I think your third question reflects a common misconception. The Roth IRA doesn't have to grow enough to "catch up" because of the tax paid on the conversion; in fact, as long as the money withdrawn from the traditional IRA would be taxed at the same rate now with a Roth conversion, as it would be later without the conversion (i.e., no tax arbitrage), the Roth conversion will be ahead of not converting and that advantage will grow larger over time. That is true no matter how long a time interval between the conversion and withdrawal. This becomes clearer if you think of a traditional IRA as having two sub-accounts: one is your money, the other is the government's (which it will claim when you withdraw both from the IRA). Scenario 1 (Roth conversion now): Assume your share of the traditional IRA is amount A now and the government's account is amount B. You convert both A+B to a Roth now, and pay the tax due with amount B(taxable) (equal to B but in your taxable account). A and B BOTH grow tax sheltered within the Roth IRA, say with a value after y years of n times the current amount. After y years, your tax-sheltered Roth account will grow to n(A+B) and you withdraw it and get to put it in your taxable account. You end up with n(A+B) in your taxable account. Scenario 2 (no conversion): If you do not do a conversion now, A and B are in your tax-sheltered traditional IRA. You also start with amount B(taxable) in your taxable account, because you don't need to send it to the government because you did not do a conversion. After y years A and B grow tax-sheltered within the traditional IRA to become nA and nB. You withdraw nA and nB, you put nA in your taxable account, and the government gets nB. But you also get to keep what B(taxable) grew to over the years. If you assume it grew to nB(taxable), then you end up with nA + nB(taxable) in your taxable account. If nB = nB(taxable), then it's a wash: you end up with n(A+B) either way. But nB does NOT equal nB(taxable): nB(taxable) is less because it grew in a taxable account, not a tax-sheltered account. So you end up with less than nA + nB. The tax drag on B(taxable) is significant and increases over longer periods of time. So the misconception that the Roth conversion has to "catch up" because of the tax paid on the conversion has it backward: the Roth IRA conversion is ahead over any time period (all other things being equal, of course). What a Roth IRA conversion does in effect is to move the money you use to pay tax on the conversion from the taxable account into the Roth account. That's a good thing. But the future is unpredictable, and all other things will never be equal. There are many other factors that can have an important influence on the decision. See the White Coat Investor's take this week at: https://www.whitecoatinvestor.com/roth-contribution-or-conversion/?utm_source=convertkit&utm_medium=email&utm_campaign=The%20White%20Coat%20Investor%20%E2%80%93%20Investing%20&%20Personal%20Finance%20for%20Doctors%20-%2016878320
The financial planning software I use, Maxifi, also models Roth conversions taking into account the myriad of factors that affect the outcomes. All of the assumptions (future inflation, interest rates, tax rates, your longevity, etc.) can be varied by you, so you can test various scenarios of your choosing to see their effects. There are many variables so it's an extremely complicated analysis that requires a sophisticated software program; there is no way individuals can model this well on their own. I find this very useful in making decisions about what to do. One example of how many factors go into this that did not occur to me but I learned about from researching Roth conversions, is that a conversion also effectively converts assets from your taxable account (the tax you pay on the conversion) to a Roth account, thus eliminating the tax drag on appreciation in the taxable account for that money. That's an increase in your tax-sheltered assets, it's not an insignificant effect especially over longer periods of time, and it's beneficial no matter what the tax rates are in the future. One thing is clear to me: tax rates do not have to increase in the future for partial Roth conversions to be advantageous. If they remain the same they are still beneficial in multiple ways, and conversions can be beneficial even with decreases in tax rates (such as from 24% to 22%). What the Maxifi program is recommending to me, in two years of semi-retirement before claiming SS, is very high Roth conversions that would increase my taxes (including IRMAA, NIT) significantly. For now I've decided not to go as far as the program recommends, in part because of all the uncertainty about the future. But it's thought-provoking and I'll keep revisiting.
