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

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

Post by cas »

wrongfunds wrote: Thu Sep 30, 2021 9:31 am Is Massachusetts "community property"? Also does it matter if we are talking about married couple?
If you type something like "step up joint child" into the search box at the top of this page, quite a few threads where this topic is discussed will pop up. The estates and trusts lawyer types have replied in those threads, so you will probably find them more useful than trying to explore this topic in this thread.
smitcat
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by smitcat »

wrongfunds wrote: Thu Sep 30, 2021 9:31 am
RetiredAL wrote: Thu Sep 30, 2021 9:26 am
wrongfunds wrote: Thu Sep 30, 2021 8:38 am How does step-up work on a joint/wros/tod type of accounts or home titled in both the names? I thought step up only comes in to picture when both owners pass away.
Wrongfunds -- It depends on if the state is "community property" or not.

Calif is a community property state, so there is full step-up on the passing of one. (simple explanation)

No direct experience, but as I understand it, in a non-community property state, a "joint titled asset" is stepped up 50% on the passing of one.
Is Massachusetts "community property"? Also does it matter if we are talking about married couple?

No, its not, there are only 8 (9 if you count Alaska)
https://www.investopedia.com/personal-f ... ty-states/
mfFrom35k
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by mfFrom35k »

wrongfunds wrote: Thu Sep 30, 2021 9:31 am
RetiredAL wrote: Thu Sep 30, 2021 9:26 am
wrongfunds wrote: Thu Sep 30, 2021 8:38 am How does step-up work on a joint/wros/tod type of accounts or home titled in both the names? I thought step up only comes in to picture when both owners pass away.
Wrongfunds -- It depends on if the state is "community property" or not.

Calif is a community property state, so there is full step-up on the passing of one. (simple explanation)

No direct experience, but as I understand it, in a non-community property state, a "joint titled asset" is stepped up 50% on the passing of one.
Is Massachusetts "community property"? Also does it matter if we are talking about married couple?
Massachusetts is NOT a community property state. There are nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
Topic Author
McQ
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Location: California

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

Post by McQ »

marcopolo wrote: Wed Sep 29, 2021 10:53 pm
RetiredAL wrote: Wed Sep 29, 2021 10:24 pm
... concerned about both the Single Tax Bracket impacts AND IRMAA up-charges.

When my Mom passed in Feb 2013, the income loss was relatively minor, but the next year Dad got a largely increased tax bill as he was thrust much higher, percent of his income-wise, into the 24% tax bracket. And the year after that, by IRMAA.

This has driven me to model how DW or I, as the last person standing, will be taxed in the aggregate. Unfortunately, there is no simple cut-n-dried solution to the question of convert or not, or convert how much.

I take comfort in understanding that even if I pick a poorer conversion path for converting part of my differed I plan on converting, the result is likely to be no worse than not having converted.
This is only true if the portfolio continues to grow.
Not to take this thread off-topic, but this analysis is mostly for wealthy people, or those with large protected income, who will not need their portfolio to live on, and are mostly concerned about maximizing after tax inheritance to heirs.

If one has to live off their portfolio, and the goal is to ensure they have sufficient funds to support their spending needs, they should at least consider the assymetric nature of the risks of converting vs. not converting.

Not converting carries the risk that if the portfolio does well, one ends up paying some additional taxes, and have less money to spend, but they probably don't need the extra money to support their spending because markets have done so well.

Converting carries the risk that the person has less money to support their spending when markets perform poorly, just when they need the extra money the most, simply to support their spending.

One needs to decide which risk is most important to them to mitigate.

On a forum where people are always worried about poor future market performance (See all the "2% SWR is too risky", or "Valuations and low bond yields doom future return" type threads), I am surprised there is so little consideration about how such concerns might inform the decision to convert or not.
Marcopolo, you make a couple of points in this post that I’d like to ratify or qualify, because all of them advance the discussion.

1. “thread mostly for wealthy people … who will not need their portfolio to live on”
No to the first part, yes to the second part. That’s why it was so important to restrict the goal space of the conversion upfront: to having greater after-tax wealth in the more or less distant future. You can’t be spending the Roth dollars or TDA dollars all along, if the goal is to accumulate wealth later.

But you don’t have to be wealthy to expect or project surplus funds in retirement that might be managed to that goal of greater wealth. Any prosperous wage earner or investor, whose tastes were set at middle class levels years ago, might be on track to have a comfortable surplus in retirement, and thus able to pursue a goal of wealth increase via Roth conversion. I’ve heard that over and over from BH who revealed enough about their personal situation to confirm they are not wealthy.

2. Asymmetric risks of conversion
On the other hand, if this were some other thread, or a future chapter of this thread, where the focus was whether gaining Roth funds through conversion would enhance spending power year by year, relative to not converting, then I think your point about asymmetric risks is spot on.

3. Worries about market performance
Keep in mind that “off-camera” as it were, there is either a large TDA, a significant pension, and/or high levels of social security. That’s the only way to get the marginal RMDs taxed at 22% or 24%. So the market performance of the converted amounts and their counterfactual could be quite poor without affecting lifestyle. And as agreed above, these were surplus funds in any case.

The whole calculus changes when Roth funds are expected to be spent year by year, and I thank you for getting that point up on the board.
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.
jhawktx
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by jhawktx »

Many people have no problem using their RMDs for living expenses. I think at some point after making enough Roth conversions, most people would be using all their RMDs for living expenses. This seems like a mostly theoretical concept with little practical application. Waiting 100 years for a Roth conversion to pay off?
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FiveK
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FiveK »

jhawktx wrote: Thu Sep 30, 2021 6:36 pm Many people have no problem using their RMDs for living expenses. I think at some point after making enough Roth conversions, most people would be using all their RMDs for living expenses. This seems like a mostly theoretical concept with little practical application. Waiting 100 years for a Roth conversion to pay off?
Yes, if one has to wait 100 years then there is no point.

But what about 10 years?
Walkure
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by Walkure »

dodecahedron wrote: Wed Sep 29, 2021 5:28 pm
McQ wrote: Wed Sep 29, 2021 5:20 pm
LadyGeek wrote: Tue Sep 28, 2021 4:27 pm
McQ wrote: Tue Sep 28, 2021 4:08 pm My guess at your realization: Roth conversions always pay out, iff one of you lives long enough.
I assume "iff" is the academic shorthand for "If and only if", i.e. "if and only if one of you lives long enough."
Yes; but I had assumed it was an abbreviation in widespread use
Widely used in theoretical math and related academic disciplines (logic, etc.) Not really used much outside academia.
I knew it from the proofs in my 7th grade geometry textbook. Back when I was just an honorary junior BH and all my money was in STAR because of the low minimum... :wink:
FlamePoint
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FlamePoint »

McQ wrote: Thu Sep 30, 2021 5:57 pm
marcopolo wrote: Wed Sep 29, 2021 10:53 pm
RetiredAL wrote: Wed Sep 29, 2021 10:24 pm
... concerned about both the Single Tax Bracket impacts AND IRMAA up-charges.

When my Mom passed in Feb 2013, the income loss was relatively minor, but the next year Dad got a largely increased tax bill as he was thrust much higher, percent of his income-wise, into the 24% tax bracket. And the year after that, by IRMAA.

This has driven me to model how DW or I, as the last person standing, will be taxed in the aggregate. Unfortunately, there is no simple cut-n-dried solution to the question of convert or not, or convert how much.

I take comfort in understanding that even if I pick a poorer conversion path for converting part of my differed I plan on converting, the result is likely to be no worse than not having converted.
This is only true if the portfolio continues to grow.
Not to take this thread off-topic, but this analysis is mostly for wealthy people, or those with large protected income, who will not need their portfolio to live on, and are mostly concerned about maximizing after tax inheritance to heirs.

If one has to live off their portfolio, and the goal is to ensure they have sufficient funds to support their spending needs, they should at least consider the assymetric nature of the risks of converting vs. not converting.

Not converting carries the risk that if the portfolio does well, one ends up paying some additional taxes, and have less money to spend, but they probably don't need the extra money to support their spending because markets have done so well.

Converting carries the risk that the person has less money to support their spending when markets perform poorly, just when they need the extra money the most, simply to support their spending.

One needs to decide which risk is most important to them to mitigate.

On a forum where people are always worried about poor future market performance (See all the "2% SWR is too risky", or "Valuations and low bond yields doom future return" type threads), I am surprised there is so little consideration about how such concerns might inform the decision to convert or not.
Marcopolo, you make a couple of points in this post that I’d like to ratify or qualify, because all of them advance the discussion.

1. “thread mostly for wealthy people … who will not need their portfolio to live on”
No to the first part, yes to the second part. That’s why it was so important to restrict the goal space of the conversion upfront: to having greater after-tax wealth in the more or less distant future. You can’t be spending the Roth dollars or TDA dollars all along, if the goal is to accumulate wealth later.

But you don’t have to be wealthy to expect or project surplus funds in retirement that might be managed to that goal of greater wealth. Any prosperous wage earner or investor, whose tastes were set at middle class levels years ago, might be on track to have a comfortable surplus in retirement, and thus able to pursue a goal of wealth increase via Roth conversion. I’ve heard that over and over from BH who revealed enough about their personal situation to confirm they are not wealthy.

2. Asymmetric risks of conversion
On the other hand, if this were some other thread, or a future chapter of this thread, where the focus was whether gaining Roth funds through conversion would enhance spending power year by year, relative to not converting, then I think your point about asymmetric risks is spot on.

3. Worries about market performance
Keep in mind that “off-camera” as it were, there is either a large TDA, a significant pension, and/or high levels of social security. That’s the only way to get the marginal RMDs taxed at 22% or 24%. So the market performance of the converted amounts and their counterfactual could be quite poor without affecting lifestyle. And as agreed above, these were surplus funds in any case.

The whole calculus changes when Roth funds are expected to be spent year by year, and I thank you for getting that point up on the board.
I think we might fit some of what’s being discussed here. We have a $4M tax deferred account and $400k in taxable. Living expenses are $125k per year, including taxes. We anticipate a $20K annuity at age 65 and $86k (todays $’s) in SS at age 70. Without doing conversions, it appears our combined annuity, SS, and RMD’s will eventually push us into a tax bracket higher than the one we were in during our working years. Anything converted to Roth will be used as legacy funds for our heirs (who are currently working on STEM degrees with high earning potential).

We’re 59 so plan is to do Roth conversions through age 62. I’m following this thread closely because I’m still trying to determine the optimal amount/tax bracket to convert at.
smitcat
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by smitcat »

McQ wrote: Thu Sep 30, 2021 5:57 pm
marcopolo wrote: Wed Sep 29, 2021 10:53 pm
RetiredAL wrote: Wed Sep 29, 2021 10:24 pm
... concerned about both the Single Tax Bracket impacts AND IRMAA up-charges.

When my Mom passed in Feb 2013, the income loss was relatively minor, but the next year Dad got a largely increased tax bill as he was thrust much higher, percent of his income-wise, into the 24% tax bracket. And the year after that, by IRMAA.

This has driven me to model how DW or I, as the last person standing, will be taxed in the aggregate. Unfortunately, there is no simple cut-n-dried solution to the question of convert or not, or convert how much.

