A Simple ROTH Conversion Quiz

[Franz Kafka]

Padthai, I'm not sure what you meant by your PM. If you meant you were having a joke then it's all cool and I apologize for not catching it but if you meant I was having a joke, I'm not and I'm not trying to argue for argument's sake, either. Others have already pointed out that it was a wash so I'm not sure what it is that you don't get.

At 28% bracket, the cost basis for a converted $100K ROTH is $128K not $100K. Using the same cost basis of $128K in a traditional IRA you would double up to $256K and not $200K. You pay $56K tax and end up with $200K just like you'd in a converted ROTH.

The second point: If your bracket was 28% while you accumulate fund in a ROTH, regardless of how much you end up with you have already paid 28% on that money. If however, you accumulate a portion of your retirement fund in a traditional IRA and mix the distribution with that of ROTH, you can end up paying much lower tax (or possible no tax at all) on the distribution from your traditional IRA. If on the other hand you had 100% of your fund in ROTH alone, tax on that amount would always be 28%.

Again if you were just kidding, forgive me for not catching it.

 

[padthaiforlunch]

I see what your doing. Your math is a little rough. You're including the cost of paying the taxes as a lost opportunity.

So let's take a look....


Client A has $100k in trad. IRA. Uses non-qual. money to pay 28%, or $28k.

His $100k Roth grows to $200k in value.

Client A then withdraws the full amount. He has paid 28k in taxes on $200k withdrawal. If we combine it with the $28k of lost opportunity, he is out 56k.


Client B has $100k in trad. IRA. He lets it grow to $200k, and then takes a full withdrawal. The $28k non-qual money he didn't pay for conversion costs also doubles to $56k, so he has $256.

He pays $56k in tax on the IRA portion. Now consider the other $28k gain.

Let's be generous and assume the long-term capital gains rate will not increase above 15% (take a look at this rate on a historical basis, and you will doubt it stays this low). On this $28k gain, he pays 15% or $4200.

Best case for client B is that he pays $60k (or more) in taxes. He now has $194k.

Client A, who converted has $200k.


Even with the opportunity cost client A is still ahead.

The second point seems moot.

 

[Franz Kafka]

I see what your doing. Your math is a little rough. You're including the cost of paying the taxes as a lost opportunity.

Now you see what I'm doing (?)

"I see what you're doing, Mr. client. Your math is a little rough. You're including the cost of paying the taxes as a lost opportunity."

Is that what you say to your clients once they realize that there's really no $28K savings like you just told them (?)

Every ROTH conversion webinar I've heard automatically assumes the inclusion of the lost opportunity cost and focuses only on capital gains on 28K (strangely enough they all come up with the same $6K savings) because that's something - well - that's kind of hard to miss.

Do you say something like this to your client as well?

"Mr. Client, there's no opportunity cost here because that 28K you keep in your piggy bank has either a zero or less than zero opportunity cost"

I keep getting this feeling that you're a slick talker and not a straigt shooter and I sure hope as hell that you DO TALK ABOUT the lost opportunity with your clients before they do because that's not something you just lightly mention as an after thought.

The second point seems moot.

I guess I've been feeding all my clients stale ole moots. For some reason, they all get that moot, though.

Gute Nacht!

 

[padthaiforlunch]

I keep getting this feeling that you're a slick talker and not a straigt shooter and I sure hope as hell that you DO TALK ABOUT the lost opportunity with your clients before they do because that's not something you just lightly mention as an after thought.

I'm beginning to resent the insinuation. Is my math wrong? Please to be less accusatory in what you think I'm telling my clients and more articulate in explaining why you think the math in my example is wrong.

As for your second point: They may be better off with some qual. money. If the opportunity cost is nil, then the tax rate is inverse to the gains as they increase. Again, if I'm missing something, please expound rather than impugn my character.

 

[Franz Kafka]

I'm beginning to resent the insinuation. Is my math wrong? Please to be less accusatory in what you think I'm telling my clients and more articulate in explaining why you think the math in my example is wrong.

As for your second point: They may be better off with some qual. money. If the opportunity cost is nil, then the tax rate is inverse to the gains as they increase. Again, if I'm missing something, please expound rather than impugn my character.

If my assumptions were completely off base, please accept my apology since all the ad hominems were based on how I perceived your communication to your clients in regards to the conversion - viz. mentioning of the tax savings without including the opportunity cost.

My intents on the thread was not about discussing technical ins and out of the conversion but about honest communication in dealing with clients who were not versed in technicalities of the subject and that's why I attacked you because I falsely assumed your character when you categorically excluded the opportunity cost.

I hope you can understand why I was being upset from reading my last reply. Again it wasn't in regards to the technicalities of the subject but to the character involved in communicating the matter to the clients.

I use a bare bone language using poker chips as visual aid when I present ideas to clients and make sure they see what happens to the 28K of "tax savings". I have found some to use "selective truth" whereby misleading the clients to come to their intended conclusion. I assumed that's what you did, and if that's not the case please accept my "sincere" apology.

 

[Charpress]

Let me jump into this fray.

In my humble opinion Roth conversions are advisable for most families once a few assumptions are satisfied. What are the ages of the parties? Are the taxes being paid from outside the IRA? What does the IRA owner plan to do with the assets and what is the owner doing with RMDs -or what will he/she be doing with RMDs down the road? Are they taking distributions now? Does the IRA owner give a flip about their kids and how a Roth will impact what they inherit?

Not everyone really cares about how the family does in the long run. That's fine, nobody is making them convert. If that is the attitude and if the person is much over 60, then a Roth is probably not good.

The software I use calculates lost income on taxes AND lost opportunity on reinvesting RMDs throughout life expectancy. Still, the family dynamic, in my view, is more important than the bean counting. If you are going to take a CPA approach, then just assume this: 60 years old = Roth good; 70 years old = Roth tossup; 80 years old = Roth bad. I'm being somewhat facetious here, but you get the idea.

I can actually take any Roth scenario and show a person in reasonably good health how they can beat a Roth conversion simply using life insurance. Tax free is tax free, after all -but I digress.

It may be unfortunate that a lot of advisers are reading a chapter in a Slott book and advising people the wrong way. The Slott God is actually coming to my home town next week to put on his dog and pony show sponsored by a local adviser. Of course, never in a million years will they be advising people to convert for inappropriate, non suitable, or self-serving reasons. No, never happen.

 

[Death Cab For Tootie]

Without using your financial calculator, if Joe's current tax bracket is 28% and will remain the same after he retires, about how much will he be able to save in taxes by converting to ROTH now?

There's too much subtle BS going on with these conversion webinars ...

The answer is ZERO.

 

[insuranceexec]

Just another way for agents to hammer the square peg in the circle hole.