Wed Dec 05, 2018 12:58 pm
You should retain a solid emergency fund in non-retirement accounts, but I think paying a big tax bill to add more Roth money to your extended "emergency fund" would be a mistake. Given the numbers you cite, you also have a sizable and growing taxable account that you haven't called out.

There's no good reason to withdraw from Roth in even a prolonged catastrophe unless you'd already depleted your taxable account. Remember that in a scenario where you lose most of your income for long enough to spend your whole emergency fund, you are going to be cutting expenses like crazy and your tax rate will also be much lower. That makes pulling from taxable and sparing the Roth even more attractive.
OK I think you guys have fully changed my mind.
Writing reasons to keep as much money in pre-tax accounts for myself in the future and other readers:
- 31% marginal tax rate is significant and should be avoided
- Accessible cash is not a problem, we have a growing taxable account and if worst comes to worst, we can withdraw contributions from our Roth. In case of emergency, we'll be cutting expenses like crazy so hopefully we won't get to that point. We're also young, abled and resourceful so we'd hopefully find a way to make some income during a crisis.
- Having too much pre-tax money is a rich person's problem. In the case that this becomes a "problem", we may change our minds and stop working early, which would allow us to convert at a lower tax rate

Thanks all for your thoughts, and keep them coming!

curmudgeon
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Re: Young professionals in CA - $80K Roth conversion?

Post by curmudgeon » Wed Dec 05, 2018 1:55 pm

Tough call. I'd agree that you may well be at potentially your lowest tax rate, though if/when you start a family things may change. Paying the tax on conversion now (from taxable) is another form of saving for the future. Paying medical expenses out of pocket while saving the receipts and keeping the money in the HSA is another. You've already got a great start on retirement savings and a nice chunk in Roth. One of the great things about such a high savings rate is that it gives you more options in the future, though at some point you have to consider why you are accumulating all this money, unless it's your goal to be buried as the "richest man in the graveyard".

I have no faith in future tax rates remaining this low, or even the Roth conversion option remaining open (though since Roth conversions bring in tax dollars now, rather than sometime in the future, they are more likely to survive a change in political control).

megabad
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Re: Young professionals in CA - $80K Roth conversion?

Post by megabad » Wed Dec 05, 2018 1:59 pm

I'll be the contrarian here, but I don't feel that strongly. In your case in the 24% bracket, I would probably convert. You imply you may be in 32% soon and for a while. Per current law, the fed tax rate will be higher in the mid 2020s. The only thing that gives me pause is your state taxes, but you state that you will likely retire in CA and so state taxes cannot be avoided. A few years abroad would not affect my decision as you will not have many years to convert and you will likely already have significant other pretax accounts that could be converted during this time. Either way works though, like I said, I don't have a strong preference and 80k will not be a great sum for you in the long run given your savings rate (which is awesome for you, btw).

bloom2708
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Re: Young professionals in CA - $80K Roth conversion?

Post by bloom2708 » Wed Dec 05, 2018 2:11 pm

boglesthemind wrote:
Wed Dec 05, 2018 12:55 pm
bloom2708 wrote:
Wed Dec 05, 2018 12:04 pm
Once you pay a tax dollar, it can never be unpaid.

A lot can happen over the next 30-40 years. I would not convert or be in a hurry to pay 31% tax.

With the current tax brackets it takes $2,000,000 pre-tax to get to the 24% bracket using 4% withdrawal.

People will scrimp and save .1% or .2% on expense ratios and happily pay 30% in tax on purpose. I don't like it.

I'm sure others will add their ideas.
Sorry to sort of thread hijack but I’m in a very similar situation. If you account for the OP’s age and current savings, they are on tract for a retirement nest egg of more than $2 million. If that is mostly in tax deferred or taxable accounts and with RMD, they will be looking at at least a 24% federal tax bracket if hypothetically nothing happens to the tax laws (improbable). Is it really cut and dry that it’s a bad move to lock in the 22-24% rate now knowing the long term gains are tax-free (at age 27, the investment will continue for a long time)? You also have more tax diversification in your retirement accounts so you can tap into the tax-free Roth IRA pool during retirement if necessary instead of drawing from the tax-deferred accounts that can raise your tax bracket higher in retirement. I’m asking because I’m in a similar situation in a 22% tax bracket and have the option at my work to put to tax-deferred accounts or contribute post-tax funds and do in-service Roth IRA conversions. I have a long ways to go from retiring and I have been electing to do the latter to build up my Roth IRA pool because I am finishing training soon and may not have the option of this mega Roth in the future when I start working a real job.
We can't know the future. Do the things that are more likely to get you to a big pile when you are 75/80. Paying a bunch of tax young is not the path.

