Opinion: Should I make this Roth conversion before Congress bans them?


A reader just wrote urging me to review the Roth IRAs. This follows on from my previous column, where I said I was wary of them, in part because I thought I would pay a lower tax rate in retirement than when I work.

“The tax rate is not the problem, it’s the amount of tax you are going to pay,” he reminds me. And he argues that many people will end up paying less tax over their lifetime if they use an after-tax Roth IRA instead of a traditional before-tax IRA.

I return to this topic because it raises a very good question – and because Congress is considering slamming the door on Roth IRAs in earnest for upper-middle-class earners. So we may only have a few months to make this big financial decision, which could have a disproportionate effect on the amount we have in retirement.

First obvious point: calculations are complicated and if in doubt you should speak to a financial advisor.

But in very general terms, there are two simple principles that the reader raises.

First off, if you are very bullish on the outlook for investing and think stocks are going to explode for the rest of your working life, then the math says you should lean towards the Roth. Better to pay a small amount of tax now than the huge sums you will have to pay on your millions over time.

Second, if you plan to pay a marginal tax rate in retirement similar to what you are paying now, you should look to the Roth as well.

On the other hand, if you don’t share these two assumptions, it’s not that clear.

My reader illustrated his point by imagining someone in the 24% federal tax bracket when working and in the 22% tax bracket in retirement, and earning an average of 8% per year on their income. investments. By the time this person reaches retirement age, my reader points out, the tax they will have to pay on a traditional IRA will be far more than the amount they would have paid over the years if they had instead contributed to a Roth. . The tax bill could be several times higher.

He is right. But I am nervous about these assumptions.

Do I think I will earn 8% per year in the long run on my investments? Since we are using real, constant dollars in these assumptions, this means: do I think I will earn 8% per year in “real” terms or after inflation?

My dark point of view: Dream on.

The long-term average for US stocks has been around 6% in real terms, and even to hit that number we have to include the skyrocketing returns of the past 40 years. My problem with including all of the 1980 comebacks is not that they didn’t happen, but if they will happen again in the next 40 years. The folks on Wall Street use a lot of Greek letters, extravagant calculations, and incomprehensible economics to explain why the more expensive stocks, the better their future returns, but they just don’t make sense to me. Isn’t that double counting? Equities relative to underlying fundamentals are much, much more expensive than they were 40 years ago. Doesn’t that mean their future long-term returns are likely to be lower?

I’m also worried that I will pay the same tax rate in retirement as I do while working. I expect to earn less from my investments than as a worker bee. I can also move to a lower tax state. Many upper-middle-class workers currently pay state as well as federal taxes, and some, like those in New York City, also pay municipal taxes.

It seems to me that I would only have to worry about this if my retirement plans are loaded by the time I retire – and in this case, I’m not that worried about taxes. My real concern is not how much tax I pay, but how much I will have left to retire. My worry is paying extra taxes now, at high marginal rates, and then having to tighten my belt when I’m 80 (if I can).

One of the things I love about traditional IRAs is that they will only charge me a big tax bill in retirement if I am doing pretty well.

Then there is the final concern, as I mentioned in my article, that if I volunteer to pay additional taxes now to convert a Traditional IRA to a Roth, what will prevent a future Congress? to tax this money again – formulated, of course, not as double taxation but as a “crackdown” on “loopholes”.

I may be too cynical.

One thing that Roth IRAs have is that they actually involve a larger annual contribution to your IRA. With a traditional IRA, you can contribute up to $ 6,000, or $ 7,000 if you’re over 49. But some of that money needs to be effectively set aside to pay for the taxes you will pay when you withdraw the money.

With a Roth, you’ve already paid those future taxes, so you’re contributing more. Someone in a 24% federal tax bracket who contributes $ 6,000 to a Roth IRA (using a Roth backdoor or a conversion) is actually contributing around $ 8,000 gross because they first pay around $ 2. $ 000 tax on money.

So maybe I should bite the bullet. And trust the stock market and Congress. (Laughs.)

Of course, it would really help a lot if the powers that be could stage another financial panic by Christmas, so that we can all convert our traditional IRAs to Roths at depressed values ​​and save on taxes. Looking at the MarketWatch homepage, I see the Dow Jones Industrial Average DJIA,
+ 1.15%
is down about 1,500 points since mid-August, and the S&P 500 SPY,
+ 0.87%
is 5% in a month. So maybe they are. How thoughtful!

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