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

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

Post by WoodSpinner »

McQ wrote: Sat Sep 25, 2021 12:51 pm
WoodSpinner wrote: Fri Sep 24, 2021 6:01 pm McQ,

I am looking forward to this discussion, many thanks for posting it here! I also appreciate the kind words!

What I would find interesting in a future iteration is to:
  1. Include a series of Roth Conversions before RMDs begin an a better illustration of their affects over time. For instance, convert $100,000/year from 60-71 and then RMDs.
  2. Be able to demonstrate a mechanism to help determine if you are converting too much or too little given your assumptions. I think this would require a more dynamic approach to Tax Rates than the current model provides.
  3. Affect of turbo-charging the Conversions and RMDs by moving Equities from the TDA to a more optimal asset location for future growth. In other wards while keeping the same overall Equity/Bond allocation try and fill Roth with only Equities, Taxable with Equities and Bonds (if necessary) and TDA with Bonds and Equities ( if necessary).
Thanks

WoodSpinner
Hello Woodspinner: thanks for those questions, I learn more when I learn what my audience really cares about. Brief replies, mostly placeholders:

1. This one doesn't actually make a difference (if tax is paid from the conversion). Imagine you converted $100,000 seven years earlier at age 64 all in the 24% bracket; you'd start with $100,000 in the counterfactual and $76,000 in the Roth, same as my age 71 example. Seven years later you'd have about $200,000 in the counterfactual and $152,000 in the Roth, because until RMDs begin, the two will always be in the ratio of 100/76, because both are in the same asset and tax is deferred on both.
So, there's no difference in pattern of outcomes if you convert $800,000 at age 71 or $100,000 a year for eight years; excepting the fact that you can't convert $800,000 at 24% in a single year.
If tax is paid from outside, the starting age does make a difference; I'll cover that in a later post.

Well one big difference of course is it is highly unlikely you could convert $800,000 in one year and stay within the 24% bracket. We see several posters a year that are contemplating truly massive conversions over very short periods of time without really understanding the full implications. I suspect that the Payback Period for a $800,000 conversion is much different than 8 x $100,000 conversions.

I agree that the general point that the conversion will Pay Off in time. Illustrating a series of conversions will increase the magnitude of the Deltas and be more realistic.

2. Not sure I will be able to get beyond the rule of thumb I gave you earlier, but I'll keep this idea in the back of my mind. Once I release the SS, it will be easy enough to supply the tax rate year by year rather than leaving it constant; then one can run sensitivity tests, per DSBH, with tax rates going up by yay much, going down by yay much; or going up and down versus going down and up. Pegging out the extremes will give you a sense of the robustness of the conversion amount.

At this point I am very comfortable with my approach discussed in Roth Conversion Metric thread.

That said, I suspect that pegging out extremes (e.g. converting $800,000) using actual tax rates might easily show that the Payback Period will extend beyond a lifetime.



3. Will do. In a first pass, I let the Roth and taxable earn 10% while the TDA counterfactual earns 6%1 (i.e., so much stock sculpted out of it that it earned a return more like the Vanguard Retirement Income fund, which is 30/70). Huge increase in the Roth surplus, of course; but depressed values in the TDA and the taxable. Still thinking about the proper conceptualization.
[/quote]

Thanks again for posting! I would have enjoyed being one of your students. It’s nice to read an academic perspective that I can relate with.

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

Post by JoMoney »

McQ wrote: Thu Sep 23, 2021 12:28 pm... I will assume throughout that indeed, that was the goal of the conversion: to accumulate greater after-tax wealth at some unknown but distant future date, by reducing tax exposure that would otherwise be incurred by having to take RMDs not needed for living expenses. The claim made in the title of the thread presumes this is the goal of the conversion; if your goal in converting is to achieve something else, this thread may not be relevant to you.
...
Perhaps that's the critical caveat? Conversions are most beneficial for people that expect to have so much money in retirement that they don't actually need the money accumulated inside a retirement account.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
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LilyFleur
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by LilyFleur »

I don't want to get into the weeds on this very detailed spreadsheet, but, bottom line, is this what you are saying?

a. This entire projection is based on 100% stock in all accounts, earning 10% nominal, 7% actual, every year?

b. Tax brackets will increase by 3% each year, due to inflation?
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

JoMoney wrote: Sat Sep 25, 2021 7:53 pm
McQ wrote: Thu Sep 23, 2021 12:28 pm... I will assume throughout that indeed, that was the goal of the conversion: to accumulate greater after-tax wealth at some unknown but distant future date, by reducing tax exposure that would otherwise be incurred by having to take RMDs not needed for living expenses. The claim made in the title of the thread presumes this is the goal of the conversion; if your goal in converting is to achieve something else, this thread may not be relevant to you.
...
Perhaps that's the critical caveat? Conversions are most beneficial for people that expect to have so much money in retirement that they don't actually need the money accumulated inside a retirement account.
I guess that caveat would be fine if the analysis did not then put a pretty big finger on the scale and assume money in taxable account pays capital gains tax every year on all gains. If you don't need any of this money, you would leave it in a tax efficient ETF and get step up basis on death. Much of the benefit in the analysis comes from this tax drag on the taxable account.
Once in a while you get shown the light, in the strangest of places if you look at it right.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

McQ wrote: Sat Sep 25, 2021 12:51 pm
WoodSpinner wrote: Fri Sep 24, 2021 6:01 pm McQ,

I am looking forward to this discussion, many thanks for posting it here! I also appreciate the kind words!

What I would find interesting in a future iteration is to:
  1. Include a series of Roth Conversions before RMDs begin an a better illustration of their affects over time. For instance, convert $100,000/year from 60-71 and then RMDs.
  2. Be able to demonstrate a mechanism to help determine if you are converting too much or too little given your assumptions. I think this would require a more dynamic approach to Tax Rates than the current model provides.
  3. Affect of turbo-charging the Conversions and RMDs by moving Equities from the TDA to a more optimal asset location for future growth. In other wards while keeping the same overall Equity/Bond allocation try and fill Roth with only Equities, Taxable with Equities and Bonds (if necessary) and TDA with Bonds and Equities ( if necessary).
Thanks

WoodSpinner
Hello Woodspinner: thanks for those questions, I learn more when I learn what my audience really cares about. Brief replies, mostly placeholders:

1. This one doesn't actually make a difference (if tax is paid from the conversion). Imagine you converted $100,000 seven years earlier at age 64 all in the 24% bracket; you'd start with $100,000 in the counterfactual and $76,000 in the Roth, same as my age 71 example. Seven years later you'd have about $200,000 in the counterfactual and $152,000 in the Roth, because until RMDs begin, the two will always be in the ratio of 100/76, because both are in the same asset and tax is deferred on both.
So, there's no difference in pattern of outcomes if you convert $800,000 at age 71 or $100,000 a year for eight years; excepting the fact that you can't convert $800,000 at 24% in a single year.
If tax is paid from outside, the starting age does make a difference; I'll cover that in a later post.

2. Not sure I will be able to get beyond the rule of thumb I gave you earlier, but I'll keep this idea in the back of my mind. Once I release the SS, it will be easy enough to supply the tax rate year by year rather than leaving it constant; then one can run sensitivity tests, per DSBH, with tax rates going up by yay much, going down by yay much; or going up and down versus going down and up. Pegging out the extremes will give you a sense of the robustness of the conversion amount.

3. Will do. In a first pass, I let the Roth and taxable earn 10% while the TDA counterfactual earns 6% (i.e., so much stock sculpted out of it that it earned a return more like the Vanguard Retirement Income fund, which is 30/70). Huge increase in the Roth surplus, of course; but depressed values in the TDA and the taxable. Still thinking about the proper conceptualization.
Regarding item 3, This is the same (huge) problem that the calculator I-ORP introduces when analyzing Roth Conversions.

For a tax-efficient portfolio, you want to generally keep as much bonds as possible in TDA, and as much equities as possible in Roth and Taxable account. But, the "as possible" qualifier needs to include a constraint that one maintain a consistent tax-adjusted asset allocation. Otherwise, most of the perceived gains from doing the Roth Conversions comes from taking on more risk (increasing overall tax-adjusted equity allocation) rather than from more efficient tax planning, which I believe is what you are trying to isolate.
Once in a while you get shown the light, in the strangest of places if you look at it right.
sc9182
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by sc9182 »

marcopolo wrote: Sat Sep 25, 2021 10:23 pm
McQ wrote: Sat Sep 25, 2021 12:51 pm
WoodSpinner wrote: Fri Sep 24, 2021 6:01 pm McQ,

I am looking forward to this discussion, many thanks for posting it here! I also appreciate the kind words!

What I would find interesting in a future iteration is to:
  1. Include a series of Roth Conversions before RMDs begin an a better illustration of their affects over time. For instance, convert $100,000/year from 60-71 and then RMDs.
  2. Be able to demonstrate a mechanism to help determine if you are converting too much or too little given your assumptions. I think this would require a more dynamic approach to Tax Rates than the current model provides.
  3. Affect of turbo-charging the Conversions and RMDs by moving Equities from the TDA to a more optimal asset location for future growth. In other wards while keeping the same overall Equity/Bond allocation try and fill Roth with only Equities, Taxable with Equities and Bonds (if necessary) and TDA with Bonds and Equities ( if necessary).
Thanks

WoodSpinner
Hello Woodspinner: thanks for those questions, I learn more when I learn what my audience really cares about. Brief replies, mostly placeholders:

1. This one doesn't actually make a difference (if tax is paid from the conversion). Imagine you converted $100,000 seven years earlier at age 64 all in the 24% bracket; you'd start with $100,000 in the counterfactual and $76,000 in the Roth, same as my age 71 example. Seven years later you'd have about $200,000 in the counterfactual and $152,000 in the Roth, because until RMDs begin, the two will always be in the ratio of 100/76, because both are in the same asset and tax is deferred on both.
So, there's no difference in pattern of outcomes if you convert $800,000 at age 71 or $100,000 a year for eight years; excepting the fact that you can't convert $800,000 at 24% in a single year.
If tax is paid from outside, the starting age does make a difference; I'll cover that in a later post.

