Be A Sloth and Don’t ROTH – Why Converting To A ROTH Is A Mistake!
If I read one more biased article pushing people to convert to a ROTH IRA I’m going to lose it! Not to be melodramatic or anything, but the lack of unbiased analysis is like seeing a sea of zombies instructed to walk off a cliff. Wake up zombies, wake up! Don’t make a decision without seeing what lies down below.
The ROTH IRA conversion idea is that those who have pre-tax funded retirement accounts such as a 401K or Traditional IRA pay taxes UPFRONT, so as to not pay taxes when you retire. This is just absolute hogwash donkey dumb for a large majority of people out there.
Proponents of the ROTH IRA conversion argue:
1) Tax rates are low and are just going to go up in the future.
2) You will likely make more money in your retirement years, and hence pay more taxes.
3) Paying taxes now improves performance in the long run all else being equal.
THE SAMURAI REBUTTAL:
1) The government is smarter than you. They are geniuses at spending other people’s money, and extracting as much money from you! Despite so much red-tape, when it comes to fiscal and monetary policy, they’ve got geniuses running the show. Sure, back in the 70′s and 80′s the absolute marginal tax rates were higher, but there were many more income levels of taxation, and if you calculate the inflation-adjusted income levels, we’re actually better off now!
Think about why the government introduced this wacky piece of legislation from the government’s point of view. Obama and team are running a $2-3 trillion deficit. How the heck are they going to fund their binge spending? By introducing a new idea to be able to allow millions of people, and billions of dollars to be taxed right now to shore up their deficit!
They convince the masses that doing a ROTH IRA conversion is a GREAT IDEA, knowing in the back of their minds that taxes can’t go much higher than what Obama is proposing already. Furthermore, the government gets people who make over $100,000/yr excited when they say “no income cap in terms of contribution and conversion”! Another smart move so they can collect MORE tax dollars from the wealthier population now which already pay all taxes!
2) Love your enthusiasm that you think you’ll make more in your retirement years than in your prime 30-50 earning years. But I just have one question. Are you crazy? Let’s say you average $100,000 / year until you retire. To replicate $100,000 in income, you will have to have at least 25X your income in capital, or $2.5 million at a 4% risk free return to produce $100,000/year! The last time I checked, the best 5-yr CD’s now pay 2.5%, which means you need 40X your income, or US$4 million to produce $100,000 of income. GOOD LUCK SUCKER!
Let’s say Social Security brings in $25,000 a year, to make $75,000 still requires you to have $1,875,000 to $3,000,000 in liquid assets at a risk free 4%-2.5% return. When people are struggling to accumulate 10X their income in retirement savings, what makes you think you’ll be able to achieve 19-40X?
Let’s be realistic here guys. The only age group that might make sense are those in their 20′s, when their earnings power and therefore tax rate is still relatively low. Then again, if you are earning a smaller amount, the absolute tax savings won’t be that important anyway.
3) The results are the same based on 2nd grade math. Whether you pay taxes now and let your investment grow tax free, or you let your pre-tax investments grow, and then tax it upon retirement results is more or less the same! Don’t believe me? Do a calculation yourself. Here’s an equation: Y = A * B. Re-arrange to A = Y / B. Or Y = A * B is equal to Y = B * A. Trust me, I was a rock star in the 2nd grade!
Whenever something sounds too good to be true, it probably is. There is a reason why the government is offering this new “one time”, no income limit ROTH IRA conversion. The reason is they need your money! The government knows that they can’t possibly raise income taxes much further than the already 5-10% increase Obama proposes in 2011, 2012, and beyond, otherwise nobody would work, and capitalism would fall for good!
Lucky for you, you’re not a mindless zombie listening to everything the government and other sites tells you. You realize there are seven no income tax states in America you can retire in, thereby immediately wiping away 5-10% of your taxable bill. If you move to Hawaii, the state can’t legally tax your pension or retirement contribution!
It’s a good problem to have if you are making more in retirement than during your working life. However, the facts reflect a high unlikelihood you will have have 20X-40X+ your income in capital to draw from when the time comes. And remember, 20X your income is just the BREAK EVEN amount in taxes you’ll have to pay, all else being equal. You need to have 30X+ your income as capital for a ROTH IRA conversion to make sense at an interest rate return of 4%. Even if you do have 30X your income in your 401K, you can draw on the NUT at a much LOWER level to keep you in a lower tax bracket.
Never pay taxes unless you absolutely have to. Can you imagine when you’re about to retire, the government introduces new legislation which benefits Traditional IRA and 401K holders by offering LOWER tax rates? Meanwhile, over the past 20-40 years, the government has been using your ROTH IRA conversion to spend on a party that one day needs to be repaid. I’d be pissed. Don’t let the government trick you into converting. Once you pay them, you can NEVER get the money back.
Recommendations To Grow Your Wealth
1) Manage Your Finances In One Place: Get a handle on your finances by signing up with Personal Capital. They are a free online platform which aggregates all your financial accounts in one place so you can see where you can optimize. Before Personal Capital, I had to log into eight different systems to track 25+ difference accounts (brokerage, multiple banks, 401K, etc) to manage my finances. Now, I can just log into Personal Capital to see how my stock accounts are doing and when my CDs are expiring. I can also see how much I’m spending every month. If you are interested, they can even provide tailored financial advice for much cheaper than traditional wealth managers.
2) Use E*Trade To Rollover Your IRA. I’ve been using E*Trade for the past 12 years and they are excellent. If you have switched jobs, consider rolling over your IRA. Open an E*TRADE Rollover IRA. No Fees. No minimums.
Sam @ Financial Samurai – “Slicing Through Money’s Mysteries”