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.


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.

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Sam @ Financial Samurai – “Slicing Through Money’s Mysteries”

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship. Sam focuses on helping readers build more income in real estate, investing, entrepreneurship, and alternative investments in order to achieve financial independence sooner, rather than later.

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  1. says

    Howdy MLR – the quote you took was my rebuttal to an assumption another made. Obviously the US will still be around in 30 years, although perhaps as a great socialist country as some may argue.

    You’re making the wrong assumption on taxes. I certainly hope and expect you to make more as you move into your 30s, 40s, 50s. However, you need to compare the taxes rate you pay upon RETIREMENT vs. the tax rate you pay now, since between 30-50, the contributions to your traditonal IRA and ROTH are tax free.

    Check out JoeTaxPayer’s reasoning above as well.

    @ Kevin – Yep, JTP explained it well. Thanks for highlighting the exeption in the first place though!

  2. says

    Hey Samurai, those are some great points that you’ve made. It’s really refreshing to hear the other side of the Roth versus Traditional argument.

    That being said there are a lot of valid reasons why someone may want to convert their Traditional IRA to a Roth IRA in 2010.

    1. Roth IRA’s do not have a mandatory distribution at 70.5 like the Traditional IRA does
    2. Principal contributions may be withdrawn at any time.
    3. The liability for the tax paid at conversion can be spread over two years: 2011 & 2012

    Here are supporting arguments for each point:

    1. Because the Roth IRA does not have a mandatory distribution like a Traditional IRA does, the conversion makes sense for people who want additional tax-free growth past the age of 70.5. For example, if you’re wealthy and plan on passing the assets in your IRA to your heirs rather than making withdrawals at retirement, this makes a lot of sense.

    2. Contributions of principal can be withdrawn at any time in a Roth IRA without penalty unlike the Traditional IRA. For those people who were planning on tapping their Traditional IRA due to tough times or are planning to use their Roth IRA as their emergency fund, the conversion makes sense.

    3. The tax liability for conversion can be spread over the next two tax years; for those who were planning a conversion due to points #1 and #2, it’s better to delay the payment of your liabilities as long as you can.

    As you mentioned in your post “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!” So if you get the benefits of points #1 and #2, why shouldn’t you do the conversion? Am I missing something?

    Big fan of your blog, by the way.


    .-= Mike´s last blog ..5 Reasons to Subscribe =-.

  3. says

    Hey Mike! First of all, love the gravatar and your site’s theme. However, not sure if we can ever be friends since you are a Ninja, and I am a Samurai! lol.

    Good positive arguments you make. Doesn’t your #1 and #2 kind of cancel out though?

    Also very good reminder that the tax liability can be spread out over two years. Ah, so much complication, and what a pain in the bum for the masses though.

    I believe in slicing your pools of money for maximum returns. The retirement money in your IRA, 401k, whatever should never ever be touched, unless you’re about to go bankrupt. Hence, wrt to your argument #2, although it’s a nice option to have, that’s what one’s savings account in their bank is for. No co-mingling of funds!

    The overriding thesis of this post is that it is ludicrous to give more of your hard earned money to the government, when they are demonstrating irresponsible spending, while promising you that you will save money when you are old. The returns are roughly the same, but I believe for a large majority of people, they will NOT be making more money in retirement from their assets, than during their working lives. Hence, retirees will pay LESS taxes, so don’t be fooled.

    Hope to see you around more often! Appreciate your analysis.

    Best, Sam

    ps it takes a while for the system to auto approve comments for new commenters. eventually, it will learn.

  4. says


    To address these points.
    1. But to what end? As I showed, there’s a cost to convert and for most, a 10 or 15% tax upon withdrawal. If those RMDs are destined to be taxed at this low rate, what does it matter that the withdrawal is required?
    2. Hmm. Those with a lot of money are less concerned about this. So I’d agree, that if you are in the low enough income level that this appeals to you, you probably are a Roth candidate.
    3. But at what rate?

    For all three of your points, I can offer (contrive?) scenarios where this supports your position or takes the opposite view. But it all starts with understanding more about each person’s finances.
    .-= JoeTaxpayer´s last blog ..More on Estate Planning =-.

  5. says

    For readers following this thread, RMD = Required Minimum Distributions. If I was 69, I’d for sure withdraw my money, b/c I’d be worried I’d die before enjoying it! Ya never know!

    RMD Explained:

    When you reach age 70½, the IRS requires you to withdraw at least a minimum amount each year from all your IRAs and retirement plans and pay ordinary income taxes on the taxable portion of your withdrawal.

    Required minimum distributions (RMDs) ensure that the government collects the taxes it deferred all the years you were saving in a traditional IRA or your retirement plan. What do you do with the money once it’s withdrawn? That’s pretty much up to you and your individual needs. Just be sure to take at least the minimum withdrawal each year. When you do, you can:

    Reinvest some or all of it in a taxable account.
    Spend all of your money.
    If you don’t take your RMD, you’ll owe a 50% federal penalty tax on the difference between the amount you withdrew and the amount you should have withdrawn. And you’ll still have to withdraw the required amount and pay any income tax due on the taxable amount.

  6. says


    Joe, I completely agree with you that there are both scenarios where the 2010 conversion is a great deal and other scenarios where it doesn’t make sense.

    Regarding mandatory distributions, it absolutely matters when they’re withdrawn! You’re right that distributions are “destined to be taxed” at the same low rate but the difference between paying those taxes now and 20 years later is a very big deal. Time value of money?


    I’ll be honest with you. I’m not a real ninja.

    As a matter of fact, I don’t know the first thing about ninja-samurai etiquette. But, if you say we can’t be friends, then we must battle to the death (If television has taught me anything, I know ninjas and samurais do that)!! But really, I’m not good at fighting; I’m a consultant for goodness sake!

    Anyway, back to the discussion… the required minimum distributions of a traditional IRA and the option to withdraw principal are two different things and don’t cancel each other out. The implication is:

    1. I have the option to have all of my principal and earnings continue its tax-free growth past 70.5 in my Roth IRA indefinitely. I don’t have that option with the Traditional IRA.

    2. I have the option to withdraw any or all of contributions to my Roth IRA at any time in my entire life without penalty. I don’t get that option with the Traditional IRA until age 59.

    The way I see it is with the Roth you have the option to continue investing (earning) past 70.5 and the option to withdraw at any time if you have an emergency (emergency fund). I’m on the same page as you when you say that you shouldn’t touch your retirement assets but if studying finance has taught me anything – the option to do anything is always worth something.

    Thanks for letting me know about the comments… Did I accidently send that post through 5 times? Can you let that I’m passionate about the topic? Haha..

    .-= Mike´s last blog ..5 Reasons to Subscribe =-.

