Roth IRA Calculators

Using VeriPlan to evaluate Roth retirement account contribution and conversion trade-offs

This is the third part of a three-part article on Roth conversions and Roth IRA contribution calculators. The first part discusses the Roth account investment and asset conversion decision and the need for a sophisticated lifetime financial planning software tool to enable informed decision-making about Roth investment strategies.

The second part discusses additional considerations when evaluating a conversion of traditional IRA accounts into Roth IRA accounts. This third part discusses what VeriPlan can do for you and how to use VeriPlan to evaluate Roth investing decisions related to Roth accounts within the context of your family’s comprehensive lifetime financial plan.

Introduction to VeriPlan and its Roth analysis functionality

To understand the Roth functionality of VeriPlan, as well as, its sophisticated and automated lifetime financial planning capabilities, the inexpensive VeriPlan CD provides three software files that you can chose from. You could start by building a lifetime financial planning model for your family from scratch using the core product. This direct approach will get you well on the way to developing and fine tuning a baseline financial plan for your family and then making a well-informed decision about Roth account investments for your family.

Alternatively, if you want to learn about how VeriPlan works, you could just look at the two “Sue and Sam Saver” tutorial files that are built on top of the core VeriPlan product. In particular, you could use the VTUTRLIV VeriPlan file with all tutorial inputs and assumptions unlocked. This VTUTRLIV VeriPlan file allows you could play with Sue and Sam’s baseline model data running on top of a fully functional version of VeriPlan.

Any change that you make anywhere to any plan developed in VeriPlan is fully integrated with all of its other functionality, including the Roth analysis functionality. Just open separate instances of your current VeriPlan model, and keep one of these instances as your comparison model. Then, with the alternate VeriPlan test case model, begin to change one, two, or dozens of data points and assumptions — as many as you need to model an alternative financial decision for your family. Then, simply compare future total asset values at the same arbitrary future age, e.g. 55 years of age, 95 years, etc. You can make these comparisons at any future age through age 100.

Such comparisons will indicate whether the alternative strategy enhances or detracts from your current plan and by how much. If you like the new financial plan revisions that you have made, then simply adopt the revised planning model as your “baseline” financial plan. Repeat as necessary to fine tune your plan. Move on to the next financial decision you want to consider.

If one decision impacts another, make as many changes as you want. VeriPlan’s robust automation and this iterative planning process allows you to converge quickly on a comprehensive family financial plan that will simultaneous reflects all of your financial decisions in a fully integrated manner.

Comparisons between projection models can be made quickly and easily. All standard output graphics have supporting data tables and all are formatted for printing. There is no waiting between projection scenario revisions. Revision performance has been optimized to achieve sub-second response times on PCs with less than average speed and systems resources.

Your Roth account investment decision could involve current Roth conversions and/or a series of future annual Roth account contributions. The opportunity to convert into Roth IRA assets is just one slice of the overall Roth investment puzzle. The viability of your Roth investment strategy decision will depend upon your lifetime income, expenses, debts, asset appreciation, investment costs, and a wide range of taxes related to your income, investments, and properties.

Therefore, you should solidify your decisions about other goals and objectives in your lifetime financial plan first. In effect, a proper Roth decision is a tax optimization built upon a developed lifetime financial plan. Interim financial planning decisions, such as home purchases, consumption management, early retirement, and many other family financial planning factors can dramatically affect the wisdom of your lifetime Roth tax optimization decision. Any financial planning analysis performed that disregards these other factors is dubious at best.

Using VeriPlan’s tutorial files to understand VeriPlan’s Roth investment calculator capabilities

Some people like to learn VeriPlan as they go by working directly on their own family financial plan. They dive right into VeriPlan by loading their financial data, reflecting their future financial plans in their model, playing with alternatives, and converging on a refined lifetime personal finance plan for their families. Others want to study and learn a bit before starting on their own plan. Either approach is valid.

If you want to dive right in, just use the core VeriPlan product file without any data or parameter adjustments. All instructions and documentation are embedded within VeriPlan at the point that you need the information. Links at the top of every input page tell you which sections need “required” or “optional” inputs from you and which sections are solely informational.

However, if you would first like to see what VeriPlan can do, the VeriPlan CD comes with two different tutorial files that are both built upon a fully developed financial plan for “Sue and Sam Saver” built with VeriPlan. One version of this tutorial has the financial data and planning parameters locked and includes more tutorial overlay commentary. Just start with the left-most “Read Me First” page and work you way page by page from left to right.

There is a second version of the Sue and Sam’s VeriPlan tutorial with the same financial data and financial planning parameter settings, but everything is unlocked. You can change anything that you want in this VTUTRLIV file to see what would happen with Sue and Sam’s lifetime plan. Since this is a well-developed, comprehensive lifetime financial plan for Sue and Sam, you can use their plan to get a better understanding of all of VeriPlan’s rich, automated, and fully integrated capabilities. In addition, you can use Sue and Sam’s plan to understand how VeriPlan’s retirement planning capabilities work — including VeriPlan’s Roth IRA savings calculator and Roth investment analysis features.

Next, I will describe how you could use the VTUTRLIV tutorial file to understand better the Roth annual contributions decision. Following that I will discuss methods to model and evaluate whether or not one-time traditional IRA to Roth IRA conversions might make sense might make sense to you, based upon your own financial plan developed in VeriPlan.

Your lifetime annual Roth retirement contribution strategy

Before I describe how to model a traditional IRA to Roth IRA conversion of retirement assets that you already own, let me quickly summarize VeriPlan’s fully automated annual Roth contributions facilities in the next two sections. VeriPlan fully automates the lifetime projection process for traditional versus Roth contributions into IRA, 401k, and 403b plans during your working years.

VeriPlan provides a very easy to use tool that allows you to vary the percentage of your potential future contributions that you would make to traditional and/or Roth retirement plans. All you have to do is to set the percentage from 0% to 100% of your total annual tax-advantaged retirement account contributions that you would contribute to Roth accounts.

VeriPlan handles the rest automatically. For your traditional tax-advantaged accounts and your Roth tax-advantaged accounts, VeriPlan checks all the legal contribution limits related to projected minimum and maximum allowable annual income, the impact of qualified work plans on IRA deductibility, spousal contributions, over 55 catch-up contributions, etc. All of these parameters are user changeable, if tax laws were change in the future or if you wanted to test the impact of different limits and restrictions. VeriPlan automatically manages contributions taxation, asset growth, annual asset re-balancing, withdrawals taxation, etc. for these Roth accounts, as well as for all of your other cash, bond, and equity assets in taxable account and in traditional tax-advantaged accounts.

With this highly automated Roth contribution modeling tool, all you have to do is to set various percentages of Roth contributions and use the scenario comparison methods detailed in the section immediately following. Because this annual Roth contributions facility is so automated, you should use this facility to test the potential benefits of contributing none, some, or all of your available retirement plan contributions into Roth accounts rather than traditional retirement accounts.

Modeling Roth conversions will require you to do direct adjustments to your asset entries in VeriPlan. Therefore, VeriPlan’s automated annual Roth retirement contributions tool can be very useful to use first. The results may give you a preliminary, but very quick, indication of whether traditional IRA asset conversions into Roth accounts might or might not be attractive, as well. (However, for those whose annual taxable income exceeds Roth contribution limits, this tool will not provide such an indication. If you have relatively high income, then you may not be able to make annual Roth retirement contributions, but you still may be able to convert your current Roth IRA assets. (See IRS Publications 560 and 590.)

Specifics on how to model annual traditional and Roth retirement plan contributions with VeriPlan

This section provides specifics on how to use VeriPlan’s automated traditional IRA, designated 401(k), 403(b), and Roth IRA savings calculator functions for optimizing annual contributions with respect to taxes. First, refine your family’s baseline VeriPlan model to reflect all of your other important pre-retirement family financial goals, objectives, and plans. Then, use VeriPlan’s “Tax-Advantaged Plan Tool” to optimize your retirement contributions tax strategy to boost your available assets in retirement.

