An argument for doing a Roth conversion, even in a high bracket


Kaye Thomas makes his case:
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(I have no connection w/Fairmark other than following it at least ten
years, now.)
--
Rich Carreiro snipped-for-privacy@rlcarr.com
Reply to
Rich Carreiro
MY biggest Roth Mania peeve are the 25%ers who stand a snowball's chance of cracking out of 15% in retirement all jumping on this as if they have so much at risk not converting.
Joe
Reply to
JoeTaxpayer
Rich Carreiro writes:
The words are a bit screwy. "increase the tax benefit you get from your retirement account by 54%" is just a badly written sentence.
What they mean, of course, is "increase the proportion of your assets which are in tax-favored accounts substantially".
The options he describes as all having the same immediate spendable value are (assuming flat 35% marginal tax rate)
A) $100,000 in a taxable account B1) $35,000 taxable, $100,000 in a Traditional IRA B2) $35,000 taxable, $65,000 in a Roth C) $100,000 in a Roth.
Noting that it's always preferable to have a higher proportion ofyour money in a tax favored account, any way to get closer to C is good.
There's nothing particularly surprising about it.
And he (probably rightfully) ignores
C2) $153,846 in a traditional IRA
As he said, they're all equivalent if liquidated and spent today.
But if left alone, and, say, doubling over the course of several years, C1 and C2 remain precisely equivalent, while any scenario which leaves some of the money in a taxable account subject to the ongoing tax friction along the way to doubling -- likely comes out behind.
(ignoring a variety of things - suppose that the taxable portion was in a fabulously tax-efficient investment and was earning undistributed capital gains? Then the along-the-way friction is minimal and the liquidation is taxed at favorable cap-gains rates, just as one example)
So - yes - if you have taxable assets and a traditional IRA, doing the conversion and paying taxes out of current taxable assets is equivalent to having been able to put a greater amount into a tax-protected account. But it's not the Roth-ness which makes it magical (again, see C1 vs. C2)
It's really the same computation as noting that the Roth effectively allows one to protect a higher pre-tax amount of monay into an IRA. $5000 in a Roth (at 35% marginal income taxes) is equivalent to $7692 in pre-tax money. You can't put $7692 into a traditional IRA via normal annual contributions - only $5000 pre-tax. To get to the same level of immediate savings via a traditional IRA, $5000 goes into the IRA and you pay taxes on the remaining $2693 (leaving $1750) which you invest in a taxable account. Of course the Roth is (likely) better - and the higher your tax bracket, the higher the effectively higher limit is. ($5000/(1-marginal tax rate))
Frankly, a much more compelling reason to consider the Roth conversion may be estate taxes. The money used to pay taxes on the conversion is out of the estate now. Were it to remain in the estate and be taxed at the absurd estate tax rates, then after the death, there's that much less left to pay income taxes on withdrawal from the IRA.
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BreadWithSpam

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