Pre-tax vs Roth for HNW

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neopsych12
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Pre-tax vs Roth for HNW

Post by neopsych12 »

At what net worth would you consider making ROTH 401k contributions during your working years EVEN in the highest federal tax bracket (37%)? No state tax.

Typically it is advisable to make pre-tax contributions when in the highest tax bracket but there must be a point in net worth where ROTH is more favorable long-term (future tax liability >37% either because rates are increased or the HNW individual never makes it to a low tax bracket due to portfolio income/RMDs/SS.
KlangFool
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Re: Pre-tax vs Roth for HNW

Post by KlangFool »

OP,

"At what net worth would you consider making ROTH 401k contributions during your working years EVEN in the highest federal tax bracket (37%)? No state tax."

It does not exists for me. Before that point, there is no reason for me to continue working.

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steadyosmosis
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Re: Pre-tax vs Roth for HNW

Post by steadyosmosis »

neopsych12 wrote: Fri Jun 07, 2024 6:52 pm At what net worth would you consider making ROTH 401k contributions during your working years EVEN in the highest federal tax bracket (37%)? No state tax.

Typically it is advisable to make pre-tax contributions when in the highest tax bracket but there must be a point in net worth where ROTH is more favorable long-term (future tax liability >37% either because rates are increased or the HNW individual never makes it to a low tax bracket due to portfolio income/RMDs/SS.
Regardless of my net worth, the higher my marginal tax rate, the more I wish to tax-defer (aka avoid Roth).
Age<59.5 | Early-retired | AA 52/48 | Taxable=100% VTI | Roth IRA=94% equities | HSA=94% equities | Traditional IRA=100% fixed income | I spend from the taxable account |
evancox10
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Re: Pre-tax vs Roth for HNW

Post by evancox10 »

At the point where the Roth contributions save you estate tax that you know you would otherwise have to pay. So somewhere around the >$26 million net worth range.
PowderDay9
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Re: Pre-tax vs Roth for HNW

Post by PowderDay9 »

KlangFool wrote: Fri Jun 07, 2024 7:01 pm OP,

"At what net worth would you consider making ROTH 401k contributions during your working years EVEN in the highest federal tax bracket (37%)? No state tax."

It does not exists for me. Before that point, there is no reason for me to continue working.

KlangFool
+1. Same for me.
sailaway
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Re: Pre-tax vs Roth for HNW

Post by sailaway »

At some point, tax deferred can be pulled out $100k a year for charity (QCDs). Tax deferred can also be left to charity without ever having paid taxes on it. That isn't an option everyone is interested in, but it makes a difference to me.
fyre4ce
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Re: Pre-tax vs Roth for HNW

Post by fyre4ce »

It's not about your total net worth, it's about your current and future marginal tax rates. Some assets (eg. pre-tax retirement accounts) generate lots of taxable income, raising future tax rates. Others (eg. Roth accounts) generate none. Taxable accounts are somewhere in between. Your tax planning decisions should be very different if you expect to have $10M in pre-tax accounts when retired, than if you had the same net worth but all in Roth accounts.

Your best bet is to just run the numbers. I have a calculator that does just that. Try it out and let us know how it goes.
babystep
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Re: Pre-tax vs Roth for HNW

Post by babystep »

neopsych12 wrote: Fri Jun 07, 2024 6:52 pm At what net worth would you consider making ROTH 401k contributions during your working years EVEN in the highest federal tax bracket (37%)? No state tax.

Typically it is advisable to make pre-tax contributions when in the highest tax bracket but there must be a point in net worth where ROTH is more favorable long-term (future tax liability >37% either because rates are increased or the HNW individual never makes it to a low tax bracket due to portfolio income/RMDs/SS.
Depends. One example of more than 25M.

20M in taxable at 2% = 400k
5M in 401k at 4% = 200k

600k is still within 35% bracket.
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FiveK
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Re: Pre-tax vs Roth for HNW

Post by FiveK »

babystep wrote: Sat Jun 08, 2024 1:43 am
neopsych12 wrote: Fri Jun 07, 2024 6:52 pm At what net worth would you consider making ROTH 401k contributions during your working years EVEN in the highest federal tax bracket (37%)? No state tax.

Typically it is advisable to make pre-tax contributions when in the highest tax bracket but there must be a point in net worth where ROTH is more favorable long-term (future tax liability >37% either because rates are increased or the HNW individual never makes it to a low tax bracket due to portfolio income/RMDs/SS.
Depends. One example of more than 25M.

20M in taxable at 2% = 400k
5M in 401k at 4% = 200k

600k is still within 35% bracket.
And if the $400K is all qualified dividends, it's only a 25.8% federal marginal rate to take a few more thousand out of the $401k.
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TomatoTomahto
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Re: Pre-tax vs Roth for HNW

Post by TomatoTomahto »

sailaway wrote: Fri Jun 07, 2024 8:09 pm At some point, tax deferred can be pulled out $100k a year for charity (QCDs). Tax deferred can also be left to charity without ever having paid taxes on it. That isn't an option everyone is interested in, but it makes a difference to me.
I was going to raise that point, but with a small amendment. QCD (Qualified Charitable Distributions) can now be $105k and will continue to be inflation adjusted.