2. Not sure I will be able to get beyond the rule of thumb I gave you earlier, but I'll keep this idea in the back of my mind. Once I release the SS, it will be easy enough to supply the tax rate year by year rather than leaving it constant; then one can run sensitivity tests, per DSBH, with tax rates going up by yay much, going down by yay much; or going up and down versus going down and up. Pegging out the extremes will give you a sense of the robustness of the conversion amount.

3. Will do. In a first pass, I let the Roth and taxable earn 10% while the TDA counterfactual earns 6% (i.e., so much stock sculpted out of it that it earned a return more like the Vanguard Retirement Income fund, which is 30/70). Huge increase in the Roth surplus, of course; but depressed values in the TDA and the taxable. Still thinking about the proper conceptualization.
Regarding item 3, This is the same (huge) problem that the calculator I-ORP introduces when analyzing Roth Conversions.

For a tax-efficient portfolio, you want to generally keep as much bonds as possible in TDA, and as much equities as possible in Roth and Taxable account. But, the "as possible" qualifier needs to include a constraint that one maintain a consistent tax-adjusted asset allocation. Otherwise, most of the perceived gains from doing the Roth Conversions comes from taking on more risk (increasing overall tax-adjusted equity allocation) rather than from more efficient tax planning, which I believe is what you are trying to isolate.
Yes great point - and this also assumes you never needed the Roth Nor TDA monies towards living expenses to begin with.

If you ever need those monies for living expenses, and if market takes a dive just around the time when you ever need those Roth monies (which are aggressively invested in mostly-stock allocation) — you then be in a big Mess !! As Roth accounts have taken a 50% + dive during worst markets, and you need to withdraw at most in-opportunistic times :-(

Then again, the party-line of this thread is: allow sufficient time past age 94, 96, or 100 years (almost eternity on human scale)., then Roth could still come out ahead as markets could recover fully. Then again - you never needed those Roth monies in current life - and Roths are exclusively earmarked for posthumously + 10 years post inheritance (also assuming all your heirs never need those monies during those 10 years). So yes, most likely Roth succeeds due to the long runway and allowing those monies to compound left un-touched (although the outperformance is slight%) ..

Yes, I am for Roth ! But, not over-eager to put/convert all chips aggressively into Roth. Tax diversification is the Mantra.
Last edited by sc9182 on Sun Sep 26, 2021 2:26 pm, edited 2 times in total.
WhiteMaxima
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by WhiteMaxima »

I assume standard deduction is $24000. So for a couple can roth conversion $80,250+$24000=$104250/year to keep tax bracket below 12% (15% after 2025). Is this right?
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FiveK »

WhiteMaxima wrote: Sun Sep 26, 2021 12:13 am I assume standard deduction is $24000. So for a couple can roth conversion $80,250+$24000=$104250/year to keep tax bracket below 12% (15% after 2025). Is this right?
For 2021, standard deduction for MFJ both under age 65 is $25,100 and the top of the 12% bracket is $81,050. So yes, if the Roth conversion is the only income, a $106,150 Roth conversion will stay below a 22% federal marginal tax rate and cost $9,334 in federal tax.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by WhiteMaxima »

FiveK wrote: Sun Sep 26, 2021 12:43 am
WhiteMaxima wrote: Sun Sep 26, 2021 12:13 am I assume standard deduction is $24000. So for a couple can roth conversion $80,250+$24000=$104250/year to keep tax bracket below 12% (15% after 2025). Is this right?
For 2021, standard deduction for MFJ both under age 65 is $25,100 and the top of the 12% bracket is $81,050. So yes, if the Roth conversion is the only income, a $106,150 Roth conversion will stay below a 22% federal marginal tax rate and cost $9,334 in federal tax.
I think you mean a $106,150 Roth conversion will stay below a 12% bracket.
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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 »

WhiteMaxima wrote: Sun Sep 26, 2021 12:55 am
FiveK wrote: Sun Sep 26, 2021 12:43 am
WhiteMaxima wrote: Sun Sep 26, 2021 12:13 am I assume standard deduction is $24000. So for a couple can roth conversion $80,250+$24000=$104250/year to keep tax bracket below 12% (15% after 2025). Is this right?
For 2021, standard deduction for MFJ both under age 65 is $25,100 and the top of the 12% bracket is $81,050. So yes, if the Roth conversion is the only income, a $106,150 Roth conversion will stay below a 22% federal marginal tax rate and cost $9,334 in federal tax.
I think you mean a $106,150 Roth conversion will stay below a 12% bracket.
To stay below the 12% federal bracket, that MFJ couple could convert no more than $45,000. See What Is My Tax Bracket? 2020-2021 Federal Tax Brackets. If by "below" you mean "within" or "below the top of" then yes.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by WhiteMaxima »

FiveK wrote: Sun Sep 26, 2021 1:05 am
WhiteMaxima wrote: Sun Sep 26, 2021 12:55 am
FiveK wrote: Sun Sep 26, 2021 12:43 am
WhiteMaxima wrote: Sun Sep 26, 2021 12:13 am I assume standard deduction is $24000. So for a couple can roth conversion $80,250+$24000=$104250/year to keep tax bracket below 12% (15% after 2025). Is this right?
For 2021, standard deduction for MFJ both under age 65 is $25,100 and the top of the 12% bracket is $81,050. So yes, if the Roth conversion is the only income, a $106,150 Roth conversion will stay below a 22% federal marginal tax rate and cost $9,334 in federal tax.
I think you mean a $106,150 Roth conversion will stay below a 12% bracket.
To stay below the 12% federal bracket, that MFJ couple could convert no more than $45,000. See What Is My Tax Bracket? 2020-2021 Federal Tax Brackets. If by "below" you mean "within" or "below the top of" then yes.
I see MFJ 12% bracket is $80250, so below that is 12% not 22%.
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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 »

WhiteMaxima wrote: Sun Sep 26, 2021 1:15 am
FiveK wrote: Sun Sep 26, 2021 1:05 am To stay below the 12% federal bracket, that MFJ couple could convert no more than $45,000. See What Is My Tax Bracket? 2020-2021 Federal Tax Brackets. If by "below" you mean "within" or "below the top of" then yes.
I see MFJ 12% bracket is $80250, so below that is 12% not 22%.
Other than defining the word "below" differently, we're saying the same thing. :beer
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McQ
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

JoMoney wrote: Sat Sep 25, 2021 7:53 pm
McQ wrote: Thu Sep 23, 2021 12:28 pm... I will assume throughout that indeed, that was the goal of the conversion: to accumulate greater after-tax wealth at some unknown but distant future date, by reducing tax exposure that would otherwise be incurred by having to take RMDs not needed for living expenses. The claim made in the title of the thread presumes this is the goal of the conversion; if your goal in converting is to achieve something else, this thread may not be relevant to you.
...
Perhaps that's the critical caveat? Conversions are most beneficial for people that expect to have so much money in retirement that they don't actually need the money accumulated inside a retirement account.
Yes, it is the critical stipulation, and yes, it does assume surplus funds have been accumulated. But it is quite consistent with what countless posters here on BH have told me is their goal.

Later, after "always" has been established, I'll look at cases where the expected surplus wasn't there, and either the TDA or the Roth has to be tapped. I'll also look briefly at a different goal: the goal of living better, in the here and not-so-distant future, by tapping tax-free Roth accumulations for living expenses. My hunch, based on the first run, conducted in the SSRN paper: conversions may blow up if not left undisturbed, i.e., become a losing proposition.

But that post is still a week or more out.
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.
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McQ
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

cbeck wrote: Sat Sep 25, 2021 6:12 pm I miss the part about the source of funds to pay the taxes. Does this analysis assume that taxes are paid from the IRA or from other, after-tax funds? If from after-tax funds, then that amounts to a conversion of taxable funds to Roth, which is a guaranteed winner, no?
The first series of posts assumes funds will be paid from the conversion. A second series considers paying funds from outside.

As FiveK indicated in his/her reply, that will make a difference, but (my words now) rather less than many people expect.
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.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by LilyFleur »

sc9182 wrote: Sat Sep 25, 2021 11:50 pm
marcopolo wrote: Sat Sep 25, 2021 10:23 pm
McQ wrote: Sat Sep 25, 2021 12:51 pm
WoodSpinner wrote: Fri Sep 24, 2021 6:01 pm McQ,

I am looking forward to this discussion, many thanks for posting it here! I also appreciate the kind words!

What I would find interesting in a future iteration is to:
  1. Include a series of Roth Conversions before RMDs begin an a better illustration of their affects over time. For instance, convert $100,000/year from 60-71 and then RMDs.
  2. Be able to demonstrate a mechanism to help determine if you are converting too much or too little given your assumptions. I think this would require a more dynamic approach to Tax Rates than the current model provides.
  3. Affect of turbo-charging the Conversions and RMDs by moving Equities from the TDA to a more optimal asset location for future growth. In other wards while keeping the same overall Equity/Bond allocation try and fill Roth with only Equities, Taxable with Equities and Bonds (if necessary) and TDA with Bonds and Equities ( if necessary).
Thanks

WoodSpinner
Hello Woodspinner: thanks for those questions, I learn more when I learn what my audience really cares about. Brief replies, mostly placeholders:

1. This one doesn't actually make a difference (if tax is paid from the conversion). Imagine you converted $100,000 seven years earlier at age 64 all in the 24% bracket; you'd start with $100,000 in the counterfactual and $76,000 in the Roth, same as my age 71 example. Seven years later you'd have about $200,000 in the counterfactual and $152,000 in the Roth, because until RMDs begin, the two will always be in the ratio of 100/76, because both are in the same asset and tax is deferred on both.
So, there's no difference in pattern of outcomes if you convert $800,000 at age 71 or $100,000 a year for eight years; excepting the fact that you can't convert $800,000 at 24% in a single year.
If tax is paid from outside, the starting age does make a difference; I'll cover that in a later post.