    • says

      Hi Mike – Yes, do some research on Ninjas in Japanese folkllore. Ninja’s are deceptive warriors and are oftened accompanied with the phrase “Ninja Assasin” if that gives you any clue. Ninja is also called “Shinobi”, and are often times spies. Ninja’s descended from a demon that was half man, half crow, and evolved to oppose the “upper-class contemporaries” (Samurais) in feudal Japan.

      Ninjutsu, is the art of stealth. If a Ninja was honorable, there would be no need for stealth!

      Ninjutsu versus Bushido:
      Ninjutsu developed as an opposing force to the samurai code of bushido.

      Samurai valued loyalty and honor above all else.

      Going into battle, a samurai would select a single opponent, announce his challenge, list his family pedigree, and then attack. Samurai wore bright colors on their armor to announce their clan identity.

      Bushido was very noble, but it couldn’t always get the job done.

      That is where ninjutsu came in: the ninja code valued accomplishing a mission by whatever means necessary. Sneak attacks, poison, seduction and spying were all shameful to the samurai, but fair play by the rules of the ninja.

      Thanks for being honest and telling us you aren’t a real ninja!

      On to your points, yes, having an option has a value, but the value is what is questioned if you already have your emergency after 20-45 years of savings. The government WANTS you to keep your money growing tax free past 70.5 and never touch your money. That way, fund managers can earn fees off you, and perhaps you’ll pass away after age 70.5 and never get to realize your money. I surely hope nobody withdraws from their traditional IRA before age 59, otherwise, what’s the point of contributing in the first place? That would be dishonorable.

      Yes, your comment posted 3X. It’s cool, but that’s what I expect from a Ninja! :)

      Best, Sam-urai

  7. says

    I think you should win some kind of prize for coining “hogwash donkey dumb”. Haha!
    .-= Mike´s last blog ..5 Reasons to Subscribe =-.

  8. says


    Commutative property of math?

    (Little Money * .75) * 10 = (Little Money * 10) * .75

    The 10 is growth over say 20 years, but it doesn’t matter, 2X 10X.
    All that matters is the rate. If it’s the same, it’s the same. If different, well, it can be big either way.
    .-= JoeTaxpayer´s last blog ..More on Estate Planning =-.

  9. says

    It looks like there are a lot of young folks who are discovering this post, defending their justification for doing a ROTH. Having a ROTH isn’t bad… I don’t think this is a case of bad vs. good. This is a case of good vs. less good.

    MLR, your thought process is off regarding your tax comparisons like Sam-san said. Mike, good points on option value, but only the weak think about giving up and withdrawing money from their retirement fund.
    .-= The Genius´s last blog ..Stock, students enjoy ‘reel’ relationship with Cuban filmmakers =-.

  10. says

    1. Ninjas are mammals
    2. Ninjas are totally awesome

    You should check out if you have some time and want a laugh. It seems like you a pretty good sense of humor. Haha.

    And, I can’t believe you just gave me the entire history of ninjas and samurais in a comment. You my friend, are awesome. Haha.

    But…. back to your point: there is no conspiracy between the government and fund managers. The IRS doesn’t want us to withdraw our funds so that fund managers can make more fees off of us? I just don’t believe that. What the government wants is to not have a bunch of homeless elderly people living on the streets (think US Recession of 1980’s).
    “Between 1980 and 1993, the total number of older households in the United States –that is, households headed by someone over the age of 65 — increased by 31% (Gaberlavage and Sloan, 1997). ”
    This is the reason why tax advantaged retirement accounts were created in the first place – to encourage saving for retirement. Not to mention, you don’t even have to invest in mutual funds with your Roth IRA anyway.

    To both your and @TheGenius’ point about not withdrawing money from a retirement fund: it’s really dumb to withdraw money from your retirement fund – agreed. It’s even dumber if you take a penalty to withdraw that money.
    But sometimes there are circumstances beyond all of our control (emergency, anyone?) where we need money and there isn’t any other way to get it. I think we’re lucky that nothing so terrible ever happened to us that we ever needed to do it. But I wouldn’t demonize the person who had to.

    That sounds a little honorable, doesn’t it? Haha.

    Hey Joe, Sorry if my comment earlier seemed a little stand-off’ish.
    I’m not sure what you meant in your above comment. Is the .75 supposed to represent a 25% tax rate and then the 10 is the amount of growth?

    If so, here’s why that relationship doesn’t always hold for Traditional v Roth IRA

    You say that ($ *.75)*10 = ($*10)*.75
    or Roth = Traditional

    While this holds true most of the time, when this doesn’t hold true is when you plug in the limit for the Roth IRA number. For example, you can contribute $5000 in 2009 to your IRA, right?
    But, $5,000 to a Roth IRA is worth more than $5,000 to a Traditional IRA.
    If you think about it, you’re essentially contributing more money when you contribute an equal amount to a Roth IRA since the contributions are made with after-tax dollars, right?
    So a $5,000 Roth IRA contribution is equivalent to a $6,667 Traditional IRA contribution.

    I think we can agree on a few points here:

    1. Investing in both Roth and Traditional IRA’s are good because they’re both tax advantaged accounts.
    2. A $5000 Roth IRA contribution is worth more than a $5000 Traditional IRA contribution
    3. There is a $5000 limit for 2009, 2010 – there will always be a limit.

    So, you can contribute more money to tax advantaged accounts if you contribute to a Roth IRA account.

    Plus, a person with a Traditional IRA would have to invest his tax savings from contributions into an investment account that beats the tax-free return of a Roth. And since you can basically invest in anything with a Roth IRA account, it’s near to impossible.
    .-= Mike´s last blog ..5 Reasons to Subscribe =-.

  11. says

    Goodness me with the Ninja vs. Samurai debate!

    But Sam, after your thesis, you’ve convinced me that I would rather be a ninja. Stealth, spy, seduction, the underdog, efficient attack; they all sound sexy to me.
    What’s so sexy about long boring speech on your family pedigree? :D
    Yeah, yeah, I might change my mind when I get older, later… way later.

    Talking about getting old, enlighten me, in math term, is this (the discussion) about paying $20 now vs. paying $20 later (present value vs. future value)?
    If there is no lower tax incentive when you retire (ie. retirees have the same tax structure as the rest of the population), it is only beneficial that you do this ROTH IRA thing when your income is very low now. You’re correct.

    On the other hand, I also agree with Ninja Mike that the flexibility of being able to withdraw it anytime is definitely a plus point. That is the reason why I stopped making extra contribution to my retirement fund. Here, the employers are required to make 9% contribution and any extra contribution from me is tax free now but will be taxed for 15% when I retire. The money is locked until I’m 64 and who knows whether I’m going to live that long. So I’d rather put my extra money in a fluid investment now.

    That being said, what is the extra benefit of ROTH IRA compared to other normal mutual fund (if your income level is average or better and flexibility is what you’re after)?
    Anyway, that’s a 5 cents’ worth from a curious foreigner.
    .-= Bytta @151 Days Off´s last blog ..Day 6: Four Reasons I’m Not A Diva (And Neither Are You) =-.