As one attains higher net worth, one’s heirs’ needs tend to be met, one’s own needs are likely to be taken care of, and it’s time to consider charity. I stopped any expensive Roth conversions/contributions (ie, backdoor is free, since that money would be taxed regardless) a few years ago once I came to this realization. I somewhat regret the expensive Roth, but hey, nobody’s perfect.
I get the FI part but not the RE part of FIRE.
ThankYouJack
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Re: Pre-tax vs Roth for HNW

Post by ThankYouJack »

I'd probably go Roth with a net worth where my future taxable income is most likely going to be $300k or higher. A couple factors would be:

* Roth could be better even if future marginal tax rates are lower due to the Roth vs Traditional + Taxable comparison
* tax rates may go up
* moving to a state with state income taxes
* Having some Roth increases tax diversity -- can be a good thing and increases flexibility
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Wiggums
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Re: Pre-tax vs Roth for HNW

Post by Wiggums »

Do you have other deferred compensation expected that would keep you in the 32% bracket in retirement?

You should consider your FUTURE tax bracket, retirement age, medicare premium, age you want to retire, pension and social security income expected, etc. Do you currently have a DAF? Are you likely to take advantage of QCDs?
"I started with nothing and I still have most of it left."
VanGar+Goyle
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Re: Pre-tax vs Roth for HNW

Post by VanGar+Goyle »

neopsych12 wrote: Fri Jun 07, 2024 6:52 pm At what net worth would you consider making ROTH 401k contributions during your working years EVEN in the highest federal tax bracket (37%)? No state tax.

Typically it is advisable to make pre-tax contributions when in the highest tax bracket but there must be a point in net worth where ROTH is more favorable long-term (future tax liability >37% either because rates are increased or the HNW individual never makes it to a low tax bracket due to portfolio income/RMDs/SS.
You should consider your total income picture, which may include Net Investment Income Tax of 3.8%, Medicare IRMAA, State income taxes, possible changes in Federal income taxes, like expiration of TCJA in 2026. If you only think about simple Federal Income Tax brackets, you could be off by 20%.
If you don't spend your Roth 401(k), like most people, then you should think about your beneficiaries, including any charities.
But it is not based on net worth, but possible taxable income from tax-deferred accounts.
aristotelian
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Re: Pre-tax vs Roth for HNW

Post by aristotelian »

I would be seeking to max pretax accounts all day, every day, at that income level.
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Re: Pre-tax vs Roth for HNW

Post by jebmke »

Never. At that level, my perspective would have been that the new layers would likely end up going to charity. That has proven true and as a result, I abruptly stopped doing Roth conversions many years ago.
When you discover that you are riding a dead horse, the best strategy is to dismount.
smitcat
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Re: Pre-tax vs Roth for HNW

Post by smitcat »

At that level it depends on the end goal of the accumulated funds.
Tax deferred is typically preferred for charitable goals.
Roth is typically preferred for heirs.
Taxable is the rest of the funds ...and is typically used to balance over time between the other two.
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TomatoTomahto
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Re: Pre-tax vs Roth for HNW

Post by TomatoTomahto »

smitcat wrote: Sat Jun 08, 2024 7:03 am Roth is typically preferred for heirs.
I have 4 heirs. Only one of them (currently) has marginal tax rate as high as ours, and tbh they don’t need the inheritance. Tax deferred for the win.
I get the FI part but not the RE part of FIRE.
smitcat
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Re: Pre-tax vs Roth for HNW

Post by smitcat »

TomatoTomahto wrote: Sat Jun 08, 2024 7:17 am
smitcat wrote: Sat Jun 08, 2024 7:03 am Roth is typically preferred for heirs.
I have 4 heirs. Only one of them (currently) has marginal tax rate as high as ours, and tbh they don’t need the inheritance. Tax deferred for the win.
Two thoughts....
- they do not need to have a tax rate as high as yours for it to make a lot of sense.
- the tax deferred space is limited, the results will typically be in taxable
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TomatoTomahto
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Re: Pre-tax vs Roth for HNW

Post by TomatoTomahto »

smitcat wrote: Sat Jun 08, 2024 7:31 am
TomatoTomahto wrote: Sat Jun 08, 2024 7:17 am
smitcat wrote: Sat Jun 08, 2024 7:03 am Roth is typically preferred for heirs.
I have 4 heirs. Only one of them (currently) has marginal tax rate as high as ours, and tbh they don’t need the inheritance. Tax deferred for the win.
Two thoughts....
- they do not need to have a tax rate as high as yours for it to make a lot of sense.
- the tax deferred space is limited, the results will typically be in taxable
It costs us a lot (about 50%) to put a dollar in Roth. It costs them half that, or less, to inherit a dollar in traditional. Explain to me why it makes “a lot of sense.” I’m not disputing you or trying to be difficult; I honestly don’t see it.
I get the FI part but not the RE part of FIRE.
toddthebod
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Re: Pre-tax vs Roth for HNW

Post by toddthebod »

TomatoTomahto wrote: Sat Jun 08, 2024 7:36 am
smitcat wrote: Sat Jun 08, 2024 7:31 am
TomatoTomahto wrote: Sat Jun 08, 2024 7:17 am
smitcat wrote: Sat Jun 08, 2024 7:03 am Roth is typically preferred for heirs.
I have 4 heirs. Only one of them (currently) has marginal tax rate as high as ours, and tbh they don’t need the inheritance. Tax deferred for the win.
Two thoughts....
- they do not need to have a tax rate as high as yours for it to make a lot of sense.
- the tax deferred space is limited, the results will typically be in taxable
It costs us a lot (about 50%) to put a dollar in Roth. It costs them half that, or less, to inherit a dollar in traditional. Explain to me why it makes “a lot of sense.” I’m not disputing you or trying to be difficult; I honestly don’t see it.
The only advantage I can think of is no RMD.
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TomatoTomahto
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Re: Pre-tax vs Roth for HNW