I take comfort in understanding that even if I pick a poorer conversion path for converting part of my differed I plan on converting, the result is likely to be no worse than not having converted.
This is only true if the portfolio continues to grow.
Not to take this thread off-topic, but this analysis is mostly for wealthy people, or those with large protected income, who will not need their portfolio to live on, and are mostly concerned about maximizing after tax inheritance to heirs.

If one has to live off their portfolio, and the goal is to ensure they have sufficient funds to support their spending needs, they should at least consider the assymetric nature of the risks of converting vs. not converting.

Not converting carries the risk that if the portfolio does well, one ends up paying some additional taxes, and have less money to spend, but they probably don't need the extra money to support their spending because markets have done so well.

Converting carries the risk that the person has less money to support their spending when markets perform poorly, just when they need the extra money the most, simply to support their spending.

One needs to decide which risk is most important to them to mitigate.

On a forum where people are always worried about poor future market performance (See all the "2% SWR is too risky", or "Valuations and low bond yields doom future return" type threads), I am surprised there is so little consideration about how such concerns might inform the decision to convert or not.
Marcopolo, you make a couple of points in this post that I’d like to ratify or qualify, because all of them advance the discussion.

1. “thread mostly for wealthy people … who will not need their portfolio to live on”
No to the first part, yes to the second part. That’s why it was so important to restrict the goal space of the conversion upfront: to having greater after-tax wealth in the more or less distant future. You can’t be spending the Roth dollars or TDA dollars all along, if the goal is to accumulate wealth later.

But you don’t have to be wealthy to expect or project surplus funds in retirement that might be managed to that goal of greater wealth. Any prosperous wage earner or investor, whose tastes were set at middle class levels years ago, might be on track to have a comfortable surplus in retirement, and thus able to pursue a goal of wealth increase via Roth conversion. I’ve heard that over and over from BH who revealed enough about their personal situation to confirm they are not wealthy.

2. Asymmetric risks of conversion
On the other hand, if this were some other thread, or a future chapter of this thread, where the focus was whether gaining Roth funds through conversion would enhance spending power year by year, relative to not converting, then I think your point about asymmetric risks is spot on.

3. Worries about market performance
Keep in mind that “off-camera” as it were, there is either a large TDA, a significant pension, and/or high levels of social security. That’s the only way to get the marginal RMDs taxed at 22% or 24%. So the market performance of the converted amounts and their counterfactual could be quite poor without affecting lifestyle. And as agreed above, these were surplus funds in any case.

The whole calculus changes when Roth funds are expected to be spent year by year, and I thank you for getting that point up on the board.
"1. “thread mostly for wealthy people … who will not need their portfolio to live on”
No to the first part, yes to the second part. That’s why it was so important to restrict the goal space of the conversion upfront: to having greater after-tax wealth in the more or less distant future. You can’t be spending the Roth dollars or TDA dollars all along, if the goal is to accumulate wealth later."
Yes - agreed 100%.

"2.Asymmetric risks of conversion"
The assymetric risk of those who will choose to draw at say 4% will be loaded to the upside as you see from any historical testing. In more cases the folks drawing at that 4% will end up with more than they started with. As you go to lower and lower draw rates say from 4% to 1% the assymetric risk of higher Roth conversions always favor the roth conversion with one caveat - you also must consider the heirs tax situation and/or the end purpose of those funds.

"3.Worries about market performance
Keep in mind that “off-camera” as it were, there is either a large TDA, a significant pension, and/or high levels of social security. That’s the only way to get the marginal RMDs taxed at 22% or 24%."
Off camera could include a larger TDA, significant pension(s), higher SS and also high taxable accounts. When identifying folks with these 'problems' I have found there are more pensions and higher taxable accounts out there then most would imagine - the larger TDA's and SS are mostly expected in this sample set.
marcopolo
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

smitcat wrote: Thu Sep 30, 2021 8:05 pm
McQ wrote: Thu Sep 30, 2021 5:57 pm
marcopolo wrote: Wed Sep 29, 2021 10:53 pm
RetiredAL wrote: Wed Sep 29, 2021 10:24 pm
... concerned about both the Single Tax Bracket impacts AND IRMAA up-charges.

When my Mom passed in Feb 2013, the income loss was relatively minor, but the next year Dad got a largely increased tax bill as he was thrust much higher, percent of his income-wise, into the 24% tax bracket. And the year after that, by IRMAA.

This has driven me to model how DW or I, as the last person standing, will be taxed in the aggregate. Unfortunately, there is no simple cut-n-dried solution to the question of convert or not, or convert how much.

I take comfort in understanding that even if I pick a poorer conversion path for converting part of my differed I plan on converting, the result is likely to be no worse than not having converted.
This is only true if the portfolio continues to grow.
Not to take this thread off-topic, but this analysis is mostly for wealthy people, or those with large protected income, who will not need their portfolio to live on, and are mostly concerned about maximizing after tax inheritance to heirs.

If one has to live off their portfolio, and the goal is to ensure they have sufficient funds to support their spending needs, they should at least consider the assymetric nature of the risks of converting vs. not converting.

Not converting carries the risk that if the portfolio does well, one ends up paying some additional taxes, and have less money to spend, but they probably don't need the extra money to support their spending because markets have done so well.

Converting carries the risk that the person has less money to support their spending when markets perform poorly, just when they need the extra money the most, simply to support their spending.

One needs to decide which risk is most important to them to mitigate.

On a forum where people are always worried about poor future market performance (See all the "2% SWR is too risky", or "Valuations and low bond yields doom future return" type threads), I am surprised there is so little consideration about how such concerns might inform the decision to convert or not.
Marcopolo, you make a couple of points in this post that I’d like to ratify or qualify, because all of them advance the discussion.

1. “thread mostly for wealthy people … who will not need their portfolio to live on”
No to the first part, yes to the second part. That’s why it was so important to restrict the goal space of the conversion upfront: to having greater after-tax wealth in the more or less distant future. You can’t be spending the Roth dollars or TDA dollars all along, if the goal is to accumulate wealth later.

But you don’t have to be wealthy to expect or project surplus funds in retirement that might be managed to that goal of greater wealth. Any prosperous wage earner or investor, whose tastes were set at middle class levels years ago, might be on track to have a comfortable surplus in retirement, and thus able to pursue a goal of wealth increase via Roth conversion. I’ve heard that over and over from BH who revealed enough about their personal situation to confirm they are not wealthy.

2. Asymmetric risks of conversion
On the other hand, if this were some other thread, or a future chapter of this thread, where the focus was whether gaining Roth funds through conversion would enhance spending power year by year, relative to not converting, then I think your point about asymmetric risks is spot on.

3. Worries about market performance
Keep in mind that “off-camera” as it were, there is either a large TDA, a significant pension, and/or high levels of social security. That’s the only way to get the marginal RMDs taxed at 22% or 24%. So the market performance of the converted amounts and their counterfactual could be quite poor without affecting lifestyle. And as agreed above, these were surplus funds in any case.

The whole calculus changes when Roth funds are expected to be spent year by year, and I thank you for getting that point up on the board.
"1. “thread mostly for wealthy people … who will not need their portfolio to live on”
No to the first part, yes to the second part. That’s why it was so important to restrict the goal space of the conversion upfront: to having greater after-tax wealth in the more or less distant future. You can’t be spending the Roth dollars or TDA dollars all along, if the goal is to accumulate wealth later."
Yes - agreed 100%.

"2.Asymmetric risks of conversion"
The assymetric risk of those who will choose to draw at say 4% will be loaded to the upside as you see from any historical testing. In more cases the folks drawing at that 4% will end up with more than they started with. As you go to lower and lower draw rates say from 4% to 1% the assymetric risk of higher Roth conversions always favor the roth conversion with one caveat - you also must consider the heirs tax situation and/or the end purpose of those funds.

"3.Worries about market performance
Keep in mind that “off-camera” as it were, there is either a large TDA, a significant pension, and/or high levels of social security. That’s the only way to get the marginal RMDs taxed at 22% or 24%."
Off camera could include a larger TDA, significant pension(s), higher SS and also high taxable accounts. When identifying folks with these 'problems' I have found there are more pensions and higher taxable accounts out there then most would imagine - the larger TDA's and SS are mostly expected in this sample set.
Both of your responses to (1) and (2)/(3) seem at odds with each other.

If you have all these massive off-camera assets, it is hard to see how that does not translate to this being an issue for wealthy people.

There is nothing wrong with developing this framework for such individuals. But to claim that the target subject is not wealthy seems out of touch with the vast majority of people, even on this forum.
Once in a while you get shown the light, in the strangest of places if you look at it right.
wrongfunds
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by wrongfunds »

Come on marco, we all know instinctively that wealthy people have at least double the assets than we have if not more!
RetiredAL
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by RetiredAL »

Wealth is relative. To the street people around town, I'm fabulously wealthy. However, I do not feel I'm wealthy, but I think I have ample. I am certainly not wealthy by BH standards.

I find this "if long enough" concept as very relative to me. Even though I am only 71, functionally my conversions started 22 years ago. You see, I made the decision to max fund our Roth's over max funding our differed (my 401K, her IRA) and its effect has been similar (the same?) to that of classic conversions, which I have done modestly since I retired in 2016. Today we sit at $500K in our Roth's, only $100K of which has been added via classic conversions since retirement. Most of those contributions went in at 15%. If those Roth contributions had gone into differed instead, we'd be staring at being somewhat into the current 22% bracket when my RMD's (DW has no differed) starts next year. My fear has been around when it comes to that time for the last person standing tax rate to happen, that person will see a greatly larger tax bill on a only modestly lower total income. The reduction in income will only be the loss of the spousal side of the SS. This fear is what has driven to convert the last several years

In all likelihood, we will not need any of our Roth $ already set aside. Our IPS says the Roth $ is to the last to speed. When RMD's start, I have been planning on somewhere around 1/2 of that RMD $ will just go into taxable investments. With all of this analysis/dialog in this thread, I need to re-look at that plan. For sure, if the RMD, at today's basis, increases greatly due to continuing fabulous returns, I will need to convert more just to hold an even keel.