  12. says

    @ Mike – You’re right. The govt doesn’t want broke folks come retirement, hence the intro of these funds. Hence why you just argued my case that to allow people the option of raiding their accounts for an “emergency”, like buying a big screen TV is estupido, but is sheer GENIUS by the govt!

    The govt wants to take all the money can from you right now to pay for the budget deficit and has propagated this “no penalty” withdrawal for a ROTH to get people to contribute! They know the inflow of tax dollars will be greater than the outflow of “emergency” withdrawals with this propaganda.

    The ROTH contributor is making the ultimate sacrifice, giving up more of their tax dollars than they have to vs a traditional. Once the govt got yo monay, you can KISS your money buh bye!

    Conceptually, Roth vs. Traditional are both good. This is just a case of which is less good.

    Stay on the honorable path!

  13. says

    @Bytta – I understand where u r coming from regarding not being able to touch the money until afe 64 or whenever. Hence, feel free to spend your money like there is no tomorrow, bc a dollar now, esp when you don’t have much in reserves is ironically worth way more than a dollar in the future when you also may have a ton more!

    Just know that savings is insurance, just in case tomorrow does come. Then what?

  14. says

    I agree with you about the government just wanting out money and being smarter than we think, but I also think you are going over the top about how it’s better not to go with a Roth. I think different people have different situations and therefore some should open a roth while others a tradition IRA.

    What I tell all my readers at is that the most important thing is that they invest- PERIOD! People get too caught up in what to invest in, that they forget to invest on a automatic basis and just leave it alone. It’s not worth wasting your life trying to save pennies here and there.

    Anywho, those are my thoughts. Thanks for the post. I like your style!

  15. 20smoney says

    Wow lots to think about here. Great post and great comments. Thanks for presenting a sound argument!
    .-= 20smoney´s last blog ..Boost Your “Yield” By Writing Covered Calls =-.

  16. says


    You are correct for someone who is just starting, just invest. The thing is when have a decent sized net worth taxes can dramatically suck the life out your investments. We aren’t talking about pennies either.
    .-= Investor Junkie´s last blog ..What is a Master Limited Partnership (MLP)? =-.

  17. says

    Hi Griff – Welcome to the community! I agree in that the most important thing is to save and invest for retirement. What this post attempts to address is the fallacy of CONVERTING to a ROTH IRA, and not investing in a ROTH IRA. Hope to see you around!

    Thanks. Feel free to share your thoughts. Careful about them covered calls writing just in case the stock rips much higher! Guess you win with an underlying position too.

  18. says

    An excellent and informative post, as always, FS. Let me attempt, in my preferred role as Devil’s Advocate, to rebut your rebuttals:

    1) Let’s be honest, if we’re going to get out of the financial hole we are in as a country, we’re going to need higher taxes, less government spending, increased inflation or a combination of the three. Perhaps you’re right, perhaps Obama can’t raise taxes much beyond where they are now, but other politicians following him, starting from a higher level of taxation, can continue to slowly ramp up the tax brackets. (Let’s be honest, tax levels have been higher in the past, without causing the country’s economy to collapse; unless you have access to some detailed psychological research you’re not sharing, the idea that anymore than a 5-10 increase in tax rates (which, if I’m not mistaken, is only effective on the highest tax brackets, anyway) will cause the bulk of the country to say, ‘Screw it, it’s not worth working anymore’ seems far fetched).

    Now, I’ll admit, I have no idea where Uncle Sam’s taxing hand will fall hardest in the future. Perhaps tax rates will be lower than they are now, making a traditional IRA a better deal. Maybe ordinary tax rates will be much higher than they are now (which is what many of those recommending these conversions are counting on), giving Roth accounts an edge. And of course, if we go from an income based tax system to a spending tax or VAT tax, all bets are off about how retirement accounts will be affected. Short of a time machine to see what the tax system looks like between when we retire and when we die (assuming we do eventually die and aren’t turned into immortal cyborgs or something), the best we can do is try to diversify to ensure that we’re ready for many eventualities.

    (Side note: This conversion limit cap removal plan was put into effect in 2006, when, as you’ll recall, we had Bush Jr. in the White House and Republicans controlled the Congress. Now, Obama and team do stand to benefit from the timing of all this, I’m not denying that, but if anyone was trying to get people to voluntarily increase the amount they (the taxpayers) were paying in taxes to cover their (the politicians’) deficit spending, it’s the Right side of the aisle. Just to set the record straight.)

    2) I honestly never heard anyone espousing the idea that they (or I) would be earning (or rather, pulling from retirement or other accounts) more in retirement than while working; in fact, I thought the commonly cited figure was 80% of your final income. Again, this seems to be related to the whole idea that taxes will rise in the future, making Roths seem more attractive (although again, we don’t know for certain what will happen in the future, tax-wise, so….diversify!)

    3) Again, I’ve never heard that one before; paying taxes upfront would seem to have no effect on investment performance. But again, it comes back to the expectation that in the future, tax rates are going to be higher than they are currently. If it is, then Roth accounts are better; if it’s lower, then traditional accounts will be more profitable. If they do remain exactly the same, which is the only scenario I’d guarantee won’t happen if we’re looking at decades down the road, then it doesn’t really matter; but again, what’s the chance of politicians not messing with taxes between now and 2047 (when I turn 65)? (And of course, the same holds true for state income tax levels, as well; who’s to say that when retirement rolls around, there will still be states that charge no income tax for you to retire in?)

    Don’t get me wrong, I do see your points, both about not paying taxes before you have to and about how much you need to save in order to generate your current level of income. Again, the best thing to do seems to be to diversify your retirement funds, holding a mix of traditional and Roth accounts (as well as a taxable account or two, in case they end benefiting from future changes more than the retirement accounts). I’m just saying, maybe the zombies have a reason for making this particular suggestion, one that is unrelated to doing Obama’s dirty work of boosting tax income.
    .-= Roger´s last blog ..Small Business 101: Useful Skills to Have =-.

  19. says

    Ah, Roger, the great policy geniuses have captured your mind, and I’m sad I’ve done very little to change the way you think.

    At least you are contributing to your retirement. That’s the most important thing. The gov’t and the people of America thank you for paying more taxes than you have to, to fund our ways. In fact, part of your extra tax donations to the government is going to help reward big bonuses to the bailed out executives of AIG. Goodness bless America!
    .-= admin´s last blog ..Samurai Predictions And Resolutions For 2010 =-.

  20. Alfreda says

    Wow!!. This is a really great website. I am not as well versed in finances as your other commentors as I am really just trying to soak up as much info as I can. I learn something new everytime I visit. Even the comments are informative. Being able to view both sides of an argument really helps me make informed decisions. Great job.

  21. fredct says

    I find it extraordinary that you try to frame this as Obama’s idea when it was actually passed as part of the 2003 Bush Tax cuts (or the 2006(?) extension? I’m not sure which). Anyway, I really find it sad that in your first point you try to play politics in this and don’t even give a consideration to the fact that this has nothing to do with the current administration. I’ve never seen a financial equation that took into account which administration passed a law anyway.