Post by TomatoTomahto »

toddthebod wrote: Sat Jun 08, 2024 7:37 am
TomatoTomahto wrote: Sat Jun 08, 2024 7:36 am
smitcat wrote: Sat Jun 08, 2024 7:31 am
TomatoTomahto wrote: Sat Jun 08, 2024 7:17 am
smitcat wrote: Sat Jun 08, 2024 7:03 am Roth is typically preferred for heirs.
I have 4 heirs. Only one of them (currently) has marginal tax rate as high as ours, and tbh they don’t need the inheritance. Tax deferred for the win.
Two thoughts....
- they do not need to have a tax rate as high as yours for it to make a lot of sense.
- the tax deferred space is limited, the results will typically be in taxable
It costs us a lot (about 50%) to put a dollar in Roth. It costs them half that, or less, to inherit a dollar in traditional. Explain to me why it makes “a lot of sense.” I’m not disputing you or trying to be difficult; I honestly don’t see it.
The only advantage I can think of is no RMD.
There is also the fact that Roth and traditional are treated equally for estate tax purposes even though they are not equal in “value,” but that analysis is beyond my math abilities.
I get the FI part but not the RE part of FIRE.
toddthebod
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Re: Pre-tax vs Roth for HNW

Post by toddthebod »

TomatoTomahto wrote: Sat Jun 08, 2024 7:40 am
toddthebod wrote: Sat Jun 08, 2024 7:37 am
TomatoTomahto wrote: Sat Jun 08, 2024 7:36 am
smitcat wrote: Sat Jun 08, 2024 7:31 am
TomatoTomahto wrote: Sat Jun 08, 2024 7:17 am

I have 4 heirs. Only one of them (currently) has marginal tax rate as high as ours, and tbh they don’t need the inheritance. Tax deferred for the win.
Two thoughts....
- they do not need to have a tax rate as high as yours for it to make a lot of sense.
- the tax deferred space is limited, the results will typically be in taxable
It costs us a lot (about 50%) to put a dollar in Roth. It costs them half that, or less, to inherit a dollar in traditional. Explain to me why it makes “a lot of sense.” I’m not disputing you or trying to be difficult; I honestly don’t see it.
The only advantage I can think of is no RMD.
There is also the fact that Roth and traditional are treated equally for estate tax purposes even though they are not equal in “value,” but that analysis is beyond my math abilities.
Also, given the ability to pay conversion taxes out of your taxable account, at a given marginal tax rate, Roth always wins.
daektr
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Re: Pre-tax vs Roth for HNW

Post by daektr »

evancox10 wrote: Fri Jun 07, 2024 7:24 pm At the point where the Roth contributions save you estate tax that you know you would otherwise have to pay. So somewhere around the >$26 million net worth range.
This.

Or if the tax rates will be the same, skipping the hassle of RMD’s.
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Re: Pre-tax vs Roth for HNW

Post by Jack FFR1846 »

You would want to look ahead to RMD ages. When you are pulling RMDs from 401k traditional and IRA traditional, you raise your income and can easily hit IRMAA on both your Medicare premiums and your spouse's Medicare premiums. At that point, income will include:

RMDs
interest
social security for both of you
dividends in taxable
Any W2, 1099, royalties, etc

If you have a few million in traditional IRA/401k, expect to hit the first IRMAA penalty range. But also keep in mind that if your income from the above list climbs higher than that, IRMAA has the next level and the next level above that. And Both you and your spouse pay the higher amount, so is sort of a double penalty for a married couple.
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toddthebod
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Re: Pre-tax vs Roth for HNW

Post by toddthebod »

daektr wrote: Sat Jun 08, 2024 9:20 am
evancox10 wrote: Fri Jun 07, 2024 7:24 pm At the point where the Roth contributions save you estate tax that you know you would otherwise have to pay. So somewhere around the >$26 million net worth range.
This.
Disagree. It's a commutative multiplication problem. It doesn't matter if you take out estate taxes before income taxes or income taxes before estate taxes.

(1 - income tax rate) x (1 - estate tax rate) = (1 - estate tax rate) x (1 - income tax rate)

To be fair, there are other reasons why, given a fixed marginal tax rate, conversions makes sense (namely, the ability to pay taxes outside of the IRA, and eliminating RMDs), but saving on estate taxes is not one of them.
smitcat
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Re: Pre-tax vs Roth for HNW

Post by smitcat »

TomatoTomahto wrote: Sat Jun 08, 2024 7:36 am
smitcat wrote: Sat Jun 08, 2024 7:31 am
TomatoTomahto wrote: Sat Jun 08, 2024 7:17 am
smitcat wrote: Sat Jun 08, 2024 7:03 am Roth is typically preferred for heirs.
I have 4 heirs. Only one of them (currently) has marginal tax rate as high as ours, and tbh they don’t need the inheritance. Tax deferred for the win.
Two thoughts....
- they do not need to have a tax rate as high as yours for it to make a lot of sense.
- the tax deferred space is limited, the results will typically be in taxable
It costs us a lot (about 50%) to put a dollar in Roth. It costs them half that, or less, to inherit a dollar in traditional. Explain to me why it makes “a lot of sense.” I’m not disputing you or trying to be difficult; I honestly don’t see it.
"It costs them half that, or less, to inherit a dollar in traditional."
Less than half is a lot to make up - in our case the difference will not be so large.
But we also need to calculate the expenses of inheritance taxes and IRMMA , that is why utilizing a calculator is valuable.
States like Mass. are some of the best reasons to consider a plan for the entire life of each account type - tax deferred, Roth, and taxable.
smitcat
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Re: Pre-tax vs Roth for HNW

Post by smitcat »