To be honest, none of these Roth longevity advantages discussed here was planned in the beginning 22 years ago. I just stumbled into it. My after retirement conversion modeling did touch on some of this, but nowhere to the detail that the Prof and others have achieved with their much more refined models.
marcopolo
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

RetiredAL wrote: Thu Sep 30, 2021 10:27 pm Wealth is relative. To the street people around town, I'm fabulously wealthy. However, I do not feel I'm wealthy, but I think I have ample. I am certainly not wealthy by BH standards.
We have a net worth of about $7M, yet we do not meet several of the criteria of the scenario being modeled, so the people to whom this would apply likely have significantly larger net worth. I know it is relative, but I am not sure in what realm a net worth approaching 8 figures is not considered wealthy.
Once in a while you get shown the light, in the strangest of places if you look at it right.
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FiveK
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FiveK »

marcopolo wrote: Fri Oct 01, 2021 12:53 am We have a net worth of about $7M, yet we do not meet several of the criteria of the scenario being modeled....
Other than "invest the RMD and don't withdraw converted funds from the Roth account" what criteria apply?
marcopolo
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

FiveK wrote: Fri Oct 01, 2021 1:31 am
marcopolo wrote: Fri Oct 01, 2021 12:53 am We have a net worth of about $7M, yet we do not meet several of the criteria of the scenario being modeled....
Other than "invest the RMD and don't withdraw converted funds from the Roth account" what criteria apply?
Well, quoting directly from Prof McQ post title Part II (describing the scenario he will be exploring):
McQ wrote: Wed Sep 29, 2021 6:00 pm For discussion purposes, I’ll take the middle time frame of 15 years and the 22%/24% boundary. For you to have a lock on the juicy Roth conversion outcomes discussed above, you would need an AGI, in 2036, RMDs included, of $313,000.
McQ wrote: Wed Sep 29, 2021 6:00 pm That indicates a TDA balance at age 72 of just over $7.2 million dollars.
McQ wrote: Wed Sep 29, 2021 6:00 pm They had pension income twice their social security income, an extra $100,000 in 2036. Which means they only have to project $4.5 million in their TDAs
We don't anticipate having $313k of taxable income in 15 years
We don't anticipate having $7.2M in a TDA
We don't have a $100k pension (more like 5k), nor likely to have a TDA of $4.5M

We have a little over $1.5M in our TDA, we keep only fixed income assets in the TDA, which will likely not do much more than keep up with inflation.
I suspect that is not that unusual for people in our ball park of net worth.
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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Joined: Mon Nov 07, 2016 9:51 am

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

Post by smitcat »

marcopolo wrote: Thu Sep 30, 2021 8:47 pm
smitcat wrote: Thu Sep 30, 2021 8:05 pm
McQ wrote: Thu Sep 30, 2021 5:57 pm
marcopolo wrote: Wed Sep 29, 2021 10:53 pm
RetiredAL wrote: Wed Sep 29, 2021 10:24 pm
... concerned about both the Single Tax Bracket impacts AND IRMAA up-charges.

When my Mom passed in Feb 2013, the income loss was relatively minor, but the next year Dad got a largely increased tax bill as he was thrust much higher, percent of his income-wise, into the 24% tax bracket. And the year after that, by IRMAA.

This has driven me to model how DW or I, as the last person standing, will be taxed in the aggregate. Unfortunately, there is no simple cut-n-dried solution to the question of convert or not, or convert how much.

I take comfort in understanding that even if I pick a poorer conversion path for converting part of my differed I plan on converting, the result is likely to be no worse than not having converted.
This is only true if the portfolio continues to grow.
Not to take this thread off-topic, but this analysis is mostly for wealthy people, or those with large protected income, who will not need their portfolio to live on, and are mostly concerned about maximizing after tax inheritance to heirs.

If one has to live off their portfolio, and the goal is to ensure they have sufficient funds to support their spending needs, they should at least consider the assymetric nature of the risks of converting vs. not converting.

Not converting carries the risk that if the portfolio does well, one ends up paying some additional taxes, and have less money to spend, but they probably don't need the extra money to support their spending because markets have done so well.

Converting carries the risk that the person has less money to support their spending when markets perform poorly, just when they need the extra money the most, simply to support their spending.

One needs to decide which risk is most important to them to mitigate.

On a forum where people are always worried about poor future market performance (See all the "2% SWR is too risky", or "Valuations and low bond yields doom future return" type threads), I am surprised there is so little consideration about how such concerns might inform the decision to convert or not.
Marcopolo, you make a couple of points in this post that I’d like to ratify or qualify, because all of them advance the discussion.

1. “thread mostly for wealthy people … who will not need their portfolio to live on”
No to the first part, yes to the second part. That’s why it was so important to restrict the goal space of the conversion upfront: to having greater after-tax wealth in the more or less distant future. You can’t be spending the Roth dollars or TDA dollars all along, if the goal is to accumulate wealth later.

But you don’t have to be wealthy to expect or project surplus funds in retirement that might be managed to that goal of greater wealth. Any prosperous wage earner or investor, whose tastes were set at middle class levels years ago, might be on track to have a comfortable surplus in retirement, and thus able to pursue a goal of wealth increase via Roth conversion. I’ve heard that over and over from BH who revealed enough about their personal situation to confirm they are not wealthy.

2. Asymmetric risks of conversion
On the other hand, if this were some other thread, or a future chapter of this thread, where the focus was whether gaining Roth funds through conversion would enhance spending power year by year, relative to not converting, then I think your point about asymmetric risks is spot on.

3. Worries about market performance
Keep in mind that “off-camera” as it were, there is either a large TDA, a significant pension, and/or high levels of social security. That’s the only way to get the marginal RMDs taxed at 22% or 24%. So the market performance of the converted amounts and their counterfactual could be quite poor without affecting lifestyle. And as agreed above, these were surplus funds in any case.

The whole calculus changes when Roth funds are expected to be spent year by year, and I thank you for getting that point up on the board.
"1. “thread mostly for wealthy people … who will not need their portfolio to live on”
No to the first part, yes to the second part. That’s why it was so important to restrict the goal space of the conversion upfront: to having greater after-tax wealth in the more or less distant future. You can’t be spending the Roth dollars or TDA dollars all along, if the goal is to accumulate wealth later."
Yes - agreed 100%.

"2.Asymmetric risks of conversion"
The assymetric risk of those who will choose to draw at say 4% will be loaded to the upside as you see from any historical testing. In more cases the folks drawing at that 4% will end up with more than they started with. As you go to lower and lower draw rates say from 4% to 1% the assymetric risk of higher Roth conversions always favor the roth conversion with one caveat - you also must consider the heirs tax situation and/or the end purpose of those funds.

"3.Worries about market performance
Keep in mind that “off-camera” as it were, there is either a large TDA, a significant pension, and/or high levels of social security. That’s the only way to get the marginal RMDs taxed at 22% or 24%."
Off camera could include a larger TDA, significant pension(s), higher SS and also high taxable accounts. When identifying folks with these 'problems' I have found there are more pensions and higher taxable accounts out there then most would imagine - the larger TDA's and SS are mostly expected in this sample set.
Both of your responses to (1) and (2)/(3) seem at odds with each other.

If you have all these massive off-camera assets, it is hard to see how that does not translate to this being an issue for wealthy people.

There is nothing wrong with developing this framework for such individuals. But to claim that the target subject is not wealthy seems out of touch with the vast majority of people, even on this forum.
If one has reasonable assetts (not massive) but spends at a much lower rate then the earnings then it will likely apply.
smitcat
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by smitcat »

marcopolo wrote: Fri Oct 01, 2021 12:53 am
RetiredAL wrote: Thu Sep 30, 2021 10:27 pm Wealth is relative. To the street people around town, I'm fabulously wealthy. However, I do not feel I'm wealthy, but I think I have ample. I am certainly not wealthy by BH standards.
We have a net worth of about $7M, yet we do not meet several of the criteria of the scenario being modeled, so the people to whom this would apply likely have significantly larger net worth. I know it is relative, but I am not sure in what realm a net worth approaching 8 figures is not considered wealthy.
Not at all really - with your examples these could be the numbers
"We have a net worth of about $7M
We don't anticipate having $313k of taxable income in 15 years
We don't anticipate having $7.2M in a TDA
We don't have a $100k pension (more like 5k), nor likely to have a TDA of $4.5M
We have a little over $1.5M in our TDA,"

You could have a home value of $500K and that would leave $6.5 million of investable assets with 1.5 million currently in a TDA.
You could have one or more pensions at $50-$60K per year which could cover most or all of your desired expenses even before SS began.
Very likely all acocunts will grow over time, very likely after tax accounts are throwing off $100K - $125K already.
In 15 years the combination of after tax accounts, one pension, SS and TDA will be over your target
sc9182
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by sc9182 »

smitcat wrote: Fri Oct 01, 2021 7:33 am
marcopolo wrote: Thu Sep 30, 2021 8:47 pm
smitcat wrote: Thu Sep 30, 2021 8:05 pm
McQ wrote: Thu Sep 30, 2021 5:57 pm
marcopolo wrote: Wed Sep 29, 2021 10:53 pm

This is only true if the portfolio continues to grow.
Not to take this thread off-topic, but this analysis is mostly for wealthy people, or those with large protected income, who will not need their portfolio to live on, and are mostly concerned about maximizing after tax inheritance to heirs.

If one has to live off their portfolio, and the goal is to ensure they have sufficient funds to support their spending needs, they should at least consider the assymetric nature of the risks of converting vs. not converting.

Not converting carries the risk that if the portfolio does well, one ends up paying some additional taxes, and have less money to spend, but they probably don't need the extra money to support their spending because markets have done so well.

Converting carries the risk that the person has less money to support their spending when markets perform poorly, just when they need the extra money the most, simply to support their spending.

One needs to decide which risk is most important to them to mitigate.

On a forum where people are always worried about poor future market performance (See all the "2% SWR is too risky", or "Valuations and low bond yields doom future return" type threads), I am surprised there is so little consideration about how such concerns might inform the decision to convert or not.
Marcopolo, you make a couple of points in this post that I’d like to ratify or qualify, because all of them advance the discussion.

1. “thread mostly for wealthy people … who will not need their portfolio to live on”
No to the first part, yes to the second part. That’s why it was so important to restrict the goal space of the conversion upfront: to having greater after-tax wealth in the more or less distant future. You can’t be spending the Roth dollars or TDA dollars all along, if the goal is to accumulate wealth later.

But you don’t have to be wealthy to expect or project surplus funds in retirement that might be managed to that goal of greater wealth. Any prosperous wage earner or investor, whose tastes were set at middle class levels years ago, might be on track to have a comfortable surplus in retirement, and thus able to pursue a goal of wealth increase via Roth conversion. I’ve heard that over and over from BH who revealed enough about their personal situation to confirm they are not wealthy.

2. Asymmetric risks of conversion
On the other hand, if this were some other thread, or a future chapter of this thread, where the focus was whether gaining Roth funds through conversion would enhance spending power year by year, relative to not converting, then I think your point about asymmetric risks is spot on.

3. Worries about market performance
Keep in mind that “off-camera” as it were, there is either a large TDA, a significant pension, and/or high levels of social security. That’s the only way to get the marginal RMDs taxed at 22% or 24%. So the market performance of the converted amounts and their counterfactual could be quite poor without affecting lifestyle. And as agreed above, these were surplus funds in any case.

The whole calculus changes when Roth funds are expected to be spent year by year, and I thank you for getting that point up on the board.
"1. “thread mostly for wealthy people … who will not need their portfolio to live on”
No to the first part, yes to the second part. That’s why it was so important to restrict the goal space of the conversion upfront: to having greater after-tax wealth in the more or less distant future. You can’t be spending the Roth dollars or TDA dollars all along, if the goal is to accumulate wealth later."
Yes - agreed 100%.

"2.Asymmetric risks of conversion"
The assymetric risk of those who will choose to draw at say 4% will be loaded to the upside as you see from any historical testing. In more cases the folks drawing at that 4% will end up with more than they started with. As you go to lower and lower draw rates say from 4% to 1% the assymetric risk of higher Roth conversions always favor the roth conversion with one caveat - you also must consider the heirs tax situation and/or the end purpose of those funds.

