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Here are the circumstances; the wife and I, no debt, SS and a small pension will be about 50K a year, 1.4 million in a 401K, 300K+ cash or equivalent. I'm considering converting half the 401K to a Roth IRA which will cost me well over 200K in taxes. The calculator tells me that I will be 700K+ better off in the long run if I do this. If I convert 80% I will apparently be over a million dollars better of in the long run but of course the taxes on the conversion will be larger. I do want to leave a substantial amount to my children. Should I do it? Should I pay the taxes out of cash? Should I stop chewing on this and just enjoy life as it comes?
Good question. I am dealing wih the same issue. We need to take required distribution which makes our tax rate go up and converting to roth will minimize what goes into our AGI. Also good estate plan, as you have said. I am struggling with how to balance the taxes saved in the long run to the big tax wallop now. We figure about 75k for the amt we want to convert. This will push up marginal rate as well. What if we instead invest that (gift) in a roth ira for the children instead of giving it to the IRS earlier than nescessary?
I'm not retired yet (working on it). Our financial guy looked at the distributions available for my 401K and told us they were a good selection for younger people, but not appropriate for someone like me who's close to retirement. So we did an "in-service rollover" and he's moving it to more appropriate investment vehicles.
So consider what your 401K is invested in. If you don't have a good selection of funds, then consider moving it.
Are you sure about the 200K in taxes? My "in-service rollover" comes with no penalties since I'm over 59 years old.
I'm not retired yet (working on it). Our financial guy looked at the distributions available for my 401K and told us they were a good selection for younger people, but not appropriate for someone like me who's close to retirement. So we did an "in-service rollover" and he's moving it to more appropriate investment vehicles.
So consider what your 401K is invested in. If you don't have a good selection of funds, then consider moving it.
Are you sure about the 200K in taxes? My "in-service rollover" comes with no penalties since I'm over 59 years old.
I think you're confusing a regular rollover from one kind of pre-tax account to another kind of pre-tax account with a conversion from a pre-tax account to a ROTH. When you convert money from a non-ROTH to a ROTH - the amount you convert is included in your taxable income in the year it's converted.
I have a large (7 figure) IRA. And have grappled with the issue of rolling over a substantial % of it to a ROTH (I've rolled over small parts in the past - and all of my husband's relatively small IRA too).
And it honestly doesn't make sense to me and my husband (we've gone through the issue a few times). For a few reasons. First off - none of those calculators is sophisticated enough to factor in the concept of "present value". If I pay X in taxes today - it's X. If I have to pay taxes 10 years from now - I have to reduce that amount to present value to compare apples to apples. So X paid 10 years from now will always be worth less than X paid today. X paid 15-30 years from now will always be worth a heck of a lot less than X paid today.
Also - it's simply impossible to predict tax things in the future. I am old enough to remember the year when an excise tax was imposed on IRAs worth $1 million (and it did last only a year). Who's to say that the rules on ROTHs won't be changed in some way shape or form - especially for larger ROTH accounts.
And what happens if my husband and I don't live to our "normal" life expectancy (which is what happens to pretty much half of all people). I will have paid Uncle Sam a whole lot of money - and lost my ability to spend/enjoy it during my less than average life expectancy.
OTOH - what happens if you live to a really ripe old age (perhaps 85-90+)? You and/or your spouse will probably wind up in some kind of senior care facility. If you need advanced ALF or SNF care - well it's tax deductible. And could easily cost more than $100k a year. Voila - you won't owe any taxes at all after your medical deductions (that's what happened with my late FIL for almost 3 years). Also note that if you pay Uncle Sam big up front now - that's less you'll have available to spend on this very expensive care.
FWIW - I don't care beans about my heirs. And - if the OP has $1+ million to give to his kids - they're getting plenty IMO. I would worry most about maximizing the money I had 5-10-20-30 years down the road.