Go to VeriPlan’s “Tax-Advantaged Plan Tool” page to make your choices about future contributions into traditional versus Roth accounts. Set the percentage of your total allowable annual retirement plan contributions that you would like to invest in Roth accounts during your working years. If one or both earners are eligible to participate in designated Roth 401k or Roth 403b retirement plans, then just indicate the maximum contributions allowed. Also, enter any maximum matching dollar amounts that your employer might provide. If you do, VeriPlan will automatically model your future annual allowable contributions into designated Roth 401k and Roth 403b plans, with employer contributions, as well.

With VeriPlan, you can easily determine whether or not future Roth contributions are likely be advantageous to your family. You can tune these contribution proportions from 100% traditional contributions (and 0% Roth qualified employer retirement plan contributions) up to 100% Roth contributions (and 0% traditional qualified employer retirement plan contributions). Or, you can choose any percentage in between for an annual combination of traditional and Roth contributions up to allowable limits.

Everything is automated with this annual Roth contributions projection facility. Just set the parameters and everything else will just ripple through your fully integrated VeriPlan model. Such integrated and automated computations would include future year-by-year asset deposits and withdrawals as required between various account types; asset allocations and rebalancing; asset taxes; investment costs; etc. VeriPlan would quickly execute projection calculations for all model factors affected by your choice between traditional and/or Roth account annual contributions over your lifetimes.

Try as many alternate scenarios as you wish and compare total projected future asset values at arbitrary future ages. Note differences in scenario asset values. Note their magnitude. View the Tax Assets graphic for the proportions of financial assets projected in taxable, traditional tax-advantaged, and Roth accounts over the years. View the Transactions graphic to understand net annual flows between your taxable and traditional and Roth tax-advantaged accounts.

If your total projected financial assets would be exhausted before you are 100, carefully note the age at which this is projected to occur. (Note that financial assets are your cash, bonds, and stock assets in taxable, traditional retirement accounts, and Roth retirement accounts. Financial assets do not include your real estate and other assets.)

Compare the projected age that your financial assets would be exhausted, between the two scenarios. Your choice of traditional versus Roth assets could significantly impact how long your financial assets would last, one way or the other. Keep in mind that the age that your financial assets are exhausted is an important indicator of your optimal retirement tax strategy.

Also, obviously if and when you run out of financial assets, you would need to have other assets, such as real estate equity or property than could be accessed or sold, to cover your living expenses. Otherwise you would be destitute. VeriPlan automatically projects the anticipated growth of your real estate and other property assets and graphs their value in layers on top of your cash, bond, and stock financial assets.

If you see that VeriPlan projects that you would have financial assets remaining at age 100, then this really becomes an estate planning subject, and future estate planning and estate taxes on your residual assets are highly uncertain. In fact, VeriPlan’s projections act as an annual estimator of your gross estate at any age.

You probably do not wish to predict/plan the date of death for you and your spouse, and VeriPlan does not require you to do so. Regarding your accumulated excess assets at any age, just realize that VeriPlan will automatically project everything for you through age 100. For example, VeriPlan will automatically transfer the RMD each year out of your traditional retirement plan accounts and will apply the appropriate federal, state, and local income taxes. If your annual taxable “required minimum distribution” (RMD) from your traditional retirement accounts exceeds your annual living expenses plus RMD taxes and other taxes, then any excess will be transferred automatically into your taxable financial asset accounts. Otherwise, if your living expenses and taxes exceed the RMD, VeriPlan will automatically draw down your taxable accounts (and then Roth accounts, if your taxable financial assets are exhausted) to make up the difference.

Using VeriPlan to evaluate a one-time traditional IRA retirement account to Roth IRA conversion

Concerning the evaluation of one-time Roth IRA conversions, again, keep one model instance open as your comparison baseline. Then, open another instance of the same VeriPlan file, and go to any of the cash, bond, or equity assets on the corresponding input tables. In developing any VeriPlan financial projection planning model, all current cash, bond, stock, property, and other asset holdings information would already have been entered into the appropriate financial data entry pages.

Decide on the amount to be converted from any of the traditional tax-advantaged plan cash, bond, or stock assets that are already entered into the model. Which type of financial asset or the particular financial asset you choose is not very relevant, for testing purposes. This is the case, because VeriPlan will automatically rebalance your asset portfolio at the beginning of the second projection year and the beginnings of all subsequent projection years up to age 100, according to your settings in one of the five flexible and automated asset allocation models that VeriPlan provides. However, if you are seriously considering a conversion, then select the account that you intend to convert. Note that VeriPlan is user up-datable over time, and you can use it to model the future value of your portfolio, and you can update your portfolio in VeriPlan to reflect asset acquisitions and disposals.

If you want to convert the full asset value of a single retirement account or several accounts to a Roth IRA, just change the “0″ (for traditional tax-advantaged assets) to a “2″ (for Roth tax-advantaged assets) in the asset tax-ability column. If the conversion would be just a portion of the assets in that financial account row, simply make a new row for the same asset account. Then, apportion the current asset values between the two rows — one row with a “0″ in the asset tax-ability column (for the remaining traditional tax-advantaged assets) and the other row with a “2″ in its asset tax-ability column (for the Roth tax-advantaged assets that would be converted).

Now, choose how to pay the conversion taxes. If your total taxable cash holdings exceed your preferred minimum emergency cash reserves, then just reduce those amounts in VeriPlan to reflect the federal, state, and local taxes that you would need to pay. Otherwise pick the taxable bonds or stocks you would sell to pay the taxes on the Roth IRA conversion.

While Roth conversions funded by existing taxable assets are obviously much more preferable, if taxable assets are inadequate to fund the total taxes due, then some traditional tax-advantaged account assets could also be sold instead. If Roth conversion taxes were to be funded from existing traditional tax-advantaged retirement asset accounts, then these adjustments would simply be made to traditional tax-deferred account assets rather than taxable assets in VeriPlan. Remember to allow for some additional withdrawal amount to cover the taxes that would be due on these retirement account withdrawals.

While not necessarily prohibitive, note that having to withdraw additional traditional retirement assets is a potential red flag related to the wisdom of such a conversion. Of course, you can use VeriPlan to evaluate the trade-offs, but withdrawing traditional retirement assets to pay Roth IRA conversion taxes will raise the payback hurdle at the front-end that you would need to overcome to justify the conversion. Furthermore, not only do the increased taxes up front raise the hurdle, these withdrawals also reduce the amount of assets you have in your traditional retirement plans. In turn, fewer traditional retirement account assets would mean less appreciation, lower RMDs in retirement, and fewer taxes related to these smaller RMDs. This would reduce the future benefit of tax avoidance and lessen the value of doing a Roth IRA conversion.

Finally, note that if you are under age 59 and 1/2 then and additional 10% early withdrawal penalty might be due on IRA withdrawals that were not rolled over, but instead, were used to pay Roth conversion taxes. Also, a few states assess additional early withdrawal penalties. For example, California adds a 2.5% penalty. Obviously, early withdrawal penalties would significantly raise total front end taxes and reduce the appeal of doing a conversion. Nevertheless, you can still model these early withdrawal penalties in VeriPlan in the manner described above.

As summarized in earlier sections, to analyze the trade-offs, all you would need to do next is to compare the projected total financial asset values of the different scenario models at the same arbitrary future age, e.g. 80 years, 95 years, etc. Note differences in scenario asset values. Note their magnitude. Compare the age at which your cash, bond, and stock financial assets would be exhausted, if your cash, bond, and stock financial assets would run out prior to age 100.

If you want to adjust the long-term tax rates for federal taxes, for any state taxes, or for any locality, just make the changes on the “Your Taxes” page. All income, expense, debt, tax, and asset modeling assumptions are user changeable. All documentation is fully integrated within VeriPlan.

VeriPlan’s financial data and parameters are all user adjustable. No black box — no rigid, one size fits all assumptions.