Let's flip it around and say you want to be a big giver when you are older and have a big pile of money to roll around on. Why not start giving money away today? Lots of it. If you do it enough, you will not have to worry about having a big pile of money when you are older.

Roth conversions are available. Paying tax when 75/80 isn't the worst scenario I can think of. It means my strategy worked and I have a nice big nest egg. Continuous employment is not guaranteed. Working in 50s and 60s is not guaranteed. You may want to retire at 45. Many paths ahead.
"We are not here to please, but to provoke thoughtfulness." --Unknown Boglehead

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Tamarind
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Re: Young professionals in CA - $80K Roth conversion?

Post by Tamarind » Wed Dec 05, 2018 2:58 pm

boglehat wrote:
Wed Dec 05, 2018 1:33 pm
- Having too much pre-tax money is a rich person's problem. In the case that this becomes a "problem", we may change our minds and stop working early, which would allow us to convert at a lower tax rate.
This is the best reason not to worry about converting now. If you see your pre-tax balance getting truly huge, it's the easiest thing in the world to stop working and ensure a few low income years to execute conversions. Your biggest problem at that point will be having to pay full freight for ACA coverage.

megabad
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Re: Young professionals in CA - $80K Roth conversion?

Post by megabad » Wed Dec 05, 2018 9:35 pm

bloom2708 wrote:
Wed Dec 05, 2018 2:11 pm
We can't know the future. Do the things that are more likely to get you to a big pile when you are 75/80. Paying a bunch of tax young is not the path.

Let's flip it around and say you want to be a big giver when you are older and have a big pile of money to roll around on. Why not start giving money away today? Lots of it. If you do it enough, you will not have to worry about having a big pile of money when you are older.

Roth conversions are available. Paying tax when 75/80 isn't the worst scenario I can think of. It means my strategy worked and I have a nice big nest egg. Continuous employment is not guaranteed. Working in 50s and 60s is not guaranteed. You may want to retire at 45. Many paths ahead.
Agree with the 1st sentence. I don't follow the rest. Tax is not a choice (like charity). Paying tax at 75 or 80 is no different than paying tax today. The only thing that matters is the difference between marginal rate today and marginal rate upon withdrawal. This can lead you to either conclusion though (Roth or Traditional).

justsomeguy2018
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Re: Young professionals in CA - $80K Roth conversion?

Post by justsomeguy2018 » Wed Dec 05, 2018 10:27 pm

boglehat wrote:
Wed Dec 05, 2018 1:33 pm
Tamarind wrote:
Wed Dec 05, 2018 12:58 pm
Where is your emergency fund? Is it synonymous with your taxable account and invested? If so you might get more peace of mind from establishing a formal e-fund that is only in MM or CDs.
We have a year+ of living expenses in cash (3 months) + MM/bonds (9+ months). MM/Bonds are technically part of the asset allocation I listed above, so our portfolio stock allocation if you take out emergency fund is closer to 100%, but I'm OK with this given our age and low expense/income ratio. Wife and I are also in different industries so theres a bit less likelihood that we'd both lose jobs at the same time.
Tamarind wrote:
Wed Dec 05, 2018 12:58 pm
You should retain a solid emergency fund in non-retirement accounts, but I think paying a big tax bill to add more Roth money to your extended "emergency fund" would be a mistake. Given the numbers you cite, you also have a sizable and growing taxable account that you haven't called out.