2. Not sure I will be able to get beyond the rule of thumb I gave you earlier, but I'll keep this idea in the back of my mind. Once I release the SS, it will be easy enough to supply the tax rate year by year rather than leaving it constant; then one can run sensitivity tests, per DSBH, with tax rates going up by yay much, going down by yay much; or going up and down versus going down and up. Pegging out the extremes will give you a sense of the robustness of the conversion amount.

3. Will do. In a first pass, I let the Roth and taxable earn 10% while the TDA counterfactual earns 6% (i.e., so much stock sculpted out of it that it earned a return more like the Vanguard Retirement Income fund, which is 30/70). Huge increase in the Roth surplus, of course; but depressed values in the TDA and the taxable. Still thinking about the proper conceptualization.
Regarding item 3, This is the same (huge) problem that the calculator I-ORP introduces when analyzing Roth Conversions.

For a tax-efficient portfolio, you want to generally keep as much bonds as possible in TDA, and as much equities as possible in Roth and Taxable account. But, the "as possible" qualifier needs to include a constraint that one maintain a consistent tax-adjusted asset allocation. Otherwise, most of the perceived gains from doing the Roth Conversions comes from taking on more risk (increasing overall tax-adjusted equity allocation) rather than from more efficient tax planning, which I believe is what you are trying to isolate.
Yes great point - and this also assumes you never needed the Roth Nor TDA monies towards living expenses to begin with.

If you ever need those monies for living expenses, and if market takes a dive just around the time when you ever need those Roth monies (which are aggressively invested in mostly-stock allocation) — you then be in a big Mess !! As Roth accounts have taken a 50% + dive during worst markets, and you need to withdraw at most in-opportunistic times :-(

Then again, the party-line of this thread is: allow sufficient time past age 94, 96, or 100 years (almost eternity on human scale)., then Roth could still come out ahead as markets could recover fully. Then again - you never needed those Roth monies in current life - and Roths are exclusively earmarked for posthumously + 10 years post inheritance (also assuming all your heirs never need those monies during those 10 years). So yes, most likely Roth succeeds due to the long runway and allowing those monies to compound left un-touched (although the outperformance is slight%) ..

Yes, I am for Roth ! But, not greedy to put/convert all chips aggressively into Roth. Tax diversification is the Mantra.
If the market takes a dive, wouldn't you then take living expenses out of cash or bonds? Presumably those are not in your Roth.
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McQ
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

LilyFleur wrote: Sat Sep 25, 2021 8:18 pm I don't want to get into the weeds on this very detailed spreadsheet, but, bottom line, is this what you are saying?

a. This entire projection is based on 100% stock in all accounts, earning 10% nominal, 7% actual, every year?
Yes. But the SS is set up so that you can enter a different rate of return. But then the tax drag would be different on taxable (e.g., income other than qualified dividends). So stocks only, stocks everywhere, is a simplification while I work through the initial demonstration.
b. Tax brackets will increase by 3% each year, due to inflation?
Yes, but that only matters when projecting poor Bob and Barb's miscalculation. This (much simplified) spreadsheet holds the tax rate constant without worrying about tax brackets, which of course, would be determined by the entire asset mix plus pension plus social security, which would in turn be different for everyone, which in turn would despoil the simplicity of the demonstration. My current take on my SSRN paper, and the reason why I launched this thread, in preparation for its revision, is that the spreadsheets there tried to do too much.
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.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by smitcat »

LilyFleur wrote: Sun Sep 26, 2021 2:22 pm
sc9182 wrote: Sat Sep 25, 2021 11:50 pm
marcopolo wrote: Sat Sep 25, 2021 10:23 pm
McQ wrote: Sat Sep 25, 2021 12:51 pm
WoodSpinner wrote: Fri Sep 24, 2021 6:01 pm McQ,

I am looking forward to this discussion, many thanks for posting it here! I also appreciate the kind words!

What I would find interesting in a future iteration is to:
  1. Include a series of Roth Conversions before RMDs begin an a better illustration of their affects over time. For instance, convert $100,000/year from 60-71 and then RMDs.
  2. Be able to demonstrate a mechanism to help determine if you are converting too much or too little given your assumptions. I think this would require a more dynamic approach to Tax Rates than the current model provides.
  3. Affect of turbo-charging the Conversions and RMDs by moving Equities from the TDA to a more optimal asset location for future growth. In other wards while keeping the same overall Equity/Bond allocation try and fill Roth with only Equities, Taxable with Equities and Bonds (if necessary) and TDA with Bonds and Equities ( if necessary).
Thanks

WoodSpinner
Hello Woodspinner: thanks for those questions, I learn more when I learn what my audience really cares about. Brief replies, mostly placeholders:

1. This one doesn't actually make a difference (if tax is paid from the conversion). Imagine you converted $100,000 seven years earlier at age 64 all in the 24% bracket; you'd start with $100,000 in the counterfactual and $76,000 in the Roth, same as my age 71 example. Seven years later you'd have about $200,000 in the counterfactual and $152,000 in the Roth, because until RMDs begin, the two will always be in the ratio of 100/76, because both are in the same asset and tax is deferred on both.
So, there's no difference in pattern of outcomes if you convert $800,000 at age 71 or $100,000 a year for eight years; excepting the fact that you can't convert $800,000 at 24% in a single year.
If tax is paid from outside, the starting age does make a difference; I'll cover that in a later post.

2. Not sure I will be able to get beyond the rule of thumb I gave you earlier, but I'll keep this idea in the back of my mind. Once I release the SS, it will be easy enough to supply the tax rate year by year rather than leaving it constant; then one can run sensitivity tests, per DSBH, with tax rates going up by yay much, going down by yay much; or going up and down versus going down and up. Pegging out the extremes will give you a sense of the robustness of the conversion amount.

3. Will do. In a first pass, I let the Roth and taxable earn 10% while the TDA counterfactual earns 6% (i.e., so much stock sculpted out of it that it earned a return more like the Vanguard Retirement Income fund, which is 30/70). Huge increase in the Roth surplus, of course; but depressed values in the TDA and the taxable. Still thinking about the proper conceptualization.
Regarding item 3, This is the same (huge) problem that the calculator I-ORP introduces when analyzing Roth Conversions.

For a tax-efficient portfolio, you want to generally keep as much bonds as possible in TDA, and as much equities as possible in Roth and Taxable account. But, the "as possible" qualifier needs to include a constraint that one maintain a consistent tax-adjusted asset allocation. Otherwise, most of the perceived gains from doing the Roth Conversions comes from taking on more risk (increasing overall tax-adjusted equity allocation) rather than from more efficient tax planning, which I believe is what you are trying to isolate.
Yes great point - and this also assumes you never needed the Roth Nor TDA monies towards living expenses to begin with.

If you ever need those monies for living expenses, and if market takes a dive just around the time when you ever need those Roth monies (which are aggressively invested in mostly-stock allocation) — you then be in a big Mess !! As Roth accounts have taken a 50% + dive during worst markets, and you need to withdraw at most in-opportunistic times :-(

Then again, the party-line of this thread is: allow sufficient time past age 94, 96, or 100 years (almost eternity on human scale)., then Roth could still come out ahead as markets could recover fully. Then again - you never needed those Roth monies in current life - and Roths are exclusively earmarked for posthumously + 10 years post inheritance (also assuming all your heirs never need those monies during those 10 years). So yes, most likely Roth succeeds due to the long runway and allowing those monies to compound left un-touched (although the outperformance is slight%) ..

Yes, I am for Roth ! But, not greedy to put/convert all chips aggressively into Roth. Tax diversification is the Mantra.
If the market takes a dive, wouldn't you then take living expenses out of cash or bonds? Presumably those are not in your Roth.
Yes - that would be our plan.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by McQ »

marcopolo wrote: Sat Sep 25, 2021 10:12 pm
JoMoney wrote: Sat Sep 25, 2021 7:53 pm
McQ wrote: Thu Sep 23, 2021 12:28 pm... I will assume throughout that indeed, that was the goal of the conversion: to accumulate greater after-tax wealth at some unknown but distant future date, by reducing tax exposure that would otherwise be incurred by having to take RMDs not needed for living expenses. The claim made in the title of the thread presumes this is the goal of the conversion; if your goal in converting is to achieve something else, this thread may not be relevant to you.
...
Perhaps that's the critical caveat? Conversions are most beneficial for people that expect to have so much money in retirement that they don't actually need the money accumulated inside a retirement account.
I guess that caveat would be fine if the analysis did not then put a pretty big finger on the scale and assume money in taxable account pays capital gains tax every year on all gains. If you don't need any of this money, you would leave it in a tax efficient ETF and get step up basis on death. Much of the benefit in the analysis comes from this tax drag on the taxable account.
I think I disagree. I do agree that the dollar payoff is enhanced by removing any prospect of a step up on the taxable at death.
But I don't think that matters at the current juncture, which is to demonstrate "always."

