I have advice for those of you who dare to question your conventional knowledge of converting losses to a 401 (k) or IRA:
Be prepared for a big backlash.
I devoted, so I need to know Last week’s column To question that conventional knowledge. While Roth’s conversion often works in the end, it turns out that the benefits take much longer than in most cases, and in any case the benefits are usually very small. Reported on an extensive investigation.
The· the study Conducted by Edward McQuarrie, Professor Emeritus of the Leavey School of Business at Santa Clara University.Fully aware that his findings cause this backlash, he Elaborate spreadsheet He incorporates a myriad of factors involved in determining if a transformation makes sense. In an interview, he said: But it’s your own responsibility to prove it in a spreadsheet. ”
In this column, I’ll reply to some of the emails I received after last week’s column. In each case, I asked McCulley for his insights. It is included below.
“This study doesn’t mention the potential benefits of loss conversions. It’s about reducing the minimum allocation (RMD) required for the portion of retirement funds left in traditional IRAs a few years ago (actually). (When the income tax rate was high), I gradually converted about half of my retirement portfolio into losses. As a result, my RMD is significantly lower each year. “
McCulley’s response: Reducing RMD is a common motivation for Roth conversions. But it’s not clear if doing so will make you better. I don’t know your specific situation, but it’s quite possible that you paid a 28% tax rate on your conversions. In return, you can reduce the RMD that was taxed at 22%. In that case, in terms of net present value, it will take decades for the conversion to reach the break-even point.Please refer to the Spreadsheet provided on the website About the calculation method. As shown in the spreadsheet, a 2021 couple must have a total income (RMD + social security + other income) of more than about $ 200,000 to be taxed at a tax rate above 22%. There is. This is a high hurdle, which increases each year as the tax rate is adjusted for inflation.
“I use Ross as a kind of trust fund for my daughter. I’m in my 40s now. Due to tax law revisions, she needs to be monetized within 10 years of my death, but inherited traditional I don’t pay income tax like IRA. It could save her much more than the tax I paid for conversion. “
McCulley’s response: I don’t know if we are taking into account the time value of money here. Let’s assume that your daughter inherited in 20 years and the traditional IRA in her hands was taxed at about the same rate you paid at the time of conversion. Instead, I chose to give my daughter a tax-reduced converted amount in my Roth account. The daughter does not pay taxes on it and does not thank her thereafter. However, it also passes the (negative) future value of the tax paid to convert. This should have remained in the traditional IRA. She’s probably better, Ross’s conversion is always rewarded for decades at a near constant tax rate. However, please show in your spreadsheet that the conversion can save you “much more than the tax I paid” in terms of net present value.
“You didn’t mention the moment of life that many people would actually benefit from the conversion of Ross. I recently retired, have a small pension and still get social security. Not and about 7 years away from RMD. But I have a great fat IRA. When those RMDs hit, I face huge taxes and much higher Medicare premiums It seems that the conversion of Ross will be a wise move every year for the next few years. We will pay taxes on the converted amount at a much lower rate than RMD. “
McCulley’s response: YOur age and situation was the exact focus of my treatise. Let’s take a concrete look at your “nice fat IRA”. Is it over $ 1.2 million if you are single ($ 2.4 million if you are married)? If not, you don’t have to pay the first level Medicare surcharge in anticipation of 7 years, you just fall into the 22% tax range, which is not considered a “huge amount”. Still, if you can convert within the 12% range today, your income cap is about $ 52,000 per taxpayer, but in fact, the loss conversion won’t pay off in that many years. The $ 52,000 conversion will reduce RMD by about $ 2,500 in the first year and save over $ 500 in income tax at a 22% tax rate. These savings will continue thereafter. But what kind of money do you live in during the year you convert? If you have taxable income (such as a pension), you cannot convert up to $ 52,000. This means that your income tax savings will be less than $ 500.
Your article on Roth conversion omits one important issue. Traditional retirement IRA allocations can increase the taxable status of social security benefits, bringing the 12% tax rate effectively closer to 20%. Ross, on the other hand, does not cause many of your social security payments to be taxed. This can benefit low-income taxpayers more than it is obvious when overlooking the issue of social security taxes.
McCulley’s Answer: You have a good point. If your income is high enough and some of your social security benefits are taxable, the effective retirement rate will be high. If you can perform a Roth conversion at 12% today, you can save 20 +%. Of course, it’s a payment, but it’s relatively quick to do. But what kind of money do you spend to live during the turning year? For every $ 1 taxable income, the amount that can be converted is reduced by 12%. And can it be converted at 12% enough to make a difference? (To reduce RMD by $ 1,000 in the first year, it takes about $ 18,000 to convert at age 65.)
What conclusion do I draw from this discussion? The wisdom of Ross conversion, or its lack, cannot be understood by oneself using simple rules of thumb. You need to run the numbers. Be my guest.
Mark Hulbert is a regular MarketWatch contributor. His Hulbert Ratings tracks investment newsletters that pay a flat rate to be audited.He can reach at email@example.com
Would you like to lose or not? Part II
http://www.marketwatch.com/news/story.asp?guid=%7B20C05575-04D4-B545-74BD-31F9D9E26BEA%7D&siteid=rss&rss=1 Would you like to lose or not? Part II