There's no good reason to withdraw from Roth in even a prolonged catastrophe unless you'd already depleted your taxable account. Remember that in a scenario where you lose most of your income for long enough to spend your whole emergency fund, you are going to be cutting expenses like crazy and your tax rate will also be much lower. That makes pulling from taxable and sparing the Roth even more attractive.
OK I think you guys have fully changed my mind.
Writing reasons to keep as much money in pre-tax accounts for myself in the future and other readers:
- 31% marginal tax rate is significant and should be avoided
- Accessible cash is not a problem, we have a growing taxable account and if worst comes to worst, we can withdraw contributions from our Roth. In case of emergency, we'll be cutting expenses like crazy so hopefully we won't get to that point. We're also young, abled and resourceful so we'd hopefully find a way to make some income during a crisis.
- Having too much pre-tax money is a rich person's problem. In the case that this becomes a "problem", we may change our minds and stop working early, which would allow us to convert at a lower tax rate

Thanks all for your thoughts, and keep them coming!
Do you have the option to contribute to a Roth 401k?

We are in similar situation (24%, but no state tax). I haven't been wrestling with conversion, but debating how much to allocate to Roth vs non-Roth contributions.

With CA high taxes and at 31% rate, I would agree with not converting, personally.

But if you want to hedge, maybe consider putting some % (3%?) of the 401k contribution into Roth 401k to keep building up some Roth money beyond the Roth IRA annual limit, if that's an option.

That is probably what I am going to do.

Chip
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Re: Young professionals in CA - $80K Roth conversion?

Post by Chip » Thu Dec 06, 2018 6:56 am

megabad wrote:
Wed Dec 05, 2018 9:35 pm
Agree with the 1st sentence. I don't follow the rest. Tax is not a choice (like charity). Paying tax at 75 or 80 is no different than paying tax today. The only thing that matters is the difference between marginal rate today and marginal rate upon withdrawal. This can lead you to either conclusion though (Roth or Traditional).
I fully understand what bloom2708 is saying. The future tax rate is unknown, as are investment returns. While one can make an informed guess about those future rates and returns, there is a lack of certainty that increases substantially as the time to withdrawal increases. Making a decision to pay tax now is in essence a bet about an unknowable future.

If you pay tax now and investment returns are lousy, and/or you lose your job, and/or you have high medical bills your future tax rates will likely be much lower than they are now. And in those situations you will have a big need for that money you spent years before prepaying taxes.

In the reverse situation, where investment returns have been great, employment has been continuous, etc., your tax rate in retirement may rise. But it is precisely because things have gone well. So yes, in that situation you would pay more taxes than if you had converted to Roth way back when. But since you have the money to pay those taxes it's not nearly as big a deal as the reverse situation.

Prokofiev said it very well in another thread:
Prokofiev wrote:Roth conversions are pre-paying your taxes and you can never get that money back. So pre-paying at the highest rate is taking a risk that you will never need than 30-40% of your TIRA. Not pre-paying can be seen as an insurance policy against negative future events - namely a portfolio crash or large medical/LTC expenses. If none of this happens and I pay higher taxes from 70-end, well so be it. It just means I was too rich and life will be fine. But if my portfolio suddenly drops - think 2007-2009, AND I need several $100k in expenses I will regret those high bracket conversions right when I need that money the most.

megabad
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Re: Young professionals in CA - $80K Roth conversion?

Post by megabad » Thu Dec 06, 2018 10:56 am

Chip wrote:
Thu Dec 06, 2018 6:56 am
megabad wrote:
Wed Dec 05, 2018 9:35 pm
Agree with the 1st sentence. I don't follow the rest. Tax is not a choice (like charity). Paying tax at 75 or 80 is no different than paying tax today. The only thing that matters is the difference between marginal rate today and marginal rate upon withdrawal. This can lead you to either conclusion though (Roth or Traditional).
I fully understand what bloom2708 is saying. The future tax rate is unknown, as are investment returns. While one can make an informed guess about those future rates and returns, there is a lack of certainty that increases substantially as the time to withdrawal increases. Making a decision to pay tax now is in essence a bet about an unknowable future.
True and making a decision to not pay taxes is also a bet in exactly the same manner.

If you pay tax now and investment returns are lousy, and/or you lose your job, and/or you have high medical bills your future tax rates will likely be much lower than they are now. And in those situations you will have a big need for that money you spent years before prepaying taxes.
Yes, if you know that your future tax rates will be lower, you will come out ahead deferring taxes.