Also - if for some reason there's a tax holiday on ROTH conversions - like I could convert 100% at 15% - I'd do it in about 10 seconds. But not today considering current tax rates. And I'm not holding my breath for the former . Robyn
P.S. I think you can take most of these calculators and throw them in the garbage. Have you ever seen one that assumes you have an $80k year medical deduction because you/spouse are in a SNF?
And I'm quite certain none can deal with the present value of future cash flows. Robyn
unless you are at the junction where you are going to get your social security taxed forever if you cross that dividing line the conversions may not help all that much late in life.
the real power of a roth is not whether or not you think your retirement years will be in higher or lower tax bracket compared to your more recent working years. there is no way to real tell so far in advance.
the power of a roth is in having the ability to start very young if you are a youngin today , us older folks didn't have that ability.
most jobs ramp up over decades in income. you start out low and build and build over time. your average income and tax bracket over decades may actually be a lot lower then your end of career income as well as your retirement income if it is close to the income range of your end of career..
you can surely end up in a higher tax bracket in retirement then your career average was with so many years at lower pay.
research has shown that many folks took so many years to ramp up to where there income is in later years that had they been doing roths all along they could have as much as 20% more spendable money in retirement then had they used a deductable ira.
but that only holds true if the roths were started very early on and contributed to regularly.
If you want to pass the ROTH to your children it probably is best to convert. I would try and convert over several years if you are able. The reason would be to avoid a large peak in taxable income in the year of conversion.
The big problem is the unknown. I think I have read about proposals that would make inherited IRA's taxable faster than they are now. Thus the rules for ROTH could change in the future.
Remember any assets in your name (not in a 401k or IRA) get a stepped up basis at death so taking distributions from your 401k each year and buying stock in your name might be a good alternative.
Also - it's simply impossible to predict tax things in the future. I am old enough to remember the year when an excise tax was imposed on IRAs worth $1 million (and it did last only a year). Who's to say that the rules on ROTHs won't be changed in some way shape or form - especially for larger ROTH accounts.
The simple solution to this is to withdraw all funds from your Roth, should any legislation be enacted.
If you want to leave a good portion of your estate to your children, I would consider whatever amount you would feel comfortable setting aside for that from your 401k to be rolled over into an annuity, preferably indexed which will outpace inflation and generally give MINIMUM rate of 6% and a generous signing bonus as well. This can make it so the value will keep growing as well as when you peacefully pass on the amount will be passed on tax-free as a death benefit. Just need to make sure to find this kind of good annuity and not just any random one as they are all not the same. Another thing you could also do is front load a (G)IUL policy with the cash you have and of course whatever you are comfortable with. Depending on which policy you get, GIUL will give you tax-deferred growth like a ROTH IRA, but again be indexed giving a minimum of 0% interest to an unlimited cap on the gains. An IUL will grow tax-deferred same way but with typically a minimum of 1% and max growth of 15%. These both can give you tax-free cash value that you could access as needed and also have death benefits attached to them which will of course be given to the beneficiaries tax-free and give all the cash value and growth tax-free to the beneficiaries as well. These are just some of the few things I would recommend if you want to leave a large estate for your loved ones.
personally i would just buy the investments in my taxable account and let them inherit it tax free at market value if i did my tax planning right. or i would take my deferred ira money ,buy a nice leveraged whole life policy, pay the amount of taxes due on what the policy cost and leave them nice leveraged tax free money that i pass outside my estate free from state taxes .
becareful leaving heirs most annuities.
"your beneficiaries will be saddled with paying capital-gains tax on any profit your annuity generated. If your original $50,000 annuity grew to $75,000, your heirs would owe tax on the $25,000 profit. In contrast, if you had placed your money in taxable mutual funds, because of the step-up in basis, your kids would get that $25,000 tax free."
my opinion is any annuity outside of an immediate or a deferred fixed acting as longevity insurance is more often than not going to be to complex and to expensive to be of much real use . there generally is a better way to achieve the same end game without the complexity and expense of most of the other annuity types.
Last edited by mathjak107; 07-10-2014 at 03:08 AM..
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. Robyn