TomatoTomahto wrote: Sat Jun 08, 2024 7:40 am
toddthebod wrote: Sat Jun 08, 2024 7:37 am
TomatoTomahto wrote: Sat Jun 08, 2024 7:36 am
smitcat wrote: Sat Jun 08, 2024 7:31 am
TomatoTomahto wrote: Sat Jun 08, 2024 7:17 am

I have 4 heirs. Only one of them (currently) has marginal tax rate as high as ours, and tbh they don’t need the inheritance. Tax deferred for the win.
Two thoughts....
- they do not need to have a tax rate as high as yours for it to make a lot of sense.
- the tax deferred space is limited, the results will typically be in taxable
It costs us a lot (about 50%) to put a dollar in Roth. It costs them half that, or less, to inherit a dollar in traditional. Explain to me why it makes “a lot of sense.” I’m not disputing you or trying to be difficult; I honestly don’t see it.
The only advantage I can think of is no RMD.
There is also the fact that Roth and traditional are treated equally for estate tax purposes even though they are not equal in “value,” but that analysis is beyond my math abilities.
Both RPM and Pralana can handle these for you easily.
I favor Pralana as it has options to 'automatically' optimize Roth converrsions and drawdowns or make it manual.
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Re: Pre-tax vs Roth for HNW

Post by smitcat »

daektr wrote: Sat Jun 08, 2024 9:20 am
evancox10 wrote: Fri Jun 07, 2024 7:24 pm At the point where the Roth contributions save you estate tax that you know you would otherwise have to pay. So somewhere around the >$26 million net worth range.
This.

Or if the tax rates will be the same, skipping the hassle of RMD’s.
You missed the possiblity of State taxes on estates and/or inheritances.
privateer79
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Re: Pre-tax vs Roth for HNW

Post by privateer79 »

I wonder how much of this hangs on state tax rate arbitrage?

being in a ~15% state and local bracket + high federal, pretax lets me avoid the 15% state haircut by withdrawing later in a retiree-friendly state (florida, Arizona, etc)

being in a 0 % income tax state takes alot of that benefit away.
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TomatoTomahto
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Re: Pre-tax vs Roth for HNW

Post by TomatoTomahto »

smitcat wrote: Sat Jun 08, 2024 10:57 am States like Mass. are some of the best reasons to consider a plan for the entire life of each account type - tax deferred, Roth, and taxable.
The single best thing we could do for our heirs financially is to move to another state. But, bad luck for them, we like it here in Mass. :D
I get the FI part but not the RE part of FIRE.
smitcat
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Re: Pre-tax vs Roth for HNW

Post by smitcat »

TomatoTomahto wrote: Sat Jun 08, 2024 11:15 am
smitcat wrote: Sat Jun 08, 2024 10:57 am States like Mass. are some of the best reasons to consider a plan for the entire life of each account type - tax deferred, Roth, and taxable.
The single best thing we could do for our heirs financially is to move to another state. But, bad luck for them, we like it here in Mass. :D
Staying does not affect your ability to manage the accounts for your best goals.
smitcat
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Re: Pre-tax vs Roth for HNW

Post by smitcat »

privateer79 wrote: Sat Jun 08, 2024 11:05 am I wonder how much of this hangs on state tax rate arbitrage?

being in a ~15% state and local bracket + high federal, pretax lets me avoid the 15% state haircut by withdrawing later in a retiree-friendly state (florida, Arizona, etc)

being in a 0 % income tax state takes alot of that benefit away.

I was unaware that any state levied a 15% tax.
Geoarbitration works fairly well as long as you have a desire for those destinations.
Best to consider all of the costs when comparing any two locations not just the income taxes.
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celia
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Re: Pre-tax vs Roth for HNW

Post by celia »

neopsych12 wrote: Fri Jun 07, 2024 6:52 pm At what net worth would you consider making ROTH 401k contributions during your working years EVEN in the highest federal tax bracket (37%)? No state tax.
State tax or not, you would pay the same taxes whether you put your excess money in Roth or Taxable. But in a Roth, you wouldn't have to pay taxes on the future growth.
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.
sc9182
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Re: Pre-tax vs Roth for HNW

Post by sc9182 »

Some folks have misconception regarding associative principle of math. It’s ok to be math challenged a little.

While some folks talk as if: Roth is (or backdoor Roth) is an huge/unlimited bucket and has existed since BC !! Sure it wasn’t ..

Definitely diversity- but, no need to go greedy/all-in on Roth — unless you earmark such Roth monies specifically for legacy-reasons and/or to maintain some opportunistic low-AGI years.

Using Roth monies: Have anyone tried QCDs, paying for large-medical expenses which may be mostly tax-deductible, or LTC costs, or leaving legacy to low/mid income brood, or zero-taxed charities !? Good luck - you might not realize how low-IQ move that is - since one is already rolling 6-feet under.

Roth is good - but going greedy on it - indeed have many negative (financial) consequences.
toddthebod
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Re: Pre-tax vs Roth for HNW

Post by toddthebod »

sc9182 wrote: Sat Jun 08, 2024 12:57 pm Some folks have misconception regarding associative principle of math. It’s ok to be math challenged a little.
Says the person who mixed up the associative and commutative properties! :D
evancox10
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Re: Pre-tax vs Roth for HNW

Post by evancox10 »

toddthebod wrote: Sat Jun 08, 2024 10:33 am
daektr wrote: Sat Jun 08, 2024 9:20 am
evancox10 wrote: Fri Jun 07, 2024 7:24 pm At the point where the Roth contributions save you estate tax that you know you would otherwise have to pay. So somewhere around the >$26 million net worth range.
This.
Disagree. It's a commutative multiplication problem. It doesn't matter if you take out estate taxes before income taxes or income taxes before estate taxes.