In the reverse situation, where investment returns have been great, employment has been continuous, etc., your tax rate in retirement may rise. But it is precisely because things have gone well. So yes, in that situation you would pay more taxes than if you had converted to Roth way back when. But since you have the money to pay those taxes it's not nearly as big a deal as the reverse situation.
It could certainly be a big deal or bigger than the reverse situation. If you do not have enough saved and you pay more in tax, you may be more likely to deplete your assets more quickly than you would have otherwise. Just because you have "a lot" of money the day you retire doesn't mean you will have a lot of money into your 80s and 90s or 100s. And remember that with pre-tax monies, the government decides what your income will be, you do not (at least the minimum).

Prokofiev said it very well in another thread:
Prokofiev wrote:Roth conversions are pre-paying your taxes and you can never get that money back. So pre-paying at the highest rate is taking a risk that you will never need than 30-40% of your TIRA. Not pre-paying can be seen as an insurance policy against negative future events - namely a portfolio crash or large medical/LTC expenses. If none of this happens and I pay higher taxes from 70-end, well so be it. It just means I was too rich and life will be fine. But if my portfolio suddenly drops - think 2007-2009, AND I need several $100k in expenses I will regret those high bracket conversions right when I need that money the most.
This quote is based on the same future predictions which may be correct or not.

I am actually a strong proponent of pre-tax retirements savings (over Roth) most of the time, but not all the time. Every situation is different. All I would stress is that the only thing that matters is your prediction of the difference in your marginal tax rates. There is no instance where it is financially better for the individual to pay more total taxes than they could have, but it is very difficult to know with certainty which path to take to pay the least. For this reason, I generally "tax diversify" somewhat to mitigate the damage of me predicting wrong no matter what I predict.

Chip
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Re: Young professionals in CA - $80K Roth conversion?

Post by Chip » Thu Dec 06, 2018 12:04 pm

megabad wrote:
Thu Dec 06, 2018 10:56 am
It could certainly be a big deal or bigger than the reverse situation. If you do not have enough saved and you pay more in tax, you may be more likely to deplete your assets more quickly than you would have otherwise. Just because you have "a lot" of money the day you retire doesn't mean you will have a lot of money into your 80s and 90s or 100s. And remember that with pre-tax monies, the government decides what your income will be, you do not (at least the minimum).
I still don't think you're fully understanding what Prokofiev said. If things go badly your IRA/401k will be much smaller than if things had gone well and so will the ultimate tax burden. You'll wish you had that tax money you spent long ago. If you have big LTC expenses you may not pay tax on tIRA withdrawals at all. By converting and paying tax early you are increasing your downside risk in retirement in the hopes of increasing the upside. It may work out. It may not.
I am actually a strong proponent of pre-tax retirements savings (over Roth) most of the time, but not all the time. Every situation is different. All I would stress is that the only thing that matters is your prediction of the difference in your marginal tax rates. There is no instance where it is financially better for the individual to pay more total taxes than they could have, but it is very difficult to know with certainty which path to take to pay the least. For this reason, I generally "tax diversify" somewhat to mitigate the damage of me predicting wrong no matter what I predict.
I'm in full agreement with all of that, though I would suggest that the prediction doesn't matter, it's what actually happens. The OP is suggesting converting now at a high tax rate. They are assuming long continuous employment, no early retirement and no significant medical expenses. Perhaps those assumptions are what need to be tested.

I tax diversify myself, but I did all my Roth conversions at very low rates after early retirement.

megabad
Posts: 828
Joined: Fri Jun 01, 2018 4:00 pm

Re: Young professionals in CA - $80K Roth conversion?

