Here's a question for the hive mind! We are retired, not contributing to 401k or IRAs anymore. But have a fair amount sitting in Traditional IRAs in cash, not invested.

We can convert some to a Roth - CPA has advised how much for this year based on probable tax bracket for 2020 - but I suddenly wondered, why convert?

If we are paying the taxes anyway, is there any benefit to the Conversion rather than just taking it out? Except maybe it's more protected in a retirement account? (Learned that from OJ, but don't know if it applies to Roths!)

The benefit to converting it is that it will continue to grow tax free for as long as you have it. If when your heirs inherit any funds remaining they also will pay no taxes on it. If it is in an IRA, traditional or Roth it is a protected asset (in NC) and federally (I believe)....can’t be touched in the event you are sued.

Jerry, I disagree.

It all depends on how much the account grows because while you spent some money on taxes when you converted now all the future earnings will also be tax free. If you don’t convert they will all be taxable. Furthermore you don’t even get the benefit of the lower capital gains tax rates as all the withdrawals are taxed as regular income when withdrawn from a taxable account.

Jerry, I disagree.

It all depends on how much the account grows because while you spent some money on taxes when you converted now all the future earnings will also be tax free. If you don’t convert they will all be taxable. Furthermore you don’t even get the benefit of the lower capital gains tax rates as all the withdrawals are taxed as regular income when withdrawn from a taxable account.

Jerry, I disagree.

It all depends on how much the account grows because while you spent some money on taxes when you converted now all the future earnings will also be tax free. If you don’t convert they will all be taxable. Furthermore you don’t even get the benefit of the lower capital gains tax rates as all the withdrawals are taxed as regular income when withdrawn from a taxable account.

It turns out the how much the account grows doesn't matter. The only things that matter are the tax rates at the beginning, and the tax rate at the end.

If the investment returns an average rate of return RoR, a Roth IRA value at the end of N years is (1 - ITR) * RoR^N, where ITR is the initial tax rate when you put the money into the IRA.

On the other hand, a traditional would have a value of RoR^N * (1 - RTR), where RTR is the tax rate when you pull the money out in retirement.

I personally have zero faith in the Fed or State governments to do whatever they have promised.

I have some in Roth IRAs and some in regular IRAs.

Does anyone really think that when the Feds want our money, they won't renege on the original deal to not tax the Roths again? When they decide that they want more tax money and see that you have saved plenty, what exactly is going to stop them from taking whatever percentage they say they need or want?

You would have to give real world examples for that to make sense to me. Paying taxes on a smaller amount now can sometimes be the smarter move even when the tax rate stays the same because you aren’t paying taxes on the future growth. Sure you lose the ability to invest the money you used to pay the taxes but that may or may not make a difference.

Lisa, sorry about making it too abstract. Let's say we start out with $1,000 and our tax rate is 30%. For a Roth that means we invest $700 (after paying $300 in taxes), while the traditional IRA would allow us to invest the whole $1,000.

Then assume that over the next 30 years we have a 10x return. In 30 years the Roth would would grow to $7,000 and could take the money without paying any taxes. Also assume that our tax rate in 30 years goes down to 20%. In the traditional IRA the $1,000 would grow to $10,000, but we would have to pay $2,000 in taxes when we take the money out, leaving us with $8,000.

I think Jerry is wrong but I am ready to be corrected.

If you have 100K and you are at 30% tax rate. you pay 30K in taxes to convert and you are done with taxes.

10 years roll by and if the account doubles and you didn't do anything you would pay 60K in taxes upon distribution.

Bonanza, in your example the Roth would net you $140K, doubling the $70K you invested after paying the taxes.

On the other hand, $100K invested in a traditional IRA would grow to $200K, from which you would need to pay taxes. If your tax rate in retirement falls to 20% you would net $160K, which is more than you would get with the Roth.

WMH,

Is this account self directed?

It really depends how you plan on investing the money. If you are doing shirt term lending or flips - the taxes are treated as short term gains. It will not take long at all to make up the initial taxes paid in the conversion if you are stuck paying short term gains in the traditional IRA.

If however you are doing buy and hold real estate investing in a traditional IRA, you are slowing down the velocity of your money and reducing your yield.

You have your act together so it would not take too much for you network your way into higher yields, but that also requires some more risk. If you partnered up with another investor and lent each other say $50,000 to one another ( assuming you are not related) .........your risk is minimized and you have an opportunity to coach someone to eventually buy you out

Jerry

You can not use the money in the traditional IRA to pay the taxes. that would be a distribution and if less than 59 1/2 get you a tax penalty, so you have to come up with the taxes outside of the IRA and the whole amount gets put in the Roth.