If VeriPlan indicates that a Roth IRA conversion could be attractive, run proforma tax returns to verify your assumptions about taxes due

A traditional IRA conversion to Roth retirement account conversion requires a reasonably accurate estimate of the taxes that would be due related to the conversion. While you can model a guesstimate of the taxes due in VeriPlan by reducing your current asset as described in the prior section, you should do pro forma tax returns before doing a conversion.

The more involved part of the Roth IRA conversion analysis is separate from the internal logic of VeriPlan. Since the up-front tax payment is the disincentive to convert to a Roth account, it is important to carefully evaluate the taxes due for the current year (or over two years, if splitting tax payments over two years is available to you). There are several ways to do this, but all of them essentially imply that you do a proforma draft of the tax returns that you would file in the springtime.

Whether or not you have decided to use VeriPlan, some free Roth conversion tool on the Internet, or the modeling software that a financial adviser has, getting a proper estimate of taxes due is one of the first orders of business. If you decide to go ahead with a Roth conversion, it will involve some retirement account paperwork to implement the conversion. Eventually you will need to file your tax returns anyway. If you decide later on that doing the conversion was not what you really wanted to do, then you may be able to reverse (re-characterize) the transaction before your tax returns are due. However, to reverse a Roth IRA conversion will require some more time-consuming paperwork.

So, why not just draft your proforma income tax returns before you make a final decision and start the conversion paperwork process? If you have a good understanding of income tax laws, you can estimate how much total tax would be due related to the amount of Roth assets that you want to convert. This is even easier, if you develop your own tax returns using a home tax return program such as TurboTax.

If you are not comfortable with doing this yourself, then your friendly CPA would probably be happy to run some tax estimates for you. Your tax accountant probably would be trilled to do this for you, if you asked for this analysis when it was not in the middle of peak tax filing season for real income tax returns.

While you should consult IRA Publications 560 and 590 (see the links in Part 1 of this article), make sure that your current year tax estimate reflects any federal, state, and/or local taxes due on the conversion amount less any proportional tax basis that you may have across your various traditional tax-advantaged retirement accounts for IRAs.

Attention should also be paid to any asset tax basis which might be associated with the tax-advantaged asset holdings. Appropriate decrements for any proportional tax basis should be taken out. (Note that VeriPlan supports lifetime asset tax-basis modeling as a fully automated background process.)

VeriPlan is the most cost-effective way to evaluate Roth retirement account contribution and conversion strategies

VeriPlan is marketed on the Internet from the front page of this “My Financial Freedom Plan” (http://www.myfinancialfreedomplan.com/) website. Do-it-yourself end users can purchase the VeriPlan CD and a household license for a very inexpensive price. There are no support charges, and there are no forced future upgrades. VeriPlan is a mature, robust, and highly functional comprehensive lifetime financial planning application and retirement planning calculator. All functionality is exposed and all projection model assumptions are user update-able. Therefore, future upgrades are simply unnecessary.

Financial planning advisors also can obtain VeriPlan for use with their clients. Financial planners can:
• incorporate VeriPlan into their service offering,
• develop comprehensive models and unlimited scenarios,
• use it live with clients for informed scenario planning and financial decision-making,
• incorporate VeriPlan’s output into their printed financial plans for clients, and
• provide the VeriPlan product and customized models to clients for use at home.

For advisors, volume pricing is available starting at five units of VeriPlan. Financial advisors will find VeriPlan to be an excellent new tool to model the Roth conversion puzzle within the context of each client’s particular comprehensive financial planning situation. At the same time, advisor will also be able to see how VeriPlan can meet a myriad of other requirements for comprehensive, integrated, and automated financial planning decision support software.

Evaluating Roth IRA Conversions

This is the second part of a three-part article on Roth conversions, including information about Roth IRA conversion calculators and Roth IRA investment calculators. This article could help you to make a more informed decision about your family’s Roth investment strategy. Key to you making a better decision about your lifetime Roth account contribution and asset conversion strategy is the need for a sophisticated financial planning software tool. The second part of this article discusses some additional lifetime financial planning considerations, when you are evaluating the wisdom of a conversion of traditional IRA account assets into Roth IRA accounts. Part three explains what lifetime personal finance software can do for you and how to use it to evaluate Roth account decisions within the context of your family’s own do-it-yourself comprehensive lifetime financial plan.

Trying to decide about a traditional IRA to Roth IRA conversion without first having a comprehensive lifetime financial plan in place makes absolutely no sense. Without such a plan, you cannot figure out whether or not you are likely to achieve the tax savings in retirement that would warrant paying higher taxes now. Furthermore, without a lifetime financial plan to pursue, you have absolutely no idea of what you must do with your financial affairs along the way. Without such a plan how would your keep on track toward realize the long-term tax savings benefits of having done a traditional IRA conversion to Roth IRA transaction in the first place? Do you really want to take uninformed shots in the dark regarding your family’s financial future?

Considerations when evaluating a conversion to a Roth IRA for your family

When you develop your own lifetime family personal finance plan using automated personal finance software, you should incorporate all of your other interim financial planning objectives first. This part of this three part article focuses on the subject of getting your financial plan in place, before deciding upon your Roth retirement account conversion and contributions strategy. Then, the article provides two scenarios that illustrate just how much your interim lifetime financial planning decisions can dramatically affect the wisdom of your Roth IRA vs traditional IRA conversion decision.

After you understand what a sophisticated do-it-yourself lifetime financial planning tool could do for you, it is time to develop your baseline family financial plan. This would take you some time, because you would need to collect your family financial data for entry into your model. Then, you would also need to make decisions about your long-term family financial goals and objectives and reflect them in your automated financial planning model, as well.

While you may have discovered this website, because you wanted to understand quickly whether or not to do a traditional IRA conversion to Roth assets, you should pause and consider the real implications of the Roth conversion decision for your family. Keep in mind that performing any Roth trade-off analysis would be one of the last optimization analyses that you do after you have developed your baseline family financial plan. Developing a financial plan that reflects your existing family financial situation and your assumptions about the future is the first thing that you should do.

If you are tempted to rush through this process of building your family’s financial plan, then I will caution that you may wish to change this get-it-done quickly perspective. A lot of money may be on the line in additional taxes, so cutting corners with a quick and dirty Roth decision could be very costly. The more quality you put into your family financial planning model, then the more benefit you will receive in understanding the full range of your financial goals and objectives. In addition, a more informed and appropriate Roth decision near the end of your financial planning process will be just one of the many benefits to you and your family.

You must achieve your interim family financial planning goals, before you can reap the tax benefits of a Roth IRA conversion

For example, if one of your primary life goals is to model the purchase or upgrading of a home, make sure that you have made these decisions and reflected them in your financial planning model first. If you intend to send your kids to college and/or to private secondary schools, then make sure that these educational expenses are already reflected in your model. If you want to understand better your investment risk tolerance and adopt an asset allocation strategy that differs from your current investment strategy, then make sure that your revised investment strategy is also reflected in your model.

If you reach a realization that your investment expenses are too high, then plan to revise you investment holdings with very broadly diversified, very low cost index funds. If you want to understand an accelerated debt repayment strategy, reflect this in your personal finance model. If you do not have a good understanding of your consumption expenditures and your savings rate (or lack thereof), then address these factors.

Why am I suggesting that you do so many other things with your family financial plan instead of jumping in and doing a quick analysis of the Roth IRA conversions question that you first wanted to ask? The answer is quite simple. The viability and wisdom of ANY Roth conversion decision is dependent upon ALL other interim and planned financial factors that you believe would occur in your lifetime ahead of reaping or not reaping the Roth tax savings benefits you would hope to obtain during your retirement.

Buying a bigger house affects tax deductions along the way and changes the composition and tax-ability of your retirement asset portfolio. If you do not understand your income expectations, expense planning (including children’s education expenses), and savings goals along the way, you have no idea whether you are going to be penny pincher in retirement on a constrained income. Alternatively, you could be a successful wealth accumulator and your retirement investment returns could far outdistance your expense needs to live a happy and fulfilling life of truly golden years.

