Why Roth conversions always pay off—if you can hold on long enough

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dodecahedron
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by dodecahedron »

teen persuasion wrote: Sat Oct 23, 2021 6:08 pm
MattB wrote: Fri Oct 22, 2021 11:53 pm
cas wrote: Fri Oct 22, 2021 4:26 pm
MattB wrote: Fri Oct 22, 2021 4:02 pm
I think my question was skipped over upthread. So, I'll repeated it: If Roth conversions always paid off (if you can hold long enough), then what would be the point of traditional 401k accounts in the first place?
Your question (routed through Roothy asking it again) got 2 responses upthread (page 3 of thread)

McQ here
FiveK here
Thank you for pointing this out. I saw it was initially passed over and never bothered to wade back into the fray.

McQ's answer is more slight of hand.

FiveK's, that: "The primary answer: conversions don't always pay out," seems to be on the ball.

Thanks again.
For us, the point of traditional 401k contributions was eligibility for federal refundable tax credits, and then more refundable credits when our state partially matched the federal credits.

We are in a low bracket (where Roth is usually recommended), but the stacked credit phaseout rates create a high marginal tax rate. We'd likely owe little to no federal tax even if we did go all Roth, because of other nonrefundable credits, but the extra refunds allow us to save even more (and those $ go to Roth IRAs, because tIRA contributions won't increase the credits as trad 401k contributions do). So we aren't ALL traditional, we have a mix of Roth IRAs and traditional 401k. As we are in a low tax bracket, we can Roth convert the traditional accounts after early retirement a bit at a time in 0 and 10% brackets - no need to go any higher.

Another reason to use traditional 401k contributions was to reduce our AGI while filing FAFSA, to be eligible for Simplified Needs Test (no asset reporting) or Auto EFC = 0.
Along similar lines, for Boglehead Ron Ronnerson the point of making traditional contributions of $50K per year was to secure $15K in refundable ACA health insurance premium tax credits (in addition to the garden variety income tax savings).

Simply looking at the statutory tax bracket tables is really inadequate for making the decision about tax-deferred vs. Roth, especially for low and moderate income households subject to many phaseout provisions and/or cliff effects of eligibility.
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McQ
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

teen persuasion wrote: Sat Oct 23, 2021 6:08 pm
For us, the point of traditional 401k contributions was eligibility for federal refundable tax credits, and then more refundable credits when our state partially matched the federal credits.

We are in a low bracket (where Roth is usually recommended), but the stacked credit phaseout rates create a high marginal tax rate. We'd likely owe little to no federal tax even if we did go all Roth, because of other nonrefundable credits, but the extra refunds allow us to save even more (and those $ go to Roth IRAs, because tIRA contributions won't increase the credits as trad 401k contributions do). So we aren't ALL traditional, we have a mix of Roth IRAs and traditional 401k. As we are in a low tax bracket, we can Roth convert the traditional accounts after early retirement a bit at a time in 0 and 10% brackets - no need to go any higher.

Another reason to use traditional 401k contributions was to reduce our AGI while filing FAFSA, to be eligible for Simplified Needs Test (no asset reporting) or Auto EFC = 0.
That's a helpful reminder to me of what goes on, down near the bottom of the progressive tax structure. Tipping my hat to dodecahedron's follow-up as well, in all practical work it is the total marginal tax rate that must be grasped, not just the income tax rate, with the social security tax torpedo and the IRMAA cliff but two of multiple examples. If PEP and Pease provisions return post-TCJA, the list will get longer still.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
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McQ
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

cas wrote: Fri Oct 22, 2021 3:17 pm
(And ... I think this was probably mostly a typo on your part, but it involves a real-life mistake that I see people making in boglehead's threads, so I'll point it out anyway: IRMAA when Medicare starts at 65 is determined by MAGI at age 63. So, conversions that avoid IRMAA considerations need to happen before age 63.)
Hello cas: the age 63 thing had me scratching my head. Regarding age 63 income driving initial IRMAA determination: popular sites say one thing, government sites another. It seems to me one of two things must be true:
Either:
1. The statute requires the SSA to use income from exactly two years before to determine IRMAA;
Or
2. Regulators charged with implementing the statute recognized that tax returns from two years prior would be the most up-to-date information reliably available to the SSA in the mass, hence are used faute de mieux to estimate, in this case, age 65 income, with the recipient allowed to furnish a more recent update if they can.

If #2, one simply sends the SSA the age 64 income tax return, as more recent information, and the age 63 conversion will not trigger IRMAA, i.e., the initial determination will be reversed. I saw that option on the hhs.gov site, independent of the life changes that everyone discusses as a way to escape IRMAA. https://www.hhs.gov/about/agencies/omha ... index.html

But I defer to tax professionals on this one.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
ROIGuy
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by ROIGuy »

Gaston wrote: Sat Oct 23, 2021 7:43 pm A key assumption in nearly all Roth conversion calculations is that the US government will keep its word, and not tax Roth distributions. With the growth in government spending programs and the ever-increasing national debt, I will not be surprised if, one day, Congress retroactively changes the rules on Roths. I hope I am wrong.
But then the government would be taxing that particular investment twice. I don't see how any elected official would keep his job voting to approve that.
2pedals
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by 2pedals »

Mr.BB wrote: Sun Oct 24, 2021 2:57 pm
Gaston wrote: Sat Oct 23, 2021 7:43 pm A key assumption in nearly all Roth conversion calculations is that the US government will keep its word, and not tax Roth distributions. With the growth in government spending programs and the ever-increasing national debt, I will not be surprised if, one day, Congress retroactively changes the rules on Roths. I hope I am wrong.
But then the government would be taxing that particular investment twice. I don't see how any elected official would keep his job voting to approve that.
We are not really allowed to discuss likely or unlikely possible future changes in the tax law on bogleheads.org. We don't want this thread to get locked.
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McQ
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

2pedals wrote: Sun Oct 24, 2021 5:17 pm
Mr.BB wrote: Sun Oct 24, 2021 2:57 pm
Gaston wrote: Sat Oct 23, 2021 7:43 pm A key assumption in nearly all Roth conversion calculations is that the US government will keep its word, and not tax Roth distributions. With the growth in government spending programs and the ever-increasing national debt, I will not be surprised if, one day, Congress retroactively changes the rules on Roths. I hope I am wrong.
But then the government would be taxing that particular investment twice. I don't see how any elected official would keep his job voting to approve that.
We are not really allowed to discuss likely or unlikely possible future changes in the tax law on bogleheads.org. We don't want this thread to get locked.
Indeed, let's not discuss future tax law. But it should be okay to ask, in the spirit of risk-adjusted returns, how certain can we be that the tax treatment of Roth accounts will never become less favorable than today? And the answer is, we cannot be 100% certain.

To Gaston and BB's point: it is highly unlikely that Roth distributions would be subject to an in-your-face income tax. But there are many, many sneaky ways that the tax treatment of Roth distributions can be made less favorable.

The most relevant one for the present thread:
1. municipal bond interest is and remains free of income tax
2. But tax free interest is factored into MAGI when computing social security income subject to taxation and when testing for IRMAA.
3. Easy enough to slightly reword the code to read "tax free income" goes into MAGI, and not the present "tax free interest."
4. In which case, those who converted to Roth in the hope of drawing income that would not put them into the SS tax torpedo or trigger IRMAA will be sorely disappointed.

That hasn't mattered yet in this thread, because Roth funds are not spent in the scenarios thus far; but down the road, when cases where Roth funds are spent are considered, tax risk will have to be factored into the expected payoff.

Boglehead policy on the matter of tax legislation is clear (and wise) and I hope not to run afoul of it. But acknowledging tax risk, when discussing the pay off from converting into a tax free structure, seems only prudent.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
2pedals
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by 2pedals »

McQ wrote: Sun Oct 24, 2021 6:02 pm ......cut.....
That hasn't mattered yet in this thread, because Roth funds are not spent in the scenarios thus far; but down the road, when cases where Roth funds are spent are considered, tax risk will have to be factored into the expected payoff.
......cut.....
I plan to spend Roth down for discretionary lumpy expenses to avoid bumping up into higher tax brackets or higher IRMAA. The future risk is that I wouldn't be able to spend Roth for discretionary lumpy expenses without tax consequences. There always seems to be an analogous risk for not doing something, such as no/reduced deductibility of QCDs, medical expenses, etc. When do we stop looking at all the risks that can't be predicted?
sc9182
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by sc9182 »

2pedals wrote: Sun Oct 24, 2021 8:50 pm
McQ wrote: Sun Oct 24, 2021 6:02 pm ......cut.....
That hasn't mattered yet in this thread, because Roth funds are not spent in the scenarios thus far; but down the road, when cases where Roth funds are spent are considered, tax risk will have to be factored into the expected payoff.
......cut.....
I plan to spend Roth down for discretionary lumpy expenses to avoid bumping up into higher tax brackets or higher IRMAA. The future risk is that I wouldn't be able to spend Roth for discretionary lumpy expenses without tax consequences. There always seems to be an analogous risk for not doing something, such as no/reduced deductibility of QCDs, medical expenses, etc. When do we stop looking at all the risks that can't be predicted?
These two risks are NOT identical. Typical saver hasn’t necessarily saved in Trad 401k/IRA/TDA with the “expectation” that one day they be able to deduct QCD, or large medical expenses— instead., to use for retirement/living expenses (and corresponding tax arbitrage). The QCD or other benefits are kinda bonus in excess of tax-arbitrage.

Where as Roth/Roth-conversion has tax arbitrage mainly/only in mind — and any potential changes could lead to possible slightly “negative” consequences on top of already converted monies. Most of the “Roth” success models depend on providing long/longer runway for them to succeed (ie., you DONT need those monies towards living expenses or withdrawals for looong time-frames)

You never know future - hence, do have different tax diversified buckets (doesn’t have to be equal buckets!!)

One main thing most of folks don’t figure is — decent chunk of the monies in 401k type corp plans are due to Matching monies — ESPECIALLY the 2-3-$4-5 millions+ Huge TDAs. It’s hard to achieve such large TDA portfolios with mere $10k-$20k /year own contributions (or 2x for two income households) alone. Good chunk of 401k/TDA monies may have originated/contributions from employer Matching. Ie., a good chunk of someone’s TDA portfolios are “unavoidable” due to employer matches - you can’t possibly have it ALL in Roth to begin with.
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McQ
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

marcopolo wrote: Fri Oct 22, 2021 4:52 pm
cas wrote: Fri Oct 22, 2021 4:26 pm
MattB wrote: Fri Oct 22, 2021 4:02 pm
I think my question was skipped over upthread. So, I'll repeated it: If Roth conversions always paid off (if you can hold long enough), then what would be the point of traditional 401k accounts in the first place?
Your question (routed through Roothy asking it again) got 2 responses upthread (page 3 of thread)

McQ here
FiveK here
The first of those answers seems to be at odds with the rest of the formulation where there is so much "off camera" income (pensions, Soc Sec) such that all RMDs are assumed to be in the 22% or higher bracket. So, I don't see how the 0, 10, and 12% space could now be used to justify trad 401k in the first place, under those assumptions.
Hmmm...I’m coming to appreciate the downsides of the “off-camera” spreadsheet style I use in this thread, even though it did solve problems with the “all on camera” spreadsheet style used in the SSRN paper.

Let me try to clarify:
1. The on-camera results are the marginal results, the last $100,000 on the TDA stack, which is either converted or not.
2. Off-camera, there must be at least $108,750 of taxable income, if the last $100,000 is going to generate tax at 22%; likewise, when RMDs start, if they are to be taxed at 22%
3. Two average SS payouts equals about $37,000; so in the no-pension case, there would have to be about $70,000 of RMDs off-camera: these would fill part of the 10% and all of the 12% brackets. About $2.5 million or more in the TDA off-camera would suffice to generate that $70K in RMDs.

That’s why I can say that not all RMDs are taxed at 22% in the running example.

Social Security too small in this first example? If you like, let there be one max SS payment at full retirement of about $37,000 plus one spousal SS at $18,500. Then there would need to be $53,000 of RMD income off camera, about $2 million in the TDA.

So, the last $3650 of RMD income taxed is taxed at 22%; but there are still tens of thousands more RMDs taxed at 12%, per my earlier explanation.
Outside the big pension case, generally the first $1 million or $2 million dollars of TDA will generate RMDs taxed at 12%.

Of course, in the government pension case, SS and pension alone might equal $108,750, and no RMD would ever be taxed at 12%, and then MattB’s point might hold.