    I think you’re making the wrong comparison however. I agree with you that converting from a deductible IRA to a Roth is only good if tax rates go up drastically in the future (although with the deficit doing what it’s done in the last, oh, 20 years or so), that’s not impossible.

    But the *real* use it not for people who have access to deductible IRAs, its for people who have yet-so-far been above the Roth limits and may have contributed to non-deductible IRAs. If this is your situation, then conversion to a Roth IRA gives you relatively little taxes to pay now, and gives you all the benefits of a Roth in perpetuity.

    Finally, there are other benefits of Roth’s that you haven’t even scratched the surface on. Assuming you have a 401K, having a Roth also will allow you to chose the source of your income, and optimize your tax situation. It also may allow you to retire earlier by giving you tax & penalty free access to your contributions.

    You are correct that some of the arguments you refute are very possibly inaccurate, but you miss a lot of others that are quite accurate.

    • says

      Fredct – You shouldn’t have to defend Obama, because the post is not an attack on Obama. It’s the criticism of American GOVERNMENT policy, regardless of who is in office.

      I’m happy you think you will have multi-millions when you retire in capital that will equate to more than your formidable earnings years of age 30-60, but others aren’t as fortunate.

      The people of America are happy that you want to pay more taxes, because someone has to pay for the government’s spending binge, that someone should be the person who is benefitting the most, which sounds like you.

      Best, Sam

  22. says

    admin :
    Ah, Roger, the great policy geniuses have captured your mind, and I’m sad I’ve done very little to change the way you think.
    At least you are contributing to your retirement. That’s the most important thing. The gov’t and the people of America thank you for paying more taxes than you have to, to fund our ways. In fact, part of your extra tax donations to the government is going to help reward big bonuses to the bailed out executives of AIG. Goodness bless America!
    admin´s last blog ..Samurai Predictions And Resolutions For 2010

    On the contrary, you’ve done quite a lot to change the way I think; you, the responses to this message, and my own research in attempting to argue my point, all have given me a new perspective. While before I would have been whole-heartedly in favor of Roth accounts, I do see that traditional accounts have their advantages, and I’m actually planning not to convert my own (fairly small) traditional account into a Roth, as a result.

    What you haven’t done, however, is convince me that (a) future tax rates will not be a major determinant of which type of account will be better and (b) future tax rates will not be higher. Let’s look at your proposed deal with us, giving you 25-30% percent of our money now, with the promise that you would pay it back in 20-40 years. If we want to make it really representative of choosing between conversion or not, let’s make this bet instead: I’ll give you 25% (my 2010 marginal tax bracket) of my traditional IRA money now, but when I retire, you have to give me the current prevailing marginal rate on the amount my account would have grown (less the current tax, if any leveled on Roth withdrawals).

    I’ve a got a little over $1000 in my traditional account now; that’s $250 I’d owe you now. My somewhat reduced nest egg ($750) grows over time, safe in a Roth account, to about $6866 by 2047 (assuming a 6% rate of return). If I had kept the money in a traditional IRA, $1000 would grow to be $9154 in 2047 at 6 percent. If there’s still a 25% marginal rate of taxation on money pulled from a traditional account (and a 0% rate on Roths), you’ll owe me $9154*(25%-0%)=$2288, exactly the difference between the value of the traditional account and the Roth account. Assuming tax rates are the same when we start our accounts as when we end them, we’ll have the same amount in after tax money to spend regardless of whether we use a Roth or a traditional account. Assuming you invested the $250 I gave at the same rate I invested the rest of my money, you’ll be able to pay me back with just those proceeds, leaving you with a net of $0.

    But let’s say the marginal tax rate I pay rises to 50%, through a combination of my increased earning potential and higher marginal tax brackets while Roths are still untaxed. Now, you’ll owe me $9154*(50%-0%)=$4596. Suddenly, I’m sitting much prettier with my untaxed Roth, and you owe more than you could get by investing my $250. In this case, I win; by using a Roth and paying taxes up front, I’d end up with more after-tax retirement spending money than by using a traditional account.

    Of course, I might not be the victor; if the marginal tax rate falls (let’s say your hope for a flat tax of 15% comes true), then the amount you owe me drops: $9154*(15%-0%)=$1373; I would have been better off keeping the $250 and investing it, then paying the taxes on it. Even worse, for my situation would be if Roths were being taxed at the same percentage as traditional accounts; whether that’s the marginal tax rate (if Roths lose their tax-free withdrawals) or at zero percentage (if we switch to a spending tax), the math works out the same: $9154*(25%-25% OR 0%-0%)=$0; I’ll have given up my $250 without getting any benefit. The point being, how good a deal such a switch is depends on future tax rates compared to current ones.

    (You might ask why you don’t merely abscond with the money during the 37 years it will take to conclude our bet (or equivalently, what makes me think that the government will keep its promises years, or even decades from now). In the case of our bet, I’d have to depend on your samurai honor to ensure that I’d get an appropriate settlement when our bet concludes. ;) For the government, there’s more tangible reasons to expect that they’ll keep their promises: the government is controlled by politicians, politicians who want to be re-elected. You think that raising taxes beyond 5-10% will cause people to revolt and the government to collapse; I think that breaking their word regarding retirement accounts and how they will be taxed will be even worse. Greed is a powerful motivator for politicians, but fear is even more motivational ;) ).
    .-= Roger´s last blog ..Fifteen Things to Tell A Younger Me =-.

    • says

      Roger – Glad you are thinking things through more! That makes me happy. :)

      Yes, I will take your money now, and promise to pay your taxes when you retire in 37 years. As JoeTP and Kevin pointed out, $2 million in capital is taxed at a 15% rate due to the deductions. I really do hope you have much more than $2 million in assets…. closer to $4 million to start paying a blended tax rate of 25%, I really do.

      But for now, I will use your $250 to buy myself some new shoes, take my wife out to a steak dinner, and maybe buy some new tennis grip! This is what’s needed to stimulate the economy (this is what the gov’t is doing). I promise to pay you back in 37 years.

      Best, Sam

  23. says


    Roger, maybe this will help. My deposit to my 401(k) are taken out at 28%. As they are taken off top like that strange film that forms on pudding, the entire deposit is skimmed at 28%. This is a fact. The known known, which I know, now.

    As I stated further up (and to Genius’ point, this topic is dry, and very Ben Steinish, I know that) at retirement, if it were today, the first $11,400 comes out at zero. Now, this is a fact, too. You are welcome to think what you will about future tax structures, and I won’t criticize your prognostication, or even disagree. You just need to first really understand marginal rates that get passed through first before hitting the current bracket. Again, look at current rates and shift by a full bracket, so you can assume that 25% cutoff today is the 15% cutoff at your own retirement. You’d still need $1.3M in today’s dollar to fill that 25% bracket (I took the big shift into account).