If you fail to get control of excessive annual investment costs, then your pot of money in retirement might be dramatically smaller. As a result, your required minimum withdrawals (RDMs) from traditional IRAs would be much lower in retirement and so would your taxes. Then, for you, sadly your long ago decision to do a traditional IRA to Roth IRA conversion might seem rather foolish decision. Along the way, unfortunately, you gave away so much of your retirement money through excessive fees to the financial services industry that you enabled them to reach their personal IRA Roth conversion tax savings goals, while you unwittingly sabotaged your own!

Plan for the retirement that you want first — then, decide whether you can optimize your lifetime taxation with a Roth conversion IRA

While I could go on with numerous other examples of lifetime financial planning decisions that could trump the Roth conversion decision, keep this in mind. Properly considered, the Roth conversion and annual contribution decision is just a lifetime tax optimization of a financial plan — after other interim aspects have been optimized first. The Roth decision is simply a lifetime tax optimization decision related to your retirement investment assets and your income taxes in retirement. Optimize your baseline lifetime financial plan for your family first. Only then, should you evaluate the Roth optimization decision.

However, do not assume that optimizing your baseline financial plan first will necessarily reduce or increase the value of the Roth conversion decision for your family. On the one hand, you might be working on your plan and be pretty satisfied with it. Then, you might start looking at the impact of a Roth conversion and find that it only seems marginally beneficially to you. However, there are financial planning decisions that you might make that could significantly increase or diminish the appeal of doing a Roth IRA conversion or of making Roth account contributions during your working years.

Consider these two alternative scenarios:

Scenario 1 — Planning for a Roth retirement account estate planning legacy with Roth conversion IRA accounts

You and your spouse might have fifteen more years of employment doing work that you both really enjoy. You realize that you have put into your lifetime financial plan an ample expense buffer for your working years and your retirement years. Using the automated Roth IRA conversion calculator facilities of your lifetime financial planning software, your customized projection model indicated that converting traditional IRA accounts into Roth accounts might only be slightly beneficial to your family over the long-term.

However, since the taxes on the conversion would be paid now and the return would be years into the future and subject to a lot of uncertainty, you have made a preliminary decision not to convert any of your traditional IRA accounts to Roth accounts. Therefore, your lifetime financial plan incorporates all your other goals and objective, but at this point, your plan assumes you would not do any Roth conversions or make any available annual Roth contributions before retirement.

Yet, while you were developing your automated projection plan, you remained concerned that your children are teachers, have married other teachers, and have young families. You are sure you could spend a little less along the way to grow your estate for the benefit of your children and grandchildren. Therefore, you decide to revise your financial planning model with just a few percent lower annual expenditures. You are very confident that you can reduce your annual expenditures slightly and hardly feel it. Then, you run the scenario with these slightly reduced living expenses.

Surprise! The modest increase in your savings rate dramatically pushes up your lifetime asset accumulation. Now, your assets keep rising throughout retirement even after you have covered all your projected expenses. It looks like you could meet all your expenses along the way to age 100 and still have about $2 million in financial assets plus all the equity in your home.

Then, you decide to test the benefits of a Roth conversion and the total value of your projected assets jumps up by a couple hundred thousand more dollars. Furthermore, instead of owning a lot of taxable assets in your old age with all the uncertainty about estate taxes over the long-run, the majority of your assets would be composed of Roth accounts that your grandchildren could inherit for the benefit their families. (*** See the Roth IRA conversion estate planning note below.)

Therefore, you and your spouse decide that your final plan will involve converting a substantial portion of your traditional IRA assets into Roth IRA accounts. With your comprehensive lifetime financial plan, you are now much more confident that it is worth it to convert to Roth IRAs and to pay the added taxes now — however unappealing paying taxes might seem. You view making these tax payments now to be a good investment with a reasonably appealing long-term payoff. To realize a return on this current ‘tax investment,’ you and your spouse primarily need to keep working at the jobs that you enjoy anyway and to watch more closely and constrain your living expenses a bit more to achieve your long-term financial plan.

Scenario 2 — Taking early retirement and eliminating the potential value of any Roth IRA conversions to you

On the other hand, you could change just a few of the facts and assumptions in the first scenario above and completely reverse the wisdom of doing a Roth conversion or making any annual Roth contributions along the way. Just assume instead that your kids have graduated from college and have families, but they have gone into professions that are much more lucrative than teaching. It looks like they were not going to have constrained finances and that you have much less worry about providing any financial resources for your grandchildren.

Furthermore, let us assume instead that you and your spouse are not really that thrilled about your jobs. You would be willing, indeed, very happy to retire five or ten years early. You would even be willing to cut down your living expenses more, if that were necessary so that you could retire early.

You decide to re-run your automated financial planning software model with this early retirement scenario. In this second scenario, it becomes quite clear that doing a Roth conversion would probably be very unattractive financially. You would waste money paying Roth conversion taxes up front and would be unlikely to achieve significant tax savings in retirement.

You and your spouse would work fewer years, and you would have fewer retirement assets and lower retirement income. Your taxes in retirement associated with your projected required minimum distributions (RDM) from your traditional IRA accounts would be taxed at significantly lower rates. This would negate the justification for converting any of your assets into Roth accounts.

Furthermore, the taxable account cash that you would have paid out for the taxes on a Roth IRA conversion would still be in your accounts. You realize that this cash could buy an attractive RV now and that cash would left over for RV replacements in the future. In this alternative scenario, you happily decide against a Roth conversion, and instead you and your spouse begin to plan for an early retirement with a lot of time spent on the open road.

Your automated lifetime financial projection model also indicates that your financial assets might begin to run out in your early-90s. But, you decide that you could always sell your big house, buy a smaller one, boost your financial assets, and live off the difference for many more years.

In almost any event, it looks reasonable that you could cover your financial needs even if you both lived to be 100. Retiring 5 or 10 years early would give you more time to enjoy life. You decide that understanding how your money could work for you — rather than you for it — is one of the major reasons for having a lifetime financial plan in the first place. The potential long-term tax optimization benefits of a Roth conversion are just not worth the cost in this scenario.

Conclusion: The wisdom of a Roth IRA conversion depends upon developing and sticking to an achievable lifetime financial plan

In summary, if you are considering the wisdom of a Roth retirement contribution and/or conversion strategy, and you do not already have a comprehensive financial plan in place, then doing such a plan should be the first order of business. If you do not have a comprehensive financial plan built upon an automated and integrated lifetime financial planning software tool, you cannot evaluate whether Roth retirement account assets might or might not make sense in your particular circumstances.

Moreover, if you do not have a well-defined long-range financial plan, then you do not have any road map to get to your financial goals and objectives. You have no way to judge your financial progress. It is one thing to decide to convert some or all of your traditional IRA account assets into Roth assets and pay significantly more taxes at the outset. It is an entirely different thing to pursue a lifetime financial plan that will put you into the position where you actually would reap the tax savings in retirement!

*** Roth IRA Conversion Estate Planning Note:

Estate taxation laws tend to be in flux frequently. Since sophisticated lifetime financial projection modeling software would use real dollar projections (constant purchasing power dollars with inflation extracted), the $2 million in Scenario 1 could be much higher with inflation, when expressed in ‘nominal’ rather than ‘real’ dollars. Inflated over about 50 years, $2 million could be a significantly larger nominal dollar amount — almost $9 million in nominal dollars using a 3% geometric average inflation rate.

What future federal or state estate taxes limits would be is anybody’s guess. How $2 million inflated for 50 years in nominal dollars would be treated for estate tax purposes is anyone’s guess. However, to expect estate taxes to disappear entirely would seem a bit of a pipe dream.