Later, I'll redo the spreadsheet so that capital gains are not taken but left embedded. Dollar payoff for the conversion will be reduced at any given evaluation age, is my expectation. Per the opening post, after showing "always," I intend to move onto "but generally not much of a pay off, and not soon."
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by sc9182 »

LilyFleur wrote: Sun Sep 26, 2021 2:22 pm If the market takes a dive, wouldn't you then take living expenses out of cash or bonds? Presumably those are not in your Roth.
Thats the whole point - do have assets in each tax-type bucket. Don’t be overly aggressive in conveying everything to Roth, nor overly be afraid of the RMDs - especially if one ever needs TDA and/or Roth monies for any living or one-time expenses (and multiple other things such as Large medical expenses, or nursing-home etc expenses, charity, or QCDs are on mind)
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by LilyFleur »

McQ wrote: Sun Sep 26, 2021 2:28 pm
LilyFleur wrote: Sat Sep 25, 2021 8:18 pm I don't want to get into the weeds on this very detailed spreadsheet, but, bottom line, is this what you are saying?

a. This entire projection is based on 100% stock in all accounts, earning 10% nominal, 7% actual, every year?
Yes. But the SS is set up so that you can enter a different rate of return. But then the tax drag would be different on taxable (e.g., income other than qualified dividends). So stocks only, stocks everywhere, is a simplification while I work through the initial demonstration.
b. Tax brackets will increase by 3% each year, due to inflation?
Yes, but that only matters when projecting poor Bob and Barb's miscalculation. This (much simplified) spreadsheet holds the tax rate constant without worrying about tax brackets, which of course, would be determined by the entire asset mix plus pension plus social security, which would in turn be different for everyone, which in turn would despoil the simplicity of the demonstration. My current take on my SSRN paper, and the reason why I launched this thread, in preparation for its revision, is that the spreadsheets there tried to do too much.
I just cannot get past the earnings estimate in a Roth decision. I've done two conversions, realizing it is a bit of a gamble. When I'm 85 (if I make it to 85), I could have a nice big tax problem due to my 401k balance, or no tax problem at all.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by LilyFleur »

sc9182 wrote: Sun Sep 26, 2021 2:35 pm
LilyFleur wrote: Sun Sep 26, 2021 2:22 pm If the market takes a dive, wouldn't you then take living expenses out of cash or bonds? Presumably those are not in your Roth.
Thats the whole point - do have assets in each tax-type bucket. Don’t be overly aggressive in conveying everything to Roth, nor overly be afraid of the RMDs - especially if one ever needs TDA and/or Roth monies for any living or one-time expenses (and multiple other things such as Large medical expenses, or nursing-home etc expenses, charity, or QCDs are on mind)
I agree.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by WoodSpinner »

sc9182 wrote: Sun Sep 26, 2021 2:35 pm
LilyFleur wrote: Sun Sep 26, 2021 2:22 pm If the market takes a dive, wouldn't you then take living expenses out of cash or bonds? Presumably those are not in your Roth.
Thats the whole point - do have assets in each tax-type bucket. Don’t be overly aggressive in conveying everything to Roth, nor overly be afraid of the RMDs - especially if one ever needs TDA and/or Roth monies for any living or one-time expenses (and multiple other things such as Large medical expenses, or nursing-home etc expenses, charity, or QCDs are on mind)
I use an alternate approach….

I hold only Equities in Roth. When I need to spend from them, I exchange Bonds for Equities in the IRA.

It’s pretty simple and usually done once a year as part of my annual rebalancing.

Roth space is too precious to waste on Bonds (IMHO).

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

Post by sc9182 »

WoodSpinner wrote: Sun Sep 26, 2021 2:55 pm
sc9182 wrote: Sun Sep 26, 2021 2:35 pm
LilyFleur wrote: Sun Sep 26, 2021 2:22 pm If the market takes a dive, wouldn't you then take living expenses out of cash or bonds? Presumably those are not in your Roth.
Thats the whole point - do have assets in each tax-type bucket. Don’t be overly aggressive in conveying everything to Roth, nor overly be afraid of the RMDs - especially if one ever needs TDA and/or Roth monies for any living or one-time expenses (and multiple other things such as Large medical expenses, or nursing-home etc expenses, charity, or QCDs are on mind)
I use an alternate approach….

I hold only Equities in Roth. When I need to spend from them, I exchange Bonds for Equities in the IRA.

It’s pretty simple and usually done once a year as part of my annual rebalancing.

Roth space is too precious to waste on Bonds (IMHO).

WoodSpinner
Now - not only your Roths are full of equities, and higher-than previous % of your IRA assets got into equities as well — hasn’t that upended overall asset allocation - now tilted more-aggressively towards equities ?

We haven’t figured the hypothesis of — fill up Roth with 100% equities (Q: why not add a sliver of 3x leverages in it, while making/keeping Roth aggressively in equities!?)., and keep most/all bonds in IRA. Don’t necessarily know this hypothesis is fully vetted here or elsewhere!? Or if it stands test of times (and tougher times!? Have to see ..
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by WoodSpinner »

sc9182 wrote: Sun Sep 26, 2021 3:05 pm
WoodSpinner wrote: Sun Sep 26, 2021 2:55 pm
sc9182 wrote: Sun Sep 26, 2021 2:35 pm
LilyFleur wrote: Sun Sep 26, 2021 2:22 pm If the market takes a dive, wouldn't you then take living expenses out of cash or bonds? Presumably those are not in your Roth.
Thats the whole point - do have assets in each tax-type bucket. Don’t be overly aggressive in conveying everything to Roth, nor overly be afraid of the RMDs - especially if one ever needs TDA and/or Roth monies for any living or one-time expenses (and multiple other things such as Large medical expenses, or nursing-home etc expenses, charity, or QCDs are on mind)
I use an alternate approach….

I hold only Equities in Roth. When I need to spend from them, I exchange Bonds for Equities in the IRA.

It’s pretty simple and usually done once a year as part of my annual rebalancing.

Roth space is too precious to waste on Bonds (IMHO).

WoodSpinner
Now - not only your Roths are full of equities, and higher-than previous % of your IRA assets got into equities as well — hasn’t that upended overall asset allocation - now tilted more-aggressively towards equities ?
Not sure I understand your point, can you elaborate?

For Example:
1. Sell $50,000 of VTI in Roth for for yearly expenses
2. Sell $50,000 of VGIT in IRA And Buy $50,000 of VTI
3. Rebalance as needed.

*Note: I have NO taxable assets at this time, only Roth or IRA.

Overall AA remains consistent.

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

Post by McQ »

Terrible, horrible, no good, very bad Roth conversions

I know from prior threads that there are some BH out there who struggle with whether to convert up into the 22% bracket. It makes them uncomfortable to pay that much, but the prospect of paying 25% post-TCJA, maybe more with IRMAA, serves as a spur. And if they project their stock gains over the last 10 years forward over the next ten years 😉, it is easy to tell a story where RMDs put them in the 24% bracket, or post-TCJA, the 28% bracket. Hence, they agonize: is converting now at 22% really a good idea?

But if you can imagine the past decade’s stock returns continuing at the same rate for the next ten years (!), you can also imagine the rules on taxation of social security benefits being relaxed so that most of yours will not to be taxable. You can likewise imagine the standard deduction doubling once again; and it is all too easy to imagine the performance of stocks over the next ten years looking rather more like what we saw from 1999 to 2009, which might drive down the real value of your portfolio by over half.

Put it all together, and it becomes conceivable that a conversion today, at 22%, will suffice only to avert RMDs that would have been taxed at … 0%. Here's the spreadsheet showing how that scenario plays out.
Image

Not to worry, the conversion will stay pay off. But … it will take longer. In fact, I, ahem, did have to add more rows to the spreadsheet, but as you can see, the Roth conversion will begin to pay off by age 107, and will actually be fairly lucrative by age 110.

1st apology to the Eagles:
“Roth will win/
In the long run”

Next, the reductio. I have no story to tell here; simply the math of the worst imaginable case under the current tax structure. That would be to convert at the top rate of 37%, to avert RMDs that would only have been taxed at … zero. This is a pure reductio. I cannot imagine a real world case that would produce this course of events; or put another way, an investor who would be so foolish as to convert at 37% to save taxes at zero. But, some investors suffer from tax phobia, mysterious are the ways of Congress, and mighty is the voting power of affluent seniors, so … who knows?

Can a conversion at 37%, that serves only to reduce RMDs that would have been taxed at 0%, possibly pay off? Sure; you just have to wait a long, long, long time. ‘Til about age 122:

Image


Here I want to acknowledge comments made upthread by dodecahedron and FiveK about how long is too long to wait for a Roth conversion to pay off.

In that vein, some of you may object that a payoff that does not occur until an age of 122 is not really a pay off achieved in human time, hence, not suitable as proof for the claim made in the title of the thread.

But consider: not a few BH have posted that their goal in converting is to produce greater after-tax wealth for their heirs. Because heirs have 10 years to distribute, 122 is really a matter of 112 at death. Next, the Uniform Life Table covers spouses up to 10 years younger; which means that 122 might correspond to age 102 for a younger spouse second to die. And if you don’t think there are any BH in their 60s today who are going to live to 102, you have not kept up with changes in life expectancy among the well-educated, well-off population in the US.

Roth conversions always pay off—if you can hold on long enough. True, it wouldn’t be much fun to be down $450,000 on the conversion as late as age 112, but look at the magnitude of the pay off by age 125. :happy And consider as well that people who convert at 37% often convert millions, not a measly $100,000. So multiply that age 125 dollar payoff by 10 …

With this post the bulk of what I hoped to accomplish by the thread has been laid out. In a little bit, I’ll proceed to several extensions.
1. What if you faced a sudden expense of some tens of thousands of dollars—wouldn’t it be great to have a Roth so that you could cover that expense without taking it from the TDA and bumping yourself up into a higher tax bracket? Or having to liquidate taxable accounts with a big embedded capital gain? That would be great—wouldn’t it??
2. What about the widowed survivor facing single tax brackets—won’t Roth conversions bring a particularly strong pay off in that case?
3. Suppose, ten or fifteen years in, a couple decides to start spending from their Roth account, to live better without incurring any additional tax burden. What does that do to Roth conversion outcomes?

Before proceeding to those issues, though, it will be important to develop a metric more suitable than just raw nominal dollars. I reference chip’s comment above about real versus nominal dollars; the farther in the future we project, the more important it becomes to work with real values.

There will be a few other loose ends as well, plus, hopefully, unanticipated issues raised in the comments. If no additional errors in the SS are uncovered, I’ll also release the SS itself, the better to get feedback from the BH community.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

McQ wrote: Sun Sep 26, 2021 5:18 pm Terrible, horrible, no good, very bad Roth conversions

I know from prior threads that there are some BH out there who struggle with whether to convert up into the 22% bracket. It makes them uncomfortable to pay that much, but the prospect of paying 25% post-TCJA, maybe more with IRMAA, serves as a spur. And if they project their stock gains over the last 10 years forward over the next ten years 😉, it is easy to tell a story where RMDs put them in the 24% bracket, or post-TCJA, the 28% bracket. Hence, they agonize: is converting now at 22% really a good idea?