You would simply need to be certain of those results starting thirty-five to forty years prior. Then you might never do a traditional 401(k), because of your constant lifetime tax bracket, contributions at all ages, RMDs at all ages, all taxed at 22%, none at 12%.

I don’t believe that outcome can be known in advance. Every mishap drives retirement accumulations & income lower, making you happy to have used a traditional 401(k), contributing at 22% or 24%, withdrawing (mostly) at 12%.

And I haven’t even got to teen persuasion’s helpful comment about ACA provisions and other credits that become available when you use a traditional 401(k) to drive income down below the cliff edge.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
Chip
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by Chip »

Dr. McQuarrie's threads have inspired me to analyze our previous Roth conversions using a framework similar to what he's created, though using actual annual portfolio returns and actual conversion taxes paid. My goal was to separate the pure tax effects of the conversion from the effects of all the other portfolio moves we made over the years, such as filling the tIRAs with bonds, building a tax-efficient taxable account, etc.

We early retired in 2001 without pensions or other regular income. We began converting in 2003, intending to take advantage of the lower tax brackets. All conversion taxes were paid from our taxable account. We varied our conversion amounts based on other income and the marginal rates facing us each year.

I ended up with three scenarios:

Case 1 -- No conversions (simulated): Methodology was to start with our actual account balances (taxable, TDA, Roth) at the end of 2002, then grow each of those accounts by the actual returns of our entire portfolio, less actual living expenses (except conversion taxes) withdrawn from the taxable account.

Case 2 -- Conversions (simulated): Same as above, but conversion amounts are moved to the Roth each year and TDA is reduced by the same amount. Taxable account is reduced by additional conversion taxes, but "credited" with the tax drag that was avoided on all previous conversion taxes paid.

Case 3 -- Conversions (actual): This is what actually happened each year. Returns in each type of account were different since stock/bond ratios were different.

Results:

Weighted average conversion tax rate paid: 15.3% federal & state

Projected total federal and state taxes assuming 1st year RMDs and full social security:

Case 1: 37k including Tier 1 IRMAA

Case 2: 19k, no IRMAA

Case 3: 17k, no IRMAA

Taxable/TDA/Roth account value percentages:

Case 1: 26/73/1

Case 2: 23/44/33

Case 3: 32/31/37 this is different from Case 2 primarily due to making the TDA all bonds, concentrating growth in the taxable and Roth accounts

So after 18 years Case 2 begins recovering the prepaid conversion taxes in larger amounts, starting at 18k per year and rising from there as RMD percentages increase. Our actual recovery (Case 3) will start at 20k/year when compared to Case 1. Note that the TDAs in Cases 1 & 2 will likely continue to grow for years as they have the same 60/40 stock/bond ratio as the rest of the portfolio. Since our actual TDA is 100% bonds the tax gaps between Case 3 and Cases 1 & 2 should continue to grow.

My next step is to project the 3 cases out into the future with some varying return and spending assumptions, including the effects of the expiration of TCJA.

Comments?

For those interested, the data I used:

1. Actual portfolio returns: These were calculated using XIRR on all portfolio cash flows each year.
2. Taxes including conversions: Taken from actual tax returns.
3. Taxes without conversions: Previous year's returns were recalculated assuming no conversions. Marginal rates for capital gains/qualified dividends and ordinary income were also recalculated.
4. Conversion taxes paid = 2 - 3
5. Tax drag avoided: First I assumed that conversion taxes removed from the portfolio would have compounded along with the rest of the portfolio had the conversions not occurred. Then I calculated the capital gains (LTCG) and ordinary investment income (OII) on this amount by assuming it would be in the same proportion as the actual LTCG and OII vs. actual taxable portfolio balance. For example, assume actual taxable portfolio balance was 500k. Actual LTCG was 10k and OII was 5k. If the "no conversion" scenario resulted in an extra 100k in the portfolio due to compounded avoided taxes, I assume that the LTCG and OII in that year will would have increased by 2k (100/500 * 10k) and 1k (100/500 * 5k). Then the marginal tax rates for LTCG and OII in Case 1 were applied. I'm not sure this is valid or even reasonable approach but it's the best I've come up with so far.
marcopolo
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

McQ wrote: Sun Oct 24, 2021 11:58 pm
marcopolo wrote: Fri Oct 22, 2021 4:52 pm
cas wrote: Fri Oct 22, 2021 4:26 pm
MattB wrote: Fri Oct 22, 2021 4:02 pm
I think my question was skipped over upthread. So, I'll repeated it: If Roth conversions always paid off (if you can hold long enough), then what would be the point of traditional 401k accounts in the first place?
Your question (routed through Roothy asking it again) got 2 responses upthread (page 3 of thread)

McQ here
FiveK here
The first of those answers seems to be at odds with the rest of the formulation where there is so much "off camera" income (pensions, Soc Sec) such that all RMDs are assumed to be in the 22% or higher bracket. So, I don't see how the 0, 10, and 12% space could now be used to justify trad 401k in the first place, under those assumptions.
Hmmm...I’m coming to appreciate the downsides of the “off-camera” spreadsheet style I use in this thread, even though it did solve problems with the “all on camera” spreadsheet style used in the SSRN paper.

Let me try to clarify:
1. The on-camera results are the marginal results, the last $100,000 on the TDA stack, which is either converted or not.
2. Off-camera, there must be at least $108,750 of taxable income, if the last $100,000 is going to generate tax at 22%; likewise, when RMDs start, if they are to be taxed at 22%
3. Two average SS payouts equals about $37,000; so in the no-pension case, there would have to be about $70,000 of RMDs off-camera: these would fill part of the 10% and all of the 12% brackets. About $2.5 million or more in the TDA off-camera would suffice to generate that $70K in RMDs.

That’s why I can say that not all RMDs are taxed at 22% in the running example.

Social Security too small in this first example? If you like, let there be one max SS payment at full retirement of about $37,000 plus one spousal SS at $18,500. Then there would need to be $53,000 of RMD income off camera, about $2 million in the TDA.

So, the last $3650 of RMD income taxed is taxed at 22%; but there are still tens of thousands more RMDs taxed at 12%, per my earlier explanation.
Outside the big pension case, generally the first $1 million or $2 million dollars of TDA will generate RMDs taxed at 12%.

Of course, in the government pension case, SS and pension alone might equal $108,750, and no RMD would ever be taxed at 12%, and then MattB’s point might hold.

You would simply need to be certain of those results starting thirty-five to forty years prior. Then you might never do a traditional 401(k), because of your constant lifetime tax bracket, contributions at all ages, RMDs at all ages, all taxed at 22%, none at 12%.

I don’t believe that outcome can be known in advance. Every mishap drives retirement accumulations & income lower, making you happy to have used a traditional 401(k), contributing at 22% or 24%, withdrawing (mostly) at 12%.

And I haven’t even got to teen persuasion’s helpful comment about ACA provisions and other credits that become available when you use a traditional 401(k) to drive income down below the cliff edge.
Fair points.
Although from your other thread it seems everyone, except me and a handful of other people, have 6 figure COLA'd pensions :beer

While the points you make are valid when taking RMDs, I am less sure about that when doing the conversions, as the retirees will have to live on something. The withdrawals to fund living expenses will likely fill the bottom brackets, unless they have a wealthy "off-camera" benefactor gifting them large sums each years.
Once in a while you get shown the light, in the strangest of places if you look at it right.
smitcat
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by smitcat »

marcopolo wrote: Mon Oct 25, 2021 2:21 pm
McQ wrote: Sun Oct 24, 2021 11:58 pm
marcopolo wrote: Fri Oct 22, 2021 4:52 pm
cas wrote: Fri Oct 22, 2021 4:26 pm
MattB wrote: Fri Oct 22, 2021 4:02 pm
I think my question was skipped over upthread. So, I'll repeated it: If Roth conversions always paid off (if you can hold long enough), then what would be the point of traditional 401k accounts in the first place?
Your question (routed through Roothy asking it again) got 2 responses upthread (page 3 of thread)

McQ here
FiveK here
The first of those answers seems to be at odds with the rest of the formulation where there is so much "off camera" income (pensions, Soc Sec) such that all RMDs are assumed to be in the 22% or higher bracket. So, I don't see how the 0, 10, and 12% space could now be used to justify trad 401k in the first place, under those assumptions.
Hmmm...I’m coming to appreciate the downsides of the “off-camera” spreadsheet style I use in this thread, even though it did solve problems with the “all on camera” spreadsheet style used in the SSRN paper.

Let me try to clarify:
1. The on-camera results are the marginal results, the last $100,000 on the TDA stack, which is either converted or not.
2. Off-camera, there must be at least $108,750 of taxable income, if the last $100,000 is going to generate tax at 22%; likewise, when RMDs start, if they are to be taxed at 22%
3. Two average SS payouts equals about $37,000; so in the no-pension case, there would have to be about $70,000 of RMDs off-camera: these would fill part of the 10% and all of the 12% brackets. About $2.5 million or more in the TDA off-camera would suffice to generate that $70K in RMDs.

That’s why I can say that not all RMDs are taxed at 22% in the running example.

Social Security too small in this first example? If you like, let there be one max SS payment at full retirement of about $37,000 plus one spousal SS at $18,500. Then there would need to be $53,000 of RMD income off camera, about $2 million in the TDA.

So, the last $3650 of RMD income taxed is taxed at 22%; but there are still tens of thousands more RMDs taxed at 12%, per my earlier explanation.
Outside the big pension case, generally the first $1 million or $2 million dollars of TDA will generate RMDs taxed at 12%.

Of course, in the government pension case, SS and pension alone might equal $108,750, and no RMD would ever be taxed at 12%, and then MattB’s point might hold.

You would simply need to be certain of those results starting thirty-five to forty years prior. Then you might never do a traditional 401(k), because of your constant lifetime tax bracket, contributions at all ages, RMDs at all ages, all taxed at 22%, none at 12%.

I don’t believe that outcome can be known in advance. Every mishap drives retirement accumulations & income lower, making you happy to have used a traditional 401(k), contributing at 22% or 24%, withdrawing (mostly) at 12%.

And I haven’t even got to teen persuasion’s helpful comment about ACA provisions and other credits that become available when you use a traditional 401(k) to drive income down below the cliff edge.
Fair points.
Although from your other thread it seems everyone, except me and a handful of other people, have 6 figure COLA'd pensions :beer

While the points you make are valid when taking RMDs, I am less sure about that when doing the conversions, as the retirees will have to live on something. The withdrawals to fund living expenses will likely fill the bottom brackets, unless they have a wealthy "off-camera" benefactor gifting them large sums each years.
"While the points you make are valid when taking RMDs, I am less sure about that when doing the conversions, as the retirees will have to live on something. The withdrawals to fund living expenses will likely fill the bottom brackets, unless they have a wealthy "off-camera" benefactor gifting them large sums each years."
Maybe a few possibilities...
- perhaps they sold a home
- maybe they sold a business
- or perhaps an inheritance
- maybe a larger severance package
marcopolo
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

smitcat wrote: Mon Oct 25, 2021 3:02 pm
marcopolo wrote: Mon Oct 25, 2021 2:21 pm
McQ wrote: Sun Oct 24, 2021 11:58 pm
marcopolo wrote: Fri Oct 22, 2021 4:52 pm
cas wrote: Fri Oct 22, 2021 4:26 pm

Your question (routed through Roothy asking it again) got 2 responses upthread (page 3 of thread)

McQ here
FiveK here
The first of those answers seems to be at odds with the rest of the formulation where there is so much "off camera" income (pensions, Soc Sec) such that all RMDs are assumed to be in the 22% or higher bracket. So, I don't see how the 0, 10, and 12% space could now be used to justify trad 401k in the first place, under those assumptions.
Hmmm...I’m coming to appreciate the downsides of the “off-camera” spreadsheet style I use in this thread, even though it did solve problems with the “all on camera” spreadsheet style used in the SSRN paper.

Let me try to clarify:
1. The on-camera results are the marginal results, the last $100,000 on the TDA stack, which is either converted or not.
2. Off-camera, there must be at least $108,750 of taxable income, if the last $100,000 is going to generate tax at 22%; likewise, when RMDs start, if they are to be taxed at 22%
3. Two average SS payouts equals about $37,000; so in the no-pension case, there would have to be about $70,000 of RMDs off-camera: these would fill part of the 10% and all of the 12% brackets. About $2.5 million or more in the TDA off-camera would suffice to generate that $70K in RMDs.

That’s why I can say that not all RMDs are taxed at 22% in the running example.

