Financial advisors suggest transferring some amount from IRAs to a Roth IRA in order to reduce future RMDs. For example, fill out the current tax bracket.
(Of course, I'm talking about after age 59 1/2.)
How does that square with the "time value of money"?
Doesn't TMV imply that we should defer taxes, not accelerate them?
59-1/2 doesn't really matter much here. What matters more is (a) your current tax bracket. i.e. the marginal rate you pay on the last $100 taxed, From the line "taxable income." And (b) The total amount you have in pretax savings, as this impacts the snowballing nature of RMD amounts.
A simple strategy of topping off your current bracket can help shift money over the years. Keep in mind, you can use a Roth conversion at any age, while working, while retired, even while over 70-1/2 and taking RMDs.
Aside from avoiding the increasing RMDs, you should be aware of HR5282, ??Retirement Enhancement and Savings Act of 2018??.
The main feature (i.e. the only one I care about) is that when you die, a non-spouse beneficiary has a 5 year limit on withdrawals. They would no longer be permitted to take withdrawals over their own lifetime. For those of us who saved mostly pre-tax (the Roth not introduced until we were already in a high bracket) and have only one child, this rule can be devastating. Money saved over the decades at 15/25%, taxed (mostly) at 35%+ on forced withdrawal.
Time value of money is irrelevant here. If you project the growth of your traditional IRA and then subtract the tax on the increased value of the account when withdrawn, it will be exactly equal to the increased value of the Roth IRA account at that time.
In other words, the time value of money rate for the tax paid now is the same rate as for the investment account.
The reas> Financial advisors suggest transferring some amount from IRAs to a Roth IRA in order to reduce future RMDs. For example, fill out the current tax bracket.
If you work through the math, a Roth conversion is the mathematical equivalent of contributing the taxes paid to a Roth. TMV is irrelevant since both assets appreciate at the same rate, tax-free/deferred.
However, it's like sheltering more money. Think of it this way, say you are in the 25% bracket now and will be later. If you convert $100K now and hold until the money doubles, you will have $200K tax-free. If you took the $25K used to pay the taxes and held it in a taxable account, you'd be paying the taxes each year on that amount, and when you withdraw the $200K from the traditional IRA later, the $25K you could have paid the tax with today won't have doubled to enough to pay the $50K in tax due later, due to the tax on earnings.
So that argues somewhat in favor of converting. But the real question is, will you be taxed on the conversion today at a higher or lower rate than you'd be taxed on withdrawals later? When you try to build in the effect of taxes on social security, it becomes mind-numblingly complex. If you're married and expect to retire/collect social security at a different time than your spouse, the calculations will drive you mad.
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