Case Study 3: Convert $50k for You

Roth IRA Conversion Case Studies

This case study is a bit different than the two previous ones.  In this instance, due to the ages of the individuals and the selected payment method, there’s not as much time for the invested assets to compound in the tax-deferred or tax-free environment; therefore, the MTR variables have a more significant impact on the projected outcome.  However, even in a shorter time frame, the Roth’s unique tax environment which yields higher rates of return on investments of comparable risk, tips the scale in its favor more often than not.  The examples that follow support the theory that it’s typically best to spend down your after-tax savings first, your pre-tax assets next, and your Roth assets last. To access background information relevant to these studies, go to: Save to Retire: Pre-tax, After-tax or Roth?; Roth 401(k) Case Studies

Case Study 3(a):

This particular case study considers the following variables: Individual is age 40; $50,000 is coverted in 2010; MTR at coversion is 25%; side fund is $12,500; MTRs at distribution are: 15%, 25%, and 33%; gender and RMDs are not factors since we are assuming that this individual receives 15 equal annual payments from age 71 to age 85.

age 40 convert 50k 15 25 33 71-85

Conversion to a Roth IRA is preferable if the individual’s MTR remains static or increases.  Not converting is modestly preferable (by 4,659) if the individual’s MTR decreases by 10% (to a 15% MTR).

Commenatry Be mindful that the combined pre-tax and side fund account’s modestly preferable outcome above assumes that the individual saves the additional $12,500 in a savings account, or that the tax on the conversion is paid for out of the converted assets (which will cost more than $12,500 if the individual is not age 59 1/2).

Case Study 3(b):

Same variables as above except the invidual is age 45.

Convert 50k Age 45 15 25 33 pay 15 yrs 71-85

A similar outcome to case study3(a); conversion to a Roth IRA is preferable if the individual’s MTR remains static or increases.  Not converting is modestly preferable if the individual’s MTR decreases by 10% (to a 15% MTR); however, in this instance the modest differential increases from $4,659 to $7,977 since the individual converts at an older age.  Again, this modestly preferable outcome assumes that the individual saves the additional $12,500 in a savings account, or that the tax on the conversion is paid for out of the converted assets (which will cost more than $12,500 if the individual is not age 59 1/2).

Case Study 3(c):

Same variables as above except the invidual is age 50; MTR at coversion is 28%; side fund is $14,000; and MTRs at distribution are: 25%, 28%, and 33%.

Convert 50k Age 50 25 28 33 pay 15 yrs 71-85

Although this individual is 5 and 10 years older than the individuals in the previous examples, conversion to a Roth IRA is preferable if his/her MTR decreases, remains static or increases.  In this particular example, the differential in one’s MTR at the time of conversion versus one’s MTR when receiving distributions is more significant.  Note that the MTR in the projected decrease scenario is only 3% lower; whereas, it’s 10% lower in the previous examples.

Bottom line Based on one’s individual facts and circumstances, there are numerous variables to consider in determining if it’s preferrable to convert.  These variables include one’s: marginal tax rate (MTR) when contributing, MTR when receiving distributions, age, gender, rate of return and taxation on invested assets, retirement benefit’s payment method, financial means, estate, and last but certainly not least, the uncertain variable: future changes in tax law and regulations.  See: Save to Retire: Pre-tax, After-tax or Roth?; Roth 401(k) Case Studies

Copyright © 2009 Barry R. Milberg   All Rights Reserved

Leave a Comment, Question or Answer

You must be logged in to post a comment.