Global Statistics

All countries
192,749,257
Confirmed
Updated on 21/07/2021 10:40 pm
All countries
173,492,171
Recovered
Updated on 21/07/2021 10:40 pm
All countries
4,141,319
Deaths
Updated on 21/07/2021 10:40 pm

Global Statistics

All countries
192,749,257
Confirmed
Updated on 21/07/2021 10:40 pm
All countries
173,492,171
Recovered
Updated on 21/07/2021 10:40 pm
All countries
4,141,319
Deaths
Updated on 21/07/2021 10:40 pm

To Roth or not to Roth? Part ii

I have some advice for those of you who would dare to question the conventional wisdom about Roth conversions to your 401 (k) s or IRAs:

Be prepared for a significant setback.

You should know, because I dedicated last week’s column to questioning that conventional wisdom. I reported on extensive research that found that while Roth conversions often work in the end, it takes a lot longer than most realize to get that benefit, and in any case, the benefit is usually quite small.

The indefinite was carried out by Edward McQuarrie, professor emeritus at the Leavey School of Business at the University of Santa Clara. Fully aware that his findings will reduce this setback, he goes public with the indefinite in which he incorporates the myriad of factors that are relevant to determining whether a conversion makes sense. In an interview, he said: “In fact, you may be among the lucky few who will receive a large and fast payment from a Roth conversion, as opposed to the slow and small payment that I found to be the norm. But you owe it to yourself. test it with a spreadsheet. “

In this column I reply to a series of emails I received after last week’s column. In each case, I reached out to McQuarrie for his ideas, which are included below.

“The study does not mention a potential benefit of a Roth conversion: Reducing the Required Minimum Distribution (RMD) on the portion of retirement funds left in a traditional IRA. A few years ago (when income tax rates were actually higher), I gradually converted about half of my retirement portfolio to Roths. As a result, my RMD is quite low annually. “

McQuarrie’s answer: Lowering RMD is a common motivation for Roth conversions. But it is not clear that it will be better for having done it. Although I cannot know your specific situation, there is a good chance that you paid a tax rate of 28% on your conversions, in exchange for reducing RMDs that would otherwise have been taxed to 22%. If so, it will take decades for your conversion to break even in terms of net present value. Please see the spreadsheet I provide on my website to know how to do the calculation. As you’ll see from that spreadsheet, for couples married in 2021, total income (RMD plus Social Security plus other income) must exceed $ 200,000 to be taxed at a rate greater than 22%. That’s a big hurdle, and it increases every year as tax brackets adjust for inflation.

“I use my Roth as a kind of trust fund for my daughter, who is now 40 years old. Due to the change in tax law, she will have to collect it within 10 years of my death, but she will never pay income taxes, as she would with a traditional inherited IRA. That will likely save you a lot more than the tax I paid for the conversions. “

McQuarrie’s answer: I’m not sure you’ve taken time value for money into account here. Let’s say your daughter inherits in 20 years and the traditional IRA in her hands would have been taxed at roughly the rate she paid for the conversion. Instead, he chose to pass the tax-reduced post-conversion amount on his Roth account to his daughter, who will not pay taxes on it or the subsequent appreciation. But it also transfers the future (negative) value of the tax you paid to convert, which would have remained in the traditional IRA to appreciate. You will probably be better off, Roth conversions always pay off over several decades with roughly constant tax rates. But I challenge you to show on a spreadsheet that the conversion will save you “a lot more than the tax I paid,” in terms of net present value.

“You didn’t mention the time in life when many people would benefit from a Roth conversion. I recently retired, I have a small pension, I am not taking Social Security yet, and I am about seven years away from RMD. But I have a good IRA. When those RMDs roll in, I will face a huge tax bill plus much higher Medicare premiums. For the next several years, it seems that a Roth conversion every year would be a wise move. I will pay taxes on the converted amount at a much lower rate than I will pay in RMD. “

Response from McQuarrie: Your age and situation were the exact focus of my article. Let’s be specific about your “good IRA account.” If you are single, is it more than $ 1.2 million ($ 2.4 million if married)? Otherwise, projecting seven years forward, you won’t have to pay even the first tier of Medicare surcharges, and you’ll only be in the 22% tax bracket, which I don’t consider “huge.” However, if you can convert today within the 12% range, whose upper income limit is roughly $ 52,000 for a single taxpayer, then in fact a Roth conversion will pay off in not too many years. That $ 52,000 conversion will reduce your first year RMD by approximately $ 2,500, saving you more than $ 500 in income taxes at a rate of 22%, and these savings will continue for years to come as well. But what funds would it live on during that year it was converted? If you have any taxable income (for example, your pension), then you won’t be able to convert as much as $ 52,000, which means you’ll save less than $ 500 in income taxes.

His article on the Roth conversion missed an important topic: A traditional retirement IRA distribution can make more of your Social Security benefits taxable, resulting in a 12% rate that is actually more like 20%. On the other hand, a Roth does not cause more than your Social Security payments to be taxed. This can benefit lower-income taxpayers more than it seems when the topic of Social Security taxes is overlooked.

McQuarrie’s Response: You have a good point: Your effective tax rate in retirement will be higher if your income increases enough to make some of your social security benefits taxable. If you can do a Roth conversion today at 12%, to save more than 20%, of course it will pay off, and relatively soon. However, what funds will you use to live through the conversion year? Every dollar of taxable income reduces the amount you can convert by 12%. And can you convert enough at 12% to make a difference? (To get even a $ 1,000 reduction in your first year RMD, it will take about $ 18,000 to convert at age 65.)

What is the end result that I extract from this discussion? The wisdom of a Roth conversion, or lack thereof, is not something you can discover on your own using simple rules. You need to run the numbers. Be my guest.

Mark Hulbert is a regular contributor to MarketWatch. Your Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be contacted at [email protected]

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