"3.Worries about market performance
Keep in mind that “off-camera” as it were, there is either a large TDA, a significant pension, and/or high levels of social security. That’s the only way to get the marginal RMDs taxed at 22% or 24%."
Off camera could include a larger TDA, significant pension(s), higher SS and also high taxable accounts. When identifying folks with these 'problems' I have found there are more pensions and higher taxable accounts out there then most would imagine - the larger TDA's and SS are mostly expected in this sample set.
Both of your responses to (1) and (2)/(3) seem at odds with each other.

If you have all these massive off-camera assets, it is hard to see how that does not translate to this being an issue for wealthy people.

There is nothing wrong with developing this framework for such individuals. But to claim that the target subject is not wealthy seems out of touch with the vast majority of people, even on this forum.
If one has reasonable assetts (not massive) but spends at a much lower rate then the earnings then it will likely apply.
Why one want to live significantly below their means while trying to enrich heirs (who are already at their peak tax-rates) - it’s volition — most-likely not forced upon them .. we hope..

Believe - the not-so-subtle difference between aggressive Roth-converts and others could also be due to: double top-deck pensions, double delayed/maxed SSes, possible residual business/interest/rental income, Brokerage dividends, and/or Annuities ; add possibility of inheritance, stepped-up LTCG assets, and/or inherited IRA on-top., and likely these set of folks most likely have near zero debt (fully paid-off house, cars, kids definitely out of colleges and well-settled etc). BTW- its a good problem to have.

In such situations - obviously, TDA/IRA monies are hardly never needed toward their living expenses .. hence they plan too hard to maximize Roth conversions.

For new/younger set of folks - where Phat Pension estimates have either cut to the bare-bones, or non-existent (esp. Private Sector)., you do need monies from Brokerage and/or TDA accounts to make comfortable living post-retirement. So - for this set of folks — aggressive Roth-conversions May not prove to be as fruitful (as these set of folks can not guarantee their Roth-converted monies be left untouched —the required post-conversions long-runway may be not guaranteed — hence, the Roth-conversion tax-savings may prove to be elusive). Most importantly, this set of folks need those TDA/brokerage monies to live-on., not fully earmarked for Heirs .. hence, this set of folks do/consider Roth-conversions with balanced eye.
smitcat
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by smitcat »

sc9182 wrote: Fri Oct 01, 2021 7:53 am
smitcat wrote: Fri Oct 01, 2021 7:33 am
marcopolo wrote: Thu Sep 30, 2021 8:47 pm
smitcat wrote: Thu Sep 30, 2021 8:05 pm
McQ wrote: Thu Sep 30, 2021 5:57 pm

Marcopolo, you make a couple of points in this post that I’d like to ratify or qualify, because all of them advance the discussion.

1. “thread mostly for wealthy people … who will not need their portfolio to live on”
No to the first part, yes to the second part. That’s why it was so important to restrict the goal space of the conversion upfront: to having greater after-tax wealth in the more or less distant future. You can’t be spending the Roth dollars or TDA dollars all along, if the goal is to accumulate wealth later.

But you don’t have to be wealthy to expect or project surplus funds in retirement that might be managed to that goal of greater wealth. Any prosperous wage earner or investor, whose tastes were set at middle class levels years ago, might be on track to have a comfortable surplus in retirement, and thus able to pursue a goal of wealth increase via Roth conversion. I’ve heard that over and over from BH who revealed enough about their personal situation to confirm they are not wealthy.

2. Asymmetric risks of conversion
On the other hand, if this were some other thread, or a future chapter of this thread, where the focus was whether gaining Roth funds through conversion would enhance spending power year by year, relative to not converting, then I think your point about asymmetric risks is spot on.

3. Worries about market performance
Keep in mind that “off-camera” as it were, there is either a large TDA, a significant pension, and/or high levels of social security. That’s the only way to get the marginal RMDs taxed at 22% or 24%. So the market performance of the converted amounts and their counterfactual could be quite poor without affecting lifestyle. And as agreed above, these were surplus funds in any case.

The whole calculus changes when Roth funds are expected to be spent year by year, and I thank you for getting that point up on the board.
"1. “thread mostly for wealthy people … who will not need their portfolio to live on”
No to the first part, yes to the second part. That’s why it was so important to restrict the goal space of the conversion upfront: to having greater after-tax wealth in the more or less distant future. You can’t be spending the Roth dollars or TDA dollars all along, if the goal is to accumulate wealth later."
Yes - agreed 100%.

"2.Asymmetric risks of conversion"
The assymetric risk of those who will choose to draw at say 4% will be loaded to the upside as you see from any historical testing. In more cases the folks drawing at that 4% will end up with more than they started with. As you go to lower and lower draw rates say from 4% to 1% the assymetric risk of higher Roth conversions always favor the roth conversion with one caveat - you also must consider the heirs tax situation and/or the end purpose of those funds.

"3.Worries about market performance
Keep in mind that “off-camera” as it were, there is either a large TDA, a significant pension, and/or high levels of social security. That’s the only way to get the marginal RMDs taxed at 22% or 24%."
Off camera could include a larger TDA, significant pension(s), higher SS and also high taxable accounts. When identifying folks with these 'problems' I have found there are more pensions and higher taxable accounts out there then most would imagine - the larger TDA's and SS are mostly expected in this sample set.
Both of your responses to (1) and (2)/(3) seem at odds with each other.

If you have all these massive off-camera assets, it is hard to see how that does not translate to this being an issue for wealthy people.

There is nothing wrong with developing this framework for such individuals. But to claim that the target subject is not wealthy seems out of touch with the vast majority of people, even on this forum.
If one has reasonable assetts (not massive) but spends at a much lower rate then the earnings then it will likely apply.
Why one want to live significantly below their means while trying to enrich heirs (who are already at their peak tax-rates) - it’s volition — most-likely not forced upon them .. we hope..

Believe - the not-so-subtle difference between aggressive Roth-converts and others could also be due to: double top-deck pensions, double delayed/maxed SSes, possible residual business/interest/rental income, Brokerage dividends, and/or Annuities ; add possibility of inheritance, stepped-up LTCG assets, and/or inherited IRA on-top., and likely these set of folks most likely have near zero debt (fully paid-off house, cars, kids definitely out of colleges and well-settled etc). BTW- its a good problem to have.

In such situations - obviously, TDA/IRA monies are hardly never needed toward their living expenses .. hence they plan too hard to maximize Roth conversions.

For new/younger set of folks - where Phat Pension estimates have either cut to the bare-bones, or non-existent (esp. Private Sector)., you do need monies from Brokerage and/or TDA accounts to make comfortable living post-retirement. So - for this set of folks — aggressive Roth-conversions May not prove to be as fruitful (as these set of folks can not guarantee their Roth-converted monies be left untouched —the required post-conversions long-runway may be not guaranteed — hence, the Roth-conversion tax-savings may prove to be elusive). Most importantly, this set of folks need those TDA/brokerage monies to live-on., not fully earmarked for Heirs .. hence, this set of folks do/consider Roth-conversions with balanced eye.
I do not know what the category of "agressive roth convertsions" cover but we were talking about the 22% and 24% categories here.
There are many younger folks that are currently in very good pension plans as well as having access to 457, 403b and SS at the same time.
csmath
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by csmath »

This has been an interesting thread and I look forward to the continuation of it. I know there are a million “what-ifs” but I’d like to mention that some states don’t tax conversions resulting in no state tax in a state that does normally have an income tax. I’d imagine that would make a big difference for some people? Maybe the assumptions by the OP already exclude this scenario.
BigJohn
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by BigJohn »

I've been following this discussion with interest. Most of this thread revolves around what assumptions should be used. I don't mean to be a wet blanket but would like to make the following comments based on extensive spreadsheet work I did several years ago when I had to develop my conversion strategy having retired at age 58. Some comments on two of the most critical assumptions....

Future tax rate - Our tax code is quite convoluted with many breakpoints, phase-outs and cliffs that can have a significant impact on marginal tax rates for the next increment of conversion. This makes it a lot more complicated that just what tax bracket you're in. If you're married, you need to predict when the change from MFJ to single filing status happens since for most couples, income is not halved while the tax brackets are. Then you also need to predict what marginal tax rate your heirs will be paying within this convoluted system. This is even more difficult with multiple heirs and an even larger impact with loss of the stretch IRA. State tax rates for you and your heirs add more uncertainty. Also consider how volatile the estate tax threshold has been and whether this might impact the results if it went back to historic lows. Thinking about how the tax code changed over my adult working career, my confidence in any prediction I need to make 20-30 years from now is pretty low.

Portfolio rate of return - Just predicting the average return of stocks and bonds is problematic. Now add to that the impact that both the sequence of returns and the asset location can have. Once again, my confidence in any prediction I need to make over 20-30 is pretty low.

When I was working on my strategy, I did some sensitivity analysis on these and other key assumptions. My range of assumptions were not wild armageddon scenarios, just a range of outcomes I felt were all reasonable based on history. For example, a real rate of return of 2-6% on a 50/50 portfolio. I came to the conclusion that the accuracy I was looking for was totally swamped by the assumptions made. I didn't much like this answer but, try as I might, the conclusion was always the same. So, I had to embrace the uncertainty and begin my Roth conversions.

Ultimately I decide on a strategy that attempts to keep my current taxable income with conversions about flat with my expected taxable income once SS and RMD's start. I assume a middle of the road overall rate of return ignoring sequence and asset location. I use prior YE actual balances and TurboTax to model current year tax rates to ensure I don't end up just over some breakpoint in marginal rates. I ignore potential future tax law changes as well as the tax rate my heirs might pay. I know that a hindsight analysis will show that I either under or over converted but don't think I'm at high risk of being off either way by a large margin. It also leaves me with about a 50/50 split of tIRA/Roth (started at 100/0) which feels like a good position from a tax diversification point of view. This is certainly not be the right approach for all situations but it fits my needs well.

For those of you working on articles/spreadsheet, I applaud your efforts. Working through the messy details is the only way to help educate people on the implications for them.

For those of you working on your strategy, just keep in mind that there is no right answer. Get educated, make some reasonable assumptions for your situation, execute your plan, adjust when the world actually changes and then don't look back.

Best of luck to all :sharebeer
"The greatest enemy of a good plan is the dream of a perfect plan" - Carl Von Clausewitz
cas
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by cas »

marcopolo wrote: Fri Oct 01, 2021 2:21 am
FiveK wrote: Fri Oct 01, 2021 1:31 am
marcopolo wrote: Fri Oct 01, 2021 12:53 am We have a net worth of about $7M, yet we do not meet several of the criteria of the scenario being modeled....
Other than "invest the RMD and don't withdraw converted funds from the Roth account" what criteria apply?
Well, quoting directly from Prof McQ post title Part II (describing the scenario he will be exploring):
McQ wrote: Wed Sep 29, 2021 6:00 pm For discussion purposes, I’ll take the middle time frame of 15 years and the 22%/24% boundary. For you to have a lock on the juicy Roth conversion outcomes discussed above, you would need an AGI, in 2036, RMDs included, of $313,000.
McQ wrote: Wed Sep 29, 2021 6:00 pm That indicates a TDA balance at age 72 of just over $7.2 million dollars.
McQ wrote: Wed Sep 29, 2021 6:00 pm They had pension income twice their social security income, an extra $100,000 in 2036. Which means they only have to project $4.5 million in their TDAs
Ah, yes, that.

