When I do a Roth conversion, I’m paying a lot of taxes. My account is going down. How long will it take to earn it back and if it takes too long to earn it back, does it mean I shouldn’t do the Roth conversion?
On the surface, it might make sense to not do the Roth conversions, but I believe it is making a wrong assumption.
For example, if I have a $350,000 traditional amount that when I convert it, I lose $84,000 in taxes. Let’s stop and think for a minute. If I have a $350,000 traditional balance, how much of that balance is truly mine?
Remember the TSP balance, that’s traditional, was part of my paycheck that I chose not to get paid but instead send it to the TSP. The TSP hopefully has grown over time so whenever I touch the money, it’s taxable at my tax bracket just like my paycheck. My balance is not really 350,000 and never was. My balance is $266,000 and the IRS’ balance is 84,000. The tax portion never was mine. If I took a $350,000 distribution to go buy something, that $84,000 is not going to my checking account, but instead it is being sent to the IRS.
What if I don’t do a Roth conversion and then die. If I don’t live long enough to make it worth it, should I even Roth convert at all? If you die and leave your balance to my spouse, she doesn’t get the full $350,000. In theory, she does, but she still owes the IRS $84,000. She can postpone it some but at some point, the IRS has to get paid. Somebody somehow at some point in time is going to pay the IRS their money.
So the question is a mathematical one of when to pay the tax and at what rate. I can choose to pay it now or I can choose to postpone it. At some point when I hit my RMD age of either 72, 73, or 75 depending on my birth, I will start to pay the IRS their portion. The math problem comes down to--I want to pay them the least rate I can. Is the least rate going to be paying them now, five years from now or is it going to be my heirs paying them 25 years from now?
If you are looking at your TSP balance, the traditional, and you see the balance and you think it’s all yours. I think that’s a problem. The balance is not all yours. Now if you have a Roth TSP or a Roth IRA and you see the balance, that balance is all yours. There is no IRS baked into your Roth account. But there are taxes baked into your traditional account, and so when your account balance goes down because you paid the taxes, your balance, the balance that’s truly yours, did not adjust. You were just divesting the IRS.
The information provided is not intended as tax or legal advice. Figures shown are for illustrative purposes only furthermore, the information nor the illustrations provided may not be used to avoid any tax penalties. This content represents the general views of Christy Capital Management and should not be regarded as personalized investment advice Nothing herein is intended to be a recommendation. The opinions expressed are subject to change without notice. Retirement Benefits Institute, Inc., and a portion of its contents merged with Christy Capital Management Inc. Brandon Christy, former President of Retirement Benefits Institute, is also the current President of Christy Capital Management, Inc., a registered investment adviser.