But if you can imagine the past decade’s stock returns continuing at the same rate for the next ten years (!), you can also imagine the rules on taxation of social security benefits being relaxed so that most of yours will not to be taxable. You can likewise imagine the standard deduction doubling once again; and it is all too easy to imagine the performance of stocks over the next ten years looking rather more like what we saw from 1999 to 2009, which might drive down the real value of your portfolio by over half.

Put it all together, and it becomes conceivable that a conversion today, at 22%, will suffice only to avert RMDs that would have been taxed at … 0%. Here's the spreadsheet showing how that scenario plays out.
Image

Not to worry, the conversion will stay pay off. But … it will take longer. In fact, I, ahem, did have to add more rows to the spreadsheet, but as you can see, the Roth conversion will begin to pay off by age 107, and will actually be fairly lucrative by age 110.

1st apology to the Eagles:
“Roth will win/
In the long run”

Next, the reductio. I have no story to tell here; simply the math of the worst imaginable case under the current tax structure. That would be to convert at the top rate of 37%, to avert RMDs that would only have been taxed at … zero. This is a pure reductio. I cannot imagine a real world case that would produce this course of events; or put another way, an investor who would be so foolish as to convert at 37% to save taxes at zero. But, some investors suffer from tax phobia, mysterious are the ways of Congress, and mighty is the voting power of affluent seniors, so … who knows?

Can a conversion at 37%, that serves only to reduce RMDs that would have been taxed at 0%, possibly pay off? Sure; you just have to wait a long, long, long time. ‘Til about age 122:

Image


Here I want to acknowledge comments made upthread by dodecahedron and FiveK about how long is too long to wait for a Roth conversion to pay off.

In that vein, some of you may object that a payoff that does not occur until an age of 122 is not really a pay off achieved in human time, hence, not suitable as proof for the claim made in the title of the thread.

But consider: not a few BH have posted that their goal in converting is to produce greater after-tax wealth for their heirs. Because heirs have 10 years to distribute, 122 is really a matter of 112 at death. Next, the Uniform Life Table covers spouses up to 10 years younger; which means that 122 might correspond to age 102 for a younger spouse second to die. And if you don’t think there are any BH in their 60s today who are going to live to 102, you have not kept up with changes in life expectancy among the well-educated, well-off population in the US.

Roth conversions always pay off—if you can hold on long enough. True, it wouldn’t be much fun to be down $450,000 on the conversion as late as age 112, but look at the magnitude of the pay off by age 125. :happy And consider as well that people who convert at 37% often convert millions, not a measly $100,000. So multiply that age 125 dollar payoff by 10 …

With this post the bulk of what I hoped to accomplish by the thread has been laid out. In a little bit, I’ll proceed to several extensions.
1. What if you faced a sudden expense of some tens of thousands of dollars—wouldn’t it be great to have a Roth so that you could cover that expense without taking it from the TDA and bumping yourself up into a higher tax bracket? Or having to liquidate taxable accounts with a big embedded capital gain? That would be great—wouldn’t it??
2. What about the widowed survivor facing single tax brackets—won’t Roth conversions bring a particularly strong pay off in that case?
3. Suppose, ten or fifteen years in, a couple decides to start spending from their Roth account, to live better without incurring any additional tax burden. What does that do to Roth conversion outcomes?

Before proceeding to those issues, though, it will be important to develop a metric more suitable than just raw nominal dollars. I reference chip’s comment above about real versus nominal dollars; the farther in the future we project, the more important it becomes to work with real values.

There will be a few other loose ends as well, plus, hopefully, unanticipated issues raised in the comments. If no additional errors in the SS are uncovered, I’ll also release the SS itself, the better to get feedback from the BH community.
Huh? What embedded capital gains?
You already made the assumption that all gains are taxed each year, right?
Once in a while you get shown the light, in the strangest of places if you look at it right.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by dodecahedron »

McQ wrote: Sun Sep 26, 2021 5:18 pm Next, the reductio. I have no story to tell here; simply the math of the worst imaginable case under the current tax structure. That would be to convert at the top rate of 37%, to avert RMDs that would only have been taxed at … zero. This is a pure reductio. I cannot imagine a real world case that would produce this course of events;
I would suggest you are lacking in imagination. Simply imagine a taxpayer couple with very successful investments (e.g., a family business) throwing off large amount of taxable income such that the TPs project being in the top tax bracket for the rest of their lives (and their children's lives.)

Then imagine that, unfortunately, down the road, an embezzler employee defrauds the family business or the child designated to take over the business turns out to be incompetent, or some environmental disaster destroys the business or some unscrupulous person or charity preys upon the taxpayers with a scam that destroys their portfolio and shrinks their AGI well below original projections.

In my own small town (population 20,000), I have read of several extremely wealthy senior citizens who eventually developed dementia and were taken advantage of by embezzling attorneys who served as fiduciary trustees of large trusts designed to provide for their old age in great luxury and comfort. I am sure this happens elsewhere.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by cas »

McQ wrote: Sun Sep 26, 2021 5:18 pm Terrible, horrible, no good, very bad Roth conversions

Put it all together, and it becomes conceivable that a conversion today, at 22%, will suffice only to avert RMDs that would have been taxed at … 0%. Here's the spreadsheet showing how that scenario plays out.
I realize this is a hypothetical for demonstration purposes, but, just checking...

Your hypothetical invokes some scenario where RMDs end up taxed at 0%. (OK. Fair enough. One plausible example that is frequently discussed in bogleheads threads is a scenario where high long term care medical expenses lead to a high medical deduction.)

But then you are leaving the taxation of realized capital gains and dividends at 15%.

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

Post by sc9182 »

WoodSpinner wrote: Sun Sep 26, 2021 5:11 pm
sc9182 wrote: Sun Sep 26, 2021 3:05 pm
WoodSpinner wrote: Sun Sep 26, 2021 2:55 pm
sc9182 wrote: Sun Sep 26, 2021 2:35 pm
LilyFleur wrote: Sun Sep 26, 2021 2:22 pm If the market takes a dive, wouldn't you then take living expenses out of cash or bonds? Presumably those are not in your Roth.
Thats the whole point - do have assets in each tax-type bucket. Don’t be overly aggressive in conveying everything to Roth, nor overly be afraid of the RMDs - especially if one ever needs TDA and/or Roth monies for any living or one-time expenses (and multiple other things such as Large medical expenses, or nursing-home etc expenses, charity, or QCDs are on mind)
I use an alternate approach….

I hold only Equities in Roth. When I need to spend from them, I exchange Bonds for Equities in the IRA.

It’s pretty simple and usually done once a year as part of my annual rebalancing.

Roth space is too precious to waste on Bonds (IMHO).

WoodSpinner
Now - not only your Roths are full of equities, and higher-than previous % of your IRA assets got into equities as well — hasn’t that upended overall asset allocation - now tilted more-aggressively towards equities ?
Not sure I understand your point, can you elaborate?

For Example:
1. Sell $50,000 of VTI in Roth for for yearly expenses
2. Sell $50,000 of VGIT in IRA And Buy $50,000 of VTI
3. Rebalance as needed.

*Note: I have NO taxable assets at this time, only Roth or IRA.

Overall AA remains consistent.

WoodSpinner
In bad markets (is the condition our mini-conv started off with)., Roth May be cut in half (and that Roth is full of equities,VTI),while IRA May be full of Bonds (VGIT). And many Overly-pro BH threads mention to keep Roth full of equities and Stuff IRA with bonds.

If you sell $50k VGIT in IRA, and your Roth is already full of VTI which $50k for living expenses, now buy $50k VTI in IRA ? if you rebalance — aren’t you going to end up buying VTI/equities in IRA — while the original thought that — stuff/suffer IRA full of bonds (asset location) !? Let alone, if you rebalance say annually, now you are going to sell lot more of VGIT in IRA and going to buy VTI in IRA to maintain asset allocation during down markets .. which further deviates from asset location belief..
..
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by international001 »

JBTX wrote: Fri Sep 24, 2021 4:46 pm
Thanks. So as I understand it, the usual traditional vs Roth comparison assumption is you will deplete / spend the money at a rate equivalent to the RMDS, or faster. To the extent that isn't true, and you wish to keep invested longer, over time the Roth gets better, vs the RMDd traditional that would have been rolled into a taxable account.
I'm trying to follow the discussion. So if I understand it right:

- if you leave 1000 years, Roth conversion makes more sense because tax-drag is the important factor (i.e. you would get more compounding)
- If you do a very aggressive Roth conversion, and you live <1000 years, then perhaps your RMD will be taxed at a very low rate. And even with some tax dragging, it would have been better to do RMDs.

Am I about right? To make a good decision, all I need to know is how long am I going to live, future tax rates and future returns? Piece of cake 8-)
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by JBTX »

international001 wrote: Sun Sep 26, 2021 7:26 pm
JBTX wrote: Fri Sep 24, 2021 4:46 pm
Thanks. So as I understand it, the usual traditional vs Roth comparison assumption is you will deplete / spend the money at a rate equivalent to the RMDS, or faster. To the extent that isn't true, and you wish to keep invested longer, over time the Roth gets better, vs the RMDd traditional that would have been rolled into a taxable account.
I'm trying to follow the discussion. So if I understand it right:

- if you leave 1000 years, Roth conversion makes more sense because tax-drag is the important factor (i.e. you would get more compounding)
- If you do a very aggressive Roth conversion, and you live <1000 years, then perhaps your RMD will be taxed at a very low rate. And even with some tax dragging, it would have been better to do RMDs.

Am I about right? To make a good decision, all I need to know is how long am I going to live, future tax rates and future returns? Piece of cake 8-)
I think so, I assume your 1000 years is sarcasm.