    The bottom line is that dollars today come off the top at the marginal rate, dollars at retirement start getting taxed at zero, first filling a huge tax bucket before getting to current level. Does this help illustrate the issue?
    .-= JoeTaxpayer´s last blog ..Your Money Ratios =-.

  24. fredct says

    Its funny, Sam, because I didn’t say a single on of those things. And I myself will not be converting anything. I even agreed with you that most people shouldn’t. If you’d care to discuss my actual comments, I will be more than happy to do so.

    • says

      fredct – You have an interesting way of agreeing with me, which is fine. Feel free to share with us a couple benefits of the Roth which I haven’t scrathced the surface of. The comment thread has been a long one, and we’ve learned a lot, so please share.

      I know it may seem like I enjoy criticizing Obama, but whether it’s Obama or Bush in office, they will get the same wary critcism, b/c it’s important to fight for the people, whose tax dollars are hard at work doing something.

  25. fredct says

    Then why is it bad to provide the tax payer with additional options? No one is forcing anyone to do anything, but for those who is does make sense (and there are plenty of situations where it makes a lot of sense), they now have a new option if it makes sense for them.

    I already did provide you a couple benefits (literally… I provided you with two, which is the definition of a couple) of having a Roth. But I will gladly repeat them again. First, I pointed out that having a Roth allows you to have more flexibility in retirement to control your taxes. Specifically, since the Roth money is tax free, it allows you to pull pre-tax money to fill up the low rate brackets and then use Roth money to avoid the higher brackets. A very useless technique that is only fully available to those with Roths.

    Second, I mentioned that since your Roth contributions are withdraw-able without taxes or penalties at any age, you can retire early and begin living off of your Roth money before you reach age 59 1/2.

    And, just for fun, I’ll throw a third out there… Roth’s have no required minimum distributions, so it allows you to have more control over when and how you use the money later on.

    If you are in a position where those are particular important to you, or, for a variety of reasons, your conversion taxes would be lower than for most people, then a conversion *may* be a good idea for you. Not for most people, but for many.

    And again, no one is being forced to do anything, but I don’t see how giving them a choice is something you need to oppose in order to “fight for the people”.

  26. says

    @JoeTaxpayer: I do actually understand the concept of marginal tax rates,although I overly simplified my response to FS for the purposes of illustrating a more appropriate bet. To be truly fair, I should compare the marginal tax rate (for a Roth) to the average tax rate (for the traditional account), taking the income paid in each tax bracket into account to determine the percentage and overall amount paid into the system.

    Although, then things start to get complicated. Things like pensions will shrink the amount you can withdraw before paying higher amounts in taxes. I’m not even going to try to calculate just how all of that would affect the relative amount paid in taxes (and the after tax amounts) in each type of account; there’s just way too many unknowns to say anything for certain. And of course, I’m looking at thirty some odd years before reaching retirement age (assuming that the retirement age stays the same, yet another unknown), so who knows what the tax system will look like then.

    @FS: I was attempting to reach $5 million in assets (if not more) actually, so $4 million should be easy (although, with our normal qualification that we can only guess what the tax system will look like in 2047). I’ve been trying to save somewhere in the neighborhood of 20%, with the understanding that when I settle down with Sondra to start a family, it might not be possible (plus, compound interest rocks!).

    If you are seriously willing to bet, we’ll need to discuss the details and terms of the bet. What basis for gains we’re using, the methods of verification, the techniques of transferring the money, etc. Drop me an email at theamateurfinancier [at] gmail [dot] com so we can work it all out.
    .-= Roger´s last blog ..Fifteen Things to Tell A Younger Me =-.

  27. says


    You make excellent points. Which is why this is not a black and white situation. Do you work for a company with a traditional pension? If so, and you plan to stay, this needs to be part of your planning. If not, then this applies to others fortunate enough to have one.

    Your target is $5M? 27 years out. At 3%, money doubles in 24 years, so that’s a factor of 2. In today’s dollars, you are aiming for about $2.3M. Now, this is an amount that would just put you into the 25% bracket. If you were asking my advice (I know you’re not, really) I’d suggest you bide your time, and get closer to the end game. You’ll know if you’re on track to exceed your number or not. You’ll have the chance to convert in any year that you drop back into the 15% bracket for whatever reason. You’ll have over $1M in today’s dollars some 15-20 years from now, and if, heaven forbid, you become disabled, can withdraw those funds and stay at 15%.

  28. BG says

    FS) I guess you’d make the same argument for Traditional 401ks -vs- Roth 401ks — that the majority of people should stay in the Traditional 401k. For me, my company match is considered a traditional 401k contribution, and I put all of my own contributions into the Roth 401k side. I call it hedging my bets.

    Nobody has a crystal ball, but when we are currently living in an age of historically low income taxes, my feeling is that they can only go up. I’d rather pay the devil I know, than the one I don’t. Another huge plus going for me and my Roth-401k is that I have children and other types of credits and deductions that I can make use of to lower my current tax obligations. When I am in retirement, I will not have any of these fancy credits/deductions — so all else being equal (even if the tax rates don’t change) — I’ll be paying more in retirement.

    I say: for working families to absolutely use Roth vehicles (IRAs / 401ks).

    • says

      BG – You used the write word, “Devil”. The Devil has you under his control, and he hopes to promise you savings in the future. The Devil wins by taking more of people’s money now. Once you give the Devil your money, good luck ever getting it back.

      It is great that you will have $5million in capital when you retire to pay 25% tax based off a 4% return, but most people won’t be able to save that much to break even. Achieving 50X the a average household income of $100,000/yr household income has shown to be tough to do.

      Best, Sam

  29. BG says

    I’m not sure what you are getting at with those numbers.

    All I’m saying is that, if my retirement income is identical to my working income today (not that far fetched — 93% probability), then I’m better off investing in a Roth because I have tax credits/deductions that I can take advantage of now while I can (children in the household, mortgage interest, etc) — which effectively lowers my tax rate _today_.

    For example, if I’m in the 28% marginal tax bracket, and I have various credits/deductions that lowers my effective tax rate to 9% (today) — why would I want to defer taxes on any income if I can get away with a 9% effective tax rate right now? Pay the 9% devil today, instead of paying some unknown (and likely higher) devil in 40 years. For me, the Roth is a no-brainer.

    Am I missing something?

  30. Steve says

    While I agree that the conversion isn’t for everyone, I wholeheartedly disagree with some of the arguments in this post.
    1) The Roth Conversion Party this year has nothing to do with Obama, and was in fact created during the Bush administration. Others have already pointed this out. My understanding is that it was created as one of those accounting tricks to make the Bush tax cuts look like they would cost less money over time than they actually would. (Other tricks include having the cuts expire after a few years. Politicians use that trick all the time – that’s why they’re always having to have emergency votes to extend programs and tax rates for a few more years.)
    2) You are absolutely wrong that tax rates can’t go any higher. They have been much, much higher in the past, and may be much higher in the future than they are now. I’m not going to argue that they must go up, but neither can you argue that they can’t.
    3) The fact that this applies to people over $100k may very well mean they have enough assets at retirement to make conversion a good bet. Most of the people that only have $2MM would be people making less than 100k last year, and could have converted any time they want.