I interpret what you are asking as how else to reduce inflation risk in retirement. Your non-COLA pensions will lose considerable purchasing power over longer periods of time; if my math is right, if annual inflation is 3% for the next ten years, they'll lose 30% of their purchasing power after just 10 years. How to reduce inflation risk is a complicated and uncertain topic; probably the most common method is investing in the stock market, but buying TIPS is another, some advocate owning rental real estate, etc. Even an annuity might be viewed as part of a solution, because even though it is not inflation adjusted (or maybe just a fixed 1 or 2% a year which you pay extra for), compared to ordinary bond investments because if you live past the median you get an additional financial benefit from those in your annuity pool who die before you. Perhaps a mix of methods would be good.
Some years ago my IRA was at Schwab and I wanted to do an end-of-year Roth conversion of part of it. This required estimating my taxes for that year so I could figure out how much to convert to "fill out" my tax bracket without going into the next higher bracket. I was not able to do this until the last few days of the year, but when I attempted to do the conversion, the Schwab computers were down! The telephone reps said there was nothing they could do, just try again tomorrow. I went down to the local office and they said the computers were not going to be back running until after Jan 1, but I should hand them actual paperwork, they'd send it in, and when the computer was back up the central office would probably be able to backdate it. Despite my fears and a week of uncertainty, they did eventually accomplish that, but I immediately transferred a portion of the IRA to Vanguard so that I would have a second option in the future in case there was a problem with one company. More complexity with two companies but worth avoiding a repeat of the stress of that year! (No down computers since then with either company that I'm aware of, which I fully attribute to my move to diversify.)
Bill, have you given up flying entirely, or just flying solo? I bet your former students would be happy to take you flying with them. And members of a local flying club probably would as well.
So sorry this has happened to you, but inspired by your response that embodies the qualities that infuse your writings and life. Glad you're feeling well now, but chemotherapy, radiation, and cancer take a toll over time. As a physician, I too recommend using this time to find an excellent palliative care physician to help you when it starts affecting your quality of life more. Best wishes and thank you for everything you've done for me, my family, and everyone else.
Comments
I think your third question reflects a common misconception. The Roth IRA doesn't have to grow enough to "catch up" because of the tax paid on the conversion; in fact, as long as the money withdrawn from the traditional IRA would be taxed at the same rate now with a Roth conversion, as it would be later without the conversion (i.e., no tax arbitrage), the Roth conversion will be ahead of not converting and that advantage will grow larger over time. That is true no matter how long a time interval between the conversion and withdrawal. This becomes clearer if you think of a traditional IRA as having two sub-accounts: one is your money, the other is the government's (which it will claim when you withdraw both from the IRA). Scenario 1 (Roth conversion now): Assume your share of the traditional IRA is amount A now and the government's account is amount B. You convert both A+B to a Roth now, and pay the tax due with amount B(taxable) (equal to B but in your taxable account). A and B BOTH grow tax sheltered within the Roth IRA, say with a value after y years of n times the current amount. After y years, your tax-sheltered Roth account will grow to n(A+B) and you withdraw it and get to put it in your taxable account. You end up with n(A+B) in your taxable account. Scenario 2 (no conversion): If you do not do a conversion now, A and B are in your tax-sheltered traditional IRA. You also start with amount B(taxable) in your taxable account, because you don't need to send it to the government because you did not do a conversion. After y years A and B grow tax-sheltered within the traditional IRA to become nA and nB. You withdraw nA and nB, you put nA in your taxable account, and the government gets nB. But you also get to keep what B(taxable) grew to over the years. If you assume it grew to nB(taxable), then you end up with nA + nB(taxable) in your taxable account. If nB = nB(taxable), then it's a wash: you end up with n(A+B) either way. But nB does NOT equal nB(taxable): nB(taxable) is less because it grew in a taxable account, not a tax-sheltered account. So you end up with less than nA + nB. The tax drag on B(taxable) is significant and increases over longer periods of time. So the misconception that the Roth conversion has to "catch up" because of the tax paid on the conversion has it backward: the Roth IRA conversion is ahead over any time period (all other things being equal, of course). What a Roth IRA conversion does in effect is to move the money you use to pay tax on the conversion from the taxable account into the Roth account. That's a good thing. But the future is unpredictable, and all other things will never be equal. There are many other factors that can have an important influence on the decision. See the White Coat Investor's take this week at: https://www.whitecoatinvestor.com/roth-contribution-or-conversion/?utm_source=convertkit&utm_medium=email&utm_campaign=The%20White%20Coat%20Investor%20%E2%80%93%20Investing%20&%20Personal%20Finance%20for%20Doctors%20-%2016878320