The longer the time horizon, the more favorable Roth is, because RMD amounts convert to taxable.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by steve r »

In the end, it is all about tax rates. You can make the math complex with spread sheets, but here is a simple example of why your answer is not if you assume a constant tax rate

A constant 25 percent tax rates with returns doubling over a period of years.

Scenario 1: Initial assumption assume your taxes come from tax shelter fund.

Conversion: $100 less taxes is $75, doubles to $150
Stay in tax deferred: $100 doubles to $200, after tax of 25 percent is $150.

Scenario 2: More complex, assume you pay the tax with money that could be tax deferred. Note $33.33 of income taxed at 25% leads to $25 after tax income. Thus you can pay for a $25 conversion tax or contribute $33.33 to a tax deferred account.

Conversion: $100 (pay tax from $33.33 in taxable income), doubles to $200
Stay in tax deferred: $33.33 contribution (tax deferred) added to $100. Total is $133.33 doubles to $266.67. After 25% tax, this is $200.

You cannot compare scenario 1 to scenario 2 (you effectively start with more money invested in scenario 2).

***
Now, we cannot speculate on future tax rate "policy" on this thread. But, if you have liquidity and a low income tax year (thus low tax rate), the conversion makes sense. OTOH, you might reasonably suspect that as you age, your income will go down. Lower tax rates at withdrawal favor tax deferred.

For this reason, I have a healthy chunk of both. In addition, I know my dad was able to manage his earnings to be the top end of one of the lower brackets. This is what I intend to do. To do this game you need some in both classes.
Last edited by steve r on Mon Sep 27, 2021 6:27 am, edited 1 time in total.
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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 »

steve r wrote: Sun Sep 26, 2021 7:30 pm In the end, it is all about tax rates. You can make the math complex with spread sheets, but here is a simple example of why your answer is not if you assume a constant tax rate...
...and if one restricts the discussion to accounts in which there is no tax drag.

For Roth conversions when the tax is paid from converted funds, yes the math in the "Simplest situation" section of the Traditional versus Roth - Bogleheads wiki does apply.

When paying the conversion tax from cash on hand, however, the first of the "More complicated situations" applies. E.g., this would be the case if the $33.33 in Scenario 2 had been available in a taxable account. Paying the tax from cash on hand improves the chance (but does not guarantee) that the conversion will have been favorable when viewed in hindsight at withdrawal.

What is currently missing from the wiki is a section on the RMD effect, and that will be a "more complicated situation" of its own. Until recently, it wasn't clear that this was needed. Credit should go both to Kitces (for having published on this >10 years ago) and McQuarrie (for recent and continuing publication on the issue).

Until even more recently, it wasn't clear what practical advice we could put in the wiki for the RMD effect. For the BH wiki, usefulness for personal planning, as opposed to theoretical demonstration, is the applicable measuring stick. Assuming MDM and McQ both follow through with providing user-friendly-enough tools, referencing both of those along with a brief "it depends..." introduction in the BH wiki "Traditional versus Roth" and "Roth IRA conversion" articles would be one reasonable outcome. This would be similar to the referencing the two tools in the "More complicated situations" section as done currently.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

FiveK wrote: Sun Sep 26, 2021 8:48 pm
steve r wrote: Sun Sep 26, 2021 7:30 pm In the end, it is all about tax rates. You can make the math complex with spread sheets, but here is a simple example of why your answer is not if you assume a constant tax rate...
...and if one restricts the discussion to accounts in which there is no tax drag.

For Roth conversions when the tax is paid from converted funds, yes the math in the "Simplest situation" section of the Traditional versus Roth - Bogleheads wiki does apply.

When paying the conversion tax from cash on hand, however, the first of the "More complicated situations" applies. E.g., this would be the case if the $33.33 in Scenario 2 had been available in a taxable account. Paying the tax from cash on hand improves the chance (but does not guarantee) that the conversion will have been favorable when viewed in hindsight at withdrawal.

What is currently missing from the wiki is a section on the RMD effect, and that will be a "more complicated situation" of its own. Until recently, it wasn't clear that this was needed. Credit should go both to Kitces (for having published on this >10 years ago) and McQuarrie (for recent and continuing publication on the issue).

Until even more recently, it wasn't clear what practical advice we could put in the wiki for the RMD effect. For the BH wiki, usefulness for personal planning, as opposed to theoretical demonstration, is the applicable measuring stick. Assuming MDM and McQ both follow through with providing user-friendly-enough tools, referencing both of those along with a brief "it depends..." introduction in the BH wiki "Traditional versus Roth" and "Roth IRA conversion" articles would be one reasonable outcome. This would be similar to the referencing the two tools in the "More complicated situations" section as done currently.
I think a Prof. McQuarrie has brought up (revived) and important aspect of Roth Conversions that did not get a lot of attention in the past (what you call the RMD effect). It would indeed be a useful addition to the wiki. We do need to have a more real world definition, and attendant affect of, a realistic tax-drag on the taxable account that is used to pay the conversions tax, as well as house the RMD.
Once in a while you get shown the light, in the strangest of places if you look at it right.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

McQ wrote: Sat Sep 25, 2021 1:50 pm You guessed wrong about future tax rates--how bad will it be?

This post examines unfortunately timed Roth conversions, or perhaps, poorly analyzed conversions where future tax rates turned out not to be as expected (or feared). This post is limited to realistic pratfalls. Next post looks at terrible, horrible, no good, very bad Roth conversions that never, ever should have been done (spoiler alert: they still pay off—eventually).

.... Charts deleted for brevity
Prof. McQuarrie,

Thanks you for starting this interesting discussion.
I took the liberty of reproducing your spreadsheet. Your descriptions were quite clear and easy to follow, thanks for the detailed explanations!
I first confirmed that i was getting the same exact results as what you posted for several input scenarios.

I also ran a couple of sanity checks, like setting both tax rates equal, and setting cap gains tax rate (tax drag) to zero.
In this case, as expected, we see that the convert and non-convert cases are identical as expected.

I then took the further liberty of adding two additional changes.

1) Added a parameter that specifies the yield of the taxable account. This separates the unrealized capital gains (not taxed each year) from the annual dividend and cap gains distributions (taxed annually at specified cap gains rate).

2) Added a couple of columns to keep track of the embedded capital gains, and then at each ending year, applied the capital gains rate to the previous 10 years of accumulated unrealized gains. Since we are considering the case where the dollars under consideration are not spent, this models the case where the beneficiaries get step up basis at death of the investor, and then wait the maximum 10 years prior to liquidating the accounts, and incur capital gains taxes of the gains during those 10 years after step up.

I believe this is is a much more realistic scenario than taxing all gains in the taxable account each year.
This changes the "break even" time frame quite dramatically.

For example, at tax rates of 32% at conversion,and 24% at evaluation, your approach shows the Roth Conversion pulling ahead at age 95.
If instead, we use a 2% yield (each year has 10% gain, consisting of 2% taxable distribution, and 8% unrealized gains), what we see is that the break even age becomes 105, that is meaning the investor died at age 95, and the heirs let the accounts grow another 10 years before withdrawing.

The tax drag will eventually make up any difference in tax rates, but i think under more realistic scenarios, the time to do that can be quite significant.
Once in a while you get shown the light, in the strangest of places if you look at it right.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by FiveK »

marcopolo wrote: Mon Sep 27, 2021 3:33 am I then took the further liberty of adding two additional changes.

1) Added a parameter that specifies the yield of the taxable account. This separates the unrealized capital gains (not taxed each year) from the annual dividend and cap gains distributions (taxed annually at specified cap gains rate).
...
I believe this is is a much more realistic scenario than taxing all gains in the taxable account each year.
This changes the "break even" time frame quite dramatically.
Seems similar to a note recently posted in Re: How do RMDs affect Roth conversion choices?:
One observation: the discussion in the Bogleheads thread linked above included comments on the effect of taxing (or not) capital gains each year. Changing the "Turnover" assumption (cell B15) from 100% (all annual capital gains are realized and thus taxed) to 0% (all annual capital gains remain unrealized and thus not taxed until withdrawn) can make a significant difference....
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by steve r »

FiveK wrote: Sun Sep 26, 2021 8:48 pm
steve r wrote: Sun Sep 26, 2021 7:30 pm In the end, it is all about tax rates. You can make the math complex with spread sheets, but here is a simple example of why your answer is not if you assume a constant tax rate...
...and if one restricts the discussion to accounts in which there is no tax drag.

For Roth conversions when the tax is paid from converted funds, yes the math in the "Simplest situation" section of the Traditional versus Roth - Bogleheads wiki does apply.

When paying the conversion tax from cash on hand, however, the first of the "More complicated situations" applies. E.g., this would be the case if the $33.33 in Scenario 2 had been available in a taxable account. Paying the tax from cash on hand improves the chance (but does not guarantee) that the conversion will have been favorable when viewed in hindsight at withdrawal.
...
... Sure, but the cash on hand could have been invested as well. Effectively pay the tax on a conversion from cash is the equivalent of new money for investing.

Could the investor contribute more to tax deferred instead? Could the investor buy and hold an index fund and mostly pay cap gains tax in the end? Perhaps a tax managed index? Currently long term cap gains tax rates are lower, but in taxable accounts one would presumably pay taxes on interest/dividend income (which is a drag on returns). It is even "possible" one is better off in a taxable account (than tax preferred), but I wouldn't bet on this.

I continue to think a healthy chunk in Roth and IRA provides better tax rate management flexibility (but not so much taxable). But I could be wrong here as well.
"Owning the stock market over the long term is a winner's game. Attempting to beat the market is a loser's game. ..Don't look for the needle in the haystack. Just buy the haystack." Jack Bogle
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by HomeStretch »

marcopolo wrote: Mon Sep 27, 2021 3:33 am … I believe this is is a much more realistic scenario than taxing all gains in the taxable account each year.
This changes the "break even" time frame quite dramatically. …

… The tax drag will eventually make up any difference in tax rates, but i think under more realistic scenarios, the time to do that can be quite significant. …
I agree this is a much more realistic scenario and should be reflected in the original spreadsheet. Older investors entering retirement and contemplating Roth conversions very possibly have large Taxable accounts (either in $ or as a % of total portfolio) as Roth accounts weren’t around for their entire accumulation years and the timeframe to add large $ to Roth via a mega backdoor Roth was limited for such investors. If high earners (which are more likely to have high Taxable accounts), employee deferrals to employer plans such as a 401k were likely Traditional rather than Roth.