Social Security too small in this first example? If you like, let there be one max SS payment at full retirement of about $37,000 plus one spousal SS at $18,500. Then there would need to be $53,000 of RMD income off camera, about $2 million in the TDA.

So, the last $3650 of RMD income taxed is taxed at 22%; but there are still tens of thousands more RMDs taxed at 12%, per my earlier explanation.
Outside the big pension case, generally the first $1 million or $2 million dollars of TDA will generate RMDs taxed at 12%.

Of course, in the government pension case, SS and pension alone might equal $108,750, and no RMD would ever be taxed at 12%, and then MattB’s point might hold.

You would simply need to be certain of those results starting thirty-five to forty years prior. Then you might never do a traditional 401(k), because of your constant lifetime tax bracket, contributions at all ages, RMDs at all ages, all taxed at 22%, none at 12%.

I don’t believe that outcome can be known in advance. Every mishap drives retirement accumulations & income lower, making you happy to have used a traditional 401(k), contributing at 22% or 24%, withdrawing (mostly) at 12%.

And I haven’t even got to teen persuasion’s helpful comment about ACA provisions and other credits that become available when you use a traditional 401(k) to drive income down below the cliff edge.
Fair points.
Although from your other thread it seems everyone, except me and a handful of other people, have 6 figure COLA'd pensions :beer

While the points you make are valid when taking RMDs, I am less sure about that when doing the conversions, as the retirees will have to live on something. The withdrawals to fund living expenses will likely fill the bottom brackets, unless they have a wealthy "off-camera" benefactor gifting them large sums each years.
"While the points you make are valid when taking RMDs, I am less sure about that when doing the conversions, as the retirees will have to live on something. The withdrawals to fund living expenses will likely fill the bottom brackets, unless they have a wealthy "off-camera" benefactor gifting them large sums each years."
Maybe a few possibilities...
- perhaps they sold a home
- maybe they sold a business
- or perhaps an inheritance
- maybe a larger severance package
Sure, those are all possibilities. I am familiar with one of those.

But, I would venture to guess those are a relatively small portion of retirees.

Although, I had a similar mistaken impression about how many people have 6 figure pensions. So, maybe just about everyone does also have 10 years of spending sitting around they can tap without incurring taxes.
Once in a while you get shown the light, in the strangest of places if you look at it right.
smitcat
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by smitcat »

marcopolo wrote: Mon Oct 25, 2021 3:09 pm
smitcat wrote: Mon Oct 25, 2021 3:02 pm
marcopolo wrote: Mon Oct 25, 2021 2:21 pm
McQ wrote: Sun Oct 24, 2021 11:58 pm
marcopolo wrote: Fri Oct 22, 2021 4:52 pm

The first of those answers seems to be at odds with the rest of the formulation where there is so much "off camera" income (pensions, Soc Sec) such that all RMDs are assumed to be in the 22% or higher bracket. So, I don't see how the 0, 10, and 12% space could now be used to justify trad 401k in the first place, under those assumptions.
Hmmm...I’m coming to appreciate the downsides of the “off-camera” spreadsheet style I use in this thread, even though it did solve problems with the “all on camera” spreadsheet style used in the SSRN paper.

Let me try to clarify:
1. The on-camera results are the marginal results, the last $100,000 on the TDA stack, which is either converted or not.
2. Off-camera, there must be at least $108,750 of taxable income, if the last $100,000 is going to generate tax at 22%; likewise, when RMDs start, if they are to be taxed at 22%
3. Two average SS payouts equals about $37,000; so in the no-pension case, there would have to be about $70,000 of RMDs off-camera: these would fill part of the 10% and all of the 12% brackets. About $2.5 million or more in the TDA off-camera would suffice to generate that $70K in RMDs.

That’s why I can say that not all RMDs are taxed at 22% in the running example.

Social Security too small in this first example? If you like, let there be one max SS payment at full retirement of about $37,000 plus one spousal SS at $18,500. Then there would need to be $53,000 of RMD income off camera, about $2 million in the TDA.

So, the last $3650 of RMD income taxed is taxed at 22%; but there are still tens of thousands more RMDs taxed at 12%, per my earlier explanation.
Outside the big pension case, generally the first $1 million or $2 million dollars of TDA will generate RMDs taxed at 12%.

Of course, in the government pension case, SS and pension alone might equal $108,750, and no RMD would ever be taxed at 12%, and then MattB’s point might hold.

You would simply need to be certain of those results starting thirty-five to forty years prior. Then you might never do a traditional 401(k), because of your constant lifetime tax bracket, contributions at all ages, RMDs at all ages, all taxed at 22%, none at 12%.

I don’t believe that outcome can be known in advance. Every mishap drives retirement accumulations & income lower, making you happy to have used a traditional 401(k), contributing at 22% or 24%, withdrawing (mostly) at 12%.

And I haven’t even got to teen persuasion’s helpful comment about ACA provisions and other credits that become available when you use a traditional 401(k) to drive income down below the cliff edge.
Fair points.
Although from your other thread it seems everyone, except me and a handful of other people, have 6 figure COLA'd pensions :beer

While the points you make are valid when taking RMDs, I am less sure about that when doing the conversions, as the retirees will have to live on something. The withdrawals to fund living expenses will likely fill the bottom brackets, unless they have a wealthy "off-camera" benefactor gifting them large sums each years.
"While the points you make are valid when taking RMDs, I am less sure about that when doing the conversions, as the retirees will have to live on something. The withdrawals to fund living expenses will likely fill the bottom brackets, unless they have a wealthy "off-camera" benefactor gifting them large sums each years."
Maybe a few possibilities...
- perhaps they sold a home
- maybe they sold a business
- or perhaps an inheritance
- maybe a larger severance package
Sure, those are all possibilities. I am familiar with one of those.

But, I would venture to guess those are a relatively small portion of retirees.

Although, I had a similar mistaken impression about how many people have 6 figure pensions. So, maybe just about everyone does also have 10 years of spending sitting around they can tap without incurring taxes.
"But, I would venture to guess those are a relatively small portion of retirees."
A relatively small portion of retirees have enough saved to worry about anything within this thread really.
marcopolo
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

smitcat wrote: Mon Oct 25, 2021 3:13 pm
marcopolo wrote: Mon Oct 25, 2021 3:09 pm
smitcat wrote: Mon Oct 25, 2021 3:02 pm
marcopolo wrote: Mon Oct 25, 2021 2:21 pm
McQ wrote: Sun Oct 24, 2021 11:58 pm

Hmmm...I’m coming to appreciate the downsides of the “off-camera” spreadsheet style I use in this thread, even though it did solve problems with the “all on camera” spreadsheet style used in the SSRN paper.

Let me try to clarify:
1. The on-camera results are the marginal results, the last $100,000 on the TDA stack, which is either converted or not.
2. Off-camera, there must be at least $108,750 of taxable income, if the last $100,000 is going to generate tax at 22%; likewise, when RMDs start, if they are to be taxed at 22%
3. Two average SS payouts equals about $37,000; so in the no-pension case, there would have to be about $70,000 of RMDs off-camera: these would fill part of the 10% and all of the 12% brackets. About $2.5 million or more in the TDA off-camera would suffice to generate that $70K in RMDs.

That’s why I can say that not all RMDs are taxed at 22% in the running example.

Social Security too small in this first example? If you like, let there be one max SS payment at full retirement of about $37,000 plus one spousal SS at $18,500. Then there would need to be $53,000 of RMD income off camera, about $2 million in the TDA.

So, the last $3650 of RMD income taxed is taxed at 22%; but there are still tens of thousands more RMDs taxed at 12%, per my earlier explanation.
Outside the big pension case, generally the first $1 million or $2 million dollars of TDA will generate RMDs taxed at 12%.

Of course, in the government pension case, SS and pension alone might equal $108,750, and no RMD would ever be taxed at 12%, and then MattB’s point might hold.

You would simply need to be certain of those results starting thirty-five to forty years prior. Then you might never do a traditional 401(k), because of your constant lifetime tax bracket, contributions at all ages, RMDs at all ages, all taxed at 22%, none at 12%.

I don’t believe that outcome can be known in advance. Every mishap drives retirement accumulations & income lower, making you happy to have used a traditional 401(k), contributing at 22% or 24%, withdrawing (mostly) at 12%.

And I haven’t even got to teen persuasion’s helpful comment about ACA provisions and other credits that become available when you use a traditional 401(k) to drive income down below the cliff edge.
Fair points.
Although from your other thread it seems everyone, except me and a handful of other people, have 6 figure COLA'd pensions :beer

While the points you make are valid when taking RMDs, I am less sure about that when doing the conversions, as the retirees will have to live on something. The withdrawals to fund living expenses will likely fill the bottom brackets, unless they have a wealthy "off-camera" benefactor gifting them large sums each years.
"While the points you make are valid when taking RMDs, I am less sure about that when doing the conversions, as the retirees will have to live on something. The withdrawals to fund living expenses will likely fill the bottom brackets, unless they have a wealthy "off-camera" benefactor gifting them large sums each years."
Maybe a few possibilities...
- perhaps they sold a home
- maybe they sold a business
- or perhaps an inheritance
- maybe a larger severance package
Sure, those are all possibilities. I am familiar with one of those.

But, I would venture to guess those are a relatively small portion of retirees.

Although, I had a similar mistaken impression about how many people have 6 figure pensions. So, maybe just about everyone does also have 10 years of spending sitting around they can tap without incurring taxes.
"But, I would venture to guess those are a relatively small portion of retirees."
A relatively small portion of retirees have enough saved to worry about anything within this thread really.
That is a good point, and one I made earlier in the thread. I unfortunately used the word "wealthy", which seemed to trigger a lot of people. But, I get your point.
Once in a while you get shown the light, in the strangest of places if you look at it right.
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McQ
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

Chip wrote: Mon Oct 25, 2021 1:53 pm Dr. McQuarrie's threads have inspired me to analyze our previous Roth conversions using a framework similar to what he's created, though using actual annual portfolio returns and actual conversion taxes paid. My goal was to separate the pure tax effects of the conversion from the effects of all the other portfolio moves we made over the years, such as filling the tIRAs with bonds, building a tax-efficient taxable account, etc.

We early retired in 2001 without pensions or other regular income. We began converting in 2003, intending to take advantage of the lower tax brackets. All conversion taxes were paid from our taxable account. We varied our conversion amounts based on other income and the marginal rates facing us each year.

I ended up with three scenarios:

Case 1 -- No conversions (simulated): Methodology was to start with our actual account balances (taxable, TDA, Roth) at the end of 2002, then grow each of those accounts by the actual returns of our entire portfolio, less actual living expenses (except conversion taxes) withdrawn from the taxable account.

Case 2 -- Conversions (simulated): Same as above, but conversion amounts are moved to the Roth each year and TDA is reduced by the same amount. Taxable account is reduced by additional conversion taxes, but "credited" with the tax drag that was avoided on all previous conversion taxes paid.

Case 3 -- Conversions (actual): This is what actually happened each year. Returns in each type of account were different since stock/bond ratios were different.

Results:

Weighted average conversion tax rate paid: 15.3% federal & state

Projected total federal and state taxes assuming 1st year RMDs and full social security:

Case 1: 37k including Tier 1 IRMAA

Case 2: 19k, no IRMAA

Case 3: 17k, no IRMAA

Taxable/TDA/Roth account value percentages:

Case 1: 26/73/1

Case 2: 23/44/33

Case 3: 32/31/37 this is different from Case 2 primarily due to making the TDA all bonds, concentrating growth in the taxable and Roth accounts

So after 18 years Case 2 begins recovering the prepaid conversion taxes in larger amounts, starting at 18k per year and rising from there as RMD percentages increase. Our actual recovery (Case 3) will start at 20k/year when compared to Case 1. Note that the TDAs in Cases 1 & 2 will likely continue to grow for years as they have the same 60/40 stock/bond ratio as the rest of the portfolio. Since our actual TDA is 100% bonds the tax gaps between Case 3 and Cases 1 & 2 should continue to grow.

My next step is to project the 3 cases out into the future with some varying return and spending assumptions, including the effects of the expiration of TCJA.

Comments?