    In conclusion, while in the end I agree that a Roth conversion may not be a good idea, I disagree with nearly every other point you make in your post/

    • says

      Steve – Thanks for your thoughts. The post isn’t an attack on Obama, it is not even an attack. It’s to illustrate why the goverment (no matter what political party) is doing what they are doing. Of course tax rates go higher, but I don’t think they will increase more than the proposed 5-10% hike Obama is already going to implement next year.

      $2 million? We’re talking $5 million in capital for those to pay 25% tax.. ie get to $5mil when you retire, and that’s break even.

      The people of America, and gov’t salute you! :)

  31. says


    That 93% came from where? If that’s your own probability, that’s great. And that also suggests a bell curve, 7% chance of less. Let’s assume you are 100% confident of replacing exactly 100% of your income at retirement, no more no less. Ideally, only some small fraction would be in Roth, maybe 20%. Regardless of the exact numbers, you’d first want to fill the brackets below the one you are currently in, no?

    28%/9% ? I understand those numbers, but here’s what’s missing. Your pretax deposits now are all at 28% (unless you are right on the edge and really at 25%), but at retirement, the first X dollars are taxed at “zero”, next Y$ at 10%, next Z$ at 15%. The average rate is meaningless for your analysis, you need to understand that to find your ideal mix. The mix is different for every person, and is only 0% Roth for those who are blessed with a pension and Social Security that come close to 80-85% replacement rate. Those people are few and far between.

    From what you’ve said, you should do the math and save enough pre-tax so withdrawals fill the 15% bracket. This make sense?
    .-= JoeTaxpayer´s last blog ..Martin Luther King Jr. Day 2010 =-.

  32. BG says

    Hi JoeTaxpayer!

    The 93% number comes from FinancialEngines’ analysis of my portfolios, based on my expected retirement age, savings rates, investments, etc. I believe they use Monte Carlo simulations for various variables like inflation rates and growth rates to determine the probability of me meeting my retirement objectives. Their services are free to me as a benefit of my employer.

    Anyhow, assume I make $100k a year today, and it is predicted I will earn $100k a year off of my investments during retirement. If we assume that tax rates don’t change between now and then, most people will just claim that there is really no difference between Traditional or Roth investment accounts. Neither one has a dollar advantage over the other (if the tax rates stay the same). Do you agree with this? Practically everyone will agree with this given assumption.

    However, I disagree with that assumption — the _one_ difference is that I have child tax credits and mortgage interest deductions _today_ that I guarantee you I will not have in retirement.

    So, in this sense, it pays for me to pay income taxes today (and invest in the Roth) since my tax rate is most-likely lower now than it will be in retirement. If congress increases taxes, then even more so.

    For my future retirement effective tax rate to break-even with my current effective tax-rate, congress would have lower taxes by about 5%, to balance out my loss of the child credit and mortgage interest deduction.

    Anyhow, I can’t go completely Roth, since my employer’s 401k contributions are considered part of the traditional 401k, so there is some hedging going on whether I like it or not.

  33. says


    Nope. I disagree. You are correct in your observation. Which is why it makes more sense to talk about your taxable income.

    If that $100K at retirement is gross, you have (if single) $3650 exemption and $5700 std deduction, $9350 at zero rate. Next $8375 at 10%, Next $25,625 at 15%. This totals $43,350 that of the $100,000 would benefit you if it were pretax. You say you are in the 28% bracket. This 43K would come out at 15% tops. Total tax $4681.

    These number inflate over time of course. You can see I straddle the line. Maybe to you, paying tax at 28% instead of hoping for 25% years hence is not worth it. No push back from me.

    Look at my numbers carefully, from listening to you just this bit, your ideal mix is likely 40-45% pretax money. I’d like to hear your thoughts on that back of envelope assessment.
    .-= JoeTaxpayer´s last blog ..Martin Luther King Jr. Day 2010 =-.

  34. BG says

    Hi Joe — thanks for trying to explain all this to me. I think I am starting to wrap my head around this.

    I believe you are saying to not purchase 100% Roth (and pay taxes at today’s highest marginal tax bracket — 25% for married on $100k gross), on money that could grow tax-deferred and would actually be taxed at a much lower marginal tax bracket in retirement (the 10% and 15% brackets — there is no zero bracket).

    If you fill the lowest brackets with tax-deferred money in retirement — you are coming out ahead (25% marginal tax today -vs- 10% or 15% marginal tax in retirement). The bracket at the same rate (25%) is a wash between Roth and Traditional, and anything over the 25% bracket is best served by a Roth account.

    This makes perfect sense and sorry it took me so long to get this straight. You really gave me something to think about!

  35. says


    Yes – you got it. I often struggle to get a thought into words, and appreciate your patience.

    “there is no zero bracket”

    Indeed. I use that expression to describe the sum of the Standard deduction and exemption. It’s a misnomer but does acknowledge $9350 (single) or $18,700 (couple) that one can have as income, not subject to tax.

    Now, you have the facts you need to make an informed decision. Future marginal rates? Still unknown. But from Sam’s efforts and mine, you understand the process better. You have time to change your target as time passes to optimize your wealth.
    I will have a beverage in your honor.

    • says

      JoeTP – Phew, thanks for being so patient in explaining to the community. Very helpful! I’ll buy you a beer next time we meet up! Takes a lot of patience and explaining to do.

      In fact, you may want to encapsulate your very helpful comments from here into a new post. Join forces!

  36. BG says

    @Admin & @JoeTaxpayer:

    And I too shall drink a beer in your honor, and tell my friends about this as well. If either of you are going to do another post on this, perhaps you could also share a public Google Docs Spreadsheet so all the math is right there.

    Thanks again!

  37. Mike says

    I agree this move doesn’t make sense for everyone. But I’ll take issue with a couple of your points. First, your point #1 about how smart the government is (as well as your complete non-sequitur about Obama– the 2010 conversion rule pre-dates Obama by years. I read about it at least as early as 2006). Yes, the government likes the idea of getting tax revenues now rather than later. But their logic is akin to the pre-1789 French government’s selling future exemption from taxes: from the government’s perspective, the upside is all now and the downside is all later– and maybe WAY later. Especially because the people for whom it makes most sense to convert are the people who are 20-30 years away from retirement; if I convert $140k this year, at age 35, then they’re getting tax revenues NOW that they wouldn’t have gotten for 30 years. Even if I ultimately “win” by making this move, the people who make up the current government also win, because most of them weren’t going to be running things in 30 years anyway. So: they get the money now; the resulting shortfall comes after they’re retired, voted out, or even dead. So in one sense they’re “smart”; in another sense, they’re very short-sighted.