As an investor with 50%+ in Taxable and contemplating starting Roth conversions next year, the assumption in the original spreadsheet regarding the timing of capital gains taxation is the biggest drawback I see to the spreadsheet’s accuracy / usefulness for my situation (which I don’t think is a unicorn situation).
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by WoodSpinner »

sc9182 wrote: Sun Sep 26, 2021 6:29 pm
WoodSpinner wrote: Sun Sep 26, 2021 5:11 pm
sc9182 wrote: Sun Sep 26, 2021 3:05 pm
WoodSpinner wrote: Sun Sep 26, 2021 2:55 pm
sc9182 wrote: Sun Sep 26, 2021 2:35 pm
Thats the whole point - do have assets in each tax-type bucket. Don’t be overly aggressive in conveying everything to Roth, nor overly be afraid of the RMDs - especially if one ever needs TDA and/or Roth monies for any living or one-time expenses (and multiple other things such as Large medical expenses, or nursing-home etc expenses, charity, or QCDs are on mind)
I use an alternate approach….

I hold only Equities in Roth. When I need to spend from them, I exchange Bonds for Equities in the IRA.

It’s pretty simple and usually done once a year as part of my annual rebalancing.

Roth space is too precious to waste on Bonds (IMHO).

WoodSpinner
Now - not only your Roths are full of equities, and higher-than previous % of your IRA assets got into equities as well — hasn’t that upended overall asset allocation - now tilted more-aggressively towards equities ?
Not sure I understand your point, can you elaborate?

For Example:
1. Sell $50,000 of VTI in Roth for for yearly expenses
2. Sell $50,000 of VGIT in IRA And Buy $50,000 of VTI
3. Rebalance as needed.

*Note: I have NO taxable assets at this time, only Roth or IRA.

Overall AA remains consistent.

WoodSpinner
In bad markets (is the condition our mini-conv started off with)., Roth May be cut in half (and that Roth is full of equities,VTI),while IRA May be full of Bonds (VGIT). And many Overly-pro BH threads mention to keep Roth full of equities and Stuff IRA with bonds.

If you sell $50k VGIT in IRA, and your Roth is already full of VTI which $50k for living expenses, now buy $50k VTI in IRA ? if you rebalance — aren’t you going to end up buying VTI/equities in IRA — while the original thought that — stuff/suffer IRA full of bonds (asset location) !? Let alone, if you rebalance say annually, now you are going to sell lot more of VGIT in IRA and going to buy VTI in IRA to maintain asset allocation during down markets .. which further deviates from asset location belief..
..
Yes, my IRA will have VTI in it, but ….

It already does! There is simply not enough Roth (or Taxable space) to hold VTI anywhere else. It’s not perfect but it does keep the Roth fully invested in assets that are expected to grow the most. This is a better solution than wasting the space on Bonds (IMHO).

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

Post by WoodSpinner »

marcopolo wrote: Mon Sep 27, 2021 3:33 am
McQ wrote: Sat Sep 25, 2021 1:50 pm You guessed wrong about future tax rates--how bad will it be?

This post examines unfortunately timed Roth conversions, or perhaps, poorly analyzed conversions where future tax rates turned out not to be as expected (or feared). This post is limited to realistic pratfalls. Next post looks at terrible, horrible, no good, very bad Roth conversions that never, ever should have been done (spoiler alert: they still pay off—eventually).

.... Charts deleted for brevity
Prof. McQuarrie,

Thanks you for starting this interesting discussion.
I took the liberty of reproducing your spreadsheet. Your descriptions were quite clear and easy to follow, thanks for the detailed explanations!
I first confirmed that i was getting the same exact results as what you posted for several input scenarios.

I also ran a couple of sanity checks, like setting both tax rates equal, and setting cap gains tax rate (tax drag) to zero.
In this case, as expected, we see that the convert and non-convert cases are identical as expected.

I then took the further liberty of adding two additional changes.

1) Added a parameter that specifies the yield of the taxable account. This separates the unrealized capital gains (not taxed each year) from the annual dividend and cap gains distributions (taxed annually at specified cap gains rate).

2) Added a couple of columns to keep track of the embedded capital gains, and then at each ending year, applied the capital gains rate to the previous 10 years of accumulated unrealized gains. Since we are considering the case where the dollars under consideration are not spent, this models the case where the beneficiaries get step up basis at death of the investor, and then wait the maximum 10 years prior to liquidating the accounts, and incur capital gains taxes of the gains during those 10 years after step up.

I believe this is is a much more realistic scenario than taxing all gains in the taxable account each year.
This changes the "break even" time frame quite dramatically.

For example, at tax rates of 32% at conversion,and 24% at evaluation, your approach shows the Roth Conversion pulling ahead at age 95.
If instead, we use a 2% yield (each year has 10% gain, consisting of 2% taxable distribution, and 8% unrealized gains), what we see is that the break even age becomes 105, that is meaning the investor died at age 95, and the heirs let the accounts grow another 10 years before withdrawing.

The tax drag will eventually make up any difference in tax rates, but i think under more realistic scenarios, the time to do that can be quite significant.
Query….

Why are you assuming the beneficiaries would have to empty the Taxable account at the end of 10 years?

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

Post by marcopolo »

WoodSpinner wrote: Mon Sep 27, 2021 10:05 am
marcopolo wrote: Mon Sep 27, 2021 3:33 am
McQ wrote: Sat Sep 25, 2021 1:50 pm You guessed wrong about future tax rates--how bad will it be?

This post examines unfortunately timed Roth conversions, or perhaps, poorly analyzed conversions where future tax rates turned out not to be as expected (or feared). This post is limited to realistic pratfalls. Next post looks at terrible, horrible, no good, very bad Roth conversions that never, ever should have been done (spoiler alert: they still pay off—eventually).

.... Charts deleted for brevity
Prof. McQuarrie,

Thanks you for starting this interesting discussion.
I took the liberty of reproducing your spreadsheet. Your descriptions were quite clear and easy to follow, thanks for the detailed explanations!
I first confirmed that i was getting the same exact results as what you posted for several input scenarios.

I also ran a couple of sanity checks, like setting both tax rates equal, and setting cap gains tax rate (tax drag) to zero.
In this case, as expected, we see that the convert and non-convert cases are identical as expected.

I then took the further liberty of adding two additional changes.

1) Added a parameter that specifies the yield of the taxable account. This separates the unrealized capital gains (not taxed each year) from the annual dividend and cap gains distributions (taxed annually at specified cap gains rate).

2) Added a couple of columns to keep track of the embedded capital gains, and then at each ending year, applied the capital gains rate to the previous 10 years of accumulated unrealized gains. Since we are considering the case where the dollars under consideration are not spent, this models the case where the beneficiaries get step up basis at death of the investor, and then wait the maximum 10 years prior to liquidating the accounts, and incur capital gains taxes of the gains during those 10 years after step up.

I believe this is is a much more realistic scenario than taxing all gains in the taxable account each year.
This changes the "break even" time frame quite dramatically.

For example, at tax rates of 32% at conversion,and 24% at evaluation, your approach shows the Roth Conversion pulling ahead at age 95.
If instead, we use a 2% yield (each year has 10% gain, consisting of 2% taxable distribution, and 8% unrealized gains), what we see is that the break even age becomes 105, that is meaning the investor died at age 95, and the heirs let the accounts grow another 10 years before withdrawing.

The tax drag will eventually make up any difference in tax rates, but i think under more realistic scenarios, the time to do that can be quite significant.
Query….

Why are you assuming the beneficiaries would have to empty the Taxable account at the end of 10 years?

WoodSpinner
Really just to create a terminal point of comparison, where all taxes due are paid up.
If one assume heirs continue to keep the taxable account, only paying taxes on the distributions, then the Roth Conversions in this case (32/24 rates) never catches up.
Once in a while you get shown the light, in the strangest of places if you look at it right.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

marcopolo wrote: Mon Sep 27, 2021 3:33 am
McQ wrote: Sat Sep 25, 2021 1:50 pm You guessed wrong about future tax rates--how bad will it be?

This post examines unfortunately timed Roth conversions, or perhaps, poorly analyzed conversions where future tax rates turned out not to be as expected (or feared). This post is limited to realistic pratfalls. Next post looks at terrible, horrible, no good, very bad Roth conversions that never, ever should have been done (spoiler alert: they still pay off—eventually).

.... Charts deleted for brevity
Prof. McQuarrie,

Thanks you for starting this interesting discussion.
I took the liberty of reproducing your spreadsheet. Your descriptions were quite clear and easy to follow, thanks for the detailed explanations!
I first confirmed that i was getting the same exact results as what you posted for several input scenarios.

I also ran a couple of sanity checks, like setting both tax rates equal, and setting cap gains tax rate (tax drag) to zero.
In this case, as expected, we see that the convert and non-convert cases are identical as expected.

I then took the further liberty of adding two additional changes.

1) Added a parameter that specifies the yield of the taxable account. This separates the unrealized capital gains (not taxed each year) from the annual dividend and cap gains distributions (taxed annually at specified cap gains rate).

2) Added a couple of columns to keep track of the embedded capital gains, and then at each ending year, applied the capital gains rate to the previous 10 years of accumulated unrealized gains. Since we are considering the case where the dollars under consideration are not spent, this models the case where the beneficiaries get step up basis at death of the investor, and then wait the maximum 10 years prior to liquidating the accounts, and incur capital gains taxes of the gains during those 10 years after step up.

I believe this is is a much more realistic scenario than taxing all gains in the taxable account each year.
This changes the "break even" time frame quite dramatically.