For those interested, the data I used:

1. Actual portfolio returns: These were calculated using XIRR on all portfolio cash flows each year.
2. Taxes including conversions: Taken from actual tax returns.
3. Taxes without conversions: Previous year's returns were recalculated assuming no conversions. Marginal rates for capital gains/qualified dividends and ordinary income were also recalculated.
4. Conversion taxes paid = 2 - 3
5. Tax drag avoided: First I assumed that conversion taxes removed from the portfolio would have compounded along with the rest of the portfolio had the conversions not occurred. Then I calculated the capital gains (LTCG) and ordinary investment income (OII) on this amount by assuming it would be in the same proportion as the actual LTCG and OII vs. actual taxable portfolio balance. For example, assume actual taxable portfolio balance was 500k. Actual LTCG was 10k and OII was 5k. If the "no conversion" scenario resulted in an extra 100k in the portfolio due to compounded avoided taxes, I assume that the LTCG and OII in that year will would have increased by 2k (100/500 * 10k) and 1k (100/500 * 5k). Then the marginal tax rates for LTCG and OII in Case 1 were applied. I'm not sure this is valid or even reasonable approach but it's the best I've come up with so far.
Chip, I commend you. This sort of personal financial archaeology is ... effortful and demanding. But you are in a position to make an unusual contribution.

I can't imagine there are very many people, on BH or outside, who have compiled a 20 year record of conversions. All my work uses idealized future projections; I believe that's true of most authors. Twenty or thirty years from now things will be different; but not today. You may have some of the only extended nitty gritty data out there.

Reading between the lines, I sense that your conversions have paid off, about as expected, and not inconsistent with my estimates here; and likewise, are about to climb the exponential curve where payoffs grow rapidly. But is that a fair reading, or are you not ready yet to make such a statement?
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
Chip
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by Chip »

McQ wrote: Mon Oct 25, 2021 10:19 pm Reading between the lines, I sense that your conversions have paid off, about as expected, and not inconsistent with my estimates here; and likewise, are about to climb the exponential curve where payoffs grow rapidly. But is that a fair reading, or are you not ready yet to make such a statement?
That's a fair statement. Assuming, as someone once said, one of us lives long enough. :)

One thing that was a bit surprising was that the avoided tax drag was relatively small, about 7% of conversion taxes paid. I suppose that's a result of having a fairly tax-efficient portfolio and doing all these conversions in the lower brackets.
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McQ
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

smitcat wrote: Mon Oct 25, 2021 3:13 pm ...

"But, I would venture to guess those are a relatively small portion of retirees."
A relatively small portion of retirees have enough saved to worry about anything within this thread really.
It’s a fair comment. Part of what gave the SSRN paper its “in your face” aspect was the demonstration that to be subject to either of the middling tax brackets, 22% or 24%, you typically had to have millions of dollars in a TDA account. Maybe not that common, eh? The exception is those with a dual government pension plus high-wage social security, who might broach the 22% bracket before the first dollar of RMDs. But that case may be just as unusual as the “millions of dollars in a TDA” case.

These simple facts, so obvious to some of us on this thread, are entirely ignored in popular accounts where, in the spirit of an old economist joke, the writer just assumes a constant tax rate of 22% (or 24%) while working, and then later while drawing RMDs, without ever bothering to crosscheck the needed TDA account balance, and its likelihood of achievement given the relatively low income levels while working that suffice to push one into the 22% (24%) brackets.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
TheDogFather
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by TheDogFather »

In the case where the tax advantaged account(s) are 100% bonds and the resulting likely lower growth of the tax advantaged account relative to one with a much higher level of equities, is the triggering of high RMD payments much less of a concern?

Does an assumed lower growth rate of the tax advantaged account impact whether conversions are likely to be less beneficial or even inefficient?
smitcat
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by smitcat »

McQ wrote: Tue Oct 26, 2021 5:59 pm
smitcat wrote: Mon Oct 25, 2021 3:13 pm ...

"But, I would venture to guess those are a relatively small portion of retirees."
A relatively small portion of retirees have enough saved to worry about anything within this thread really.
It’s a fair comment. Part of what gave the SSRN paper its “in your face” aspect was the demonstration that to be subject to either of the middling tax brackets, 22% or 24%, you typically had to have millions of dollars in a TDA account. Maybe not that common, eh? The exception is those with a dual government pension plus high-wage social security, who might broach the 22% bracket before the first dollar of RMDs. But that case may be just as unusual as the “millions of dollars in a TDA” case.

These simple facts, so obvious to some of us on this thread, are entirely ignored in popular accounts where, in the spirit of an old economist joke, the writer just assumes a constant tax rate of 22% (or 24%) while working, and then later while drawing RMDs, without ever bothering to crosscheck the needed TDA account balance, and its likelihood of achievement given the relatively low income levels while working that suffice to push one into the 22% (24%) brackets.

"It’s a fair comment. Part of what gave the SSRN paper its “in your face” aspect was the demonstration that to be subject to either of the middling tax brackets, 22% or 24%, you typically had to have millions of dollars in a TDA account. Maybe not that common, eh? The exception is those with a dual government pension plus high-wage social security, who might broach the 22% bracket before the first dollar of RMDs. But that case may be just as unusual as the “millions of dollars in a TDA” case."

Pensions and retirement...
We ourselves have no pension(s) - zero. But we have come to know that many of our freinds and just folks we know of do have pensions and other income that make Roth conversions interesting andf often valuable. Although 'government' pensions come up as one source most folks may think they are rare and only Federal in nature. Some of the actual situations we see that may nearly or totally apply are combinations of teachers, school adminstration, local government , colleges, hospitals, Many LEO's, Fire , etc.
As a younger view we have our daughter and her boyfriend with and average age of 30 who will shortly be married. They each have a primary job and additional seasonal or part time jobs which add to a total of two larger pensions, two SS accounts, two smaller pensions, two 457's, and two 403b's. Their situation will easily place them where they need to manage their taxes both early on and later.

Windfall(s) and then retirement...
And then there are the 'other ways" to get well into the tax brackets without having pensions. When someone sells a small business and/or has a larger payout due to a startup - both of which are in many threads at this site. They could then have multiple millions in both TDA and in after tax accounts as well as healthy SS payments. Additionally if you spend a fair amount of time surveying this site for SWR and drawdown posts you will likely notice a larger then expected number of very conservative folks - at least that was my observation. There appears to be a number of folks who who will be getting sizable inheritances in the future and likely some each day.
Viewing the folks that may have a good application for higher tax bracket Roth conversions would include those that have current larger portfolios, those that have smaller portfolios but have larger pensions and SS, and those who will have substancial inheritances. The good applications for Roth conversions at the lower brackets can be a great benefit to many folks as well as you have identfied clearly.
FlamePoint
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FlamePoint »

McQ wrote: Tue Oct 26, 2021 5:59 pm
smitcat wrote: Mon Oct 25, 2021 3:13 pm ...

"But, I would venture to guess those are a relatively small portion of retirees."
A relatively small portion of retirees have enough saved to worry about anything within this thread really.
It’s a fair comment. Part of what gave the SSRN paper its “in your face” aspect was the demonstration that to be subject to either of the middling tax brackets, 22% or 24%, you typically had to have millions of dollars in a TDA account. Maybe not that common, eh? The exception is those with a dual government pension plus high-wage social security, who might broach the 22% bracket before the first dollar of RMDs. But that case may be just as unusual as the “millions of dollars in a TDA” case.

These simple facts, so obvious to some of us on this thread, are entirely ignored in popular accounts where, in the spirit of an old economist joke, the writer just assumes a constant tax rate of 22% (or 24%) while working, and then later while drawing RMDs, without ever bothering to crosscheck the needed TDA account balance, and its likelihood of achievement given the relatively low income levels while working that suffice to push one into the 22% (24%) brackets.

We would be considered one of those unusual cases of having “millions of dollars in a TDA”.

We were sitting on $4M last year when we both retired at age 58, which is way more $’s than we actually need to live comfortably. The TDA made up 90% of our investment portfolio. I’m now in the process of determining the best Roth conversion strategy between now and age 63, especially given the fact we will both be collecting close to the max SS when we turn 70. Our Roth will end up being our legacy fund.

Optimizing all the moving parties is quite tricky and will always be based on your unique circumstances.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

TheDogFather wrote: Tue Oct 26, 2021 11:07 pm In the case where the tax advantaged account(s) are 100% bonds and the resulting likely lower growth of the tax advantaged account relative to one with a much higher level of equities, is the triggering of high RMD payments much less of a concern?

Does an assumed lower growth rate of the tax advantaged account impact whether conversions are likely to be less beneficial or even inefficient?
Yes: the lower the projected rate of return on your TDA, the less likely you are to be pushed into a higher tax bracket by RMDs. But if your TDA is the bulk of your assets, and you have chosen to have the lowest possible return on these assets, then you will save on taxes but lose on wealth accumulation. Personally, I think it would be wonderful if I had to pay millions of dollars in taxes on my future TDA accumulation, because that would mean I had gained ten or more millions of dollars I don't have now.

More to the point, Roth conversions can be leveraged as a way to provide a home for your highest return assets, leaving your overall asset allocation undisturbed even as low return assets get concentrated in your tax-vulnerable TDA.

Conversely, the lower the asset return, the lower the payoff from converting it to have a Roth home.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

FlamePoint wrote: Wed Oct 27, 2021 10:36 am
McQ wrote: Tue Oct 26, 2021 5:59 pm
smitcat wrote: Mon Oct 25, 2021 3:13 pm ...

"But, I would venture to guess those are a relatively small portion of retirees."
A relatively small portion of retirees have enough saved to worry about anything within this thread really.
It’s a fair comment. Part of what gave the SSRN paper its “in your face” aspect was the demonstration that to be subject to either of the middling tax brackets, 22% or 24%, you typically had to have millions of dollars in a TDA account. Maybe not that common, eh? The exception is those with a dual government pension plus high-wage social security, who might broach the 22% bracket before the first dollar of RMDs. But that case may be just as unusual as the “millions of dollars in a TDA” case.

These simple facts, so obvious to some of us on this thread, are entirely ignored in popular accounts where, in the spirit of an old economist joke, the writer just assumes a constant tax rate of 22% (or 24%) while working, and then later while drawing RMDs, without ever bothering to crosscheck the needed TDA account balance, and its likelihood of achievement given the relatively low income levels while working that suffice to push one into the 22% (24%) brackets.

We would be considered one of those unusual cases of having “millions of dollars in a TDA”.

We were sitting on $4M last year when we both retired at age 58, which is way more $’s than we actually need to live comfortably. The TDA made up 90% of our investment portfolio. I’m now in the process of determining the best Roth conversion strategy between now and age 63, especially given the fact we will both be collecting close to the max SS when we turn 70. Our Roth will end up being our legacy fund.

Optimizing all the moving parties is quite tricky and will always be based on your unique circumstances.
Congrats! You would appear to be a prime target for Roth conversions. With 14 years to go to age 72, your TDA balance may be pushing $6 -7 million then; with age 70 SS X two, you could be looking at the 32% bracket, + IRMAA, call it 36-37%, +1% post-TCJA, on the last N dollars of RMDs. Oww...

So, the easy decision is to convert up to the IRMAA #1 threshold, currently $176,000, every year. Your decision calculus would focus on whether to convert more, up to near the top of the 24% bracket. At the top of IRMAA #3 in the 24% bracket you'd pay about 28% now, but 32% post-TCJA. So may have to stop converting / so much after 2025.

Once you project to be within $10,000 of the bottom of a post-72 tax bracket, remember QCD as an alternative to aggressive conversions.

Last, see my comment to cas a little upthread as to whether age 63 or age 64 income is the true IRMAA trigger.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by TheDogFather »

McQ wrote: Wed Oct 27, 2021 11:33 pm
TheDogFather wrote: Tue Oct 26, 2021 11:07 pm In the case where the tax advantaged account(s) are 100% bonds and the resulting likely lower growth of the tax advantaged account relative to one with a much higher level of equities, is the triggering of high RMD payments much less of a concern?

Does an assumed lower growth rate of the tax advantaged account impact whether conversions are likely to be less beneficial or even inefficient?
Yes: the lower the projected rate of return on your TDA, the less likely you are to be pushed into a higher tax bracket by RMDs. But if your TDA is the bulk of your assets, and you have chosen to have the lowest possible return on these assets, then you will save on taxes but lose on wealth accumulation. Personally, I think it would be wonderful if I had to pay millions of dollars in taxes on my future TDA accumulation, because that would mean I had gained ten or more millions of dollars I don't have now.

More to the point, Roth conversions can be leveraged as a way to provide a home for your highest return assets, leaving your overall asset allocation undisturbed even as low return assets get concentrated in your tax-vulnerable TDA.