    And secondly, though your point is well taken that the government can change the rules in the future, I have a hard time believing that the Roth-holding lobby is going to be powerless to get certain things “grandfathered” in. And the Roth has advantages like no minimum distributions. The biggest threat to the Roth is probably not that the government would nakedly violate the terms of the contract; it’s that taxes might be introduced on consumption so that avoiding the income tax on Roth withholdings would be useless unless you could actually avoid spending the money.

    Which is to say, the best candidates for conversion are those who are 3-4 decades away from needing the money or even better, who plan never to need the money but to pass it on to heirs; those who can pay the tax from outside the account itself; and those who are savvy enough to lower their taxable income in the year they do the conversion. Note: you don’t have to pay tax on the IRA that you convert; you have to pay tax on your total taxable income of which the converted amount makes up a part. If you can reduce your taxable income for 2010 as I am, by such moves as living in a foreign country (that’s like $90k of earned income sheltered right there) and owning rental real estate, plus who among us doesn’t have some stock losses from early 2009 to carry forward?, then you can avoid paying very much tax now for the privilege of avoiding tax in the future.

  38. BG says

    Thought about this some more (don’t cringe yet).

    I’m going back to my original argument that we should only be looking at effective tax rates — the effective tax rate is the percentage of taxes actually paid compared to gross income. That one number encompasses all the brackets, credits, deductions, and all the other crap that affects your federal tax bill.

    Using the calculator at:

    Plugging in $100k gross income (married), and nothing else: the effective tax rate is 12.2% — this would represent the tax-rate applicable in retirement (such as from tax-deferred savings).

    On that same calculator, add two dependents, with both qualifying for the Child Tax Credit. The effective rate is 8.2%. This represent my effective tax rate today.

    The difference here is 4%. I save 4% by paying taxes today (at 8.2%), investing in a Roth, to avoid the 12.2% future effective tax (when I will not have the Child-tax-credit). This is assuming that the tax codes do not change in the future, and everything remains constant. If congress raises rates, then I come out even more ahead. Congress would need to lower taxes by 4% (effective) for me to even break even with the traditional plan. So, I’m sticking with my original hypothesis, that at least for me, the Roth is a much better deal.

    • says

      Mike / BG – It’s important to believe in what you believe. If your ROTH contribution makes you happy, then that’s all that matters. Better than not contributing at all.

      Who knows what the future tax rate will be, but I’m sure as heck not giving the gov’t MORE of my money now. America commends you guys for supporting our spending.

  39. says


    I pride myself on being able to explain things in more than one way.

    See that 8.2% you cite? It’s a number that answers a particular question, I know you didn’t pull it out of thin air. No dollar was taxed at 8.2%, even though they all were.
    When it comes to putting money into a pretax account (or converting, for that matter) the question is: what is the tax on those last X$? Since I am not at a whiteboard with you in front of me, I need to keep the numbers easy to read. You already said you are in the 28% marginal bracket. I’ll assume this to mean the last $1000 you earned was taxed at 28%. Right?
    Now, I don’t really have a clue where the 12% future rate comes from and honestly, it doesn’t matter. When you go back to my post above, you have that ‘zero rate’. You married? I forget. If so, that $18,700 is tax free, zero. If you add enough 10% money, you’ll approach an average 5%. Call it quits there if you want.
    We did this already, and I concluded that 40-45% in pretax accounts appear ideal for you. So why did you plug in $100K for retirement? Use $45K and then tell me your average rate. It’s not all or none. Both are less than optimal.

    But remember the tale of the statistician who drowned in a pond whose average depth was 12 inches. In my approach, I dare say nothing happens at the average, it’s all at the margin.
    .-= JoeTaxpayer´s last blog ..The Roth IRA Conversion – Unintended Consequences =-.

  40. BG says

    JoeTaxpayer :
    …..I’ll assume this to mean the last $1000 you earned was taxed at 28%. Right?….

    Don’t think so. You are not taking into the massive effect that having two dependent children, plus claiming the Child-Tax-Credit gives me in my working years (currently). That amount is $3,917 right off of today’s tax bill. That amount off of the tax bill effectively knocks me out of the 28% (or 25%) marginal bracket, and actually puts me in the 15% marginal bracket today — down to an 8.2% effective tax rate.

    This is an important point: Earning $100k a year, with two kids, is the tax equivalent of a couple with no kids earning $64k.

    You can’t ask what the tax rate was on the last XX dollars, if you can’t yourself answer the question on which dollars are saving the $3,917 via the deductions/credits. The only solution is to work with the average / effective tax rates.

    I do admit an error in my earlier post. If I invest $15k into a tax-deferred account today, then that would lower my taxes down to an effective rate of 5.3% right now (taxes on $85k gross income). That immediate savings in taxes would free up an extra $2,900 we could invest. I’ll need to run the numbers to see if that extra money, if invested, would cancel (or beat) the higher effective tax rate in retirement. You might be right about traditional -over- Roth, but for the wrong reasons…

    I’ll work on those calculations this weekend and get back to you.

    Thanks for the great discussions!

  41. says

    Sam, please pass me the lectern. (Thanks, I was falling off the soap box and dropping my notes.)

    BG – there are two things at play. Your marginal tax rate (15%/25%) and the “phantom rate” you might experience due to phaseouts. Phantom Rate is what I call the dollars paid in federal tax on the last $100 you are taxed on. I have no trademark on it, others call it something else.

    “You can’t ask what the tax rate was on the last XX dollars”

    Of course I can. Really. I go into TurboTax (where I am a guest blogger. I think they owe me lunch) and just before I print my tax return, I increase/decrease my income by $100. The degree to which my tax goes up or down answers that question.

    I am sorry, I thought earlier on you stated you were in the 28% bracket. If your taxable income puts you in the 15% bracket, I’d suggest you use Roth and Roth conversion to the extent that it fills the 15% bracket, but doesn’t make you pay 25% on any income.

    As you get to the point where you are in the 25% bracket, I’d use pretax accounts to keep you down to 15% with an eye on enough pre-tax money to fill the 15% bucket at retirement.

    My understanding of your situation has changed. My view that average/effective rate as a red herring has not. It only serves to inject a data point useless for this analysis. If it gets you the right answer, it will have been for the wrong reason. Try to digest this, unfortunately, Vulcan mind meld not an option.
    .-= JoeTaxpayer´s last blog ..Frugal Friday Week 31 =-.

  42. BG says

    Thanks Joe. I think there was a mis-communication. I’ve been talking about $100k gross income (line 7 of the 1040), not $100k taxable income (line 43 of the 1040) — I wish though :)

    What you are calling the ‘phantom rate’, is what I’ve been calling the ‘effective rate’.

    “The effective rate of tax can often be discussed in terms of the effective marginal rate of tax – namely the amount of effective tax paid as a percentage of the last dollar earned or spent.”

