I recently read Kay Bell’s article at Don’t Mess With Taxes titled Are you ready for a Roth conversion? I commented that most people would not be likely to save their way to a higher bracket at retirement and offered some numbers. For example, a couple having a standard deduction of $11,400 + exemptions totaling $7300. First $18700/yr tax free. The 4% withdrawal rule (as good a starting number as any) means one needs $467,500 in pretax savings to generate that $18,700. This led to Kay inviting me to expand on this thought and in response I wrote an article titled Roth IRAs and your retirement income, now published there. Take a read and let Kay know if the article helped you.
Beware the Roth Mania.
Joe
So difficult. My guest post could have gone twice as long.
The numbers presented are todays’. So it gives a retiree some basis to understand the bracket they are in and the impact of a conversion. A MFJ needs $86,700 to just fill the 15% bracket, etc. With median income far lower than that, I’d stand by my suggestion that topping off the 15% bracket makes sense. I’ll even concede that those in the 10% risk little by converting right into that 15% rate.
I don’t know if the Federal Rate History helps, or confuses the issue. I see that in 1984, MFJ had a 25% marginal rate starting at $24,600. But that didn’t include the standard deduction. And in today’s dollars, that $24,600 is $50,142.
Here’s my question for you or any reader: I agree rates are likely to rise. But on whom? The current administration talks about $250K earners as middle class. $250K is the top 1.5% IIRC. So you can be in the top 2% and still be middle? Will taxes rise on the $50K income level (this puts a couple barely into the 15% bracket)?
To your point, I am not looking to squeeze out the last nickel here. There are more reasons to convert at 15% than there are to assume that the 10% is safe. i.e. I am absolutely agreeing that a conversion, with cash to pay the taxes, at 15% is probably wise. The thing I tried to point out, however is that there is a Zero Bracket, and one should keep in mind that retiring with 100% of their assets in Roth can also be a mistake as costly as being 100% in pretax accounts.
I’ll close with this thought. Finance can’t be separated from probabilities. There are too many variables for a single solution to the Roth issue. I remarked elsewhere that given one’s age, current savings (and tax status), income, and targeted years to retirement, one can at least narrow down to a better reasoned reply. I look at study after study that offers data regarding accumulated savings of those about to retire, and the picture is bleak. Most will not have enough savings to break that zero bracket I keep discussing, not even if ‘all’ their savings were pretax.
I realize you qualified your essay with the fact that no one knows what tax rates will be in 10 or 20 years. Yet it seems to me some sort of comment about how government spending in this Great Recession along with the costs of Medicare and Social Security in general argue for some serious tax increases in the coming decades. Maybe this consideration would be important for those for whom a roughly break-even scenario with a Roth conversion is likely using today’s tax rates. In which case, since I think taxes are going up, I would advise converting to a Roth. Granted Roths could end up being taxed in some odd way, too.
While it is true no one knows what tax rates will be years from now, I prefer the Roth.
There have been times when I needed to shave every dime I could off of AGI in that case extra to the 401K was the way to go.