(1 - income tax rate) x (1 - estate tax rate) = (1 - estate tax rate) x (1 - income tax rate)

To be fair, there are other reasons why, given a fixed marginal tax rate, conversions makes sense (namely, the ability to pay taxes outside of the IRA, and eliminating RMDs), but saving on estate taxes is not one of them.
I believe there are cases where it does save money overall. I worked up some examples to show the amounts. Originally I wasn't considering the IRD deduction. If you factor that in the savings are a lot smaller, but they're still there.
sc9182
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Re: Pre-tax vs Roth for HNW

Post by sc9182 »

toddthebod wrote: Sat Jun 08, 2024 1:18 pm
sc9182 wrote: Sat Jun 08, 2024 12:57 pm Some folks have misconception regarding associative principle of math. It’s ok to be math challenged a little.
Says the person who mixed up the associative and commutative properties! :D
lol - thx for correction. did say it’s ok to be challenged a bit, case in point :)
daektr
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Re: Pre-tax vs Roth for HNW

Post by daektr »

toddthebod wrote: Sat Jun 08, 2024 10:33 am
daektr wrote: Sat Jun 08, 2024 9:20 am
evancox10 wrote: Fri Jun 07, 2024 7:24 pm At the point where the Roth contributions save you estate tax that you know you would otherwise have to pay. So somewhere around the >$26 million net worth range.
This.
Disagree. It's a commutative multiplication problem. It doesn't matter if you take out estate taxes before income taxes or income taxes before estate taxes.

(1 - income tax rate) x (1 - estate tax rate) = (1 - estate tax rate) x (1 - income tax rate)

To be fair, there are other reasons why, given a fixed marginal tax rate, conversions makes sense (namely, the ability to pay taxes outside of the IRA, and eliminating RMDs), but saving on estate taxes is not one of them.
Yeah, I understand this math & initially reached a similar conclusion … The reason it still helps to convert is that when you pay the tax bill using external cash, this spend reduces the overall size of the estate that is subject to the estate tax.
avalpert1
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Re: Pre-tax vs Roth for HNW

Post by avalpert1 »

daektr wrote: Sat Jun 08, 2024 6:55 pm
toddthebod wrote: Sat Jun 08, 2024 10:33 am
daektr wrote: Sat Jun 08, 2024 9:20 am
evancox10 wrote: Fri Jun 07, 2024 7:24 pm At the point where the Roth contributions save you estate tax that you know you would otherwise have to pay. So somewhere around the >$26 million net worth range.
This.
Disagree. It's a commutative multiplication problem. It doesn't matter if you take out estate taxes before income taxes or income taxes before estate taxes.

(1 - income tax rate) x (1 - estate tax rate) = (1 - estate tax rate) x (1 - income tax rate)

To be fair, there are other reasons why, given a fixed marginal tax rate, conversions makes sense (namely, the ability to pay taxes outside of the IRA, and eliminating RMDs), but saving on estate taxes is not one of them.
Yeah, I understand this math & initially reached a similar conclusion … The reason it still helps to convert is that when you pay the tax bill using external cash, this spend reduces the overall size of the estate that is subject to the estate tax.
That basically another way of saying the marginal tax rate is increased if it goes into your estate which is subject to estate tax (which then also needs to account for other ways to reduce estate tax) so the comparison then is between the marginal rate at contribution and the estate tax + beneficiaries' marginal income tax rate on the withdrawals.
stay.the.course
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Re: Pre-tax vs Roth for HNW

Post by stay.the.course »

daektr wrote: Sat Jun 08, 2024 6:55 pm
toddthebod wrote: Sat Jun 08, 2024 10:33 am
daektr wrote: Sat Jun 08, 2024 9:20 am
evancox10 wrote: Fri Jun 07, 2024 7:24 pm At the point where the Roth contributions save you estate tax that you know you would otherwise have to pay. So somewhere around the >$26 million net worth range.
This.
Disagree. It's a commutative multiplication problem. It doesn't matter if you take out estate taxes before income taxes or income taxes before estate taxes.

(1 - income tax rate) x (1 - estate tax rate) = (1 - estate tax rate) x (1 - income tax rate)

To be fair, there are other reasons why, given a fixed marginal tax rate, conversions makes sense (namely, the ability to pay taxes outside of the IRA, and eliminating RMDs), but saving on estate taxes is not one of them.
Yeah, I understand this math & initially reached a similar conclusion … The reason it still helps to convert is that when you pay the tax bill using external cash, this spend reduces the overall size of the estate that is subject to the estate tax.

Some clarification please:

1. Assets in a Roth IRA do count towards one’s estate. So if my estate has a total of $30 million with $4 million in a Roth IRA, heirs are still responsible to pay estate tax on $4 mil or whatever the amount is above the estate tax exemption.

Is that correct?

2. Daektr, this is brilliant. I never thought of it that way. Make a big Roth conversion from a massive tax deferred account after retirement and pay the taxes from a taxable brocherage account which would bring down one’s total estate to within the estate tax exemption limit. Provided your timing is impeccable of course :)


I hired two financial advisors this year to draw me two financial plans. Why two? I like second opinions. One was trying to sell me a $10 million insurance policy and place it in an irrevocable trust so my kids can pay the expected inheritance/estate taxes. I like your idea better, Daektr.
toddthebod
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Re: Pre-tax vs Roth for HNW

Post by toddthebod »

stay.the.course wrote: Sun Jun 09, 2024 8:15 am 1. Assets in a Roth IRA do count towards one’s estate. So if my estate has a total of $30 million with $4 million in a Roth IRA, heirs are still responsible to pay estate tax on $4 mil or whatever the amount is above the estate tax exemption.