Now, of course, you could also argue that the very favorable tax treatment of inherited Roth retirement accounts could be changed in the future, as well. That is possible. However, since current Roth conversions would be heavily motivated by both their tax savings and inheritance features, there would be political hell to pay, if the inherit-ability features of Roth accounts were withdrawn in the future.

If tax-free inheritance treatment of Roth accounts was withdraw through changes in tax law, account converted prior to that time might be shielded. A guess at what would happen is that existing Roth IRA conversion accounts would have tax-free inherit-ability “grandfathered,” and only subsequent new Roth account conversions would be subject to the inheritance tax. This has been done for numerous changes in tax law, to overcome the objections of stake-holders in the status quo.

While this is just a guess about what could happen, remember that Roth accounts are relatively widely held. Restricting Roth tax-free inherit-ability is not the same as taxing the estates of a relatively narrow segment of the population — the “rich.” Whether or not the millions of Roth accounts in existence were the best decision for all holders from a tax optimization standpoint, many of these account holders may not so willing yield this tax-free inheritance feature for rational and/or emotional reasons.

Roth IRA Conversion Calculator

This is the first part of a three-part article on Roth retirement account contributions, Roth IRA contribution calculators, and traditional IRA to Roth IRA conversion calculators and strategies.

The Roth IRA Conversion Media Storm

The Roth IRA conversion and Roth 401k conversion media storm is in full swing. For some, converting traditional retirement account assets into Roth accounts can make sense and can be quite advantageous over a lifetime. For others, Roth conversions are not likely to be favorable to them financially.

Many cynical financial services industry product pushers have used the removal of the $100,000 Roth conversion income restriction for 2010 to develop a range of financial sales gimmicks. However, because only some people are likely to benefit at all from a Roth account conversion, this is an area in which individual investors should tread very carefully.

The only way to determine the answer that is appropriate for your family’s particular financial situation is to run the calculations that project your personal finances across your lifetime — with and without Roth retirement account contributions during your working years — and with or without conversions of your existing tradition IRA account assets. The Roth puzzle for asset conversions, as well as for annual Roth contributions during working years, is one of the most complex decisions that the ridiculously complex US taxation and retirement planning system forces upon individuals. It also creates significant analytical challenges for any well-intentioned financial advisor who attempts to serve individuals and their families, as a true financial planning fiduciary.

Many articles discuss the interplay between three variables: 1) current versus future tax rates, 2) avoiding the taxable “required minimum distribution” requirements of traditional IRAs and 401ks in retirement, and 3) the source and taxability of the available cash that would be needed to pay the up-front tax. While important, these three variables are just a subset of the myriad of personal finance factors that could come into play across a lifetime and that could affect the wisdom of a Roth conversion decision. Furthermore, depending upon an individual family financial planning situation, these three factors may not be the most important financial planning factors that would tip the Roth IRA conversion decision one way or the other for a particular family.

The remainder of this three-part article has various sections that can help you to develop a much better understanding of the Roth conversion decision. These sections also provide you with information about an extremely cost effective and highly functional lifetime financial planning software tool with Roth analysis functionality. This long-range family financial planning software tool provides fully integrated retirement planning software and allows you to do Roth annual contributions and one-time Roth conversion analysis within the context of your own family’s lifetime financial plan. It also allows you to develop your own highly automated lifetime financial plan.

For the average middle class American family, making the appropriate choice between Roth IRAs and traditional IRAs (and/or designated Roth 401k and 403b plans) could be worth tens of thousands of dollars over a lifetime. For some upper middle income earners with annual family incomes exceeding $100,000 per year, the lifetime value of the appropriate Roth retirement account decision could be worth hundreds of thousands of dollars over a lifetime. Yet, it is likely that only a minority of tax payers overall will benefit more by owning Roth retirement account assets rather than traditional retirement account assets.

However, those for whom Roth account assets make sense could obtain a financial benefit that would significantly increase their lifetime net worth. Furthermore, these people could accumulate substantial tax-free assets, which they could pass on to their heirs who, in turn, could also enjoy many years of additional tax-free asset growth. Yet many others, who might choose Roth account investments, would pay substantially more in income taxes at the outset and never realize a return on these higher initial tax expenditures over their lifetimes. For them, their Roth decision would reduce their lifetime net worth, and perhaps reduce their potential retirement assets substantially. Which of these two groups are you in, and what do you need to know to decide?

Roth retirement planning for IRA, 401k, and 403b retirement accounts

If you think that you understand all of the various factors that should be taken into consideration when approaching the “traditional versus Roth” retirement account decision, then you can skip this section and move on to the sections that follow. The sections that follow will focus on “how to” calculate the traditional versus Roth retirement account trade-offs for your family’s lifetime financial planning situation. However, if you would like to read more about these Roth trade-off factors, then you first might wish to spend time reading these articles and then come back to read the “how to” sections that follow.

Roth IRA Retirement Planning — This “IRA, 401k, and Roth IRA Retirement Planning” article summarizes the lifetime financial planning scenarios under which ongoing Roth account contributions and/or conversions of traditional tax-deferred retirement assets to Roth conversion IRA retirement account assets might become more advantageous. It discusses why only a minority of the population is likely to fit this profile. For the others, traditional tax-advantaged accounts contributions would tend to be preferable to Roth accounts in lifetime real dollar net present value terms.

Roth Retirement Plan Contributions — This two-part “Factors that tend to favor Roth tax-advantaged plan contributions (parts 1 and 2)” article provides additional and more detailed information about the factors discussed in the first article referenced above.

Roth Estate Planning Strategy — This “Roth Estate Planning Strategies” article summarizes what can be the icing on top of the cake for those who expect to be substantial retirement asset accumulators. A “higher saving – higher income” proportion of the individual investor population is more likely to build up a substantial estate. For these retirement asset accumulators, the significant tax advantages related Roth account inheritability can introduce an additional dimension to the analytical complexity. Despite the additional complexity, owning estate assets in Roth accounts would allow these retirement asset accumulators to pass on a significant portion their estate to heirs through Roth account inheritability provisions. Furthermore, these inherited Roth accounts would have some very appealing tax-free investment growth features for those heirs.

US Internal Revenue Service Retirement Plan Publications — If you have the time and tolerance, you can learn quite a lot about the retirement plan tax rules from US IRS publications. Here are the two primary publications to start with:
* Publication 560 — Retirement Plans for Small Business (SEP, SIMPLE and Qualified Plans)
* Publication 590 — Individual Retirement Arrangements (IRAs)
Just look for the link to “Publications” on the IRS site to find the .pdf documents that you can download. (Note that the retirement planning calculator software discussed below incorporates the primary federal retirement plan tax rules discussed in these documents. This lifetime investment calculator and retirement calculator software automates and hides the bulk of this retirement account rule complexity. This automation allows you to focus on decision analysis regarding your family’s financial security and lifetime financial planning choices.)

Avoid simplistic Roth IRA calculators

Sadly, the Roth conversion calculators that have been rushed to the market or provided on the Internet recently tend to be overly simplistic and unable to model comprehensively the lifetime financial affairs of your family. Simple tools just cannot model all the moving parts of the Roth retirement strategy decision across your lifetime. Why would any reasonably sophisticated person want to rely upon any software tool that did not measure all relevant factors that could affect their own interests with respect to Roth account contributions and Roth conversions?

The Roth decision dilemma for individuals is that it front-loads ordinary income tax payments — sometimes at quite high total local, state, and federal marginal income tax rates. Yet, the potential and uncertain payoff can only be realized years or decades into the future through tax savings during retirement. To make such an informed Roth account decision intelligently, you need to be convinced that it would likely pay off for your family. You need to have a clear, well-defined lifetime financial plan that you intend to pursue and sustain. Otherwise, making a yes or no decision on Roth accounts is like playing darts in a pitch black room!

With simple Roth conversion calculators, is it really a fair trade-off to users like you, when they lack state and local tax logic, ignore inflation adjustments, do not support differential asset allocation methods, etc. These are just a few of the things that many of the Roth conversion calculations on the market lack.