WMH,

You have to start taking RMDs (required mandatory distributions) from your traditional IRA when you are 72. This is a taxable event for you.

You do not have to take any distributions from a Roth IRA during your lifetime. The money continues to grow tax free!

The Roth conversion should be based on your specific circumstances. So, I will make the following assumptions:

If we assume you do not need your IRA money to have a comfortable retirement. Your real estate income, SSI, pensions, etc. provide all the income you need for retirement.

If we assume you want to leave a well thought out inheritance to your kids.

If we assume your kids tax rate is the same or higher than your tax rate.

If we assume you have enough disposable income to pay the taxes on the Roth conversions without effecting your life style.

Trump eliminated the stretch IRA last year when he signed the Secure Act (not very Secure Act from my point of view). The Secure Act eliminated the stretch IRA. Based on Trump's Secure Act, inherited IRAs have to be liquidated within 10 years of the inheritance.

If your kids inherit your traditional IRA, the inherited IRA has to be liquidated in 10 years. Your kids pay taxes on all the inherited traditional IRA distributions. Since we assume your kids are in a higher tax bracket than you, the kids tax bill on the inheritance is higher than if you had paid taxes on the Roth conversion while you were alive.

On the other hand, if you go ahead and convert the traditional IRA to a Roth and pay the taxes on the conversion, your kids inherit the Roth IRA. The Roth IRA has to be liquidated within 10 years of the inheritance. Since this is a Roth IRA, your kids do not pay any taxes. This is a tax free inheritance!

Bonanza, I went with keeping it simple and using the money from a distribution to pay any taxes, or repay taxes paid with other funds. Also, if there's a penalty the penalty would be used to adjust the effective tax rate. But regardless, the only two numbers that matter are the tax rate when the money is put into the IRA, and the tax rate when the money it taken out of the IRA.

If your tax rate is higher in retirement than it was when you put the money in the IRA, then you would be better off going with a Roth. In my case, my tax rates are currently lower than when I put my funds into the IRA, so I am saving money with a traditional IRA.

Jerry, you can’t use the money in the traditional IRA to pay the taxes or it may be treated as an early withdrawal and come with a penalty. It only makes sense if you have other funds to cover the taxes. Check out the bank rate conversion calculator. Even if the taxes are expected to be the same in the future it makes sense to convert in many cases.

Lisa, you don't pay taxes on a traditional IRA until the money is taken out. But once you do take the money out, you can then pay the taxes from the distribution. So if you take a distribution (after age 59.5) of $10K and you are in the 20% tax bracket, then you would need to use $2K to pay the taxes, leaving you with $8K.

There are only three possibilities:

1. If your tax rate when you put money in the IRA is GREATER than your tax rate in retirement when you take the money out, then an traditional IRA nets you more money.

2. If you tax rate when you put money in the IRA is exactly the SAME as your tax rate in retirement when you take the money out, then it doesn't matter which you choose since either will net you the same amount of money.

3. If your tax rate when you put money in the IRA is LESS than your tax rate in retirement when you take the money out, then an Roth IRA nets you more money.

I think a person’s age, health, ambition, and ability to make money in RE mist be considered.

Traditional means tax DEFERRED. You WILL pay the taxes on it, now or later (or in small bites).

Roth means never pay taxes. Your kids will not pay taxes when you are gone.

I THINK you can take Roth distributions earlier 59.5 than Traditionals.

If you look at traditional investments they come out about the same over 30 years.

BUT...you had to work extra hard and take long risk and must make way more to pay the taxes and come out even.

30% tax is too low. You are probably already in a higher bracket and add state and county income taxes. My tax total bill hits in the 40’s.

As rents go up and you make other business improvements your income SHOULD be going up.

Me? One ROTH rental makes the profit of 2 regular rentals. Plus no capital gains when sold. Image your heirs selling this after 35 more years of appreciation. So I am acquiring in my Roth and selling the regulars.

I know the deadline for 2020 contributions is April 15, 2021. Not sure how the conversion relates to that deadline.

Also, didn’t the Cares Act eliminate or delay some fines, etc on withdrawals?

My 2 cents (pre-tax!)

Plus, is there anyone here who believes taxes will NOT be increased? Another $900 bbbbillion taken from the treasury...More socialism...more free rent deals...

After the Great Recession state and local govts were hurting due to loss of sales tax and income taxes due lost jobs.

SO...

They raised rates to catch up. It's coming again.

SISCO - This may be a little off topic. Could you provide some detail on - "Using a financial friend and options"

What is a financial friend? Option on what?

Jerry, I’m not sure why you made the last post. It is far too simplistic. It doesn’t factor in the taxes on the growth.

But what you said is true if your IRA sits for years and doesn’t increase in value at all.

