Roth Conversions: Breakeven Tax Rate (BETR)

Just ask claude

My first impression is that the Vanguard calculation uses the tax free results of the Roth Conversion but compares it to the after tax result of the alternative, which is investing the money that would have paid the conversion taxes in a taxable account in this case. They don't compare those outcomes to a very valid real world scenario: many people who are working also have the option of putting those conversion taxes in their tax deferred 401K instead of a taxable account. So a real world comparison for many would be something like converting $10K to Roth vs adding say $2.7K to your trad 401K in addition to the $10K that you would have converted. In that case, if your future tax bracket is lower, trad wins, usually. If they are the same, the math works out the same: do what you want. If you've got all 401K avenues maxed, the Vanguard analysis holds water.

However, there are many other ways of looking at this, and the benefits of Roth go beyond just the math.

It really is a case by case situation, and sometimes it just really depends on what you want to do.

I am contributing to Roth 401K even though cautious math (say future growth is low, <3%) points to trad beating Roth, I still want more Roth. I am also doing some conversions even though I will be doing them at 24% and will probably only be at 22% when I need the money. I want more Roth.

Every situation is different and there just isn't a one size fits all answer to Roth Conversions.

I just put 75% in my regular and 25% in my roth (of my retirement savings). I hope that works out for me.

I’m sure I’m in the same boat as many - have studied this issue for years and done all the homework/projections and know all implications - NIIT, IRMAA, widows tax, beneficiaries, QCD’s, etc, etc.

I’m close to retirement at 57 years of age and will be doing conversions for the next 15 or so years to the top of the 24% bracket until I get my substantial (and growing all along) traditional TSP into the Roth column. I didn’t have the Roth option for the first 20 years of my career and those dollars continue to compound - a great force for wealth,

So why convert?

Simply so my kids don’t have to mess with taxes when I die. For me and my wife, sure we could do nothing and be fine just like we could convert and be fine so the main reason is so my kids won’t have to deal with this stuff hopefully in 30 years when they are in peak earning years and have a full plate with careers and family. Now, if I die in a couple of years and my TSP grows over the next 30 years in my wife’s name then my kids will simply have to deal with the taxes. But, if I can lift that burden from them then I will. And all the numbers are similar so the math is somewhat neutral. I just prefer to get dollars growing tax free as soon as I can.

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Starting to think I should spend available capital today rather than using it to fund Roth conversions..

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This is definitely part of our RMD reduction strategy. Structurally planning this - into our “enjoying would-be inheritance with kids while we are alive” plan. Hear you!

And Roth conversions. Whatever remains when you are slow-go years, designated for your heirs, may the Roth by-pass the govt turning that balance to dust (their highest tax bracket years, widow tax, etc).

To draw down pre-tax money take an annual distribution (~6%), pay the taxes, spend what you need/want and convert the remainder to Roth.

That's a good way to frame it. However, I'm too young to just take distributions unless I start SEPP 72(t). Locking in that inflexibility for next 10 years would likely create some significant inefficiency. I'm warming to the idea though. I'd rollover into several traditional IRAs and only set up 72(t) on a fraction at a time leaving the remainder available for conversions. I could draw using most aggressive calculation method and interest rate IRS allows and if that's too much at any point I can use the one time exception to recalculate a more conservative draw down.

My wife and Inhave definitely had the discussion about “spend more now and make memories” along that line. But here’s the deal, probably for most of us - we are enjoying life now and have no desire to spend just to spend. I could have 100 million and there are still things I simply wouldn’t pay for just out of principal in my own mind. For instance (not to start an argument) first class plane tickets. I’ve flown first class (didn’t have to pay) and I’ve flown coach for my 30 year career. And there is no way I’d pay the extra few hundred bucks for a few hours of time. Maybe if I was 6’4” but I couldn’t enjoy it knowing that I would be standing at baggage claim with the guy next to me who didn’t spend that extra few hundred.

Bottom line, I’ll spend what I want and buy what I want and if that means I’m essentially passing money to a grand child or great grand child that I’ll never know then so be it. But I do know the day will come when my kids will have a nice day with my savings and if that allows them to retire a few years early or enjoy a nice beach condo with my grandkids then they’ll know that’s what I worked for.