Re: another where-to-put-my-money question

Mark Freeland <> writes:
> Sandra Loosemore wrote:
> >
> > At this point, people like to recommend that you max out a
> > Roth IRA before you do anything else.... but would it make more sense
> > to use the money to pay the taxes on a Roth conversion on an existing
> > traditional IRA instead?
>
> It doesn't make a difference. For example, suppose you have $100 in a
> traditional IRA, you are in the 25% tax bracket, and you have $28 in a
> taxable account (just enough to cover the taxes on the conversion).
>
> Suppose also that after n years, your investment doubles.
>
> Case 1) You put the $25 into a Roth, and don't convert.
> After n years, you have $50 in the Roth, $200 in the traditional IRA.
> You closeout the IRAs, and use the $50 from the Roth (tax free) to pay
> the now-$56 tax bill on the traditional IRA. That leaves you with $200.
>
> Case 2) You convert the traditional IRA to a Roth, paying the $25 in
> taxes. That leaves you with $100 in the Roth. After n years, the money
> doubles, and you have $200 available tax free. Same as in case 1.
>
> It comes out the same because either way, what you are doing is moving
> the tax money into a Roth IRA (either explicitly, in case 2, or
> implicitly, in case 1 by prepaying the taxes).

Except for this, assuming, say, a 20% tax rate:

if you have $10k in a traditional IRA and another $2k in a taxable
acct, when you make the conversion, you'll owe taxes on that
$10k. You can pay those taxes with the $2k you have outside the
IRA. Effectively, you've put another $2k into your IRA.

The Roth lets you invest a greater amount of money in a
tax preferred manner. For a given amount of pre-tax money,
the performance of a Roth is identical to the performance
of a regular IRA. The differences are (a) whether taxes
go up or down; and (b) - the bigger one - the fact that you
can protect a greater amount of money this way.

If you have to pay the taxes from the converted money,
the math makes it identical (assuming same rate of return
and same tax rates). But if you have outside money available,
you come out ahead by effectively converting some of that
outside money into retirement account money.

> What I have done is convert just enough to keep me in a particular tax
> bracket. Using the 28% tax bracket as an example, if married filing
> jointly, one could bring one's ordinary income up to $182,800 (using

If she's just on the verge of going above the Roth threshold
(she mentioned that next year she probably won't be able to
contribute or convert to a Roth), then presumably her taxable
income is on the order of $90k. In both 2005 and 2006, that
puts her smack dab in the middle of the 28% bracket and
50-60 thousand short of hitting the 33% bracket ($150 or $154k).
That's a lot of room to make conversions.


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