Well, okay, let’s take your above scenario, but I’ll use a 30% marginal tax rate, since this seems more accurate for us.
I start with $30k in cash, and $100k in a 401k/Trad IRA.
Scenario 1:
Convert the $100k to a Roth IRA, pay the $30k in taxes.
Wait 25 years at 10% annual return, balance 1083k
Scenario 2:
Keep the $100k in 401k, put the $30k in an index fund
401K: Wait 25 years at 10% annual return, balance 1083k
Index fund: Wait 25 years at 8.5% after-tax return, balance $231k
Total: $1314k before taxes. An average tax of 17.6% will result in a wash. For comparison, if my my wife and I only needed to withdraw enough to pay our current bills, we’d be looking at around a 10% average tax.
Analysis: I’m not convinced my average taxes would necessarily be that high in 25 years. Even if marginal rates are up, I’ll only be withdrawing what I need to pay my bills, I’ll have a house to write off, and I can tap my normal Roth each year to reduce exposure to the nasty tax brackets. And the $231k has already been partially taxed, and will owe less than full cap gains tax when it’s redeemed.
Now, the clever way around this is to do these conversions in a year when you are intentionally unemployed, so your marginal tax rate is very low for the conversion to Roth. Then you pay almost no tax at all. You just have to hope that you can find a job when the year is up.
Of course, this all assumes we’ll have a tax structure that faintly resembles our existing system. The house write-off might not exist. There might be an extra deduction for the elderly. We might have a flat tax, or a VAT tax instead. There may be no cap gains tax, or it may be treated just like income. We might live in burbclaves that don’t care about 1040’s and Roths and just collect a flat head tax.
So, on balance, it’s probably good to put more than $4k a year into Roth-type accounts, but I’m far from sold on doing this with a large chunk of it. And I’m still curious about the rules for accessing converted principal.