For example, at tax rates of 32% at conversion,and 24% at evaluation, your approach shows the Roth Conversion pulling ahead at age 95.
If instead, we use a 2% yield (each year has 10% gain, consisting of 2% taxable distribution, and 8% unrealized gains), what we see is that the break even age becomes 105, that is meaning the investor died at age 95, and the heirs let the accounts grow another 10 years before withdrawing.

The tax drag will eventually make up any difference in tax rates, but i think under more realistic scenarios, the time to do that can be quite significant.
I ran couple more case that might be of interest.

1)
22% conversion tax rate
15% withdrawal tax rate (assuming tax rates revert)
0% tax rate on Qualified distribution
15% tax rate on non-qualified distribution
10% of distributions are non-qualified

Heirs liquidate all accounts 10 years after death of investor, paying 15% tax rate.

In this scenario, the "break even point is at age 105 (death at age 95)

2)
The same as above but convert at 24% rate
In this scenario, it appear the Roth Conversions case never catches up.
The deficit appear to be getting bigger with each subsequent year, so perhaps it even violates the "always pays off" assertion
In fact, it may actually violate the assertion that Roth Conversion always pays off, because it appears the deficit keeps growing.
Once in a while you get shown the light, in the strangest of places if you look at it right.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by cas »

marcopolo wrote: Mon Sep 27, 2021 11:53 am I ran couple more case that might be of interest.
You might be interested in taking a look at the under-development spreadsheet (from the developer of the Personal Finance Toolbox tool) that FiveK mentioned above: How do RMDs affect Roth conversion choices?

It has some of the features that you are adding to your version of the McQ spreadsheet. Some different design decisions, so not a perfect match.

(To give appropriate credit, McQ said earlier he plans to add these features to his spreadsheet, given some more time. But he is also busy providing these thorough posts to us, which I'm sure is taking lots of time that he could otherwise be using enhancing his spreadsheet.)

When I put your (marcopolo's) new scenarios into the MDM spreadsheet, the vague outline of the numbers (as far as I can infer them from your post) aren't matching up well with what you say you are seeing. That could be from me misinterpreting the assumptions behind your scenario and entering the wrong scenario numbers. Or it could be from the slightly different design decisions that I mentioned above. Or it could be from something else. But, for system test purposes of your spreadsheet, you might want to take a look.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by MattB »

Haven't read every post in the thread. But taken to its conclusion, wouldn't the premise: "roth conversions always pay off" lead to the conclusion that all contributions should be made to a Roth 401k instead of a tradition 401k?
marcopolo
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

cas wrote: Mon Sep 27, 2021 12:24 pm
marcopolo wrote: Mon Sep 27, 2021 11:53 am I ran couple more case that might be of interest.
You might be interested in taking a look at the under-development spreadsheet (from the developer of the Personal Finance Toolbox tool) that FiveK mentioned above: How do RMDs affect Roth conversion choices?

It has some of the features that you are adding to your version of the McQ spreadsheet. Some different design decisions, so not a perfect match.

(To give appropriate credit, McQ said earlier he plans to add these features to his spreadsheet, given some more time. But he is also busy providing these thorough posts to us, which I'm sure is taking lots of time that he could otherwise be using enhancing his spreadsheet.)

When I put your (marcopolo's) new scenarios into the MDM spreadsheet, the vague outline of the numbers (as far as I can infer them from your post) aren't matching up well with what you say you are seeing. That could be from me misinterpreting the assumptions behind your scenario and entering the wrong scenario numbers. Or it could be from the slightly different design decisions that I mentioned above. Or it could be from something else. But, for system test purposes of your spreadsheet, you might want to take a look.
Thanks for that link.

The structure of the spreadsheets are different, but they are computing the same things.
I checked several scenarios, and i get the same exact numbers in the upper section.

I believe there is an error in the linked spread sheet in the lower section, starting at row 83 (where beneficiary analysis is done).
Column G, which is the starting value of the taxable account, beginning at the second row this column gets its value from column P, which is the cash out value (paying all tax on all accumulated gains). I believe it should be getting its value from column O, which is the previous years ending balance with gains retained. If i correct this, I get the same exact results as my spreadsheet. Just to note, the corrected way (getting value from Column O, instead of P is how it is done in the upper section).
Once in a while you get shown the light, in the strangest of places if you look at it right.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by cas »

marcopolo wrote: Mon Sep 27, 2021 2:07 pm
I believe there is an error in the linked spread sheet in the lower section, starting at row 83 (where beneficiary analysis is done).
Column G, which is the starting value of the taxable account, beginning at the second row this column gets its value from column P, which is the cash out value (paying all tax on all accumulated gains). I believe it should be getting its value from column O, which is the previous years ending balance with gains retained. If i correct this, I get the same exact results as my spreadsheet. Just to note, the corrected way (getting value from Column O, instead of P is how it is done in the upper section).
I don't want to hijack McQ's thread, but ... just once, I saw the behavior you reported (Relevant cell incorrectly showing value from P, rather than O, even though Cell B3 "Basis Step" = 1). (I'll affirm that you aren't imagining things.)

But...

Looked at the code, but the code looked correct.

Scrolled up and manually typed a "1" in Cell B3 ("Basis Step") even though a "1" was already there as a default.

Scrolled down and looked at the beneficiary analysis again, and it had switched to correctly show the contents of O. Even if I reload the original spreadsheet, it continues correctly showing O.

I had it do something similar in a different place once before.

Shrug? I'm way too much of spreadsheet novice to wrangle that kind of transient glitch. I did import the original Excel into LibreOffice Calc, so that might be my first guess as to the source of weird glitches like that.
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by marcopolo »

cas wrote: Mon Sep 27, 2021 2:42 pm
marcopolo wrote: Mon Sep 27, 2021 2:07 pm
I believe there is an error in the linked spread sheet in the lower section, starting at row 83 (where beneficiary analysis is done).
Column G, which is the starting value of the taxable account, beginning at the second row this column gets its value from column P, which is the cash out value (paying all tax on all accumulated gains). I believe it should be getting its value from column O, which is the previous years ending balance with gains retained. If i correct this, I get the same exact results as my spreadsheet. Just to note, the corrected way (getting value from Column O, instead of P is how it is done in the upper section).
I don't want to hijack McQ's thread, but ... just once, I saw the behavior you reported (Relevant cell incorrectly showing value from P, rather than O, even though Cell B3 "Basis Step" = 1). (I'll affirm that you aren't imagining things.)

But...

Looked at the code, but the code looked correct.

Scrolled up and manually typed a "1" in Cell B3 ("Basis Step") even though a "1" was already there as a default.

Scrolled down and looked at the beneficiary analysis again, and it had switched to correctly show the contents of O. Even if I reload the original spreadsheet, it continues correctly showing O.

I had it do something similar in a different place once before.

Shrug? I'm way too much of spreadsheet novice to wrangle that kind of transient glitch. I did import the original Excel into LibreOffice Calc, so that might be my first guess as to the source of weird glitches like that.
The issue you are talking about only affects cell G83 which is the initial value of the taxable account to the heirs. This is affected by the StepUp flag.
It appeared to work fine for me. The error (i believe) is in cells G84-G92. Here the source is hard-coded to come from column P instead of O. It (correctly) should not be conditioned on the StepUp flag, but should simply come from column O.
Once in a while you get shown the light, in the strangest of places if you look at it right.
JoinToday
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by JoinToday »

There are a couple factors that need to be considered in the benefits of Roth conversions. (may have been mentioned previously)

1. Reducing trad IRA balance enables you to drop down in IRMAA brackets. This may justify higher Roth conversions and higher taxes now, to reduce future IRMAA cost, resulting in lower overall cost (taxes + medicare premiums)

2. Increased conversions now with higher taxes now will lower income in the future, which may enable qualified dividends and LTCG in the 0% tax rate. Higher taxes now results in tax savings and lower effective tax rate in the future.

These are two factors which may tip the scales towards doing larger Roth conversions. Or may not, but it is something to add to the trade.
I wish I had learned about index funds 25 years ago
sc9182
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by sc9182 »

JoinToday wrote: Mon Sep 27, 2021 3:08 pm There are a couple factors that need to be considered in the benefits of Roth conversions. (may have been mentioned previously)

1. Reducing trad IRA balance enables you to drop down in IRMAA brackets. This may justify higher Roth conversions and higher taxes now, to reduce future IRMAA cost, resulting in lower overall cost (taxes + medicare premiums)

2. Increased conversions now with higher taxes now will lower income in the future, which may enable qualified dividends and LTCG in the 0% tax rate. Higher taxes now results in tax savings and lower effective tax rate in the future.

These are two factors which may tip the scales towards doing larger Roth conversions. Or may not, but it is something to add to the trade.
Increased conversions now with higher taxes now will lower income in the future
Reminds me of good ole saying: drawing an elephant through a key hole

If we are talking converting/depleting million+ IRA to Roth — while fitting below IRMAA tiers now — chances are you be able to repeat this magic in some future years also :happy

Also, taxable/Brokerage isn’t as bad as it cracked up to be: it provides occasional opportunities such as: 0% LTCG, Gifting appreciated assets to kids/near/dear/charities, and infrequent windows for Tax Loss Harvesting (and/or resetting cost basis), step-up in basis.

Some folks be able to use Brokerage amounts to borrow cheap (margin/portfolio loan), in addition not be able to realize less income during some planned years - while still drawing living or occasional big expenses via such loans.
Last edited by sc9182 on Mon Sep 27, 2021 4:27 pm, edited 3 times in total.
cas
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Re: Why Roth conversions always pay off—if you can hold on long enough

Post by cas »

marcopolo wrote: Mon Sep 27, 2021 2:55 pm The error (i believe) is in cells G84-G92. Here the source is hard-coded to come from column P instead of O.
Ah, yes, I see what you mean. I think you are correct.

If MDM sees this, I'm sure he/she will be glad for the systems test assist.
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