I recently read a post “Why I love Roth IRAs” in which the author ignores much of the math going in and coming out. Now, I love Roths myself, but only when used to take most advantage of the tax rates involved. Let me explain. From my feature article earlier this year titled “Can you save too much, pre-tax?” we see that a couple with $447,500 in their 401(k) or Traditional, Pre-Tax IRA, can take withdrawals and remain in the 0% bracket. This is due to the combination of standard deductions and exemptions. The next $401,250 will support withdrawals at the 10% rate.
If you have a defined benefit pension (a traditional pension) the numbers certainly will shift, and you need to take this income into account. Pensions are getting more scarce and those who frequently changed jobs are likely to have never vested into any one plan.
So, now I’ll ask, what percent of retirees are likely to have saved this sum, a total $848,750 from the numbers above? I cite an article from AARP titled 2004-05 Boomers which offers a forecast. One chart in this report offers that for those born in 1956-65, their mean (this means average, important distinction from median, middle) wealth is forecast to be $839K. But reading on, we find that after subtracting non-retirement wealth and present value of Social Security benefits, we are looking at a retirement account balance of just $140K. It turns out the 4th quintile (this is the second 20% from the top) is forecast to have $906K, this scales to about $151K in retirement accounts. Even the top quintile (top 20%) will average $2028K total wealth, with maybe $350K-$400K in retirement accounts. So it’s only the upper portion of that group (in addition to those with fat traditional pensions) that need to consider the Roth while working. For the rest of us, we will likely be in the 10% or if fortunate, the 15% bracket upon retiring.
I’ll close with this thought – each family has their own set of numbers. This is why if you write in to a web site or magazine and ask “Is Roth good for me?”, it’s impossible to answer without knowing many details. We know more the closer you are to retirement, but only have a series of clues the further away you are. Another blog “The Finance Buff” offers a view similar to mine. I remain surprised at how many wave the Roth flag without some level of analysis. For those who have access to a Roth 401(k) and Roth IRA, it would be a shame to load those up and find that they missed out on the tax savings that pretax savings could have provided.
Joe
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I recently fielded this multi-part question;
First, is conversion from a traditional IRA to Roth IRA still OK when over 70 and taking RMDs (required minimum distributions)?
Ok? It’s fantastic!! I will first tell you that I believe that Roth’s value while working is slightly exaggerated. Your scenario above is ideal. I have an 80+ yr old client who is in the 15% bracket. Each year we convert just enough to ‘top off’ that bracket so the next hundred dollars would have been taxed at 25%.
Second, does the “conversion” count as part of RMD?
No, the conversion must take place after you calculate the RMD. Our RMD is based on 12/31/07 year end balance. We can do the Roth conversion any time during the year, but that RMD is fixed.
Third, is it possible to transfer stock directly from Traditional IRA to Roth IRA — using current valuation on day of transfer as the basis for amount of conversion?
Yes – you can convert stock, the broker will report that value based on the day of conversion. There is no wash sale selling in one IRA and buying in another, anyway.
Joe
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Was first publishished at TruthDig.com earlier this year. Enjoy the cartoon, visit their site.
Joe
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If you don’t own a rental property, this may not interest you. If you do, read on.
One of the rules of rental property is that you must take depreciation each year. To be clear, whether or not you “take” the depreciation on your Schedule E each year you must recapture all the required depreciation regardless. Until now, many who did not understand this wound up going back to their returns and amending them for the last three years, but losing the benefit of all the deprecation not taken.
I recently came across an article titled Allowed or Allowable which discusses new revelations that may help you recoup the money you’d have otherwise lost. The article suggests a change in accounting method, and IRS bulletin 2004-3 confirms the content of the article I cited.
As I stated in my introduction, this impacts few people, but those impacted have the chance to save quite a bit of money by reading the above.
Joe
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In a post titled “Money Merge Account Evolution” we are subject to hyperbole, but no numbers. No proof. The latest version of MMA claims that if one has a mortgage along with ten other debts, they somehow need to consider 3 million possibilities before paying a dollar to any of these debts. Wow! Did he say 3 million? Is my rule “pay the highest interest rate credit card first, until it’s paid off” too simple? Should I spend even a millisecond deciding between paying my 18% credit card or prepaying my 5% mortgage? And do I really need software to help make that decision?
To be clear, I don’t suggest that MMA is a scam. It certainly is not. It does exactly what it claim it will do.*It also lags the math that a simple spreadsheet can offer. A beautiful site called “Discover Money Merge” offers an example, one that spans the just over 10 years that MMA will take to retire a 30 year mortgage. (The site appears to be gone as are many MMA sites, I’ve removed the dead links). Now look at the year end numbers from my simple spreadsheet (this is for a 30yr, fixed, 6% loan. Their assumption and mine is an extra $1000/mo is available to pay the mortgage.)
| Year |
MTG Bal |
Tot Debt Pd |
Total Int |
| 1 |
185208.41 |
14791.59 |
11597.63 |
| 2 |
169504.52 |
30495.48 |
22282.94 |
| 3 |
152832.04 |
47167.96 |
31999.67 |
| 4 |
135131.23 |
64868.77 |
40688.08 |
| 5 |
116338.68 |
83661.32 |
48284.75 |
| 6 |
96387.05 |
103612.95 |
54722.33 |
| 7 |
75204.84 |
124795.16 |
59929.33 |
| 8 |
48835.45 |
151164.55 |
63829.87 |
| 9 |
28840.44 |
171159.56 |
66343.35 |
| 10 |
3492.10 |
196507.90 |
67384.23 |
| 11 |
0.00 |
200000.00 |
67408.24 |
Now compare this to the example linked to above. My spreadsheet – total interest paid, $67408.24, their example, $70,428.19. Where is the savings? Why didn’t the use of the HELOC they recommend along with the extra risk of borrowing funds short term at a higher rate provide any savings at all? If you are completely new to this topic please see the link list above for more details. More to come, I’m sure. If you’d like a copy of the full spreadsheet, please submit a comment with your email address and I’ll send it along.
Joe
* In the interest of disclosure, my view has changed. I left the post above in tact, but my research and reading of all the claims has led me to a different conclusion. The product is a scam, and will cost you far more than ‘do it yourself’ even if the software were free.
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