Is that correct?

2. Daektr, this is brilliant. I never thought of it that way. Make a big Roth conversion from a massive tax deferred account after retirement and pay the taxes from a taxable brocherage account which would bring down one’s total estate to within the estate tax exemption limit. Provided your timing is impeccable of course :)


I hired two financial advisors this year to draw me two financial plans. Why two? I like second opinions. One was trying to sell me a $10 million insurance policy and place it in an irrevocable trust so my kids can pay the expected inheritance/estate taxes. I like your idea better, Daektr.
1. Yes.

2. Irrevocable life insurance trusts are a somewhat common technique for UHNW individuals to reduce estate taxes.
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Re: Pre-tax vs Roth for HNW

Post by bsteiner »

toddthebod wrote: Sun Jun 09, 2024 9:30 am
stay.the.course wrote: Sun Jun 09, 2024 8:15 am 1. Assets in a Roth IRA do count towards one’s estate. So if my estate has a total of $30 million with $4 million in a Roth IRA, heirs are still responsible to pay estate tax on $4 mil or whatever the amount is above the estate tax exemption.

Is that correct?

2. Daektr, this is brilliant. I never thought of it that way. Make a big Roth conversion from a massive tax deferred account after retirement and pay the taxes from a taxable brocherage account which would bring down one’s total estate to within the estate tax exemption limit. Provided your timing is impeccable of course :)


I hired two financial advisors this year to draw me two financial plans. Why two? I like second opinions. One was trying to sell me a $10 million insurance policy and place it in an irrevocable trust so my kids can pay the expected inheritance/estate taxes. I like your idea better, Daektr.
1. Yes.

2. Irrevocable life insurance trusts are a somewhat common technique for UHNW individuals to reduce estate taxes.
1. While there are many benefits to Roth conversions, estate tax savings is not one of them in a state that doesn't have a state estate or inheritance tax. The beneficiaries of a traditional IRA get an income tax deduction for the estate tax on it, at the marginal rate. But there's a substantial estate tax savings in a state that has a state estate or inheritance tax. That's because the income tax deduction is only for the Federal estate tax, and not for the state estate or inheritance tax. Assuming a 16% state estate tax (the top rate in most states that have a state estate tax), the Federal estate tax (net of the deduction for the state estate tax) is 33.6% and the state estate tax is 16%, so the deduction only covers about 2/3 of the total estate taxes.

2. Life insurance won't reduce your estate tax. You could make gifts in the same amount as the premiums would be if you bought the insurance. If the donee (the trustee of the trust to which you make the gifts) invests in other assets, and you live close to, to, or beyond life expectancy, the trust will probably (though not necessarily) have more money at your death that if they bought life insurance.

Insurance trusts are mainly for people rich enough to pay estate tax but poor enough to need life insurance. When the estate tax exclusion amount was much lower (in 2001 it was $675,000 and it was scheduled to increase in stages to $1 million by 2006), most of our upper middle class clients expected to pay estate tax (even if we included credit shelter trusts in their Wills) but needed life insurance in case they died early. We did insurance trusts for many such clients. With the current level of the estate tax exclusion amount (even if it reverts to half of the current level as scheduled in 2026), very few clients are both rich enough to pay estate tax and poor enough to need life insurance. Of course, there are other reasons for life insurance in some cases, such as to fund a buyout of a partner, or to provide liquidity where the assets are illiquid but the client expects to sell the illiquid assets in the short or intermediate term.

The one who pitched the insurance may have been an insurance agent rather than an advisor.
stay.the.course
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Re: Pre-tax vs Roth for HNW

Post by stay.the.course »

But if the bulk of the estate is in tax deferred accounts (say two professionals who maximized tax deferred accounts plus years of cash benefit plan/SEP IRA), isn’t conversion from tax deferred to Roth after retirement and paying the taxes from a smaller brocherage account better estate tax plan strategy than buying a life insurance?

In other words, is life insurance as a hedging strategy against estate taxes ( bought and placed in an irrevocable trust, i. e. outside of one’s estate) a good option for folks like the author of this topic (massive brocherage account, small tax deferred account) but not a good option for people like me (sizable tax deferred account and small brocherage account)?

I am just trying to understand.

Many thx for the replies.
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Re: Pre-tax vs Roth for HNW

Post by illumination »

bsteiner wrote: Sun Jun 09, 2024 10:00 am

1. While there are many benefits to Roth conversions, estate tax savings is not one of them in a state that doesn't have a state estate or inheritance tax.


I'm genuinely curious about this conclusion, can you show the math on this because I'm having trouble understanding your reasoning. What sort of rebate does paying the estate tax produce for the estate?

Because the federal estate tax doesn't count a dollar in pre-tax as somehow less than a dollar in a Roth, it would seem there are substantial benefits for someone that is paying an estate tax to convert before death. They may even avoid the estate tax completely.

As a hypothetical, say someone is $1 million over the estate tax threshold and they have a large T-IRA/401k. They decide to convert $2.5 million of pre-tax to a Roth IRA. To pay the taxes owed to this conversion at 40% (just using a high marginal rate), they now go out of pocket $1 million. They now no longer pay a federal estate tax at all as they are under the threshold. So right there is a tax savings of $400k (40% of $1 million). The account owner now no longer has to pay any taxes (or RMD's on their T-IRA). AND the heirs get to have 10 years of tax free growth in an inherited Roth IRA.

