By The White Coat Investor, originally published at The White Coat Investor.
By
Jim Dahle,
WCI Founder
<!–Moderation in all things is a good way to live your life. This certainly applies to the Roth contribution/conversion dilemma, the most complicated question in personal finance and investing. Anyone who thinks this is an easy issue really doesn’t understand it well. With so many factors that go into the decision—many of the most important of which are not only unknown but unknowable with certainty—you should not use the terms “always” and “never” when it comes to this issue.
The main factor, of course, is whether the person withdrawing each dollar from the retirement account (you, your heirs, or a charity) will be doing so at a lower or higher marginal tax rate than the rate at which you contributed that dollar to a retirement account.
However, some people become so enamored with the concept of a Roth conversion (“Who wouldn’t want tax-free money?” “Do you think tax rates are going up or down?”) that they actually decide to NEVER contribute to a tax-deferred account. Or maybe they decide to do a Roth conversion of ALL of their tax-deferred money. This is almost surely a mistake for almost everybody. A certain amount of tax-deferred money is so extraordinarily useful that pretty much every wealthy WCIer ought to have a tax-deferred account of a certain size that ranges from six to even the low- to mid-seven figures.
Let me explain a few reasons why.
#1 Preserves Optionality
If you have tax-deferred money, you can always do a Roth conversion later. Once you do a Roth conversion, though, there’s no going back.
More information here:
#2 QCDs and Other Charitable Bequests
The best money to give to a charity is tax-deferred money. If you do that, neither you nor the charity pays any taxes on it. It is truly silly to pay to do a Roth conversion on money that will never be taxed anyway. Once you get to age 70 1/2, you can do a Qualified Charitable Distribution (QCD), the best way for retirees to give to charity while still living. A QCD is never-taxed money, and it replaces any Required Minimum Distribution (RMD) for the year. A QCD can be as large as $111,000 (2026) per year. If you don’t have any tax-deferred money, you can’t give any of it tax-free to charity.
#3 Leaving Money to Heirs in a Lower Bracket
While not quite as powerful as leaving tax-deferred money to a charity with a 0% marginal tax rate, leaving it to an heir in a much lower tax bracket than you is still an awfully good move. But if you already paid those taxes at 37% by making Roth contributions, you can’t go back.
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#4 Medical Expenses
Medical expenses are deductible as itemized deductions on Schedule A, at least the amount that exceeds 7.5% of your Adjusted Gross Income (AGI). But if you pay for them with Roth money and have no AGI, there’s no way to get that deduction.
More information here:
#5 Filling the Lower Brackets
The very best reason to make sure you have something in a tax-deferred account going into retirement is to fill the lower brackets. While some people can fill those brackets with Social Security, pensions, interest, rental property income not covered by depreciation, and other taxable income, a major source of income that fills those brackets for most retirees is withdrawals from tax-deferred accounts.
Speaking in general terms for a married couple in retirement, the 0% bracket is the first $30,000, the 10% bracket is the next $25,000, the 12% bracket is the next $75,000, the 22% bracket is the next $110,000, and the 24% bracket is the next $190,000. Even if you fill up a couple of those with Social Security and other income, it seems silly to pay 30%+ to do Roth conversions when you could have withdrawn that money later at 12%, 22%, and 24%.
Roth contributions and conversions are not something you should do “always” or “never.” Having at least some baseline amount of tax-deferred dollars seems wise. How big that baseline amount should be will vary by person, but it should become larger over time with inflation. RMDs at age 75 are only about 4% of the tax-deferred account, but no rule says you can’t withdraw even more than the RMD if you can take it out at 0%, 10%, or 12%. Four percent of even a $5 million RMD is only $200,000. Even combined with $50,000 in Social Security income, that’s pretty much all coming out at a 22% or lower marginal tax rate.
Whether you’re a DIY investor needing a financial checkup or you want to have an expert manage your entire portfolio, WCI has cultivated a list of trusted financial advisors who will give you outstanding personal service. They can help you design a portfolio to reach your investing goals, or they can simply make sure you’re on the right path to retirement. Check out our WCI-vetted list today and know you’re getting good advice at a fair price!
What do you think? Have you ever considered converting everything? Why or why not?
The post Don’t Roth All of Your 401(k) Money appeared first on The White Coat Investor – Investing & Personal Finance for Doctors.
Dr. Jim Dahle
WCI Founder
James M. Dahle, MD, FACEP, FAAEM is a practicing emergency physician and the founder of The White Coat Investor. After multiple run-ins with unscrupulous financial professionals early in his career, he embarked on his own self-study process to become financially literate. After seeing the benefits of financial literacy in his own life, he was inspired to start The White Coat Investor to assist his colleagues. At the time, there was nobody providing unbiased financial education to doctors at any point in their training. Now, more than a decade later, financial wellness is widely recognized as a critical life skill for all physicians and similar professionals. Dr. Dahle remains committed to the original mission of The White Coat Investor to “help those who wear the white coat get a fair shake on Wall Street.”
He currently serves as the CEO, a columnist, and the host of the podcast. Dr. Dahle is a proud father of 4 children and spends his free time adventuring around the world. If you can’t find him, he is probably hiding in the mountains or desert of his home state of Utah.
See more about Jim Dahle
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The White Coat Investor writes at The White Coat Investor. Read this article on their site.