How about being able to project flexibly your lifetime earned income, passive income, living expenses, and extraordinary expenses in detail? All this matters in determining realistic savings rates, which are bound to vary year to year due to debt payments, housing purchases/changes, educational expenses, income changes, inheritances, etc. What about the differential impact of inflation on income, expenses, debts, taxes, and assets? What about all flavors of taxes (federal, state, and local income taxes, tax deductions, property taxes, Social Security taxes, Medicare taxes, self-employment taxes, short-term and long-term capital gains taxes, etc.)?

All these financial factors are moving parts that will affect your family’s lifetime financial plan. These factors and others will all affect the Roth equation for your particular lifetime financial situation. Whenever any financial decision has a distant payback that justifies near-term investment, what happens in the intervening years will impact that decision positively or negatively. Since you do not have a time machine and all crystal balls are completely opaque, all you can do is to model the decision with the best Roth IRA savings calculator that you can find.

Regarding the Roth account investment decision, if you are not likely to accumulate significant assets for retirement, then it will not matter to you how federal, state, and local marginal income tax rates might change or stay the same in the coming decades. What matters to you in these Roth versus traditional retirement account decisions is whether your family, in particular, will achieve a high enough taxable retirement income stream that would expose you to high enough future taxes to counterbalance having paid greater income taxes many years in the past.

To analyze this decision, you must have a comprehensive planning tool that models your lifetime cash flows related to income, expenses, savings rates, debts, tax deductions, federal state and local taxes of various types, real estate ownership, property, investments, etc. How can you realistically make an appropriate “none, some or all” Roth decision, if the simple software tool you are using does not even model the taxability your projected retirement income?

People might receive retirement income from a wide variety of sources, including Social Security income payments; earned income in retirement; pension income; annuity income; rental income; investment income from cash, bond, and equity assets (held in various proportions in taxable accounts, traditional tax-advantaged accounts, and Roth accounts — subject or not subject to ordinary income taxes, short-term and long-term capital gains taxes — with or without some level of accumulated asset tax basis), etc. Will your future income and the future taxes you would pay justify the front-end taxes required to make Roth account investment?

Roth IRA conversions calculators that you might find for free somewhere on the Internet may only model a few of the factors mentioned above. Inside will be a simplistic investment returns model and a bunch of group average assumptions. These online free Roth IRA investment calculators are designed to jump quickly through their cursory financial analytics to get on to the real purpose of such free retirement calculators. That purpose is to apply an analytical veneer to the front-end of an on-line financial product sales process. Most of these tools tend to lead the user into a sales process, where overly expensive financial products are sold that may not be in the best interests of the user of the tool.

Note that the financial services industry’s use of supposedly “free” online financial planning calculators to troll for retail customers in notorious. I have discussed these subjects elsewhere. Use these links to find more information in these lists of articles:
* Straight answers about personal financial and investment planning are difficult to find
* Controlling investment fees
* Financial advisor fees
* How can individual investors trust, when so much information about investing is rubbish?

Roth retirement investment strategies have a very long payback period

When financial planners, investment advisers, and brokers advise their clients to convert their traditional IRA assets into Roth assets or to make annual Roth contributions rather than make alternative tax-deductible retirement account contributions, are asking for a huge leap of faith. Such proposals suggest that it would more beneficial to pay relatively high total federal, state, and local marginal income taxes on ordinary income now for a greater reward in retirement. This is a lot to swallow for intelligent clients who have the sense to pause to evaluate the situation.

For example, it is hard enough to convince a financial client that it is in their best interests to pay long-term capital gains taxes at significantly lower tax rates than a Roth conversion, for the sake of diversification and portfolio risk reduction. Clients who have highly concentrated equity position often resist exiting them because of the accumulated long-term capital gains tax obligation. Some do not want to pay the taxes, even when the portfolio risk reduction logic is very strong. Some hesitate to pay the capital gains taxes, even when the primary bread winner draws the family’s paycheck from the same firm. But, if and when they do pay the capital gains taxes and sell out of their concentrated position, they can get the risk reduction benefits of diversification immediately.

The Roth decision is an even steeper hill to climb. Current ordinary income tax rates are even higher, and the benefit is not immediate. Offsetting tax reductions are only available in the (distant) future during retirement and these tax savings are uncertain. Furthermore, when modeled with a sophisticated financial projection software tool, you find that only a minority of families might find the Roth account hill to be a very profitable one to climb.

Since the correctness of the Roth decision can only be known in the longer-term future, the Roth account investment decision is one that you really do want to be verified with sophisticated projection modeling. You have no other choice, unless you have the aforementioned time machine or clear crystal ball. You could “just say no,” which would be the correct decision for the majority of people. But, what if you would be one of those higher income and higher asset accumulators in retirement? You could end up paying a lot more to Uncle Sam, have a lot less in retirement, and have a smaller estate to pass to your heirs.

In many US states, combined federal, state, and local marginal income tax rates for high income earners total well above 40% and are closing in on 50%. In deciding about near-term Roth conversions of traditional retirement account assets, these people now are holding two tax-deferred “birds-in-the-hand.” In effect, they are being asked to trade away one of those birds-in-the-hand, when they pay current taxes due on a Roth conversion. In exchange, they will hope eventually to have many more “entirely tax-free Roth birds” in the future during retirement, than they would have had on an after-tax basis were they to follow a traditional tax-deferred retirement account strategy.

To evaluate this trade-off reasonably, these people need to have sufficient faith in the quality of their lifetime financial planning decision to be willing to pay high taxes now and give away one of their tax-deferred “birds-in-the-hand.” The lifetime financial planning tool demonstrating the wisdom of such a move ought to be highly sophisticated, comprehensive, and fully customized. It certainly should fully capable of projecting that family’s particular financial situation over a lifetime. The software should be able to run a range of scenarios easily and convincingly, which demonstrate the wisdom of the Roth decision, particularly since the beneficial expected harvest could be decades into the future!

A $100,000 traditional IRA to Roth IRA conversion example

For example, if you are considering converting $100,000 of traditional IRA conversion to Roth conversion IRA assets without any accumulated tax basis into a Roth account, you could face a combined federal, state, and local income marginal income tax rate of about 45%. (For example, can you say “high earned income in California?”). With a 45% tax rate, you need to come up with $45,000 to pay the taxes for a $100,000 Roth conversion. The remaining $55,000 would grow tax free and not be taxed upon withdrawal or might even be passed to your heirs, if you do not need it. Would the future value of these Roth assets exceed the value of instead leaving that $100,000 in a traditional tax deferred account to grow and then face ordinary income taxes on required minimum distributions in retirement? This is the simplistic analysis.

What about the effect of reducing your taxable assets by $45,000 dollars to pay the taxes on the Roth? Instinctively, most people would say that this is a negative for their lifetime financial plan, because they now have fewer taxable assets. However, with $45,000 fewer taxable assets you would avoid decades of federal, state, and perhaps local tax payments on the taxable returns on those assets. Those taxes would have been paid from some other account of yours and would have reduced your long-term savings rate.

Without the taxes on this $45,000, you might have saved more and funded greater investments. Numerous other factors would also come into play, such as your investment asset allocation strategy, the costs of your investments, and the ongoing taxability of your investment assets, which is dependent upon the tax efficiency of your investments driven by your “investment tax location” strategy. In short, there are a large number of moving parts and variables that could and should be reflected in the model.

A very important “bottom line” conclusion here is that you simply cannot arrive at an optimal Roth investment strategy answer for your family’s situation, unless you first develop an optimal lifetime financial plan for your family. With that optimal plan as your baseline for comparison, you can then evaluate alternative scenarios that involve annual Roth contributions and/or near-term conversions of some or all of your traditional tax-advantaged assets into Roth retirement accounts. In isolation, a simple Roth conversion calculator is far more likely to arrive at an inappropriate decision. It is simply appalling how many personal finance decisions are made using trivial tools.