I feel the 10 years of tax free growth for the heirs can't be minimized, that's an enormous tax benefit to pass to someone, likely in most cases (depending on asset allocation) to double the balance when that time frame has ended. Had the $2.5 million in a traditional IRA doubled, it would be $5 million in ordinary income being taxed to the heirs.

If the person chose to not convert, there would be 40% tax on the amount over the estate tax threshold, the heir gets an inherited pre-tax IRA that they will have to empty over the next 10 years (and likely pay taxes in a high bracket while they are in their prime earning years). The "X" variable is what sort of credit paying the estate tax is worth.
stay.the.course
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Re: Pre-tax vs Roth for HNW

Post by stay.the.course »

illumination wrote: Sun Jun 09, 2024 10:51 am
bsteiner wrote: Sun Jun 09, 2024 10:00 am

1. While there are many benefits to Roth conversions, estate tax savings is not one of them in a state that doesn't have a state estate or inheritance tax.


I'm genuinely curious about this conclusion, can you show the math on this because I'm having trouble understanding your reasoning. What sort of rebate does paying the estate tax produce for the estate?

Because the federal estate tax doesn't count a dollar in pre-tax as somehow less than a dollar in a Roth, it would seem there are substantial benefits for someone that is paying an estate tax to convert before death. They may even avoid the estate tax completely.

As a hypothetical, say someone is $1 million over the estate tax threshold and they have a large T-IRA/401k. They decide to convert $2.5 million of pre-tax to a Roth IRA. To pay the taxes owed to this conversion at 40% (just using a high marginal rate), they now go out of pocket $1 million. They now no longer pay a federal estate tax at all as they are under the threshold. So right there is a tax savings of $400k (40% of $1 million). The account owner now no longer has to pay any taxes (or RMD's on their T-IRA). AND the heirs get to have 10 years of tax free growth in an inherited Roth IRA.

I feel the 10 years of tax free growth for the heirs can't be minimized, that's an enormous tax benefit to pass to someone, likely in most cases (depending on asset allocation) to double the balance when that time frame has ended. Had the $2.5 million in a traditional IRA doubled, it would be $5 million in ordinary income being taxed to the heirs.

If the person chose to not convert, there would be 40% tax on the amount over the estate tax threshold, the heir gets an inherited pre-tax IRA that they will have to empty over the next 10 years (and likely pay taxes in a high bracket while they are in their prime earning years). The "X" variable is what sort of credit paying the estate tax is worth.
That’s the brilliance of this strategy. I had never heard of it before this post. And the $2.5 mil that was converted in your example, not only did it avert estate tax, but it avoided ordinary income tax which would have been paid by the heir had they received the money as traditional IRA. Now that they are receiving it as Roth, they get to keep it all, tax free.

This is an interesting strategy…
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Re: Pre-tax vs Roth for HNW

Post by avalpert1 »

illumination wrote: Sun Jun 09, 2024 10:51 am
bsteiner wrote: Sun Jun 09, 2024 10:00 am

1. While there are many benefits to Roth conversions, estate tax savings is not one of them in a state that doesn't have a state estate or inheritance tax.


I'm genuinely curious about this conclusion, can you show the math on this because I'm having trouble understanding your reasoning. What sort of rebate does paying the estate tax produce for the estate?

Because the federal estate tax doesn't count a dollar in pre-tax as somehow less than a dollar in a Roth, it would seem there are substantial benefits for someone that is paying an estate tax to convert before death.
You'll want to look up the Income in Respect of Descendant tax deduction.
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illumination
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Re: Pre-tax vs Roth for HNW

Post by illumination »

avalpert1 wrote: Sun Jun 09, 2024 11:37 am
illumination wrote: Sun Jun 09, 2024 10:51 am
bsteiner wrote: Sun Jun 09, 2024 10:00 am

1. While there are many benefits to Roth conversions, estate tax savings is not one of them in a state that doesn't have a state estate or inheritance tax.


I'm genuinely curious about this conclusion, can you show the math on this because I'm having trouble understanding your reasoning. What sort of rebate does paying the estate tax produce for the estate?

Because the federal estate tax doesn't count a dollar in pre-tax as somehow less than a dollar in a Roth, it would seem there are substantial benefits for someone that is paying an estate tax to convert before death.
You'll want to look up the Income in Respect of Descendant tax deduction.

And that's what I'm asking, if this deduction outweighs the benefits of converting to a Roth IRA. To me, it seems it doesn't, mostly because the 10 year inherited Roth IRA for the heirs is a huge advantage.
Luckywon
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Re: Pre-tax vs Roth for HNW

Post by Luckywon »

bsteiner wrote: Sun Jun 09, 2024 10:00 am 1. While there are many benefits to Roth conversions, estate tax savings is not one of them in a state that doesn't have a state estate or inheritance tax.
bsteiner, I was trying to validate this with a pro forma analysis as below and the IRD deduction went a long way but came up a bit short in offsetting the estate tax savings. Would appreciate any insight where my calculations may be off.

Assumptions:
- Decedent’s estate exceeds the federal estate tax exemption.
- Total estate value: $15 million.
- Traditional IRA (IRD) value: $3 million.
- Beneficiary is in a 35% income tax bracket.
- No state estate/inheritance tax
- State income tax ignored (would like to examine effect of this subsequently).

Without Roth Conversion

1. Estate Tax Calculation:
- Estate subject to estate tax: $15 million - $12.92 million (exemption) = $2.08 million.
- Estate tax rate: 40%.
- Estate tax on the estate: 40% of $2.08 million = $832,000.

