Compare a Roth conversion with keeping funds traditional or calculate the future withdrawal tax rate at which the strategies break even for retirement.
Roth Conversion Break-Even Formula
A conversion pays tax now for tax-free qualified growth. The comparison includes the opportunity cost of outside funds used to pay tax.
The converted account grows as:
Roth=(B-Tax_{account})(1+r_a)^n
The no-conversion alternative is:
Traditional=B(1+r_a)^n(1-T_f)+Tax_{outside}(1+r_o)^n
The break-even future tax rate is:
T_f=1-(Roth-OutsideOpportunity)/Traditional_{pretax}
Variables:
- B is the conversion amount
- ra is retirement-account return
- ro is outside-fund after-tax return
- Tf is future withdrawal tax rate
When tax is paid outside, the full amount enters the Roth but the tax dollars are no longer available to invest.
When tax is paid from the account, only the net amount is converted.
A real conversion plan may spread income over several years to manage brackets and other income-related costs.
Conversion Tax Examples
Immediate conversion tax equals the amount converted times the applicable marginal rate.
| Conversion amount | 22% | 24% | 32% |
|---|---|---|---|
| $50,000 | $11,000 | $12,000 | $16,000 |
| $100,000 | $22,000 | $24,000 | $32,000 |
| $200,000 | $44,000 | $48,000 | $64,000 |
| $500,000 | $110,000 | $120,000 | $160,000 |
Example Problems
Example 1: Compare the choices.
Convert $200,000 at 24 percent and compare values 15 years later at a 7 percent account return.
Example 2: Find the break-even rate.
The calculator rearranges the equality to find the future traditional-withdrawal tax rate that makes the choices equal.
Frequently Asked Questions
Why can break-even differ from today's tax rate?
Outside tax funds may earn a different return than the retirement account, changing their opportunity cost.
Are RMD effects included?
No. Avoided RMDs require a year-by-year account and tax model.
Should tax be paid from the IRA?
Doing so reduces the converted amount and may create an additional penalty in some situations.