Post by megabad » Thu Dec 06, 2018 2:03 pm

Chip wrote:
Thu Dec 06, 2018 12:04 pm
megabad wrote:
Thu Dec 06, 2018 10:56 am
It could certainly be a big deal or bigger than the reverse situation. If you do not have enough saved and you pay more in tax, you may be more likely to deplete your assets more quickly than you would have otherwise. Just because you have "a lot" of money the day you retire doesn't mean you will have a lot of money into your 80s and 90s or 100s. And remember that with pre-tax monies, the government decides what your income will be, you do not (at least the minimum).
I still don't think you're fully understanding what Prokofiev said. If things go badly your IRA/401k will be much smaller than if things had gone well and so will the ultimate tax burden. You'll wish you had that tax money you spent long ago. If you have big LTC expenses you may not pay tax on tIRA withdrawals at all. By converting and paying tax early you are increasing your downside risk in retirement in the hopes of increasing the upside. It may work out. It may not.
Your risk is still the same---your exposure to the difference in tax rates.
I am actually a strong proponent of pre-tax retirements savings (over Roth) most of the time, but not all the time. Every situation is different. All I would stress is that the only thing that matters is your prediction of the difference in your marginal tax rates. There is no instance where it is financially better for the individual to pay more total taxes than they could have, but it is very difficult to know with certainty which path to take to pay the least. For this reason, I generally "tax diversify" somewhat to mitigate the damage of me predicting wrong no matter what I predict.
I'm in full agreement with all of that, though I would suggest that the prediction doesn't matter, it's what actually happens. The OP is suggesting converting now at a high tax rate. They are assuming long continuous employment, no early retirement and no significant medical expenses. Perhaps those assumptions are what need to be tested.
The prediction is all that we have unfortunately. All the other points are valid, but only because they could affect the difference in tax rates (as do many others).

I tax diversify myself, but I did all my Roth conversions at very low rates after early retirement.

learnQuest
Posts: 2
Joined: Wed Sep 30, 2015 4:52 pm

Re: Young professionals in CA - $80K Roth conversion?

Post by learnQuest » Thu Dec 06, 2018 3:11 pm

I don't mean to hijack this thread, but since I am also in the similar question, posting it here.
We have around 170k wages and income for 2018. Looking at the recent marhet movement, I am thinking of doing ROTH conversion of my traditional IRA.
Status: Married
Ages: 55, 58
State: California
Assets: $545K
-> 290K of this is in pre-tax (traditional) accounts
-> 75K of this is in post-tax (Roth) accounts
Asset allocation: 90% stock (95% domestic, 5% international). No non-liquid assets.

We are just 7-8 years away from my retirement. Our tax bracket according to the new tax reform is 24% (157k - 315k). Next year our tax bracket is likely to go up. What are the pros and cons of ROTH conversion in our situation. Whatever we have in retirement we think if it's tax free that will good for us. If we decide to convert say 100K, how to get a ballpark estimate on the taxes we will incur. Any other thoughts/advice?

bloom2708
Posts: 5015
Joined: Wed Apr 02, 2014 2:08 pm
Location: Fargo, ND

Re: Young professionals in CA - $80K Roth conversion?

Post by bloom2708 » Thu Dec 06, 2018 3:29 pm

learnQuest wrote:
Thu Dec 06, 2018 3:11 pm
I don't mean to hijack this thread, but since I am also in the similar question, posting it here.
We have around 170k wages and income for 2018. Looking at the recent marhet movement, I am thinking of doing ROTH conversion of my traditional IRA.
Status: Married
Ages: 55, 58
State: California
Assets: $545K
-> 290K of this is in pre-tax (traditional) accounts
-> 75K of this is in post-tax (Roth) accounts
Asset allocation: 90% stock (95% domestic, 5% international). No non-liquid assets.

We are just 7-8 years away from my retirement. Our tax bracket according to the new tax reform is 24% (157k - 315k). Next year our tax bracket is likely to go up. What are the pros and cons of ROTH conversion in our situation. Whatever we have in retirement we think if it's tax free that will good for us. If we decide to convert say 100K, how to get a ballpark estimate on the taxes we will incur. Any other thoughts/advice?
It is best to do Roth Conversions in the time between retirement and SS. That way your job income is way down and your Roth Conversion income replaces it and keeps you in the lower brackets.

While working, I do not think you are a good candidate for a Roth Conversion. With $290k in Traditional, your RMD won't be big. Have you gotten estimates at what both of your SS will look like at 67 and 70? Your spending compared to SS supplimented with 4% from retirement accounts is your projected income unless you one or both have pensions.

I would look hard at being 90% stocks this close to retirement. You do not have time to recover. 60/40 would be much better. But then, people have different risk tolerance levels. A prolonged downturn would put you right in a potential retirement window with accounts at a low point.

Hopefully others have ideas.
"We are not here to please, but to provoke thoughtfulness." --Unknown Boglehead

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