Post: To Roth Convert or Not
Link to comment from March 10, 2025
The financial planning software I use, Maxifi, also models Roth conversions taking into account the myriad of factors that affect the outcomes. All of the assumptions (future inflation, interest rates, tax rates, your longevity, etc.) can be varied by you, so you can test various scenarios of your choosing to see their effects. There are many variables so it's an extremely complicated analysis that requires a sophisticated software program; there is no way individuals can model this well on their own. I find this very useful in making decisions about what to do. One example of how many factors go into this that did not occur to me but I learned about from researching Roth conversions, is that a conversion also effectively converts assets from your taxable account (the tax you pay on the conversion) to a Roth account, thus eliminating the tax drag on appreciation in the taxable account for that money. That's an increase in your tax-sheltered assets, it's not an insignificant effect especially over longer periods of time, and it's beneficial no matter what the tax rates are in the future. One thing is clear to me: tax rates do not have to increase in the future for partial Roth conversions to be advantageous. If they remain the same they are still beneficial in multiple ways, and conversions can be beneficial even with decreases in tax rates (such as from 24% to 22%). What the Maxifi program is recommending to me, in two years of semi-retirement before claiming SS, is very high Roth conversions that would increase my taxes (including IRMAA, NIT) significantly. For now I've decided not to go as far as the program recommends, in part because of all the uncertainty about the future. But it's thought-provoking and I'll keep revisiting.
Post: To Roth Convert or Not
Link to comment from March 8, 2025
I interpret what you are asking as how else to reduce inflation risk in retirement. Your non-COLA pensions will lose considerable purchasing power over longer periods of time; if my math is right, if annual inflation is 3% for the next ten years, they'll lose 30% of their purchasing power after just 10 years. How to reduce inflation risk is a complicated and uncertain topic; probably the most common method is investing in the stock market, but buying TIPS is another, some advocate owning rental real estate, etc. Even an annuity might be viewed as part of a solution, because even though it is not inflation adjusted (or maybe just a fixed 1 or 2% a year which you pay extra for), compared to ordinary bond investments because if you live past the median you get an additional financial benefit from those in your annuity pool who die before you. Perhaps a mix of methods would be good.
Post: Growth Investing or Dividend Investing in Retirement?
Link to comment from October 26, 2024
Some years ago my IRA was at Schwab and I wanted to do an end-of-year Roth conversion of part of it. This required estimating my taxes for that year so I could figure out how much to convert to "fill out" my tax bracket without going into the next higher bracket. I was not able to do this until the last few days of the year, but when I attempted to do the conversion, the Schwab computers were down! The telephone reps said there was nothing they could do, just try again tomorrow. I went down to the local office and they said the computers were not going to be back running until after Jan 1, but I should hand them actual paperwork, they'd send it in, and when the computer was back up the central office would probably be able to backdate it. Despite my fears and a week of uncertainty, they did eventually accomplish that, but I immediately transferred a portion of the IRA to Vanguard so that I would have a second option in the future in case there was a problem with one company. More complexity with two companies but worth avoiding a repeat of the stress of that year! (No down computers since then with either company that I'm aware of, which I fully attribute to my move to diversify.)
Post: Unexpected, cautionary or funny tales about managing your retirement accounts online
Link to comment from August 3, 2024
Bill, have you given up flying entirely, or just flying solo? I bet your former students would be happy to take you flying with them. And members of a local flying club probably would as well.
Post: A Painful Confession
Link to comment from June 29, 2024
So sorry this has happened to you, but inspired by your response that embodies the qualities that infuse your writings and life. Glad you're feeling well now, but chemotherapy, radiation, and cancer take a toll over time. As a physician, I too recommend using this time to find an excellent palliative care physician to help you when it starts affecting your quality of life more. Best wishes and thank you for everything you've done for me, my family, and everyone else.
Post: The C Word
Link to comment from June 15, 2024