Take a traditional IRA valued at $400,000. Assume it will grow for 10 more years at 8%.

Now assume you converted it before it grew for 10 more years at 8%.

Assume your tax rate at the time of conversion and withdrawal is 25%.

Assume if you didn’t convert the $100,000 you kept invested also earned 8%, you paid 25% tax on it over the years since it’s not in a retirement account and see what it grew to in 10 years.

In seeing this tread, I am inclined to agree with you Lisa. There are too schools of thought on this.

The question comes down to do you want to pay tax now or pay tax later.

Some will say that you make more money if you now and enjoy the remainder tax free. The counter argument is what if I die tomorrow - I paid taxes that I didn't have too. Both side have merits.

Either way you will be paying taxes. Also true, they will be putting you in a box at the end of the game. So do you want to help those that you leave behind or not.

Ray, It can be beneficial not to convert if you know the person inheriting the funds will be in a significantly lower tax bracket. Although with the change in rules where they will be forced to take distributions may force them into a higher tax bracket.

It may make sense to split the traditional IRA among several heirs so this doesn’t happen to them.

We are both above 59.5, so no penalties to be paid. Just taxes.

Roths didn't really exist when we were working - or at least, if they did, we were in a MUCH higher tax bracket than we are now (despite making a higher gross nowadays) so we chose to take the tax deferred route. Seemed like a good idea at the time. Now we are mid-60's, full-time Housing Providers so lots to write off on the houses, and the CARES act apparently allows us to take out $100k EACH in 2020 and spread the taxes over the next 3 years. We can either convert or take it out. I'm leaning towards convert because we can always take it out tax-free later.

Personally, I have a mix of both -- Roth IRA that I'm maxing out every year and then also my 401k.

Brad: I'm often a little surprise at how much people must make. Someone used 30% federal tax as an example and you are saying that is low and that they're likely in a higher tax bracket than that?

That bracket would be 32% and starts when a married couple are making more than $326,600 AGI per year! Are most people here talking about these high tax brackets (or thinking 30% is "low") REALLY making $300+k per year?

I mean, if you are, then congrats to you! That's great! But I guess I'm just surprised if most people here are making that kind of money. Again, hopefully they are! But I'm a LONG way from a 32% tax bracket...

- John...

W runs a very successful and I safely assume highly profitable business. Plus her Hubby does the work so their labor expenses are super low.

And she's still growing.

A point most RE investors fail to consider is that DEPRECIATION ends in year 27, and we lose that tax shelter. So each property becomes more profitable as they cross that year. Your income goes up.

Also be aware of the TAX THE RICH movement. NY, CA...people are moving out to avoid these penalties for earning money.

BRAD

Please be VERY careful with the advice posted online. Consult your professional tax advisor.

Lisa: When we're talking about Roth vs Traditional IRAs, we're talking about differing tax brackets over decades of time usually. If, later in life, you're selling enough houses to PROFIT over $300,000 per year, then great for you! But I still maintain that isn't the normal situation -- especially when we're talking about comparing IRA types and your tax bracket when "younger" versus "older."

Again, I'm just curious about all these 30-sometimes and 40-something that are apparently making $326,000+ per year (in AGI, not gross!).

And, yes, we ALL hate having to pay our "hard earned" dollars. But I think I kinda fall into the group where if you are PROFITING over 1/4 million per year (which is what it takes to have to pay the 3.8%), then I can't help but feel that you should have to pay a bit more than the guy making $50,000/year...

- John...

Yes John, there are lots of people like you believe someone making more than you deserves to pay more of the federal tax bill because they managed to earn more than you did. I don’t believe taking upwards of 40% of someone’s income simply because you made less is particularly moral. Nor is it particularly moral when half the population is required to pay nothing. Nothing “fair” about it.

Tax brackets change over time, not just with earnings but the actual brackets have changed.

Back when we were both earning W-2 income, in the late 80's early 90's, between Fed and State, upwards of 40% of our income was paid out in taxes. No way around it. We maxed out 401ks, gave to charity, and that was about all you could do.

Federal - 1995 Married Filing Jointly Tax Brackets

Tax Bracket Tax Rate

$0.00+ 15%

$39,000.00+ 28%

$94,250.00+ 31%

$143,600.00+ 36%

$256,500.00+ 39.6%

Virginia - Married Filing Jointly Tax Brackets

Tax Bracket Tax Rate

$0.00+ 2%

$3,000.00+ 3%

$5,000.00+ 5%

I agree Pmh. Not only might you work harder or smarter you likely also made more sacrifices and took more risks. Often the payoff comes in spurts, some up years and some down years. The reward you get is attitudes suggesting you aren’t paying your fair share or that what is fair is you should pay more simply for being successful.

