Especially around year end, I often hear the question “Should I do a Roth IRA conversion? What are the long-term benefits of paying X amount to convert now?”. To help answer this question, below is a simple Roth IRA conversion calculator, where I am making the following assumptions:
- You have a certain amount in a traditional IRA or 401(k) you are considering for a Roth conversion. This can be part of one account or the sum of several accounts.
- The “basis” is what percentage of the account balance was made up of post-tax or non-deductible IRA contributions. This would be zero for IRA or 401(k) accounts you were able to fully deduct.
- We assume a single blended tax rate on the amount you would be converting. This makes the math simpler than trying to figure out the actual brackets for your specific conversion, but means you could be paying a very different amount of tax on the conversion than we estimate here. This simple calculator also does not prevent you from assuming, say, an unrealistic 0% tax rate on a $1 million conversion.
- We assume you would be paying the tax on the Roth conversion from other money you have outside of IRA accounts. To make this apples-to-apples with not converting, we assume you would be able to instead put the same amount of money next year into a traditional or SEP IRA or other tax-deferred account, even if that’s not possible. This understates another advantage of the Roth in that it basically lets you save more money, given how pre-tax and post-tax limits are currently equal.
- We assume you start drawing from the account at the IRS’s current required minimum distribution (RMD) rate starting in December of the year you turn age 70 1/2 (using the table that assumes you do not have a spouse 10 years or more younger than you). Even though Roth IRAs have the enormous advantage of not having an RMD requirement (during your lifetime that is; after you die, your heirs must start taking them), we assume you’d make the same net-of-tax withdrawals to keep the comparison apples-to-apples.
- We ignore any additional benefits the Roth IRA may provide in not raising your adjusted gross income (AGI) with withdrawals, under current law.
- We assume a constant average marginal tax rate on these RMD withdrawals every year you would take them from the non-converted IRA.
- We assume the same rate of return on your investments in the account every year, whether you convert or not.
In general, it makes the most sense to convert when you believe the current rate of tax you would pay on the conversion would be less than your marginal tax rate in retirement, though there are cases where a Roth conversion wins even with a lower future tax bracket. In the default case below, a 45 year old converting at a 35% tax bracket would have more in the Roth than the Traditional by age 98 even with a 30% retirement tax bracket, because not having to withdraw the amount going to tax leaves more money in the IRA to compound at 6%. As always, this blog post and the below calculator are for illustration and discussion purposes only, and are not tax advice of any kind.
Roth IRA conversion calculator
|Considered Roth conversion amount:|
|Expected average tax rate on this Roth conversion (often your marginal tax bracket):|
|What percentage of this IRA have you already paid tax on? (AKA your “basis” for any non-deductible IRA contributions):|
|Expected tax bracket in retirement:|
|Rate of investment return (%):|
|Saving now vs later: which adds up to more?|
October 15th usually signals the start of the season to start looking at year-end planning for the 2018 US tax year, including this checklist of questions US taxpayers overseas should ask at least once a year. This post focuses on the question of Roth IRA conversions, as October 15th 2018 marks the last day Americans will be able to do recharacterize a 2017 conversion, as the the most recent tax bill (the “Tax Cuts and Jobs Act of 2017” or TCJA) makes 2018 and future Roth conversions irreversible. Hopefully this Roth IRA conversion calculator is a useful tool, if so, please do leave a comment below.