Why I won’t do a Roth IRA conversion—even if this is the last chance

I’ve had so many reader responses since broaching the subject of traditional and Roth IRAs. It’s clearly a big retirement topic for many people—as well it should be, given that the ability to save $6,000 a year in a tax shelter can be a real help to middle-class people who need to prepare for their senior years.

And it’s a hot topic, because the new tax bill from the House Ways and Means Committee proposes ending IRA tax savings for anyone with adjusted income above $140,000 a year. Among the proposals: Ending our ability to convert our traditional IRAs to Roths after year-end.

During the presidential election campaign, Joe Biden promised not to raise taxes on anyone making less than $400,000 a year. Whether these provisions in the bill survive is an open question.

Lots of readers have weighed in on whether a Roth IRA is better than a traditional one. In a Roth IRA, you don’t get any tax break up front. You contribute money after paying income tax—but then, at least under current law, the money and all future gains are tax-free. In a traditional IRA, you get the tax-break today. You can deduct the contribution from your current income, so that making the contribution cuts your current federal tax bill. But when you withdraw the money in retirement, it’s taxed as income.

Read: Should I convert my traditional IRA to a Roth IRA?

Various readers have argued that you will pay less tax in total if you choose a Roth, and you’ll end up with more money. But others argued that that’s a logical fallacy, and I think they’re right. If your tax rate is the same when you earn the money and when you retire, there’s no saving.

Let’s say your tax rate in both cases is 24%. If you invest $6,000 in a traditional IRA and it grows at 5% a year for 20 years, you will end up with $15,900. When you withdraw the money, and pay 24% tax, you’ll end up with $12,100. On the other hand, if you use a Roth, you have to pay 24% tax on that $6,000 upfront, leaving you $4,560 for your IRA. If it grows at 5% for 20 years, at the end you can withdraw, tax-free… $12,100.

But here’s the thing. After double-checking with professional financial planners and accountants, I’ve come to realize those calculations are moot. Most of us—including me—are almost certainly going to be way better off in a traditional IRA.

The reason? We’re paying significant income taxes today on our salaries, so the upfront tax break matters. And we’re going to be paying far lower tax rates in retirement, unless we are doing really well.

Don’t believe me? Do the math. Let’s say you retire at Social Security’s “full retirement age,” currently 66 years old, and you get the maximum Social Security income. That’s currently about $3,100 a month. And let’s assume your spouse gets another 50% on top of that. Total household income: $56,000.

Let’s say that by the time you retire you’ve paid off your home, you’ve helped your kids through college, and you’ve saved, say, $1 million in your IRA. Now in retirement you withdraw 5% a year, or $50,000.

Total income: $106,000 a year.

But that’s not your taxable income. Far from it.

There are big tax breaks on Social Security income, points out John Gehri, a financial planner with Harvest Financial Advisors in Cincinnati. For a married couple filing jointly, the first $32,000 per year is completely tax-free. The next $12,000 is 50% tax-free, and even above $44,000 you can deduct 15%. By my math, that means as far as Uncle Sam is concerned your Social Security income, for tax purposes, is just $15,300.

That would bring your taxable income down to $65,300. Then there’s the standard federal tax deduction, which for joint filers over 65 that comes to another $30,500.

Net result? In this example, that leaves you with just $35,000 of taxable income. Total federal tax bill: About $3,800.

That’s less than a 4% average tax rate on the whole shebang. You know any working stiff paying 4% in taxes?

And your top tax rate here — the tax paid on the last dollar you receive — is 12%. You’d be worse off in a Roth IRA if your top tax rate in work was any higher.

Furthermore—and when I think about my own senior years, this is a critical for me—John Gehri points out that medical expenses are tax-deductible (once they top 7.5% of your adjusted gross income). That means nursing at home, and nursing homes. If you end up using your IRA money for medical costs, the money will pretty much have avoided federal taxes altogether, going in or coming out.

Ryan Losi, an accountant at the firm Piascik in Richmond, Virginia, says Roths are really mostly valuable for those with high net worths and high income. He adds that Roth IRAs are also an especially valuable tool for tax planning for those dealing with a big estate, because the heirs can draw the money tax-free.

For me? I don’t want to a Roth conversion even if they really are going to ban them after Dec. 31. And if I end up in retirement so well off that I wish I had seized the moment, well, I’ll count myself very lucky.

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