    I’ve been calculating the effective rate as: ER=TaxPaid/GrossIncome. Gross income being line 7 of the 1040. Looking at my 2009 filings, this equals 8.92%. If you are calculating it as ER=TaxPaid/TaxableIncome, where TaxableIncome is line 43 of the 1040, then the rate is 12.32% for me in 2009.

    I think we are mind melding now.

  43. says

    We are fogetting one very important point in all these arguements.


    To some people, this is what they are most afraid of in traditional qualified retirement plans. All of these types of savings vehicles have required minimum distributions. They must occur between 59 1\2 and 70 1\2.

    Let’s say we have another recession when some poor schmuck reaches 70 and he is REQUIRED by the IRS to pull money out of his IRA, and then pay tax on it. He would effectively lock in huge losses, pay taxes on the reduced amount, and his retirement funds would be depleted even faster.

  44. says

    You are calculating effective average, not effective marginal, which is what I call Phantom Rate.
    You want to understand the impact of just the last dollar added or taken away, as this would drive your choice between tax status of retirement accounts.
    This can’t be gotten just by glancing at the tax form and dividing. You’d need to “what-if” by adding a dollar or really $100.
    You may be in the lucky situation to be able to be in the 15% exactly over the next 10 or more years choosing between the two.
    .-= JoeTaxpayer´s last blog ..Frugal Friday Week 31 =-.

  45. says

    @Benjamin Bloom

    From 59-1/2-70-1/2 withdrawals are optional, not RMD.

    RMDs are one factor. It starts at 3.6% and doesn’t get larger than 5% until age 79.

    The ‘poor schmuck’ would be worse off had he paid the taxes on the larger, pre-recession value, no? Now his taxes due are less, not more. BTW, he ‘locks in’ nothing. You can take a distribution in kind, i.e. withdraw the stock not sell it and remove cash. The withdrawn stock takes on basis as of the date of transfer out of the IRA.

    By the way, late 50’s is a great time to consider all this. Close enough to retirement to really have a grip on your pretax wealth numbers. I have an 80 year old. 15% bracket with some room to spare. For 5 years, now, we’ve been converting just enough to Roth each year to ‘fill the bracket.’ As her RMDs grow, that amount may be less each year, depending. For 2009, with no RMD we had a nice conversion number. I hope this exemplifies both my strategic use of Roth and my not ignoring RMDs.
    .-= JoeTaxpayer´s last blog ..Frugal Friday Week 31 =-.

  46. Ethan says

    Ooh, ooh pick me! I disgree! :) As I commented over on GoodFinancialCents:

    I’d like to point out my favorite feature of all Roth vehicles: they reduce the number of variables affecting your buying power in retirement. Yes, tax-deferred *may* prove superior to tax-free for some people if you are looking at it purely from a dollars standpoint. But you don’t find out until you retire; in fact you only find out year-by-year *during* retirement. In addition to your buying power depending upon returns and inflation, it also depends on tax rates if it’s coming from a traditional account.

    Imagine yourself at age 75. If your tax bracket increases that year, *even if the new rate is still lower than what you would have paid when you were making contributions*, the buying power generated by your traditional 401k distributions will decrease. Not so with distributions from a Roth vehicle. So it’s not just about which gives you more bang for your buck over the total time period, it is about whether or not you can count on your buying power once you no longer have the ability to alter it through earned income.

    So maybe I pay 25% tax on Roth contributions this year, but this is my earning phase. I can handle it. I can pay more now, not to increase my total nest egg later, but to reduce the risks to my buying power later. The alternative is to *increase* the risks to my buying power in retirement, in return for saving money today. Does that sound like a good idea? Not to me. Inflation, returns and taxation are all significant variables which most of your retirement planning efforts will revolve around diminishing as far as possible. The opportunity to remove taxation from that list completely is too good to pass up.

    (Note that it is only Federal income tax that Roth distributions avoid… they can still be subject to state income tax. But in many states no taxes would apply anyway, and at least it gives you the option of moving.)

  47. says

    But Ethan – the dollars used to pay the tax at retirement are also inflated, so to that point, it’s a wash.
    The pro-Rothers keep referencing a mythical tax increase. Yet, to be in the 25% bracket today at retirement, one would need over $2M in today’s dollars.
    So while you might be right about that 75 yr old you chose, he is in the top 5% of retirees. I can contrive a dozen scenarios where the traditional is better, but likewise a dozen where conversion is best. If in fact conversion is best for few than 10%, than why is 90% of the dialog promoting it? Why no warning about how few would benefit?
    .-= JoeTaxpayer´s last blog ..A Roth Roundup =-.

  48. Ethan says


    I wasn’t trying to make an argument about inflation – I must have been unclear there. I was just referencing that your buying power in retirement depends on 1) contributions, 2) returns, 3) inflation and 4) taxation. And that you can largely remove one of those (taxation) from the equation with a Roth vehicle.

    With my 75-year-old example, I was not referring to the situation in which a 75-year-old switches brackets, but the situation in which tax rates are increased by the government. In fact, the 75-year-old switching brackets is almost a non-issue by default. They obviously have other things going their way if they are moving *up* the bracket range. Even it means that their Roth/traditional decision wasn’t in retrospect quite as good/bad as they thought, they are obviously not hurting for it.

    No, I meant to refer to taxes simply increasing while income does not. For myself, age 75 is 43 years away. That’s a long time to predict anything about taxation. But let’s say that today I pay 25% on my Roth contribution dollars, and at 65 I find myself only in the 15% tax bracket. This would be a classic example where people would say that I should have gone traditional. Fast-forward 10 years: everyone got a 3% tax hike. The traditional is still a net gain over a Roth, but when would I have realized that gain? During my working years. When would I have payed the price? During retirement. My buying power would have just dropped (by something less than 3% due to deductions, but not 0%) and I wouldn’t have been able to do anything about it. As a Roth user I am unaffected. And I’m unaffected by taxation changes at 85, 53 years from today. And I’m unaffected by taxation changes at 95, 63 years from today, if I happen to live that long.

    I’m not saying you should pay 35% tax on Roth contributions today. Personally I usually fit into the 15% bracket, and I consider Roth’s a no-brainer at that level. But even at 25% I would recommend hedging your bets and putting half in a Roth and half in a traditional account.

  49. says


    If by ‘remove’, you mean as a variable, yes, this is true. Removing the variable doesn’t make it a good decision though.

    You say “usually” 15%. If you use pretax to stay right at 15%, and Roth for any more savings, I’d not say it was a bad decision. But – the chance of you becoming disabled or unable to work for a time is real, greater than ‘zero.’ Your standard deduction and exemption would cover a nice annual tax free withdrawal were that the case. And that 15% tax you paid would be an error, in hindsight. At 25%, I’d not recommend converting to all but a select few.
    .-= JoeTaxpayer´s last blog ..A Roth Roundup =-.

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