I don't recall if you participated, but there was quite a bit of (correct, IMHO) objection of the sort you are raising in the thread on McQ's SSRN paper (the predecessor to this thread): Roth Conversions - McQuarrie study

McQ eventually, if I recall correctly, offered the qualification that he was looking just at the personal finance world familiar to him: high income/high cost of living California + couples working in academia/corporations that had been offering high quality 403(b)/401(k) for so long that that those were the only investment accounts owned when the couple reached retirement.

To avoid unproductive distraction, I have to put on the lens of McQ's specified "sandbox" when I read some of his reasoning, then ignore stuff that isn't relevant to me.

For example, some of McQ's comments from the Part II post you (marcopolo) refer to:

[Context of comments: the risk of "doing a Bob-and-Barb: converting at 22% to save tax at 12%."]
McQ wrote:
Please don’t convert at 22% if you haven’t run the numbers, as described here, to confirm your future projected tax situation. You can compute an inflation index for the desired number of years to project tax and IRMAA brackets; can project your social security based on your wage history; and you can project your TDA balance using an assumed investment return; plus, you can vary at least the latter to do sensitivity testing.
Good advice. I agree.
McQ wrote: Before converting at 22% today, prove to your satisfaction that you will indeed have age 72 income, including RMDs, greater than the inflation-indexed value of $108,750 today.
But here is where I have to say to myself "Yep, I can see how this is correct from the point of view of McQ's "sandbox".

And struggle mightily to stuff a sock in my urge to say:

"McQ, your statement is too absolute.

"Having income in excess of $108,750 is sufficient, but not necessary to get to a 22% tax rate on your RMDs.

"People who have income less than $108,750 can still have marginal rates on their RMD greater than or equal to 22%. (e.g. among a bogleheads type crowd, relatively common scenarios involving the SS tax hump or the interaction of ordinary income and QD/LTCG income)."

Obviously the sock came loose out of my mouth just now :D . But that was in the service of this point:

For my individual purposes for reading this thread, it doesn't really matter if McQ is wrong about my personal tax picture.

It matters only that I, with my individual knowledge of my individual financial situation, am reasonably sure I have a significant likelihood of having a marginal rate approx x% lower pre-RMD than post-RMD. (But that it isn't impossible for the slings and arrows of outrageous fortune to defy my best predictions.)

For me personally, it then seems more productive to move on to other aspects and implications of McQ's argument that interest me. For example ...
  • Resiliency. The "RMD effect" causes the "Bob-and-Barb's 22% / 12% mistake" scenario to be more resilient to complete disaster than I would have expected, especially once one allows various sorts of heirs and the compressed tax brackets of a surviving spouse to be considered. (I've been "cheating" and looking at the scenario using the previously mentioned MDM spreadsheet that is similar to McQ's spreadsheet.)

    Is it resilient "enough?" Well ... not great, but probably worth discussion. And that leads to another upcoming McQ item I'm interested in, which is ...
  • The promised upcoming discussion on metrics
(Having said that, I have a suspicion that McQ's interests lie less in "resiliency" and more in "promises of acres of diamonds." But we'll see where the discussion goes.)
afan
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by afan »

I would like to propose another edge case that may never pay off.
High income couple, in the 37% federal and let's say 10% state tax bracket.
The entire Roth conversion would be at 47%.

Let's say they retire at age 50 and convert all of a $5 million tax deferred account. Assume they pay the taxes out of a taxable account, thus depleting it.

They then have only Social Security to live on. But let's say they do live on that, so the Roth account grows untouched for the rest of their lives. Give them 50 years further life plus 10 more years for their heirs to empty the Roth.

Assume that, had they kept the TDA, it would have been invested in a combination of VTI (70%?) and a state muni fund. Assume their taxable fund (which they used to pay the income tax on the Roth conversion in the Roth scenario) is invested the same way. Dividend rate from the stock portion ~1.5%. Muni fund dividends not subject to state or federal tax.

Without a Roth, their taxable income would derive from the taxable account, SS and RMDs. With their much lower tax rate in retirement, the Roth would need to clear a huge hurdle to pay off.

For simplicity, assume they die the same year, so taxes are MFJ all the time.

Would they ever recover the initial cost of the conversion? Even if we give them 60 years before the Roth is emptied out?
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cas
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by cas »

afan wrote: Fri Oct 01, 2021 10:51 am I would like to propose another edge case that may never pay off.
The MDM spreadsheet (previously referred to in this thread, currently in Beta Test and a bit ahead of McQ's similar tool) will handle that kind of scenario. Not clear to me exactly what you really mean for all the parameters, so probably best if you go play with it rather than have me guess wrong. (With my guess at what you meant, the Roth conversion pays off immediately, so I must be guessing wrong.)

MDM ... if you are reading ... I think there is a typo in the VLOOKUP calls in the Non-spouse heir 10-year payout section. The array goes up only to row 66, then kicks out "#N/A" errors if a user tries to put in really long periods of time like afan is asking about. I think you intended it to go up to row 80. (But a big thank you for switching it from XLOOKUP to VLOOKUP in V2.00 so that it works in a wider range of spreadsheet programs.)
secondopinion
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by secondopinion »

Walkure wrote: Thu Sep 30, 2021 7:46 pm
dodecahedron wrote: Wed Sep 29, 2021 5:28 pm
McQ wrote: Wed Sep 29, 2021 5:20 pm
LadyGeek wrote: Tue Sep 28, 2021 4:27 pm
McQ wrote: Tue Sep 28, 2021 4:08 pm My guess at your realization: Roth conversions always pay out, iff one of you lives long enough.
I assume "iff" is the academic shorthand for "If and only if", i.e. "if and only if one of you lives long enough."
Yes; but I had assumed it was an abbreviation in widespread use
Widely used in theoretical math and related academic disciplines (logic, etc.) Not really used much outside academia.
I knew it from the proofs in my 7th grade geometry textbook. Back when I was just an honorary junior BH and all my money was in STAR because of the low minimum... :wink:
I use "if and only if" and I am not in academics. "iff" always looked wrong to me. I am very much engrossed in mathematics as a hobby (and in my academic background); so it is something I am used to.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
secondopinion
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by secondopinion »

RetiredAL wrote: Thu Sep 30, 2021 10:27 pm Wealth is relative. To the street people around town, I'm fabulously wealthy. However, I do not feel I'm wealthy, but I think I have ample. I am certainly not wealthy by BH standards.
Agreed. I am not wealthy, but I also have zero debt. I imagine a lot of the people around me carry quite a bit of it and live more extravagantly (or "crazily" to be frankly blunt). At the end of the day, I can likely weather a depression (let alone a loss of job); I worry that many around me could not. Oh well, I guess I know who will retire well and possibly early despite not being a doctor or lawyer...
Last edited by secondopinion on Fri Oct 01, 2021 1:07 pm, edited 1 time in total.
Passive investing: not about making big bucks but making profits. Active investing: not about beating the market but meeting goals. Speculation: not about timing the market but taking profitable risks.
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FiveK
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FiveK »

marcopolo wrote: Fri Oct 01, 2021 2:21 am
FiveK wrote: Fri Oct 01, 2021 1:31 am
marcopolo wrote: Fri Oct 01, 2021 12:53 am We have a net worth of about $7M, yet we do not meet several of the criteria of the scenario being modeled....
Other than "invest the RMD and don't withdraw converted funds from the Roth account" what criteria apply?
Well, quoting directly from Prof McQ post title Part II (describing the scenario he will be exploring):
McQ wrote: Wed Sep 29, 2021 6:00 pm For discussion purposes, I’ll take the middle time frame of 15 years and the 22%/24% boundary. For you to have a lock on the juicy Roth conversion outcomes discussed above, you would need an AGI, in 2036, RMDs included, of $313,000.
McQ wrote: Wed Sep 29, 2021 6:00 pm That indicates a TDA balance at age 72 of just over $7.2 million dollars.
McQ wrote: Wed Sep 29, 2021 6:00 pm They had pension income twice their social security income, an extra $100,000 in 2036. Which means they only have to project $4.5 million in their TDAs
We don't anticipate having $313k of taxable income in 15 years
We don't anticipate having $7.2M in a TDA
We don't have a $100k pension (more like 5k), nor likely to have a TDA of $4.5M

We have a little over $1.5M in our TDA, we keep only fixed income assets in the TDA, which will likely not do much more than keep up with inflation.
I suspect that is not that unusual for people in our ball park of net worth.
Might be the difference between "non-numeric assumptions" and "specific numbers used as examples".

In other words, what do you get if you use your specific numbers (instead of the ones in McQ's example), but adhere to the assumptions that you invest the RMD and don't withdraw converted funds from the Roth account?
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by tomsense76 »

So I've read most (if not all) of this thread (I think although did take breaks), but still very well could have missed things.

That said, one thing that I didn't see come up (though again could have missed it) is heirs (particularly children) may be in different tax brackets than their parents (often higher as they are still working and may be at a high income point in their careers). Could be wrong about this, but this may shorten the time to the conversion paying off when considering inheritance.

Another thing that comes to mind (and again maybe this has come up elsewhere) is for various reasons people may Roth convert much earlier in life than retirement when their income may be lower for other reasons (like job loss, cutting back hours to go to school, taking time off to raise children or take care of aging parents, unpaid sabbaticals, early retirement, etc.). Am curious if the payoff for conversions would then be seen in one's own lifetime. It would seem likely, but maybe there are other things to consider (like longer tax-deferred growth).
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

FiveK wrote: Fri Oct 01, 2021 1:06 pm
marcopolo wrote: Fri Oct 01, 2021 2:21 am
FiveK wrote: Fri Oct 01, 2021 1:31 am
marcopolo wrote: Fri Oct 01, 2021 12:53 am We have a net worth of about $7M, yet we do not meet several of the criteria of the scenario being modeled....
Other than "invest the RMD and don't withdraw converted funds from the Roth account" what criteria apply?
Well, quoting directly from Prof McQ post title Part II (describing the scenario he will be exploring):
McQ wrote: Wed Sep 29, 2021 6:00 pm For discussion purposes, I’ll take the middle time frame of 15 years and the 22%/24% boundary. For you to have a lock on the juicy Roth conversion outcomes discussed above, you would need an AGI, in 2036, RMDs included, of $313,000.
McQ wrote: Wed Sep 29, 2021 6:00 pm That indicates a TDA balance at age 72 of just over $7.2 million dollars.
McQ wrote: Wed Sep 29, 2021 6:00 pm They had pension income twice their social security income, an extra $100,000 in 2036. Which means they only have to project $4.5 million in their TDAs
We don't anticipate having $313k of taxable income in 15 years
We don't anticipate having $7.2M in a TDA
We don't have a $100k pension (more like 5k), nor likely to have a TDA of $4.5M

We have a little over $1.5M in our TDA, we keep only fixed income assets in the TDA, which will likely not do much more than keep up with inflation.
I suspect that is not that unusual for people in our ball park of net worth.
Might be the difference between "non-numeric assumptions" and "specific numbers used as examples".

In other words, what do you get if you use your specific numbers (instead of the ones in McQ's example), but adhere to the assumptions that you invest the RMD and don't withdraw converted funds from the Roth account?
Those numbers are not just random made up numbers.
Prof McQ delves into some detail to arrive at those number to meet the "non-numeric" assumptions he has laid out for the specific scenarios he is planning to model.