Conversely, the lower the asset return, the lower the payoff from converting it to have a Roth home.
My TDA is about 22% of my assets. I need to do some modeling on the merits of converting bonds in TDA to equities in Roth, and if I do that also exchanging equities in taxable to bonds to get my allocation in the right ballpark.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FiveK »

McQ wrote: Sun Oct 24, 2021 2:16 pm
cas wrote: Fri Oct 22, 2021 3:17 pm
(And ... I think this was probably mostly a typo on your part, but it involves a real-life mistake that I see people making in boglehead's threads, so I'll point it out anyway: IRMAA when Medicare starts at 65 is determined by MAGI at age 63. So, conversions that avoid IRMAA considerations need to happen before age 63.)
Hello cas: the age 63 thing had me scratching my head. Regarding age 63 income driving initial IRMAA determination: popular sites say one thing, government sites another. It seems to me one of two things must be true:
Either:
1. The statute requires the SSA to use income from exactly two years before to determine IRMAA;
Or
2. Regulators charged with implementing the statute recognized that tax returns from two years prior would be the most up-to-date information reliably available to the SSA in the mass, hence are used faute de mieux to estimate, in this case, age 65 income, with the recipient allowed to furnish a more recent update if they can.

If #2, one simply sends the SSA the age 64 income tax return, as more recent information, and the age 63 conversion will not trigger IRMAA, i.e., the initial determination will be reversed. I saw that option on the hhs.gov site, independent of the life changes that everyone discusses as a way to escape IRMAA. https://www.hhs.gov/about/agencies/omha ... index.html

But I defer to tax professionals on this one.
Not a tax professional here, but 42 U.S. Code § 1395r - Amount of premiums for individuals enrolled under this part indicates that "thing 1" is true: there has to have been a "major life changing event" for one to use a later year's MAGI for Medicare premiums.

See https://www.ssa.gov/forms/ssa-44-ext.pdf for what qualifies as a major life changing event. Retirement (aka Work Stoppage) is one such, so an appropriately timed retirement could allow one to ignore the age 63 MAGI, but in general it's the age 63 MAGI that sets the age 65 Medicare premium. Note that if one is born in December, the age 63 MAGI will affect the age 65 Medicare premium for only one month.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

FiveK wrote: Thu Oct 28, 2021 12:12 am
McQ wrote: Sun Oct 24, 2021 2:16 pm
cas wrote: Fri Oct 22, 2021 3:17 pm
(And ... I think this was probably mostly a typo on your part, but it involves a real-life mistake that I see people making in boglehead's threads, so I'll point it out anyway: IRMAA when Medicare starts at 65 is determined by MAGI at age 63. So, conversions that avoid IRMAA considerations need to happen before age 63.)
Hello cas: the age 63 thing had me scratching my head. Regarding age 63 income driving initial IRMAA determination: popular sites say one thing, government sites another. It seems to me one of two things must be true:
Either:
1. The statute requires the SSA to use income from exactly two years before to determine IRMAA;
Or
2. Regulators charged with implementing the statute recognized that tax returns from two years prior would be the most up-to-date information reliably available to the SSA in the mass, hence are used faute de mieux to estimate, in this case, age 65 income, with the recipient allowed to furnish a more recent update if they can.

If #2, one simply sends the SSA the age 64 income tax return, as more recent information, and the age 63 conversion will not trigger IRMAA, i.e., the initial determination will be reversed. I saw that option on the hhs.gov site, independent of the life changes that everyone discusses as a way to escape IRMAA. https://www.hhs.gov/about/agencies/omha ... index.html

But I defer to tax professionals on this one.
Not a tax professional here, but 42 U.S. Code § 1395r - Amount of premiums for individuals enrolled under this part indicates that "thing 1" is true: there has to have been a "major life changing event" for one to use a later year's MAGI for Medicare premiums.

See https://www.ssa.gov/forms/ssa-44-ext.pdf for what qualifies as a major life changing event. Retirement (aka Work Stoppage) is one such, so an appropriately timed retirement could allow one to ignore the age 63 MAGI, but in general it's the age 63 MAGI that sets the age 65 Medicare premium. Note that if one is born in December, the age 63 MAGI will affect the age 65 Medicare premium for only one month.
Thanks for digging up the statute, FiveK--that nails it. Trailing t-2 tax return governs per statute. Reading a little beyond in the text, I now understand that the top half of the hhs form I linked only applies if some reason a t-3 tax return had been used, which the taxpayer is allowed to update.
On to tax finagling, anyone, what do you think:
1. retire Feb 1 of age 63. Max out the 24% bracket with Roth conversion (~$350K). When the preliminary IRMAA determination comes, file the "life change" SSA 44 form, loss of employment, and have age 63 income replaced with lower-than-IRMAA age 64 income.
2. More aggressive: pile on at age 63 (maybe one spouse retired and there is room for a $100K or $200K conversion), and then execute age 64 same as above, with second spouse retiring Feb 1. Pay IRMAA during the age 65 year and then get a refund once age 65 1040 is filed, along with SSA 44 showing second spouse loss of employment. Same for age 66.
Too clever by half? SSA will say, "only reduction in employment income counts for SSA 44"? That's above my pay grade; but, as cas indicates, there are other threads on this topic.
Please educate me.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

How does rate of return affect Roth conversion payoffs?

Short answer: the lower the return, the lower the dollar payoff.

Just upthread I compared various scenarios yielding higher and higher payoffs, relative to the base case of converting at 71 under a constant 22% tax rate. I’ve selected the following cases to run different rates of return against:
1. Base case
2. Convert at 71, tax outside
3. Convert 12 years early, tax outside.

These were all initially tested with a 10% return rate and a 3% inflation rate. That level of return with that level of inflation corresponds closely to the ninety-four-year results for the S&P index from 1926 through 2019, per the Stocks, Bonds, Bills and Inflation Yearbook (10.2%, 2.9%). For the historically inclined, “10%,” as the best estimate of nominal long-term returns on US stocks, first appears in 1955 according to the SBBI. Excepting a brief dip into the 8+% level in the early 1970s, and a brief rise above 11% in the later 1990s, that 10% estimate has held for over 60 years, as the SBBI dataset lengthened in span from three decades to nine.

So 10% seemed like a good place to start. No guarantees going forward, of course. You may experience freakishly bad outcomes instead, quite different from the three-decade returns received by those who retired from 1955 to 1989.

In the first run, I test lower returns of 9%, 8%, 7% and 6%, again assuming an all-stock portfolio with favorable rates on dividends but capital gains realized each year. I don’t go below 6% in the all-stock tests because 3% real is the worst 30-year return recorded in the post-Civil War era (see my market history paper: https://papers.ssrn.com/sol3/papers.cfm ... id=3805927). I’ll look at lower rates in a bit; but these are best represented by an asset mix that is not 100% stock.

Here are the results in table form. Age 85 results come first, then age 95 results in a separate panel below.
Age 85:

Code: Select all

Case                       10%      9%       8%      7%       6%
------------------------------------------------------------------

Base case age 71         $ 7,629  $ 6,175  $ 4,932  $ 3,874  $ 2,978
[22% --> 22%]               
Pay tax outside 
age 71)                  $17,288  $13,957  $11,118  $ 8,710  $ 6,678
Convert 12 years early 
& tax outside            $53,226  $38,665  $27,689  $19,482  $13,402
Age 95:

Code: Select all

Case                       10%      9%       8%      7%       6%
------------------------------------------------------------------

Base case age 71        $ 42,190  $31,244  $22,815  $16,371  $11,487
[22% --> 22%]               
Pay tax outside 
age 71)                 $ 72,116  $53,378  $38,957  $27,940  $19,597
Convert 12 years early 
& tax outside           $184,260  $122,608 $80,370  $51,724  $32,522
The results are straightforward if you keep in mind that returns are geometric roots and years are the exponent. In the nature of exponents, when lower returns are assumed the decrease in payoff is more dramatic at age 95 and also more dramatic when the conversion takes place 12 years early, in both cases, because the exponent is greater.

Comparing the 10% and 6% columns, the biggest drop in payoff occurs at age 95 for the case where tax is paid outside and the conversion occurs 12 years early. The smallest percentage drop occurs in the base case at age 85.

What to make of these results? Drum roll: lower asset returns produce lower Roth conversion payoffs. Or, in the vernacular: Doh!

But the Roth payoffs are still positive here in the constant tax rate case. The question for the individual Boglehead: keeping in mind that these are real dollars, earned on a tax debit of $22,000, well then—is the payoff enough for you, with your particular risk profile, the intensity of your distaste for paying taxes, the time horizon you have chosen, etc. etc.? Keep in mind that the tax treatment of Roth accounts is a promise made by one Congress and upheld by those since; but is always hostage to the next Congress. Hence, all these estimates have an overlay of uncertainty.

Each investor must answer that question for themselves. Clearly, an individual whose return assumptions are pessimistic and whose planning horizon stops at age 85 is more likely to say No, not enough of a payoff to convert.

On the other hand, it is worth calling out that the 6% return case (3% real) is just this side of unrealistic for US investors; post-1860 US stock returns were depressed that low only for thirty-year periods ending about 1933. In the US, stock returns below 8% (or more exactly, below 5% real) have been the exception not the rule. International investors have not been so fortunate; but even here, the 120-year average, per Dimson et al., would fall between the 7% and 8% columns in these tables. And at age 95, at that level of return, results still look pretty strong to my eyes.

Balanced and fixed income cases

A reminder: the $100,000 conversion on-camera sits at the top of the stack of TDA funds. Per my reply to marcopolo and MattB upthread, unless you have a sweet government pension, there is likely another $1 million or $2 million of TDA funds, or more, that weren’t able to be converted. It’s hard (for me) to imagine an asset allocation that doesn’t have at least 5% or 10% in stocks, in which case, for a single $100,000 conversion, all the Roth funds can be in stocks and the tables above govern.

But if this is the nth conversion, or if for some reason all the stock allocation has been assigned elsewhere, then of course it might be necessary for this conversion to involve some asset other than stocks. And assets other than stocks can certainly provide returns less than 6% nominal, 3% real.

But to explore these low return cases, the tax assumptions have to change. Balanced funds, fixed income investments, and stable value funds throw off ordinary income. Although a 60/40 stock bond mix would have some qualified dividends and not be taxed at exactly the ordinary rate, here 22%, for best comparability of return rates, all entries in the next table are taxed at the ordinary income tax rate of 22%. That’s going to help Roth conversion outcomes for the 6% return case; but the question is, how much does that extra tax drag help when the return moves even lower?

Here are the tables, age 85 then age 95.

Age 85:

Code: Select all

Case                       6%      5%       4%      3%       2%
------------------------------------------------------------------

Base case age 71         $ 4,299  $ 3,217  $2,309  $1,553   $  927
[22% --> 22%]               
Pay tax outside 
age 71)                  $ 9,591  $ 7,165  $5,135  $3,446   $2,054
Convert 12 years early 
& tax outside            $18,944  $12,718  $8,182  $4,924   $2,628
Age 95:

Code: Select all

Case                       6%      5%       4%      3%       2%
------------------------------------------------------------------

Base case age 71        $ 16,376  $11,200  $ 7,342  $4,505  $2,452
[22% --> 22%]               
Pay tax outside 
age 71)                 $ 27,757  $18,996  $12,460  $7,650  $4,168
Convert 12 years early 
& tax outside           $ 45,530  $27,954  $16,435  $9,035  $4,403
First comparison: the rightmost column of the tables earlier, against the leftmost columns of the new tables, 6% return assumed in both cases, but different tax treatment reflecting the different character of the underlying investment.

How to portray? If a balanced portfolio might be converted instead of an all-stock portfolio; and if you have a balanced portfolio precisely because you think stocks are going to yield a historically low return over the precise multi-decade span of your retirement; then Roth conversions may pay off satisfactorily. A balanced fund or other asset returning 6%, 3% real, is certainly a candidate for Roth conversion.

Returning to the second set of tables, and looking at the right side, the implication seems pretty clear: if you are expecting nominal returns as low as 4% or 2% (+/- 1% real, respectively, in this spreadsheet treatment), well, why bother with a Roth conversion? Your assets are going nowhere fast; which means the tax burden on their return if unconverted is correspondingly small. Assets with expected returns this low are best left in the TDA. Low performance there means low future taxes paid in absolute dollar amounts.

In sum: although Roth conversions always pay off if you can hold on long enough, if you desire an early and substantial payoff, then you should convert only assets with the highest expected return. If you have already converted your highest return assets; and / or, you had substantial Roth accounts already, from Roth contributions, adequate to hold all your highest return assets, then you should focus on assets with relatively high expected returns, with a 60/40 allocation anchoring the top of this space and a 30/70 allocation the bottom.

If the only assets left to convert are low return assets, then look at these tables and decide whether the payoff for converting, say, a 2.4% stable value fund is a game worth the candle (looking at you, iceport).

