Author Topic: Roth Ladder and Compound Interest Question  (Read 396 times)

SailormanDan

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Roth Ladder and Compound Interest Question
« on: November 18, 2017, 08:43:47 AM »
For those of you who are on the Roth Conversion Ladder system please help me get my mind right on this.  I have two general questions.  1) Why isnít compound interest discussed when looking at whether to convert funds?  At what point does it make more sense to forgo the Ladder for the sake of leaving the money in a retirement account to marinate for a longer period of time?

For example letís assume a 40-year old fully retired single guy who spends $40k per year.  He has $1MM net worth with 50% in retirement funds and 50% in non-retirement funds.  $40k works well for 4% SWR as well as near $0 taxes for long-term gains.  No annual contributions and he earns an 8% rate of return and estimates 3% inflation.  Since retirement funds cannot be accessed before 60 without a penalty he will convert $40k each year from non-retirement funds to his savings account for 1 yearsí worth of expenses.

Iíve always been told to sock as much money into my retirement accounts as possible (conventional wisdom) however I am questioning that advice as I now need to worry (I know, $1MM to ďworryĒ about - you must be joking) about taxes (now and then again later in life) but also about RMD.  By the time he reaches 60 he will have about $0 in non-retirement funds and will therefore need to start pulling retirement funds which should have grown to $2,331,000.  Since his spending habits have not changed he will reach the age of 70 (RMD age) with $3,178,000 and be required to start pulling out way more than $40k per year (roughly $116k) putting him in a much higher bracket.  2) Since we donít know our tax bracket in the future isnít it better to leave the money in non-retirement starting at age 40 and deal with the consequences of paying more taxes later in life or is there a better way?

If there is an old thread out there please point the way.
« Last Edit: November 18, 2017, 08:49:04 AM by Sailorman Dan »

ixtap

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Re: Roth Ladder and Compound Interest Question
« Reply #1 on: November 18, 2017, 08:48:35 AM »
Your scenario doesn't include a Roth conversion ladder at all. The conversions pull money out of the 401k that will have RMDs and into a Roth IRA that will not.

SailormanDan

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Re: Roth Ladder and Compound Interest Question
« Reply #2 on: November 18, 2017, 09:00:02 AM »
Correct, it doesn't but should it?  Why I asked multiple questions.

So, Roth funds are not figured into the calculation of RMD?  Didn't know that.

sokoloff

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Re: Roth Ladder and Compound Interest Question
« Reply #3 on: November 18, 2017, 09:13:10 AM »
So, Roth funds are not figured into the calculation of RMD?  Didn't know that.
Government doesn't want to wait forever to get "its" money, thus the RMDs on tax-deferred accounts and their absence on non-tax-deferred accounts.

teen persuasion

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Re: Roth Ladder and Compound Interest Question
« Reply #4 on: November 18, 2017, 09:15:13 AM »
Roth IRAs have no RMD, but Roth 401k do have RMDs.  You can roll your Roth 401k to an IRA to get around this, after you leave your employer.

The Roth ladder is both a way to access retirement accounts before age 59.5, and a way to limit the balances in traditional retirement accounts as approaching RMD age by shifting it over time to Roth.

Having sizeable taxable accounts gives you accessible income while the Roth conversions season for 5 years before they become accessible.  After the first five years, you could switch to taking out Roth contributions to live on while continuing future ladder conversions, instead of using taxable for living expenses.  Just depends on which you'd like to preserve/expand more: Roth or taxable.

terran

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Re: Roth Ladder and Compound Interest Question
« Reply #5 on: November 18, 2017, 09:16:25 AM »
IMO for the same reasons you should follow the recommended investment order when contributing, you should reverse it when withdrawing. That would mean you should spend down taxable first.

For us, we have a ridiculous amount of tax advantaged space, so even having enough available in taxable and roth contributions to get a roth conversion ladder going is going to be a challenge. For those with a larger proportion in taxable as you describe it might not make sense to live off money from a roth conversion ladder, but rather live of money from taxable for as long as it lasts.

Whether or not you live off money from a roth conversion ladder, however, you should still convert enough from traditional to roth to fill the lower tax brackets. Definitely the fill the standard deduction, probably fill the 10% bracket, and maybe fill the 15% bracket. Fill out the rest of the 15% bracket with 0% taxed capital gains. All of this while keeping an eye on health insurance subsidy limits and tax credits of course. No sense in "wasting" the lower tax brackets just because you don't need to withdraw the roth conversions to live on. Conversion amount and spending amount don't necessarily need to be the same.

And correct, roth balances are not included in RMD calculations.

MDM

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Re: Roth Ladder and Compound Interest Question
« Reply #6 on: November 19, 2017, 12:50:22 AM »