Government spending, expansion and waste is out of control. I don’t advocate the government being able to take more of anyone’s earnings no matter how much they make. It shouldn’t be the responsibility of a small group of people to fund the government. Most of the wealthy have paid more in taxes than other citizens will earn in a lifetime. To imply they haven’t paid their fair share is ridiculous.

PMH: Because that is how our tax system works.

Listen, people, if you don't like increasing percentages for tax brackets, that's fine -- feel free to fight against that if you want.

That wasn't my point at all. My point was that I often see people complaining about a 32% tax bracket (or, again, Brad saying that he thought 30% was "low" and that it would likely be higher). To get to the 32% tax bracket as a couple, you have to be making over $300k per year AGI.

I was simply curious how many were actually making that.

It wasn't about whether or not you should have to pay more in a higher tax bracket. Again, that is already a GIVEN because that is how our tax system works. It was just me being very curious about people like Brad saying that a 30% bracket number was "too low." Again, that means the couple is making $325,000 or more per year (and, again, that's AGI and not gross). I just thought that was interesting. Personally, I question how many are actually making that in their 20s, 30s, or even 40s when we're talking about whether or not to do a Roth.

I actually agree with Lisa too about much of what she said. But, again, that isn't what my question (or this thread) was about...

John, the 32% bracket starts at around $160,000 for single taxpayers. Meaning you lose a third of your income for amounts earned over that level. This is in a state with zero state income tax.

The next lowest bracket is 24%. In a state with income tax it’s not hard to get to 30%. For instance California charges single residents 9.3% earning between $60,000-$295,000.

So an individual in California pays a total combined rate of (22% federal and 9.3% state income taxes starting at amounts over $60,000 and getting progressively higher). That’s 31.3% on amounts between $60,000-$85,000.

Some cities also levy a city income tax on their residents.

Here's our scenario, which may be like some of yours and why we are doing what we are. I laid out a spreadsheet with all sources and estimated amounts of income, except property sales, until our mid 80's. Currently me 67/hubby 61. My goal is to have my Traditional IRA converted to my ROTH IRA by 72 to avoid dealing with RMD's. When I'm done, we'll convert his. The spreadsheet is extremely helpful for our yearly property budget planning. Unless I can figure out how to spread a property sale price over 2-3 years, before we sell a property we'll consult our tax guy for creative accounting options, charity, whatever.

Hubby puts into 401K, we both put into ROTH's each year. I need to know how my conversion amount will affect our income, as I can't contribute to a ROTH if our MAGI income is over the income limitation for that year. Once hubby retires it won't matter as he won't be contributing to a 401K. But until then, I can't convert all traditional $ all at once in this scenario. But doing it this way for us keeps our tax bracket and amount close to the same each year.

When your situation gets this complicated, your tax accountant is your best friend. Since conversion (a taxable event that adds to your income) my estimates must be close without going over; interest penalties aren't cheap.

Dee Ann,

I am in a similar situation and have a similar spread sheet.

When you turn 72, you can make charitable donations directly out of the traditional or 401 account. Your donation is a pre tax donation for you. The charity gets the money tax free.

If you normally donate $10,000 to charities every year, once you turn 72, you can make the donation directly from the traditional IRA. Since your donation is pre-tax, assuming you are in a 30% tax bracket, your pre-tax donation would be $13,000.

The charity gets 30% more from you.

Assuming you live for 20 more years, you can leave $200,000 in your traditional account and start the rollover on your husbands accounts a little sooner.

Dee Ann,

LisaFL: I am already fully aware of everything that you just said. Doesn't change anything from my last post.

Again, we were talking about IRA types. And people saying that the example of 30% federal was "low." I simply stated that if you are in the 32% tax bracket as a married couple -- which, again, is what we were mostly talking about, then you were making $325,000+ per year AGI. And I was curious how many here were really making that kind of money every year (not due to some one-time sale or something, of course).

I'm still curious. Lots of complaining about their tax bracket, but no one really answering that question of if they are really in the 32% (or higher) bracket. My guess is that MOST people here are not in a 32% or higher tax bracket. Or, if they are now, they certainly weren't in their 30s or 40s when they were making an IRA type decision...

- John...

What you’re not considering John is state taxes. Both my children, in their 20s would be paying that much in a state with income tax.

Also many household contain two income earners and they don’t get married because they’d pay higher overall taxes or lose things like the Obamacare subsidy or their earned income credit, etc...I know plenty of couples who avoid legal marriage due to the financial penalties that sometime accompany it.

Which is why maxing out tax DEFERRED accounts was so crucial - we all counted on the fact that our tax bracket and spending would be lower in retirement.

WMH: Yes, I agree it was different in the 1990s. That was a LITTLE while ago... :)

- John...