Would you be willing to pay $45,000 in taxes to do a $100,000 Roth conversion without first using a sophisticated lifetime financial planner software tool? Before making such a big financial decision, would you be willing to spend a few hours first developing a comprehensive financial plan for your family? What if your lifetime financial planning model indicated that your retirement income is more likely to be somewhat constrained and that your taxes in retirement would be relatively modest? Then, you would have a much more solid reason to avoid doing a Roth conversion, plus $45,000 would stay in your account rather than move to Uncle Sam’s coffers.

On the contrary, your comprehensive lifetime financial plan might indicate that, indeed, you could accumulate assets throughout your lifetime and would be much more likely to benefit substantially from doing such a Roth conversion. In that circumstance, you would have invested some hours of your time and a very small amount for software to develop a comprehensive financial plan for your family. As bi-product of this do-it-yourself financial planning effort, you would also understand far more about the implications of a variety of financial strategies for your family — including the wisdom of your decision about Roth investment accounts.

Do-it-yourself Roth IRA conversion analysis software

You might ask: “How I know this?” about optimal Roth IRA, Roth 401k, and Roth 403b decisions customized to the projected financial situations of particular families. The answer is that over the past five years, my company has developed and refined a sophisticated and automated lifetime projection modeling software tool, which is available very inexpensively for home use by individuals who want to develop a lifetime financial plan for their family.

Named VeriPlan — Lifetime Personal Finance Software, this best-in-class personal financial planning software hides the complexity of all the lifetime family financial projection factors that reasonably can be computed for you in the background. While hiding all this computational complexity, VeriPlan also allows the home PC user to change any and all financial data, assumptions, and modeling parameters and instantly develop a new projection scenario.

For the past four years, VeriPlan has had fully integrated Roth analysis features. These Roth analysis features were not just tacked on recently in response to the recent Roth IRA conversions media clamor. Roth tradeoff analysis features were planned and designed into the fundamental architecture of VeriPlan from the outset.

To learn more about VeriPlan, click here —> Personal Financial Planning Software to get to the front page of this website.

Sophisticated and comprehensive personal finance software for families in the real world

I also use the VeriPlan lifetime financial planning software to develop comprehensive financial plans for my financial planning clients. It is a very useful financial decision support tool for testing “what if” scenario alternatives with my clients during highly interactive financial planning meetings.

For several years I have used VeriPlan — including its traditional versus Roth asset analysis functionality — with my clients, when I develop comprehensive plans for them under contract. My ability to provide a fully integrated analysis of traditional retirement account versus Roth retirement account lifetime contributions and/or conversions is a rather straightforward part of the overall process of developing a comprehensive financial plan for each family. I am easily able to develop sophisticated plans and to evaluate quickly whatever alternatives my clients wish to consider. Because VeriPlan automates the complexity of long-term financial planning, we can focus on informed decision-making and evaluate a wide range of alternatives.

Since 2006, the VeriPlan lifetime financial planning software has included fully-integrated and automated functionality that allows the evaluation of Roth versus traditional IRA and 401k account trade-offs on an ordinary home computer. VeriPlan enables you to evaluate a conversion of some or all of your existing traditional IRA account assets into Roth account holdings. This comprehensive financial planner software also provides automated tools that allow you to determine whether traditional retirement plan contributions, Roth account contributions, or some combination of traditional and Roth contributions across the working lifetimes of you (and your spouse) would be more advantageous.

Furthermore, this flexible personal finance PC software can easily model the combination of both a long-term annual Roth contributions strategy plus any one-time decision about whether to convert into Roth accounts some or all of the traditional IRA, 401k, and/or 403b assets that you own currently. With these Roth analysis features, this highly customizable financial software tool automates the lifetime financial planning and decision-making process for individuals and for financial advisors who want to use it with clients.

As the designer of the VeriPlan Personal Financial Planning Software, I can tell you that VeriPlan’s Roth functionality was the last design overlay that was applied to VeriPlan, even though this functionality was planned from the outset in its software architecture. The rest of the software architecture had to be implemented, before all of the trade-offs associated with Roth account investments could be automated. This is simply because the return on a Roth investment decision can only be realized through substantial tax savings during retirement. Along the way toward your retirement and throughout your retirement, all of your other financial actions will affect the magnitude of these tax savings or whether you would realize any tax savings at all.

From my point-of-view, to analyze a lifetime Roth strategy decision with clients without a comprehensive tool like VeriPlan would be like putting a hand starter crank on a Mercedes. The Mercedes represents the richness of your family’s lifetime financial affairs — fully modeled and viewed holistically, using the VeriPlan automated lifetime cash flow projection modeling tool. The hand crank would be any disconnected financial tool that simply cannot reflect important differences between the financial lives of one family and another. Avoid making decisions about your family’s long-term financial welfare based upon simple tools that simply ignore your particular financial situation. Even a free hand crank is worthless with a Mercedes.

Roth IRA calculator tools are needed to make a thorough lifetime financial plan

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Roth IRA and Roth 401k Accounts and Roth Estate Planning Strategies

There are trade-offs in deciding how to set the proportion to contribute into Roth retirement savings accounts versus making contributions to traditional retirement accounts with tax deferral advantages. Please use the links at the bottom of this article to read our previous articles on the subject of an optimal Roth retirement account contribution strategy.

In many senses for some people, an optimal Roth retirement account contribution strategy also becomes an estate planning question. In the majority of personal finance situations, making 100% of allowable Roth contributions may not yield the greatest total estate at age 80, 90, or 100, when compared to the opportunity to make currently tax deductible contributions traditional personal IRA and traditional 401k, 403b, KEOGH, and other retirement plan accounts that reduce current taxable income.

However, when you expand your total present value analysis to include the long-term value to a multi-generational family, then Roth assets can have significantly greater value. If Roth assets remain at death, there are very significant long-term multi-generational tax avoidance advantages. In such circumstances where it is likely that a person’s assets will be adequate to cover retirement expenses even with a very long life, then it can be advantageous to live off of traditional retirement plan assets, which are subject to mandatory withdrawals and associated income taxation in retirement anyway. This means that over ones lifespan, when retirement assets are adequate for the long-term, then a larger and increasing proportion of ones future financial asset portfolio could consist of Roth assets.

For estate planning purposes, Roth retirement accounts can have some very significant advantages over traditional tax-advantaged retirement accounts.

If a family’s financial model indicates that there is a strong possibility that they will still have some tax-advantaged account assets at death, then those should be Roth tax-advantaged account assets, when feasible. Roth assets can be inherited by children and other designated beneficiaries, and these inherited Roth assets can also grow tax-free over the expected life of the person inheriting with certain mandatory withdrawal requirements.

For example, this means that a child inheriting from a very elderly senior citizen parent Roth retirement account assets, when that child is age 50, could perhaps enjoy another 40 years of tax-free investment growth with an income stream along the way. Under current law the child would face from mandatory, but non-taxable withdrawals. Only when withdrawn asset have appreciated in taxable accounts, would the fruit of these inherited Roth assets be subject to short-term or long-term capital gains taxes. Traditional tax-advantaged retirement accounts do not provide these very significant and valuable estate planning benefits.

You should note that the rules regarding Roth retirement plan accounts are in flux.

It is not clear what they might be over the course of your life. However, income limitations have changed and traditional to Roth asset conversions seem to be possible without income restrictions during 2010. These year-to-year changes are the reason why it makes a lot of sense to download from the IRS website and read the relevant US income tax publications, including IRS Publication 560 and IRS Publication 590. Again, consulting a knowledgeable certified public accountant may help you with current rules strategy.

Furthermore, you should also use the top retirement investment planning calculator to better understand the potential size of your projected Roth retirement nest egg assets in the future. You should find out whether you could be one of the minority of the US taxpaying population that could mass significant Roth retirement account assets and be able to pass them to your heirs with the associated tax advantages to your beneficiaries.