I personally would not; but all such decisions are irredeemably personal.

Addendum

Marcopolo reminds that under favorable circumstances, a taxable account holding all stocks and recording no capital gains, and held until a step up at death, is a pretty tough bogie for a Roth conversion to overcome. The dollar payoff from a Roth conversion shrinks accordingly. In this addendum I want to re-figure the dollar payoffs for the higher return cases. A graphic representation will help. And because conversions are all about compounding, I am only going to look at age 95 results.

Here is a representation of the age 95 tables above, pre-marcopolo.

Image

The exponential pattern across outcomes becomes more clear. The increase in payoff for a one percentage increase in return is much greater for moving from 9% to 10% than for moving from 6% to 7%; and converting early shows the effect in spades.

But now let’s apply a marcopolo lens. For the stock assets, with no capital gains realized, the annual tax burden is only 30 basis points (15% rate X 2 percentage points of return coming from qualified dividends). At 6% in the Roth the taxable account holding reinvested RMDs earns 5.70%, and so forth. Here is the chart. Note the change in vertical scale; dashed lines use the same values as in the previous chart.

Image

Before interpreting this second chart, a reminder: the solid lines only hold true if you never touch the funds while alive & no future Congress alters the step up rule & the rate on qualified dividends doesn’t change. If you tap the funds, the previous chart applies.

If all those assumptions hold, then a conversion that moves a balanced fund under the Roth umbrella can actually payoff more than an all-stock conversion, given a balanced fund expected to return 4%+ to 6%+. The chart reflects the power of the very favorable tax treatment potentially attainable from holding a low dividend stock index fund in a taxable account.

If you die with it untouched.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by iceport »

McQ wrote: Sat Oct 30, 2021 1:42 pm In sum: although Roth conversions always pay off if you can hold on long enough, if you desire an early and substantial payoff, then you should convert only assets with the highest expected return. If you have already converted your highest return assets; and / or, you had substantial Roth accounts already, from Roth contributions, adequate to hold all your highest return assets, then you should focus on assets with relatively high expected returns, with a 60/40 allocation anchoring the top of this space and a 30/70 allocation the bottom.

If the only assets left to convert are low return assets, then look at these tables and decide whether the payoff for converting, say, a 2.4% stable value fund is a game worth the candle (looking at you, iceport).

I personally would not; but all such decisions are irredeemably personal.
Thanks for your professional assessment, Professor McQ! I also appreciate the way you frame these results, acknowledging the uncertainty inherent in the analysis, and allowing for personal preferences.


I arrived at the basic conclusion that Roth conversions do not present a significant opportunity for me, personally, a while ago. Simple circumstances; single; no massive RMD worries; no IRMAA worries; pension w/COLA means marginal tax rate in retirement will always be roughly comparable to working marginal tax rate; only low-yielding fixed income fits in TDAs; and TDAs only make up <28% of portfolio. I'm also inclined to place a value on the concept of tax diversification, because I'm pretty sure I'm not clairvoyant, and will never be able to predict tax code changes over the long term and changes in my personal tax circumstances from year to year with any degree of reliability at all.

Then the 2017 tax cuts took effect, and all of a sudden the opportunity to convert TDA savings at 22% that were contributed just a few years earlier at 25% (and which saved me from the 28% bracket) became interesting. So the plan became to convert the sum I rolled over from a 457b plan, but leave the remaining 457b balance alone, which I left in-place solely for the access to a decent stable value fund. (Theoretically I could investigate an in-plan conversion within the 457b, but there's no real incentive to start mucking up the account that's currently 100% tax-deferred.) It will only take about 4 years to complete those planned conversions within the 22% bracket, and I'm halfway done. Assuming the scheduled return to the pre-2107 tax cut income tax rates holds up, I think this strategy makes sense, even if it won't produce a humongous benefit. There's also been a minor psychological benefit to whittling down the TDA account, even as small as it is already, relatively speaking.


What strikes me is how differently folks approach the question. I've generally been frustrated with the spreadsheet or deterministic approach to analyzing Roth conversions. They typically don't model my circumstances realistically, and accounting for tax risks is a challenge. So I've mostly relied upon the simplistic comparison of contribution tax rates to withdrawal tax rates, and attempting to factor in a reasonable range of withdrawal tax rate scenarios. I gravitated to a very general, simplistic approach to a tricky question with no certain solution. However, with the benefit of your analyses, I've come to see more value in at least attempting a detailed quantitative analysis. The results are still fuzzy — we can't lose sight of that — but they are helpful.

On the other extreme end, a neighbor is near retirement, >70, and paying taxes at a 37% marginal rate. (I can only assume that includes state taxes, because he lives near me.) He has nothing in TDAs, only Roth accounts. His income tax rate will drop to 0% once he retires — and stay there! But he's still contributing only to a Roth account! When I noted that it would be better for him to defer the taxes now, and he can start Roth conversions as soon as his income goes away if he likes, he said he'd have to build a spreadsheet to sort it all out. I even sent him a link to the "traditional vs. Roth" wiki page. But as extremely intelligent as he is, he seems to have trouble applying a general conceptual test to what I see as a clear-cut, obvious scenario. I can only hope he keeps thinking about the question, and maybe follows through with building his spreadsheet. Maybe he'll come to see that an accurate and detailed solution is not really possible in the face of tax risks, but that even on a very general conceptual level his best course of action is fairly clear.

Anyway, please excuse these OT ramblings...
"Discipline matters more than allocation.” |—| "In finance, if you’re certain of anything, you’re out of your mind." ─William Bernstein
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

iceport wrote: Mon Nov 01, 2021 2:57 pm
McQ wrote: Sat Oct 30, 2021 1:42 pm In sum: although Roth conversions always pay off if you can hold on long enough, if you desire an early and substantial payoff, then you should convert only assets with the highest expected return. If you have already converted your highest return assets; and / or, you had substantial Roth accounts already, from Roth contributions, adequate to hold all your highest return assets, then you should focus on assets with relatively high expected returns, with a 60/40 allocation anchoring the top of this space and a 30/70 allocation the bottom.

If the only assets left to convert are low return assets, then look at these tables and decide whether the payoff for converting, say, a 2.4% stable value fund is a game worth the candle (looking at you, iceport).

I personally would not; but all such decisions are irredeemably personal.
Thanks for your professional assessment, Professor McQ! I also appreciate the way you frame these results, acknowledging the uncertainty inherent in the analysis, and allowing for personal preferences.


I arrived at the basic conclusion that Roth conversions do not present a significant opportunity for me, personally, a while ago. Simple circumstances; single; no massive RMD worries; no IRMAA worries; pension w/COLA means marginal tax rate in retirement will always be roughly comparable to working marginal tax rate; only low-yielding fixed income fits in TDAs; and TDAs only make up <28% of portfolio. I'm also inclined to place a value on the concept of tax diversification, because I'm pretty sure I'm not clairvoyant, and will never be able to predict tax code changes over the long term and changes in my personal tax circumstances from year to year with any degree of reliability at all.

Then the 2017 tax cuts took effect, and all of a sudden the opportunity to convert TDA savings at 22% that were contributed just a few years earlier at 25% (and which saved me from the 28% bracket) became interesting. So the plan became to convert the sum I rolled over from a 457b plan, but leave the remaining 457b balance alone, which I left in-place solely for the access to a decent stable value fund. (Theoretically I could investigate an in-plan conversion within the 457b, but there's no real incentive to start mucking up the account that's currently 100% tax-deferred.) It will only take about 4 years to complete those planned conversions within the 22% bracket, and I'm halfway done. Assuming the scheduled return to the pre-2107 tax cut income tax rates holds up, I think this strategy makes sense, even if it won't produce a humongous benefit. There's also been a minor psychological benefit to whittling down the TDA account, even as small as it is already, relatively speaking.


What strikes me is how differently folks approach the question. I've generally been frustrated with the spreadsheet or deterministic approach to analyzing Roth conversions. They typically don't model my circumstances realistically, and accounting for tax risks is a challenge. So I've mostly relied upon the simplistic comparison of contribution tax rates to withdrawal tax rates, and attempting to factor in a reasonable range of withdrawal tax rate scenarios. I gravitated to a very general, simplistic approach to a tricky question with no certain solution. However, with the benefit of your analyses, I've come to see more value in at least attempting a detailed quantitative analysis. The results are still fuzzy — we can't lose sight of that — but they are helpful.

On the other extreme end, a neighbor is near retirement, >70, and paying taxes at a 37% marginal rate. (I can only assume that includes state taxes, because he lives near me.) He has nothing in TDAs, only Roth accounts. His income tax rate will drop to 0% once he retires — and stay there! But he's still contributing only to a Roth account! When I noted that it would be better for him to defer the taxes now, and he can start Roth conversions as soon as his income goes away if he likes, he said he'd have to build a spreadsheet to sort it all out. I even sent him a link to the "traditional vs. Roth" wiki page. But as extremely intelligent as he is, he seems to have trouble applying a general conceptual test to what I see as a clear-cut, obvious scenario. I can only hope he keeps thinking about the question, and maybe follows through with building his spreadsheet. Maybe he'll come to see that an accurate and detailed solution is not really possible in the face of tax risks, but that even on a very general conceptual level his best course of action is fairly clear.

Anyway, please excuse these OT ramblings...
Actually, iceport, I think of your remarks more as "seasoned reflections," as with chip's comments upthread. One of the benefits to me of posting at bogleheads is to see the reactions of investors who have been mulling over or implementing conversions for some time. Since I am not a financial planner, and have no clients to provide concrete instances, it helps keep me grounded, and I appreciate the time you took.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

Thread Conclusion

I’m going to wind up my planned participation in the current thread with this post. I’ve observed that threads with hundreds of posts are slightly off-putting to BH—it’s not clear where to begin, or whether the effort to start at the beginning will be worthwhile. Plus, I think the several issues that remain to be addressed would benefit from being grouped under a new title. Look for a new thread in a few weeks titled something like “Don’t touch that Roth.”

I would like to express my gratitude to everyone who participated. I learned a lot. It was a priceless opportunity to work on the revision to the SSRN paper “live” as it were.

Now to the last planned post on this thread.

What if there is a widow?

From the first thread discussing my SSRN paper here at BH, I have been reminded that if one spouse dies years before the other, the widowed survivor is going to pay taxes at the single rate, which can be a lot higher. Surely Roth conversions make even more sense / pay off even better in that case?

Short answer: of course the conversion will pay off more if future tax rates are higher; but the interesting question is to calibrate by how much. Thus, if one spouse dies at or around age 72 when the first RMD is due, then there is no difference between the “widowed” scenario and the generic “future tax rates moved higher” scenario, and no additional investigation is needed.

To have a distinct widow/er scenario requiring investigation, the first death needs to occur after RMDs have gone on for a bit at the expected MFJ rate. Logically, an exploratory test should look at several possible ages of death. I propose to evaluate conversion outcomes at age 95, and then consider the effect of having the first death occur at age 80, 85, or 90. To give some perspective on these three ages: if the first to die is the male spouse, and the couple was considering a conversion in their 60s, death about age 80 is somewhat premature on the demographics but far from unusual. Death at 85 is about as expected by the life expectancy tables; death at 90 is slightly long-lived, unless the male spouse is, say, an affluent, educated individual with a healthy lifestyle and good family history, in which case it is about as expected. Having the female spouse still alive at 95 is not at all unexpected, especially if she was still alive at 80.

In short: the widowed scenario is going to result in a blend of future tax rates, with the blend proportions varying with age at death. At other points in this thread I’ve pooh-poohed the impact of tax rate increases as compared to the effects of compounded tax drag in determining the magnitude of the Roth conversion payoff; the widowed scenario offers another chance to assess this issue.

Next question: what single tax rate should be used? This issue was considered in more depth in my SSRN paper on the widow tax hit, discussed in this thread: viewtopic.php?f=2&t=355111

Here, consistent with the almost-everything-remains off-camera-approach used in this thread, I simply need to pick a single person tax rate that’s believable and of enough magnitude to move the needle. To that end, the 22% bracket no longer seems apropos. I suppose there are BH capable of getting worked up about the widowed survivor having to pay 24% instead of the couple’s 22% rate, but …

Instead, I’ll start with the 24% MFJ bracket, which begins about $200,000 and extends to $350,000 AGI with age 65 deductions. Even with some loss of income (e.g., spousal social security), it’s easy to see the survivor pushed into the 32% bracket, the sort of hefty jump often feared (e.g., $235,000 income for MFJ, less $50,000 reduction in social security, equals a single income well into the 32% bracket).