I agree that the framework can be used for other scenarios, I was commenting on the ones the Prof is planning to focus on for his analysis.

Using our numbers I don't get to anywhere near the the scenario where converting at 22% or 24% pays off handsomely.

That is drive by these differences from assumptions above:

We don't have much of a pension
Our Soc Sec is more modest (wife was a SAHM), and I retired well before getting 35 years of contributions.
Our TDA is not huge, and is invested in all fixed income.
Our taxable investement are invested tax-efficient (thanks to help from this forum!), low turnover
Due to quirks in our local ACA market, we get sizable tax credits at income levels higher than in most other places.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FiveK »

tomsense76 wrote: Fri Oct 01, 2021 1:15 pm So I've read most (if not all) of this thread (I think although did take breaks), but still very well could have missed things.

That said, one thing that I didn't see come up (though again could have missed it) is heirs (particularly children) may be in different tax brackets than their parents (often higher as they are still working and may be at a high income point in their careers). Could be wrong about this, but this may shorten the time to the conversion paying off when considering inheritance.
You could explore that situation:
cas wrote: Fri Oct 01, 2021 12:04 pm The MDM spreadsheet (previously referred to in this thread, currently in Beta Test and a bit ahead of McQ's similar tool) will handle that kind of scenario.
Back to the next question:
Another thing that comes to mind (and again maybe this has come up elsewhere) is for various reasons people may Roth convert much earlier in life than retirement when their income may be lower for other reasons (like job loss, cutting back hours to go to school, taking time off to raise children or take care of aging parents, unpaid sabbaticals, early retirement, etc.). Am curious if the payoff for conversions would then be seen in one's own lifetime. It would seem likely, but maybe there are other things to consider (like longer tax-deferred growth).
The payoff is always immediate when a conversion is done at a marginal rate lower than what the future holds.

If, in pre-RMD years, the conversion tax is paid with cash on hand, it could be advantageous even if the future marginal rates are lower. See the first of the More complicated situations for that.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FiveK »

marcopolo wrote: Fri Oct 01, 2021 1:36 pm Those numbers are not just random made up numbers.
Prof McQ delves into some detail to arrive at those number to meet the "non-numeric" assumptions he has laid out for the specific scenarios he is planning to model.
Many numbers will meet the non-numeric assumptions. McQ's may be sufficient but not necessary.
I agree that the framework can be used for other scenarios, I was commenting on the ones the Prof is planning to focus on for his analysis.

Using our numbers I don't get to anywhere near the the scenario where converting at 22% or 24% pays off handsomely.
That could well be, and thus another example of "rules of thumb" being difficult to apply in the traditional vs. Roth space. As McQ put it,
McQ wrote: Wed Sep 29, 2021 6:00 pmPlease don’t convert at 22% if you haven’t run the numbers, as described here, to confirm your future projected tax situation.
One could delete the "at 22%" without detracting from the the wisdom of that advice.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by Chip »

FiveK wrote: Fri Oct 01, 2021 1:36 pm The payoff is always immediate when a conversion is done at a marginal rate lower than what the future holds.
I disagree that the payoff is immediate unless no tax is paid to convert. When I convert I pay extra tax now and recover that payment through lower taxes in the future. How is that an immediate payoff?
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by tomsense76 »

FiveK wrote: Fri Oct 01, 2021 1:36 pm
tomsense76 wrote: Fri Oct 01, 2021 1:15 pm So I've read most (if not all) of this thread (I think although did take breaks), but still very well could have missed things.

That said, one thing that I didn't see come up (though again could have missed it) is heirs (particularly children) may be in different tax brackets than their parents (often higher as they are still working and may be at a high income point in their careers). Could be wrong about this, but this may shorten the time to the conversion paying off when considering inheritance.
You could explore that situation:
cas wrote: Fri Oct 01, 2021 12:04 pm The MDM spreadsheet (previously referred to in this thread, currently in Beta Test and a bit ahead of McQ's similar tool) will handle that kind of scenario.
Back to the next question:
Another thing that comes to mind (and again maybe this has come up elsewhere) is for various reasons people may Roth convert much earlier in life than retirement when their income may be lower for other reasons (like job loss, cutting back hours to go to school, taking time off to raise children or take care of aging parents, unpaid sabbaticals, early retirement, etc.). Am curious if the payoff for conversions would then be seen in one's own lifetime. It would seem likely, but maybe there are other things to consider (like longer tax-deferred growth).
The payoff is always immediate when a conversion is done at a marginal rate lower than what the future holds.

If, in pre-RMD years, the conversion tax is paid with cash on hand, it could be advantageous even if the future marginal rates are lower. See the first of the More complicated situations for that.
Thanks for the reply.

Maybe there is some sort of marginal tax rate that would capture the parent's tax rate and the child's? This would be more useful for figuring out when the payoff occurs as opposed to exactly how close one is to that dividing line

Ah right good point
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FiveK »

Chip wrote: Fri Oct 01, 2021 1:53 pm
FiveK wrote: Fri Oct 01, 2021 1:36 pm The payoff is always immediate when a conversion is done at a marginal rate lower than what the future holds.
I disagree that the payoff is immediate unless no tax is paid to convert. When I convert I pay extra tax now and recover that payment through lower taxes in the future. How is that an immediate payoff?
One doesn't have an unfettered access to money in a traditional account: tax must be paid to access that money for any desired purchase.

Another way to put it is "the money in a traditional account isn't all yours - the government owns a part of it."

If one can pay a lower tax rate now (aka "keep a larger fraction while the government gets a lower fraction"), then one immediately has more spendable funds than one would have if paying a higher tax rate (aka "giving the government a higher fraction") later.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by Chip »

FiveK wrote: Fri Oct 01, 2021 2:12 pm One doesn't have an unfettered access to money in a traditional account: tax must be paid to access that money for any desired purchase.

Another way to put it is "the money in a traditional account isn't all yours - the government owns a part of it."

If one can pay a lower tax rate now (aka "keep a larger fraction while the government gets a lower fraction"), then one immediately has more spendable funds than one would have if paying a higher tax rate (aka "giving the government a higher fraction") later.
Having spendable funds isn't the same as actually spending those funds. And the government's share may change over time.

My heirs are charities. If I convert today and die tomorrow I never recover those prepaid taxes, nor do the charities. If my heirs weren't charities but I entered a LTC facility for a lengthy stay my future tax rate would decline significantly compared to my current projections.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FiveK »

Chip wrote: Fri Oct 01, 2021 2:21 pm Having spendable funds isn't the same as actually spending those funds. And the government's share may change over time.

My heirs are charities. If I convert today and die tomorrow I never recover those prepaid taxes, nor do the charities. If my heirs weren't charities but I entered a LTC facility for a lengthy stay my future tax rate would decline significantly compared to my current projections.
No disagreement with those points, but they run counter to the condition in the original post:
FiveK wrote: Fri Oct 01, 2021 1:36 pm The payoff is always immediate when a conversion is done at a marginal rate lower than what the future holds.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by cas »

Chip wrote: Fri Oct 01, 2021 2:21 pm My heirs are charities. If I convert today and die tomorrow I never recover those prepaid taxes, nor do the charities. If my heirs weren't charities but I entered a LTC facility for a lengthy stay my future tax rate would decline significantly compared to my current projections.
Not an answer to your objection, but ...

This type of scenario is one of the areas where this "RMD effect" analysis is really interesting to me.

From the introduction to the MDM spreadsheet...

[For a very specific scenario which involves a contemplated conversion at 32%, then scenarios where the assets go to tax-exempt charity (tax rate 0%) or an heir whose tax rate ends up being significantly lower than 32% (specifically, 22%)]
Some observations:

- If the original owner had lived to age 94, it would have been slightly better to do the Roth conversion even if the heir had been a tax-exempt charity.

- With the default scenario, not converting is slightly better for the heir if the heir would use the inheritance within two years. If the heir would let the money grow for the full 10 years, an age 71 conversion by the original owner would give the heir more spendable after-tax income after the 10 years.

Disclaimers:
- None of this should be interpreted to be an unqualified "Roth is better" or "traditional is better." As always, it depends....
Admittedly, those time frames do get wrapped up in what FiveK said earlier:
FiveK wrote: Fri Sep 24, 2021 3:11 pm It's not interesting (in a practical sense) if "long enough" turns out to be 1000 years or so. It would be highly interesting if "long enough" turns out to be 5 years or so. It's probably interesting enough for discussion if "long enough" turns out to be 20 years or so.
But at the "probably interesting enough for discussion" level, a result that the "RMD effect" allowed a conversion at 32% to *ever* work out for a exempt charity heir or a significantly-lower-tax-rate-heir is kind of "Whoa. That wasn't within my rules of thumb at all." It makes me want to put scenarios more specific to me into this type of tool that examines the "RMD effect," to see what happens.

And that gets back to my interest in the "resilience" of Roth conversions to future unexpected life changes.

Stuff like:

Suppose: I don't think I'll need to use this money ever in my life. My primary beneficiary is a non-spouse with a higher expected tax rate than me, but my secondary beneficiary is a charity. Should I convert to Roth?

But what if I run through all my primary funds for long term care and end up having to dip into these funds? How old would I have to be before a Roth conversion wasn't a disaster (and maybe even a boon?)?

But I outlived my primary beneficiary, so now the Roth is going to go to a charity. Was the Roth conversion a disaster? Is it ever an advantage?

But my primary beneficiary had an unexpected life change and now their tax rate is going to be much lower than expected. Was the Roth conversion a disaster? Or was it fairly resilient to that type of change in fortune?

Edit: and to bring all those thoughts back to McQ, since this is his thread: McQ is trudging patiently through details, trying to explore a framework for looking at this whole "RMD effect" idea. It isn't quite fair for me to be flitting about like a hummingbird, settling only on surprising results and chattering about particularly tasty ones.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

FiveK wrote: Fri Oct 01, 2021 1:46 pm
marcopolo wrote: Fri Oct 01, 2021 1:36 pm Those numbers are not just random made up numbers.
Prof McQ delves into some detail to arrive at those number to meet the "non-numeric" assumptions he has laid out for the specific scenarios he is planning to model.
Many numbers will meet the non-numeric assumptions. McQ's may be sufficient but not necessary.
I agree that the framework can be used for other scenarios, I was commenting on the ones the Prof is planning to focus on for his analysis.

Using our numbers I don't get to anywhere near the the scenario where converting at 22% or 24% pays off handsomely.
That could well be, and thus another example of "rules of thumb" being difficult to apply in the traditional vs. Roth space. As McQ put it,
McQ wrote: Wed Sep 29, 2021 6:00 pmPlease don’t convert at 22% if you haven’t run the numbers, as described here, to confirm your future projected tax situation.
One could delete the "at 22%" without detracting from the the wisdom of that advice.
I agree with all of that.
I think the analysis is quite helpful and interesting.

The only thing that got this particular exchange going is that I said the specific scenario Prof McQ laid out (I recognize there are others) was really geared towards wealthy people. Couple of people pushed back against that. I guess no one likes to labeled as wealthy. But, I maintain that the specific scenario he laid out, of someone with $313k of AGI coming from a $7.2m TDA ($100k pension plus $4.5m in TDA) would be considered "wealthy" by most measures.