<<<<< Go back to previous part: Roth IRA Retirement Planning

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Deciding between traditional retirement plan contributions and Roth retirement plan contributions

Whether or not to make investments into “traditional” tax-advantaged employer accounts and IRAs versus investing in “Roth” tax-advantaged employer accounts and personal IRAs is not always a straightforward decision. The decision on the trade offs happens to be one of the most complex aspects of lifetime personal financial planning.

A broad array of factors can influence whether a traditional retirement plan account contribution or a Roth retirement account contribution decision would be optimal. Given the significant importance of this decision on your lifetime financial plan and the build-up of your retirement savings, it would be worth taking a closer look at this decision. For most people’s lifetime circumstances, making deposits in traditional accounts is the preferred decision, when those contributions would be deductible against current income taxes.

Factors favoring Roth plan contributions over traditional plan contributions

Many people struggle with the traditional versus Roth contribution decision for their personal financial and investment planning. The trade-offs over a lifetime are very complex. Rules-of-thumb, back-of-the-envelope calculations, and simple retirement planning spreadsheets cannot model all the important personal financial factors.

The decision is not simply about present versus future tax rates and whether rates might be higher or lower. Instead, the decision requires a personalized and comprehensive projection and valuation of an investor’s lifetime income, expenses, debts, net assets, and taxes. (Look here for a sophisticated Roth IRA and Roth 401k calculator tool that fully automates the traditional versus Roth analysis.)

Also, be clear in noting that this discussion focuses ONLY on situations where an investor has the choice of making a CURRENTLY TAX-DEDUCTIBLE traditional IRA, 401k, etc. contribution VERSUS a CURRENTLY NON-TAX DEDUCTIBLE Roth IRA, 401k, etc. contribution. For most people, this is often they case, because they have not maxed-out their current opportunities to make tax-deductible traditional retirement plan account contributions.

If under the U.S.’s incredibly complex tax-advantaged retirement account rules, an investor does NOT have any further opportunities to make currently tax-deductible retirement account contributions, then a Roth contribution is the choice to make. Since an investor cannot take a current tax-deduction and since Roth account contributions avoid future taxation of asset appreciation in retirement, that is why such Roth contribution would be preferred over traditional retirement account contributions, under these limited circumstances of non-deductibility.

Whether or not a person or family will save enough and invest efficiently across a lifetime dominates the Roth retirement plan versus currently deductible traditional retirement plan contribution decision.

If an investor does not earn sufficiently high income, does not save aggressively, does not control investment costs, and/or does not grow a sufficiently substantial investment asset portfolio retirement nest egg, then that investor will not have to worry about being in high tax brackets in retirement — whether or not state and federal income tax brackets had moved up or down in the interim. If an investor will not have substantial assets and income in retirement, then the current tax savings an investor could get from contributing to a traditional tax-advantaged retirement savings plan will tend to be much more economically advantageous over a lifetime.

For an investor to justify making current Roth contributions in lieu of currently deductible “traditional” contributions, here are eight personal circumstances, taken together, that might reverse the average person’s preference for traditional tax-advantaged plan contributions.

Roth retirement plan contributions might be more advantageous over currently deductible traditional retirement plan contributions, when a retirement investor:

1. has a long time for her assets to appreciate before and during retirement.
2. is likely to earn high enough taxable income over her working lifetime to have a realistic chance of amassing enough assets to cover her retirement expenses easily and still build up financial assets.
3. is more likely to have increasing earned income that is expected to continue to rise in real dollar terms across a working life cycle, enhancing that investor’s ability to feed her investment program through increasing savings.
4. saves at sufficiently high percentage rates across her working lifetime. (This means consistently saving at rates that are well in excess of 10% of gross earned income.)
5. will fully fund either traditional and/or Roth tax-advantaged accounts up to maximum annual contribution limits.
6. may have proportionately higher front-loaded itemized deductions (e.g. mortgage interest and real estate taxes) and lower earned income that effectively lowers an investor’s nearer term federal, state, and local marginal ordinary income tax rates compared to her more distant retirement years.
7. will adopt a very low-cost investment strategy to improve her chances of capturing higher asset appreciation rates.
8. will maintain an investment asset allocation that is skewed heavily toward equities, and when her financial assets continue to grow at rates that are similar to long-term historical rates of return on equities.

Given all these factors, an investor may find that her assets in traditional tax-advantaged accounts would grow to be so substantial that when they are distributed under the mandatory distribution rules after age 70 and 1/2, she is pushed into much higher marginal tax brackets. If her traditional tax-deferred assets are sufficiently large, then ordinary income taxes on these mandatory distributions COULD wipe out the value of the tax shield assets that an investor gained by making traditional account contributions that reduced her taxable earned income in earlier years. This is the crossover point where Roth contributions become more desirable on a present value basis compared with currently deductible traditional retirement new investments. Again, the majority of those saving for retirement are less likely to be in this position and should therefore prefer reducing their currently taxable income through traditional retirement plan contributions.

<<<<< Go back to the previous part: Tax-Advantaged Retirement Investment Planning

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Tax-Advantaged Retirement Savings Plans

You may have the opportunity to make investments into both individual retirement (IRA) accounts and into employer or self-employed tax-advantaged retirement plans, such as a 401k. In general, if your retirement saving planning allows sufficient annual retirement savings from your earnings, most retirement investment advisers would recommend that you make the full contributions each year into these various plans through out your employment up to when your retire.

Even when you find that you cannot deduct from your income taxes your annual contributions to retirement plans, very often it still makes long-term retirement financial planning sense to make those IRA and 401k contributions, since future appreciation of these assets would be sheltered from ongoing taxation.

Traditional Tax-Advantaged IRA Contributions Versus Roth Retirement Account Investments

The article that follows provides information that will allow you to understand better the trade-offs between “traditional” and “Roth” tax-advantaged retirement accounts. Understanding the trade-offs between traditional IRA and 401k retirement contributions versus Roth 401k retirement plan contributions and Roth IRA contributions requires automated analysis of all the factors that impact this decision. Back-of-the-envelope calculations can easily be simplistic, incorrect, and deceptive. This decision can only properly be made with the assistance of a comprehensive retirement planning tool. If you do not have access to retirement planning software that can do this analysis for you, you really should get such a retirement planning software tool. The dollar amounts involved can be very large over a lifetime. Following uninformed instincts can lead to a highly sub-optimal retirement savings plan and you could accumulated many thousands of dollars less than you might save with a more optimal tax-advantaged retirement investing strategy.

For the majority of Americans, such retirement planning tools develop projections indicating that it would be more advantageous to make contributions to traditional tax-advantaged retirement accounts rather that Roth tax-advantaged retirement accounts. This tends to be true, whenever those saving for retirement can take advantage of the current tax deductibility features of traditional tax-advantaged 401k and IRA account investments.

However, when retirement savers cannot take advantage of current deductibility to reduce current taxable income and their income still allows some level of retirement plan contributions, then Roth contributions are preferred, if the tax rules allow such Roth retirement plan contributions. While the majority of retirement savers would prefer traditional retirement plan contributions to reduce current taxable income, whenever possible, you should monitor the situation each year to understand the rules in effect in a particular tax year. Unfortunately, the tax-advantaged retirement plan account rules are quite complex and some rules have been shifting from year to year.

The best way to understand this topic yourself is to download from the IRS website Publications 560 and 590. Grab some coffee and dedicate a few hours to the task of learning about retirement plan taxation. This could be a very valuable expenditure of your time, particularly if you want to answer the question: “how much do I need to retire?” and you recognize that whether your retirement savings account assets are “pre-tax” or “after-tax” can make a huge difference in determining how much money do I need to retire?!. Of course, a knowledgeable certified public accountant could also be helpful, if you would rather pay someone else to help you learn the rules.

The retirement account article that follows provides information that will allow you to understand better the trade-offs between “traditional” and “Roth” tax-advantaged retirement accounts. A subsequent article discusses the estate planning and the inheritance advantages of Roth retirement savings accounts, which can be very substantial, if your assets are likely out-live you.