To generate the numbers in the table below, I return to my base spreadsheets. I first calculate the payoff at age 95 for a constant rate of 24% for a conversion at age 71, and then again with tax paid outside and conversion 12 years early—the two extremes in terms of payoff values, see upthread. This calculation assumes that both survive to age 95.

Next, I impose a 32% tax rate on the RMDs beginning at age 80 / 85 / 90, to reflect an early death, and recompute conversion payoffs at age 95 for the survivor. The dollar amount of the payoff will go up; but by how much? Here is the table:

Widow/er conversion outcomes at age 95:

Code: Select all

                       In-conversion     Tax outside
                         tax age 71    12 years early
Both alive, 
constant rate of 24%     $41,108           $190,201

First death age 80       $58,473           $228,432

 “      “   age 85       $53,151           $216,717

 “      “   age 90       $47,624           $204,547
Let’s focus on the age 85 row: age 85 is the expected demise for a male who had survived to the middle 60s. I find the results to be distinctly underwhelming. Yes there is an improvement, but the dollars gained are less than 30% (in-conversion tax) and 15% (tax outside & early) of the payoff gained simply through the action of compounding tax drag.

Good to know the widowed survivor will be a little better off with the conversion; but the amounts are hardly sufficient to make / break the deal.

And that suggests a second scenario worth considering. Remember poor Rob and Sue, the misinformed taxpayers from upthread? They were stampeded into converting at 32% to avert RMDs that were only going to be taxed at 24%. It took them a long time to break even in the base case.

Could an early demise of one spouse rescue the survivor from a hasty and ill-considered conversion? (Please forgive the macabre staging). For the next table, in the baseline case they convert at 32% and pay tax of 24% on their RMDs with both still alive at 95. These values were given upthread but are reproduced here. Then, a first death at age 80 / 85 /90 is calculated, assuming the widowed survivor’s rate jumps to 32% from that point forward.

Conversion outcomes at age 95:

Code: Select all

                       In-conversion     Tax outside
                         tax age 71    12 years early
Both alive, convert at
32%, pay 24% on RMDs      $ 2,345         $138,151

[survivor’s rate = 32%]
First death age 80        $19,710         $176,382

 “      “   age 85        $14,389         $164,667

 “      “   age 90        $ 8,861         $152,497

Note first that the arithmetic difference between rows is the same in both tables. It’s a useful reminder that favorable changes in tax rate make an arithmetic contribution to conversion outcomes, even as compounding tax drag makes an exponential contribution.

What to make of the table? Certainly in the base case, left column, where the ill-considered conversion had just broken even at age 94, the unfortunate loss of a spouse does indeed boost the dollar payoff; but not to levels that would excite any prospective converter. I might summarize as: if you are unlucky enough to have a spouse die early, at least this can help to improve the results of any ill-considered conversion you might have made. Personally, I’d prefer my spouse stayed alive.

Results are particularly underwhelming on the right side, since the power of compounding had already rescued this ill-considered conversion.

Wait—was that not what you meant?

By this point in the post there should be at least one devoted spouse, engaged in planning for a Roth conversion, and considering the prospect of a widowed survivor, who has begun throwing things across the room in frustration: “your tables completely miss the point!”

Putting words in their mouth: “the point was not to burden the widowed survivor’s spending by them having to pay a higher rate of tax.” The contention: Having only $6800 of each $10,000 of income be spendable is way worse than having $7600 of each $10,000 be spendable, as when the couple was alive. Multiplied by the several tens of thousands of dollars of income that might fall into the 32% bracket after the first death, that is real money; and repeated year after year, that’s going to add up.

Now my turn to say whoa: this thread has assumed from the outset that the RMDs that could be avoided by a conversion were surplus, unneeded for spending. I haven’t looked at any scenario where the RMDs or the conversion amounts got spent (I will in the next thread).

Next, if these funds were surplus for the couple, wouldn’t they be surplus for the widow/er? Why should we care if the survivor has to dribble out extra dollars in tax on annual RMDs that were just going to be reinvested for heirs or held for a late in life emergency?

“You just don’t get it,” comes the reply. “When the first spouse died, their income dropped by enough that those RMDs aren’t surplus anymore, and it hurts only to be able to spend $6800 per $10,000 in RMDs rather than $7600.”

But if income dropped so much as to wipe out any surplus, how could the survivor have ended up in a higher tax bracket? See my paper on the widow tax hit for more on this “catch-22”: https://papers.ssrn.com/sol3/papers.cfm ... id=3896672

What is the goal of the Roth conversion?

In this thread only one goal was admitted: greater after-tax wealth in the distant future. Many, many other goals and motivations can be envisioned for a Roth conversion.

For instance, tax hatred may be a motivation. This would help to explain the dialogue above. I believe there are some US citizens who revile the idea that their widowed survivor would have to pay a penny more in tax—regardless of how much was saved in medical insurance costs on the first death, and regardless of whether the extra tax payment had a de minimis effect on the survivor’s lifestyle. In this view, taxes are per se bad and always to be avoided—except the one-time tax paid to convert.

Other citizens want always to have funds available on which no tax need be paid—even if homo economicus, the wealth maximizer, would calculate that it was better to leave the Roth to grow and take the grossed-up funds (spending + tax) from the TDA instead. It’s easy for tax aversion to replace rational calculation.

But again, maybe the RMDs were never surplus; maybe the converters always planned to spend from the Roth, and to achieve greater after-tax spending power year by year, rather than greater wealth accumulation in the distant future.

That case will require a different thread ...
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FinancialDave »

dodecahedron wrote: Fri Sep 24, 2021 1:08 pm

*Edited to add: I used the word almost because it is possible to construct examples with no dividend (or capital gains) drag. (E.g., if the investment portfolio throws off only dividends and LTCG and if taxpayer lives in a state with no state or local income tax and also manages to keep future taxable income sufficiently low so that qualified dividends and capital gains are taxed at zero, there is no tax drag.)

Note that I have a mathematical bent and like to consider edge cases! :D
Well, maybe I am an "edge case" but I constructed last year (mid 2022) what I call a "taxable account for the grandkids" which creates essentially zero tax drag for me. It is not a hard thing to do. The decision is based on I don't need the money - sort of like the author's decision that he doesn't need the RMDs, and he likes tax drag instead. It is also based on selecting mostly well-established companies in the S&P 500 like BRK.B, AMZN, TSLA and others. For me I chose 10 stocks, which is more than typically drives the major returns of the indexes.

Why doesn't the author try running the equations with zero tax drag?

I'm pretty sure when the professionals decide there is money to be made from zero dividend ETFs they will develop one, but by then I won't need it.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FinancialDave »

WoodSpinner wrote: Sun Sep 26, 2021 2:55 pm

I use an alternate approach….

I hold only Equities in Roth. When I need to spend from them, I exchange Bonds for Equities in the IRA.

It’s pretty simple and usually done once a year as part of my annual rebalancing.

Roth space is too precious to waste on Bonds (IMHO).

WoodSpinner
Since you don't have a taxable account, this is pretty easy to explain.

Unless you insist you know which side of the tax equation you are on and it favors the Roth there is no reason to hold "higher returns" in the Roth, even if you could predict what those look like like.

Do the math for tax rates equal:

Investor A has bonds in Roth and AAPL stock in TDA.

Investor B, or the alternative version of yourself, holds the inverse; (AAPL stock in Roth and Bonds in TDA.)

Both Investors have the same spendable income provided you agree that $10,000 starting in the IRA, is the same as $7500 starting in the Roth.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by ThankYouJack »

Is there a TLDR summary or consensus to this thread?

If I do Roth conversions this year my marginal tax rate could be ~70%. I might drawdown my TDA at a 15% rate. How would the Roth conversion pay off if held long enough?
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by steadyosmosis »

ThankYouJack wrote: Sat Dec 23, 2023 10:00 am If I do Roth conversions this year my marginal tax rate could be ~70%.
Hmmm... (post removed)
Age<59.5. Early-retired. AA ~55/45. Taxable account, Roth IRA, HSA...all are 100% equities. 100% of fixed income is in tIRA. I spend from taxable and re-balance in tIRA.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by ThankYouJack »

steadyosmosis wrote: Sat Dec 23, 2023 10:08 am
ThankYouJack wrote: Sat Dec 23, 2023 10:00 am If I do Roth conversions this year my marginal tax rate could be ~70%.
Hmmm... (post removed)
Hmmm, what? You're leaving me hanging ;)
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FinancialDave »

ThankYouJack wrote: Sat Dec 23, 2023 10:00 am Is there a TLDR summary or consensus to this thread?

If I do Roth conversions this year my marginal tax rate could be ~70%. I might drawdown my TDA at a 15% rate. How would the Roth conversion pay off if held long enough?
How long you hold the Roth has very little to do with whether it will "pay off" - it is all about the tax differentials. In other words if you have to pay 70% tax on the conversion, there is little chance in my mind that you could ever spend that Roth money to avoid that kind of tax in the future - making it "pay off."
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by jebmke »

FinancialDave wrote: Sat Dec 23, 2023 1:42 pm
ThankYouJack wrote: Sat Dec 23, 2023 10:00 am Is there a TLDR summary or consensus to this thread?

If I do Roth conversions this year my marginal tax rate could be ~70%. I might drawdown my TDA at a 15% rate. How would the Roth conversion pay off if held long enough?
How long you hold the Roth has very little to do with whether it will "pay off" - it is all about the tax differentials. In other words if you have to pay 70% tax on the conversion, there is little chance in my mind that you could ever spend that Roth money to avoid that kind of tax in the future - making it "pay off."
agree. I didn't follow the thread but couldn't come up with a realistic scenario where it pays to do Roth conversions if one plans to give it all to charity. That is the conclusion I came to so we stopped. Perhaps there is a weird edge case.
Don't trust me, look it up. https://www.irs.gov/forms-instructions-and-publications
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FiveK »

FinancialDave wrote: Sat Dec 23, 2023 1:42 pm How long you hold the Roth has very little to do with whether it will "pay off"
It does (at least to some extent) if you have a "Traditional plus taxable" vs. Roth situation. See situations b) and c) in that article.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FiveK »

jebmke wrote: Sat Dec 23, 2023 1:47 pmI didn't follow the thread but couldn't come up with a realistic scenario where it pays to do Roth conversions if one plans to give it all to charity. That is the conclusion I came to so we stopped. Perhaps there is a weird edge case.
With the charity subject to a 0% marginal rate, no voluntary Roth conversion would be beneficial to the charity, except possibly to avoid/reduce tax drag on RMDs invested instead of spent while the owner is still alive.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by LeslieSmiley »

Roth conversion is a gamble with the following factors

- future tax rate
- lifespan
- heirs

You can simulate endless numbers of scenarios that would support both "to convert" or "not to convert" choices. Ultimately, it comes down to your bet/projection/consideration of the above factors and whether or not you care about that.

The benefit of lowering your future tax liability is only meaningful if

1) you live long enough to actually receive the benefit

2) you want to lower your heirs tax burden when you die

There are those who expect a low life expectancy and/or want to spend most if not all of their money before they die, Roth conversion becomes less relevant and/or important.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by smitcat »

LeslieSmiley wrote: Sun Dec 24, 2023 6:54 am Roth conversion is a gamble with the following factors

- future tax rate
- lifespan
- heirs

You can simulate endless numbers of scenarios that would support both "to convert" or "not to convert" choices. Ultimately, it comes down to your bet/projection/consideration of the above factors and whether or not you care about that.

The benefit of lowering your future tax liability is only meaningful if

1) you live long enough to actually receive the benefit

2) you want to lower your heirs tax burden when you die

There are those who expect a low life expectancy and/or want to spend most if not all of their money before they die, Roth conversion becomes less relevant and/or important.
"There are those who expect a low life expectancy and/or want to spend most if not all of their money before they die"
A lower life expectancy combined with your #2 above can make Roth conversions both relevant and important.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by Running Bum »

LeslieSmiley wrote: Sun Dec 24, 2023 6:54 am Roth conversion is a gamble with the following factors

- future tax rate
- lifespan
- heirs

You can simulate endless numbers of scenarios that would support both "to convert" or "not to convert" choices. Ultimately, it comes down to your bet/projection/consideration of the above factors and whether or not you care about that.

The benefit of lowering your future tax liability is only meaningful if

1) you live long enough to actually receive the benefit

2) you want to lower your heirs tax burden when you die

There are those who expect a low life expectancy and/or want to spend most if not all of their money before they die, Roth conversion becomes less relevant and/or important.
Why is Roth conversion a gamble with future tax rates? You are locking in the tax rate. By not converting, you are leaving those funds subject to future unknown tax rates. That seems like a lot more of a gamble to me.