Anyway, we have drifted way off topic, sorry about that.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FiveK »

marcopolo wrote: Fri Oct 01, 2021 3:24 pmI maintain that the specific scenario he laid out, of someone with $313k of AGI coming from a $7.2m TDA ($100k pension plus $4.5m in TDA) would be considered "wealthy" by most measures.
Agreed! :sharebeer
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by wrongfunds »

FiveK wrote: Fri Oct 01, 2021 3:26 pm
marcopolo wrote: Fri Oct 01, 2021 3:24 pmI maintain that the specific scenario he laid out, of someone with $313k of AGI coming from a $7.2m TDA ($100k pension plus $4.5m in TDA) would be considered "wealthy" by most measures.
Agreed! :sharebeer
Not sure if marco considers $7m total as wealthy or not. That would be the key question.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

First, a mid-thread "THANK YOU!" to all. I am learning more than I dared hope and I am not even half way through my planned series of posts. From my perspective, anything that doesn't permanently hijack the thread or get it locked by the moderators is grist for the mill, with the prospect that I'll learn even more. Please, if you've got something to say that is in any way related to the topic, post it.

One clarification re the past 24 hours of posts, and the definition of "wealthy":
-$313,000, and $4.5 million, are inflated future 2036 dollars, today's thresholds inflated by a factor of about 1.55X (fifteen years of inflation at 3%)
-the values are those required for smallish SS, plus $100K pension, plus RMDs, to add up to enough to push a couple to the very top of what will, in 2036, be the projected ceiling of the 22% bracket.
-As a matter of principle, I refuse to call anyone located in the 22% income tax bracket, based on income from those three sources, wealthy.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

wrongfunds wrote: Fri Oct 01, 2021 4:27 pm
FiveK wrote: Fri Oct 01, 2021 3:26 pm
marcopolo wrote: Fri Oct 01, 2021 3:24 pmI maintain that the specific scenario he laid out, of someone with $313k of AGI coming from a $7.2m TDA ($100k pension plus $4.5m in TDA) would be considered "wealthy" by most measures.
Agreed! :sharebeer
Not sure if marco considers $7m total as wealthy or not. That would be the key question.
Of course not.
The rule is that someone else has to have at least double what you have to be considered wealthy. :sharebeer
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by wrongfunds »

marcopolo wrote: Fri Oct 01, 2021 4:47 pm
wrongfunds wrote: Fri Oct 01, 2021 4:27 pm
FiveK wrote: Fri Oct 01, 2021 3:26 pm
marcopolo wrote: Fri Oct 01, 2021 3:24 pmI maintain that the specific scenario he laid out, of someone with $313k of AGI coming from a $7.2m TDA ($100k pension plus $4.5m in TDA) would be considered "wealthy" by most measures.
Agreed! :sharebeer
Not sure if marco considers $7m total as wealthy or not. That would be the key question.
Of course not.
The rule is that someone else has to have at least double what you have to be considered wealthy. :sharebeer
Exactly! Being wealthy is always relative term. I know I am never going to be wealthy as long I can claim somebody else who has double the assets than me as wealthy. At least you and me are aware of that idiosyncrasy. Most have it but don't acknowledge it.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FiveK »

McQ wrote: Fri Oct 01, 2021 4:37 pm One clarification re the past 24 hours of posts, and the definition of "wealthy":
-$313,000, and $4.5 million, are inflated future 2036 dollars, today's thresholds inflated by a factor of about 1.55X (fifteen years of inflation at 3%)
-the values are those required for smallish SS, plus $100K pension, plus RMDs, to add up to enough to push a couple to the very top of what will, in 2036, be the projected ceiling of the 22% bracket.
-As a matter of principle, I refuse to call anyone located in the 22% income tax bracket, based on income from those three sources, wealthy.
Returning to today's dollars, and assuming for MFJ age 72:
top of the 22% bracket = $200K AGI
smallish SS = $20K/yr
pension = $100K/yr/1.55 = $64.5K/yr
RMD = $200K - ($20K + $64.5K) = $115.5K
Traditional balance = $115.5K * 27.4 = $3,165K

Based on Net Worth Percentile Calculator – United States, that puts them at the 96% percentile. Of course, "wealthy" is a subjective term....
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

FiveK wrote: Fri Oct 01, 2021 5:01 pm
McQ wrote: Fri Oct 01, 2021 4:37 pm One clarification re the past 24 hours of posts, and the definition of "wealthy":
-$313,000, and $4.5 million, are inflated future 2036 dollars, today's thresholds inflated by a factor of about 1.55X (fifteen years of inflation at 3%)
-the values are those required for smallish SS, plus $100K pension, plus RMDs, to add up to enough to push a couple to the very top of what will, in 2036, be the projected ceiling of the 22% bracket.
-As a matter of principle, I refuse to call anyone located in the 22% income tax bracket, based on income from those three sources, wealthy.
Returning to today's dollars, and assuming for MFJ age 72:
top of the 22% bracket = $200K AGI
smallish SS = $20K/yr
pension = $100K/yr/1.55 = $64.5K/yr
RMD = $200K - ($20K + $64.5K) = $115.5K
Traditional balance = $115.5K * 27.4 = $3,165K

Based on Net Worth Percentile Calculator – United States, that puts them at the 96% percentile. Of course, "wealthy" is a subjective term....
Did you include the NPV of that generous pension?
What fraction of people getting ready to retire soon have pensions like that?
Most of us are replacing that pension income from savings.

Take away the pension, and you are close to $5M investable assets, putting you closer to 97+% percentile.
I agree "wealthy" is subjective.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

What should be the metric for Roth conversion outcomes?

[with a shoutout to Woodspinner’s thread on this topic]

Very important: this post assumes once again that the goal is to accumulate greater after-tax wealth some decades into the future, same as my first series of posts on this thread. I’ll be using younger ages in most of the examples (85 or 90, not 100+), but that still gives a conversion made while in the 60s some decades to play out.

Other goals will require other metrics. Some of the more ideological among taxpayers may set a goal of minimizing lifetime tax payments to the hated gumnint. As has been pointed out on other threads here at BH, one of the simplest ways to achieve that goal is to earn lousy returns on the funds in your TDA—leave it all in a money market fund, for instance. Silly, of course, but I try never to underestimate the prevalence and power of tax phobia. Many of the more manipulative sales pitches I see for Roth conversions try to aggravate that phobia, which lies latent in most of us.

The goal is greater after-tax wealth available for spending. Period. For the next portion of this thread, that will be my only metric for Roth conversions. Note the slight segue in this paragraph: greater after-tax spending power, for me and DW, says nothing about my heirs. So in this second series of posts, if a conversion doesn’t seem likely to pay off except for heirs, it does not pencil out.

Further: it’s not necessary for me to exercise the increased spending power; my consumption habits are pretty well set. And if I were to start spending down any converted funds, a new analysis would be required: spending at year n means less after-tax spending power at year n + 10. That analysis will be forthcoming; I just haven’t written my way to it yet.

My point: in this second series I will focus exclusively on in-life outcomes: the after-tax spending power available to the living at each evaluation, assuming no prior tapping of the funds. In these analyses there can be no step up in basis at death, because there have not yet been two deaths.

Choosing the metric

In the SSRN paper, I more or less threw everything against the wall, in the spirit of discovering what might stick. After reflection, and stimulated by BH criticism, here I will focus on a select few and add one new metric. Thus far the only metric used has been the additional after-tax, nominal dollars, achieved by converting versus not converting. That’s a very common metric in popular accounts: that after n years, the converter will be this many dollars ahead. But it’s a week reed, as we shall see, and not only because future inflated dollars are being used.

Every Roth conversion requires a voluntary tax debit paid right now: money sent to the government that the government did not demand, and would have been happy to receive only later, many years in the future, and under what could be a generous and will likely be a very prolonged repayment plan (=tax on RMDs at some percentage like 22% or less, on annual RMDs initially figured at about 4% of the balance, continuing for decades). Imagine a payment schedule set at double-digit basis points per year—would that my bank offered a mortgage on those terms! Then again, I can pay off a mortgage; but there is no way to pay off the tax liability on my tax-sheltered funds while maintaining that shelter.

Except through a Roth conversion.

A Roth conversion, then, is like the buyout of a contract. I accepted the government subsidy year after year for decades to build up my TDA more rapidly than I could otherwise have afforded. Now, in the form of taxable RMDs, the contract requires that I “pay back” that subsidy. That’s a metaphor; I may or may not pay back more dollars after starting RMDs than the subsidy dollars I received in the decades beforehand. Either way, having to take RMDs and having to pay tax on them at then-current rates was always part of the TDA “contract.”

When I make a Roth conversion, I remove all further tax liability on the sum that remains, now called Roth funds rather than TDA funds. If it’s 1929, and the market stays down for twenty years, I probably overpaid to get out of that contract [a hail to Lee_WSJ here]. If I paid 22% to avert RMDs whose tax liability would have been only 12%, I definitely overpaid.

Paying tax upfront for an uncertain future outcome is rather like making an investment. Given the uncertainty of future tax structures and portfolio returns, it could even be called a wager. I will call the conversion an investment; and as such, the metric must be return on investment, or ROI, with the investment equal to the tax debit that had to be paid upfront to buy out of the TDA “contract.”

But how to calculate the return on that investment?

My thinking on this count has evolved, as acknowledged above. But first, a question of framing. The day after the conversion, the after-tax value of that portion of my TDA, if I had not converted, must exactly equal the value of the Roth account, if I did convert, even though the pretax values are different, $100,000 versus $78,000 in the case of constant rates at 22%. So, where is the “investment?”

Answer: can’t frame the problem that way. The whole point of analyzing a conversion is to compare outcomes for writing a check for tax now, versus dribbling out much smaller tax payments, year after year, for what could be a long, long time. That framework blows up if you liquidate the TDA and pay tax now.

The investment is fact: you really do have to send the IRS a check for $22,000 right now. And they are not giving it back; that money is gone, except as it is earned back, slowly but surely, by the future tax payments you no longer have to make.

*and again: paying tax from outside the conversion will only have a small effect. The IRS still gets its check, paid from one of your accounts or another.

In sum: a Roth conversion requires an investment. The amount of the investment is the totally unnecessary, voluntarily undertaken tax debit that had to be paid up front.

But still, what is the return on that Roth conversion investment?

In the paper, one of my metrics was to take the nth geometric root of [1 + (real Roth surplus/tax debit)]. If the conversion was $12,000 ahead in real terms/constant dollars after 10 years, on an initial debit of $24,000, that means taking the 10th root of 1.5, or 1.04138. The ROI would then be a real 4.14% annualized, not too shabby.

But that formulation nagged at me. It was, after all, the geometric root of an arithmetic difference between two exponential series. Mmmnnh.

Here I’m going to introduce a simpler formulation: the nth geometric root of [Roth value / (combined after-tax value of counterfactual TDA + taxable account holding reinvested RMDs)]. What was an arithmetic difference—the dollar pay off to the Roth conversion cited in all previous posts—is now replaced by a simple ratio, which can be glossed as with-Roth wealth / no-conversion wealth. That’s consistent with what we agreed above : the goal is greater after-tax wealth. But now we express ‘greater’ by the degree to which the ratio exceeds 1.0, rather than the amount that remains after a subtraction.