2. Income Tax on IRD for Beneficiary:
- Beneficiary inherits $3 million IRA.
- Income tax on IRA distributions: 35% of $3 million = $1.05 million.
- Deduction for estate tax attributable to IRD:
- Estate tax attributable to IRD: (IRD / Total Estate) * Total Estate Tax = ($3 million / $15 million) * $832,000 = $166,400.
- Income tax after deduction: $1.05 million - $166,400 = $883,600.

With Roth Conversion

1. Before Death:
- Convert $3 million traditional IRA to Roth IRA.
- Pay income tax on conversion: 35% of $3 million = $1.05 million.
- Remaining estate after tax payment: $15 million - $1.05 million = $13.95 million.

2. Estate Tax Calculation:
- Estate subject to estate tax: $13.95 million - $12.92 million = $1.03 million.
- Estate tax rate: 40%.
- Estate tax on the estate: 40% of $1.03 million = $412,000.

3. Roth IRA Inheritance:
- Beneficiary inherits $3 million Roth IRA (tax-free distributions).

Comparison and Offset Analysis

Without Roth Conversion:

- Total taxes paid: Estate tax ($832,000) + Beneficiary income tax ($883,600) = $1,715,600.

With Roth Conversion:
- Total taxes paid: Income tax on conversion ($1.05 million) + Estate tax ($412,000) = $1,462,000.

Savings:
- Total tax savings with Roth conversion: $1,715,600 - $1,462,000 = $253,600.
toddthebod
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Re: Pre-tax vs Roth for HNW

Post by toddthebod »

Luckywon wrote: Sun Jun 09, 2024 12:53 pm
bsteiner wrote: Sun Jun 09, 2024 10:00 am 1. While there are many benefits to Roth conversions, estate tax savings is not one of them in a state that doesn't have a state estate or inheritance tax.
bsteiner, I was trying to validate this with a pro forma analysis as below and the IRD deduction went a long way but came up a bit short in offsetting the estate tax savings. Would appreciate any insight where my calculations may be off.

Assumptions:
- Decedent’s estate exceeds the federal estate tax exemption.
- Total estate value: $15 million.
- Traditional IRA (IRD) value: $3 million.
- Beneficiary is in a 35% income tax bracket.
- No state estate/inheritance tax
- State income tax ignored (would like to examine effect of this subsequently).

Without Roth Conversion

1. Estate Tax Calculation:
- Estate subject to estate tax: $15 million - $12.92 million (exemption) = $2.08 million.
- Estate tax rate: 40%.
- Estate tax on the estate: 40% of $2.08 million = $832,000.

2. Income Tax on IRD for Beneficiary:
- Beneficiary inherits $3 million IRA.
- Income tax on IRA distributions: 35% of $3 million = $1.05 million.
- Deduction for estate tax attributable to IRD:
- Estate tax attributable to IRD: (IRD / Total Estate) * Total Estate Tax = ($3 million / $15 million) * $832,000 = $166,400.
- Income tax after deduction: $1.05 million - $166,400 = $883,600.

With Roth Conversion

1. Before Death:
- Convert $3 million traditional IRA to Roth IRA.
- Pay income tax on conversion: 35% of $3 million = $1.05 million.
- Remaining estate after tax payment: $15 million - $1.05 million = $13.95 million.

2. Estate Tax Calculation:
- Estate subject to estate tax: $13.95 million - $12.92 million = $1.03 million.
- Estate tax rate: 40%.
- Estate tax on the estate: 40% of $1.03 million = $412,000.

3. Roth IRA Inheritance:
- Beneficiary inherits $3 million Roth IRA (tax-free distributions).

Comparison and Offset Analysis

Without Roth Conversion:

- Total taxes paid: Estate tax ($832,000) + Beneficiary income tax ($883,600) = $1,715,600.

With Roth Conversion:
- Total taxes paid: Income tax on conversion ($1.05 million) + Estate tax ($412,000) = $1,462,000.

Savings:
- Total tax savings with Roth conversion: $1,715,600 - $1,462,000 = $253,600.
That is not how the IRD deduction is calculated. Based on my rudimentary understanding, I think it works as follows: you calculate the estate tax twice, once including the IRA, once without, and the difference is the deductible amount. In this case, since $15M - $3M is less than the annual exclusion, the entire $832,000 should be deductible.
Olemiss540
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Re: Pre-tax vs Roth for HNW

Post by Olemiss540 »

toddthebod wrote: Sat Jun 08, 2024 10:33 am
daektr wrote: Sat Jun 08, 2024 9:20 am
evancox10 wrote: Fri Jun 07, 2024 7:24 pm At the point where the Roth contributions save you estate tax that you know you would otherwise have to pay. So somewhere around the >$26 million net worth range.
This.
Disagree. It's a commutative multiplication problem. It doesn't matter if you take out estate taxes before income taxes or income taxes before estate taxes.

(1 - income tax rate) x (1 - estate tax rate) = (1 - estate tax rate) x (1 - income tax rate)

To be fair, there are other reasons why, given a fixed marginal tax rate, conversions makes sense (namely, the ability to pay taxes outside of the IRA, and eliminating RMDs), but saving on estate taxes is not one of them.
If you are going to withdrawal at the same marginal rate, consider the tax drag that the remaining 35% will have (tax savings) by sitting in a taxable account. Roth has the ability to shelter more money from dividends, capital gains once someone has enough expenses to require withdrawals from traditional accounts that match their current marginal rate (or have no charitable thoughts and RMDs force it).

QCDs and heir marginal rates only help if you are not HAVING to withdraw substantial amounts from traditional accounts for expenses. Also I guess it would shelter higher value assets from potential creditors?

Still would be tough to find these scenarios, but if marginal withdrawal rate is equal to marginal contribution rate would lean towards Roth as always.
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