I don't follow the logic on the other part I bolded either. If you want to spend all of your money, you would want to convert if you think your tax rate is lower now that what you expect in the future. Lower tax rate means more money to spend.

The whole idea of Roth conversions is that you predict tax rates are lower now than later. Likely this is the time from between retirement (no more job income) but before you start SS, pension, and SS. While it's possible tax rates will be lower in the future, if you can make an educated guess that they won't be because your income is lower now, you convert. That's kind of what you said, but you said it with a pretty heavy bias against converting.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by tibbitts »

Running Bum wrote: Sun Dec 24, 2023 10:54 am Why is Roth conversion a gamble with future tax rates? You are locking in the tax rate. By not converting, you are leaving those funds subject to future unknown tax rates. That seems like a lot more of a gamble to me.

...

I don't follow the logic on the other part I bolded either. If you want to spend all of your money, you would want to convert if you think your tax rate is lower now that what you expect in the future. Lower tax rate means more money to spend.

The whole idea of Roth conversions is that you predict tax rates are lower now than later. Likely this is the time from between retirement (no more job income) but before you start SS, pension, and SS. While it's possible tax rates will be lower in the future, if you can make an educated guess that they won't be because your income is lower now, you convert. That's kind of what you said, but you said it with a pretty heavy bias against converting.
Well, it's a gamble in that you don't know if the rate you're locking in will be better or worse than what you'll pay in the future. And usually that's almost always dependent on your investment returns as much as government policy.

For most of us there are very few low income years before IRMAA, then SS, then RMDs. I think many people will probably benefit from converting during that tiny window before any of those apply. But it's almost always never a sure thing; you just place your bet and hope what you're doing will turn out to be beneficial. You can model scenarios to tell you what the outcome will be based on different assumptions, but nothing can tell you which assumptions are more or less likely to play out.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by LeslieSmiley »

smitcat wrote: Sun Dec 24, 2023 10:23 am
LeslieSmiley wrote: Sun Dec 24, 2023 6:54 am Roth conversion is a gamble with the following factors

- future tax rate
- lifespan
- heirs

You can simulate endless numbers of scenarios that would support both "to convert" or "not to convert" choices. Ultimately, it comes down to your bet/projection/consideration of the above factors and whether or not you care about that.

The benefit of lowering your future tax liability is only meaningful if

1) you live long enough to actually receive the benefit

2) you want to lower your heirs tax burden when you die

There are those who expect a low life expectancy and/or want to spend most if not all of their money before they die, Roth conversion becomes less relevant and/or important.
"There are those who expect a low life expectancy and/or want to spend most if not all of their money before they die"
A lower life expectancy combined with your #2 above can make Roth conversions both relevant and important.
I didn't say you need to have 1) and 2) or else I would have included both into just 1).

They are 2 factors, so either factor applies to you would make it a reasonable choice to convert
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by LeslieSmiley »

Running Bum wrote: Sun Dec 24, 2023 10:54 am
LeslieSmiley wrote: Sun Dec 24, 2023 6:54 am Roth conversion is a gamble with the following factors

- future tax rate
- lifespan
- heirs

You can simulate endless numbers of scenarios that would support both "to convert" or "not to convert" choices. Ultimately, it comes down to your bet/projection/consideration of the above factors and whether or not you care about that.

The benefit of lowering your future tax liability is only meaningful if

1) you live long enough to actually receive the benefit

2) you want to lower your heirs tax burden when you die

There are those who expect a low life expectancy and/or want to spend most if not all of their money before they die, Roth conversion becomes less relevant and/or important.
Why is Roth conversion a gamble with future tax rates? You are locking in the tax rate. By not converting, you are leaving those funds subject to future unknown tax rates. That seems like a lot more of a gamble to me.

I don't follow the logic on the other part I bolded either. If you want to spend all of your money, you would want to convert if you think your tax rate is lower now that what you expect in the future. Lower tax rate means more money to spend.

The whole idea of Roth conversions is that you predict tax rates are lower now than later. Likely this is the time from between retirement (no more job income) but before you start SS, pension, and SS. While it's possible tax rates will be lower in the future, if you can make an educated guess that they won't be because your income is lower now, you convert. That's kind of what you said, but you said it with a pretty heavy bias against converting.
Gambling is the activity of betting an unknown outcome and you win if the desirable outcome happens and you lose if the undesirable outcome happens

So by locking in the present rate by converting now, you are still subject yourself to the possibility that your tax rate could be lower or higher in the future. Lower future tax rate would be the undesirable outcome, higher future tax rate would be the desirable outcome.

Therefore, if your tax rate in the future is lower, you lose and if your tax rate in the future is higher, you win so to speak.

So, it's the same mechanism of gambling in essence.

There are things you can consider to calculate and speculate the outcome by assessing and projecting things that are somewhat under your control that might affect your future tax rate. These factors are highly personal.

Your assertions are only true if you know for sure that your future tax rate will be higher. But in reality, that certainty cannot be obtained in many cases, hence, you need to "gamble" a bit so to speak.

Your responses are full of "IF" this then that....that's exactly my point. All those things you stated are only true "IF" this and that.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FinancialDave »

Running Bum wrote: Sun Dec 24, 2023 10:54 am
LeslieSmiley wrote: Sun Dec 24, 2023 6:54 am Roth conversion is a gamble with the following factors

- future tax rate
- lifespan
- heirs

You can simulate endless numbers of scenarios that would support both "to convert" or "not to convert" choices. Ultimately, it comes down to your bet/projection/consideration of the above factors and whether or not you care about that.

The benefit of lowering your future tax liability is only meaningful if

1) you live long enough to actually receive the benefit

2) you want to lower your heirs tax burden when you die

There are those who expect a low life expectancy and/or want to spend most if not all of their money before they die, Roth conversion becomes less relevant and/or important.
Why is Roth conversion a gamble with future tax rates? You are locking in the tax rate. By not converting, you are leaving those funds subject to future unknown tax rates. That seems like a lot more of a gamble to me.

I don't follow the logic on the other part I bolded either. If you want to spend all of your money, you would want to convert if you think your tax rate is lower now that what you expect in the future. Lower tax rate means more money to spend.

The whole idea of Roth conversions is that you predict tax rates are lower now than later. Likely this is the time from between retirement (no more job income) but before you start SS, pension, and SS. While it's possible tax rates will be lower in the future, if you can make an educated guess that they won't be because your income is lower now, you convert. That's kind of what you said, but you said it with a pretty heavy bias against converting.
I have always had a pretty heavy bias against converting as well - the reason is, that bias favors the highest number of retirees and it favors the lower SS payments which up until recently when most of the population was taking SS below 70 and even below FRA. In other words, if money is tight and you have a relatively small TIRA (million or less) the numbers favor not converting, IF your goal is more after-tax spendable income. If your only goal is lowering your tax burden and not having more spendable income then Roth conversions are for you!
If you want to spend all of your money, you would want to convert if you think your tax rate is lower now that what you expect in the future. Lower tax rate means more money to spend.
I disagree, if you want to spend all of your money you do not convert at all, that way when you mis-judge your longevity (and live longer) you are stretching out money in very low tax brackets where TIRA money goes farther. If you die earlier it doesn't matter to you!

The only way it makes sense to convert "some" money is 1) a way to do it at 12% or below, and/or 2) you consider there is absolutely no way you will spend all your TIRA money.

The person who runs out of TIRA money, because of conversions, or too much Roth, and as a result finds themselves in the zero percent bracket, in 99.9% of those situations could have benefitted by having some TIRA money to spend there.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FiveK »

FinancialDave wrote: Sun Dec 24, 2023 11:48 am The only way it makes sense to convert "some" money is 1) a way to do it at 12% or below....
Or, to give just one of many other examples, converting at 24% to avoid paying 32% later, etc.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by tibbitts »

FiveK wrote: Sun Dec 24, 2023 11:53 am
FinancialDave wrote: Sun Dec 24, 2023 11:48 am The only way it makes sense to convert "some" money is 1) a way to do it at 12% or below....
Or, to give just one of many other examples, converting at 24% to avoid paying 32% later, etc.
Yes, and since you mentioned it, I'm guessing that's a much more common situation for Bogleheads vs. any 12% scenario. Although realistically IRMAA and NIIT can add to whatever income tax marginal rates that might apply.
Last edited by tibbitts on Sun Dec 24, 2023 12:05 pm, edited 1 time in total.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by smitcat »

LeslieSmiley wrote: Sun Dec 24, 2023 11:32 am
smitcat wrote: Sun Dec 24, 2023 10:23 am
LeslieSmiley wrote: Sun Dec 24, 2023 6:54 am Roth conversion is a gamble with the following factors

- future tax rate
- lifespan
- heirs

You can simulate endless numbers of scenarios that would support both "to convert" or "not to convert" choices. Ultimately, it comes down to your bet/projection/consideration of the above factors and whether or not you care about that.

The benefit of lowering your future tax liability is only meaningful if

1) you live long enough to actually receive the benefit

2) you want to lower your heirs tax burden when you die

There are those who expect a low life expectancy and/or want to spend most if not all of their money before they die, Roth conversion becomes less relevant and/or important.
"There are those who expect a low life expectancy and/or want to spend most if not all of their money before they die"
A lower life expectancy combined with your #2 above can make Roth conversions both relevant and important.
I didn't say you need to have 1) and 2) or else I would have included both into just 1).

They are 2 factors, so either factor applies to you would make it a reasonable choice to convert
"There are those who expect a low life expectancy and/or want to spend most if not all of their money before they die, Roth conversion becomes less relevant and/or important."
With a lower expected life there are still reasons why Roth conversions can be more relevant and important.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by smitcat »

FinancialDave wrote: Sun Dec 24, 2023 11:48 am
Running Bum wrote: Sun Dec 24, 2023 10:54 am
LeslieSmiley wrote: Sun Dec 24, 2023 6:54 am Roth conversion is a gamble with the following factors

- future tax rate
- lifespan
- heirs

You can simulate endless numbers of scenarios that would support both "to convert" or "not to convert" choices. Ultimately, it comes down to your bet/projection/consideration of the above factors and whether or not you care about that.

The benefit of lowering your future tax liability is only meaningful if

1) you live long enough to actually receive the benefit

2) you want to lower your heirs tax burden when you die

There are those who expect a low life expectancy and/or want to spend most if not all of their money before they die, Roth conversion becomes less relevant and/or important.
Why is Roth conversion a gamble with future tax rates? You are locking in the tax rate. By not converting, you are leaving those funds subject to future unknown tax rates. That seems like a lot more of a gamble to me.

I don't follow the logic on the other part I bolded either. If you want to spend all of your money, you would want to convert if you think your tax rate is lower now that what you expect in the future. Lower tax rate means more money to spend.

The whole idea of Roth conversions is that you predict tax rates are lower now than later. Likely this is the time from between retirement (no more job income) but before you start SS, pension, and SS. While it's possible tax rates will be lower in the future, if you can make an educated guess that they won't be because your income is lower now, you convert. That's kind of what you said, but you said it with a pretty heavy bias against converting.
I have always had a pretty heavy bias against converting as well - the reason is, that bias favors the highest number of retirees and it favors the lower SS payments which up until recently when most of the population was taking SS below 70 and even below FRA. In other words, if money is tight and you have a relatively small TIRA (million or less) the numbers favor not converting, IF your goal is more after-tax spendable income. If your only goal is lowering your tax burden and not having more spendable income then Roth conversions are for you!
If you want to spend all of your money, you would want to convert if you think your tax rate is lower now that what you expect in the future. Lower tax rate means more money to spend.
I disagree, if you want to spend all of your money you do not convert at all, that way when you mis-judge your longevity (and live longer) you are stretching out money in very low tax brackets where TIRA money goes farther. If you die earlier it doesn't matter to you!

The only way it makes sense to convert "some" money is 1) a way to do it at 12% or below, and/or 2) you consider there is absolutely no way you will spend all your TIRA money.

The person who runs out of TIRA money, because of conversions, or too much Roth, and as a result finds themselves in the zero percent bracket, in 99.9% of those situations could have benefitted by having some TIRA money to spend there.
"The only way it makes sense to convert "some" money is 1) a way to do it at 12% or below, and/or 2) you consider there is absolutely no way you will spend all your TIRA money."
Or you convert at 22/24% and then it takes you into a maximum 15% tax rate thereafter.
Many reasons why it may work at higher numbers.
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