Here is an example. In this spreadsheet I’ve added columns to the right, hidden other columns, and rounded to the dollar, hoping to keep it all within screen. It shows results through age 100 for conversion at a constant 22%. The newly visible columns, beginning with the yellow highlighted column Q, are the focus.

Image

For conversion under a constant tax rate of 22%, the Roth surplus at age 85 is $11,540. That’s the difference between Roth wealth of $296,205 and the after-tax wealth of (no-convert TDA + taxable) of $284,665. The ratio of those two is 1.0405. The 14th root is 1.00284, making the ROI under the new metric equal to an annualized 0.28%--as of age 85, after fourteen years.

That’s not a very large number. Rather puts the $11,540 “gain from conversion” into a different perspective, don’t you think?

We may have arrived at our F. Scott Fitzgerald moment:
1. Roth conversions, even at constant or lowered tax rates, do pay off, and in large dollar amounts at later ages;
2. But not by much, when the excess return is computed as a rate, and the evaluation occurs at younger ages

For comparison, the ROI metric in the SSRN paper would have been calculated this way: 1) Convert $11,540 into its real value of $7,629; 2) calculate (1 + (7629/24000)], which is 1.3468; 3) take the 14th root, which equals 1.0215; 4) making the “SSRN paper” ROI equal to 2.15% (rounded). Put another way, if you invested $22,000 at a real rate of 2.15%/year, after fourteen years you’d have a gain of $7,629 in real dollars.

Note that by contrast, the new metric does not require deflating either sum into constant dollars; both are expressed in the same units of inflated future dollars.

Let me stop here to see if there are comments, especially critiques of the new metric. There is one obvious objection which I would like to foreground for evaluation: why not lose the geometric roots and stick with the raw ratios?

-the new metric would then indicate that after fourteen years, you would have 1.0405X the after-tax wealth with conversion as without, given a constant tax rate of 22%;
-the SSRN paper metric would indicate that after fourteen years, you’d have gained a real, after-tax, 34.68% on the initial tax debit.

I’m stuck on the need for the geometric roots, in the spirit of recognizing the time value of money; but I never worked professionally in finance, and I am open to arguments for applying a different treatment to the raw ratios.

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

Post by LadyGeek »

McQ wrote: Fri Oct 01, 2021 5:53 pm I’m stuck on the need for the geometric roots, in the spirit of recognizing the time value of money; but I never worked professionally in finance, and I am open to arguments for applying a different treatment to the raw ratios.
By "geometric" you also mean "logarithmic". From an older post of mine, follow the relevant article links: Subject: Geometric Average vs. Arithmetic Average
LadyGeek wrote: Fri Dec 22, 2017 6:06 pm ^^^ :).

To those wondering what this discussion is about, see the wiki: Percentage gain and loss (Appendix: Other units)

Here's a relevant article: Use of logarithms in economics | Econbrowser

Also: Uses of the logarithm transformation in regression and forecasting
(Not related to his discussion, but the wiki page is a good tutorial for new investors.)

Disclaimer: I also have no background in finance, but the math makes sense to me.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by smitcat »

marcopolo wrote: Fri Oct 01, 2021 1:36 pm
FiveK wrote: Fri Oct 01, 2021 1:06 pm
marcopolo wrote: Fri Oct 01, 2021 2:21 am
FiveK wrote: Fri Oct 01, 2021 1:31 am
marcopolo wrote: Fri Oct 01, 2021 12:53 am We have a net worth of about $7M, yet we do not meet several of the criteria of the scenario being modeled....
Other than "invest the RMD and don't withdraw converted funds from the Roth account" what criteria apply?
Well, quoting directly from Prof McQ post title Part II (describing the scenario he will be exploring):
McQ wrote: Wed Sep 29, 2021 6:00 pm For discussion purposes, I’ll take the middle time frame of 15 years and the 22%/24% boundary. For you to have a lock on the juicy Roth conversion outcomes discussed above, you would need an AGI, in 2036, RMDs included, of $313,000.
McQ wrote: Wed Sep 29, 2021 6:00 pm That indicates a TDA balance at age 72 of just over $7.2 million dollars.
McQ wrote: Wed Sep 29, 2021 6:00 pm They had pension income twice their social security income, an extra $100,000 in 2036. Which means they only have to project $4.5 million in their TDAs
We don't anticipate having $313k of taxable income in 15 years
We don't anticipate having $7.2M in a TDA
We don't have a $100k pension (more like 5k), nor likely to have a TDA of $4.5M

We have a little over $1.5M in our TDA, we keep only fixed income assets in the TDA, which will likely not do much more than keep up with inflation.
I suspect that is not that unusual for people in our ball park of net worth.
Might be the difference between "non-numeric assumptions" and "specific numbers used as examples".

In other words, what do you get if you use your specific numbers (instead of the ones in McQ's example), but adhere to the assumptions that you invest the RMD and don't withdraw converted funds from the Roth account?
Those numbers are not just random made up numbers.
Prof McQ delves into some detail to arrive at those number to meet the "non-numeric" assumptions he has laid out for the specific scenarios he is planning to model.

I agree that the framework can be used for other scenarios, I was commenting on the ones the Prof is planning to focus on for his analysis.

Using our numbers I don't get to anywhere near the the scenario where converting at 22% or 24% pays off handsomely.

That is drive by these differences from assumptions above:

We don't have much of a pension
Our Soc Sec is more modest (wife was a SAHM), and I retired well before getting 35 years of contributions.
Our TDA is not huge, and is invested in all fixed income.
Our taxable investement are invested tax-efficient (thanks to help from this forum!), low turnover
Due to quirks in our local ACA market, we get sizable tax credits at income levels higher than in most other places.
"Our Soc Sec is more modest (wife was a SAHM), and I retired well before getting 35 years of contributions."
FWIW I would double check that for sure , I have less than 30 years as well ...untill I count the years I worked in HS and college before graduation and getting a 'real job'. Due to the nature of SS that still leaves me with about $45K SS per year at 70 which I believe would then be 1-1/2 times that if my wife had not worked or $67.5K per year for both.

"Using our numbers I don't get to anywhere near the the scenario where converting at 22% or 24% pays off handsomely.
That is drive by these differences from assumptions above:
We don't have much of a pension.
Our TDA is not huge, and is invested in all fixed income.
Our taxable investement are invested tax-efficient (thanks to help from this forum!), low turnover
Due to quirks in our local ACA market, we get sizable tax credits at income levels higher than in most other places"

It would be great for you to explain your strategy to stay away from an eventual rise above the 22% tax rates.
With 1.5 million in TDA and maybe 4.5 million in after tax your accounts in total should be growing each year all along - correct?
What would your modeled portfolio performance ranges be? What happens with one spouses passing?
How does one eventually deplete the TDA and also utilize the funds within the aftertax along with the eventual SS without reaching 22% tax rates and above?
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by smitcat »

marcopolo wrote: Fri Oct 01, 2021 5:07 pm
FiveK wrote: Fri Oct 01, 2021 5:01 pm
McQ wrote: Fri Oct 01, 2021 4:37 pm One clarification re the past 24 hours of posts, and the definition of "wealthy":
-$313,000, and $4.5 million, are inflated future 2036 dollars, today's thresholds inflated by a factor of about 1.55X (fifteen years of inflation at 3%)
-the values are those required for smallish SS, plus $100K pension, plus RMDs, to add up to enough to push a couple to the very top of what will, in 2036, be the projected ceiling of the 22% bracket.
-As a matter of principle, I refuse to call anyone located in the 22% income tax bracket, based on income from those three sources, wealthy.
Returning to today's dollars, and assuming for MFJ age 72:
top of the 22% bracket = $200K AGI
smallish SS = $20K/yr
pension = $100K/yr/1.55 = $64.5K/yr
RMD = $200K - ($20K + $64.5K) = $115.5K
Traditional balance = $115.5K * 27.4 = $3,165K

Based on Net Worth Percentile Calculator – United States, that puts them at the 96% percentile. Of course, "wealthy" is a subjective term....
Did you include the NPV of that generous pension?
What fraction of people getting ready to retire soon have pensions like that?
Most of us are replacing that pension income from savings.

Take away the pension, and you are close to $5M investable assets, putting you closer to 97+% percentile.
I agree "wealthy" is subjective.
"What fraction of people getting ready to retire soon have pensions like that?
Most of us are replacing that pension income from savings."

I would think the number of folks recieving pensions is less than 30% as a whole.
If you remove the large % of the population that has little or no savings it looks quite different.
But then number of folks recieving pensions that would be applicable to these Roth conversion discusions will be much higher.
Last I checked the number of folks in pensions was about 30 million people.
The ones we know that have have pensions include teachers, law enforcement, water district, firefighters, nurses, janitors, small goverment officials, dept of public works, SLP, therapists , school principals and superintendents, etc.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

smitcat wrote: Fri Oct 01, 2021 6:37 pm
marcopolo wrote: Fri Oct 01, 2021 5:07 pm
FiveK wrote: Fri Oct 01, 2021 5:01 pm
McQ wrote: Fri Oct 01, 2021 4:37 pm One clarification re the past 24 hours of posts, and the definition of "wealthy":
-$313,000, and $4.5 million, are inflated future 2036 dollars, today's thresholds inflated by a factor of about 1.55X (fifteen years of inflation at 3%)
-the values are those required for smallish SS, plus $100K pension, plus RMDs, to add up to enough to push a couple to the very top of what will, in 2036, be the projected ceiling of the 22% bracket.
-As a matter of principle, I refuse to call anyone located in the 22% income tax bracket, based on income from those three sources, wealthy.
Returning to today's dollars, and assuming for MFJ age 72:
top of the 22% bracket = $200K AGI
smallish SS = $20K/yr
pension = $100K/yr/1.55 = $64.5K/yr
RMD = $200K - ($20K + $64.5K) = $115.5K
Traditional balance = $115.5K * 27.4 = $3,165K

Based on Net Worth Percentile Calculator – United States, that puts them at the 96% percentile. Of course, "wealthy" is a subjective term....
Did you include the NPV of that generous pension?
What fraction of people getting ready to retire soon have pensions like that?
Most of us are replacing that pension income from savings.

Take away the pension, and you are close to $5M investable assets, putting you closer to 97+% percentile.
I agree "wealthy" is subjective.
"What fraction of people getting ready to retire soon have pensions like that?
Most of us are replacing that pension income from savings."

I would think the number of folks recieving pensions is less than 30% as a whole.
If you remove the large % of the population that has little or no savings it looks quite different.
But then number of folks recieving pensions that would be applicable to these Roth conversion discusions will be much higher.
Last I checked the number of folks in pensions was about 30 million people.
The ones we know that have have pensions include teachers, law enforcement, water district, firefighters, nurses, janitors, small goverment officials, dept of public works, SLP, therapists , school principals and superintendents, etc.

The 30% number is likely people receiving pensions now.
As you may be aware, many institutions have been steadily eliminating pensions. I suspect that number will be lower in the future.

We will probably get included in the number of people receiving pensions, we will be getting a grand total of $420/mo, not inflation adjusted, between the two us starting at age 65, then years from now. I would guess those receiving in the neighborhood of $65k in COLA'd pensions is significantly smaller.
Once in a while you get shown the light, in the strangest of places if you look at it right.
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