Originally Posted by
Forgotmyhat
I get this, but in order to get that $1M into a Roth, it costs something...$370k. That’s money that you don’t get to spend or better yet invest...it’s gone.
For pilots (and those with equivalent career earnings) I would understand the back door Roth strategy if you think that tax rates will increase in the future...for whatever reason. But barring this, you will be taxed at your maximum life tax bracket.
Of course I maxed out my Roth when I was in the military at a VERY low tax rate (some years under 3% effective), knowing that in retirement I would likely be in a higher bracket. But now as a high-earner, I can’t make the math work to convert at this point in my career. Just doesn’t add up to me.
Yes, you pay the taxes on your investment up front, so you won't pay taxes once retired. Follow my math below, to see why that makes sense.
My assumption is 37% tax bracket now and in retirement. There is no tax rate arbitrage.
Lets pretend you have $79,365 budgeted for retirement. That would become $50,000 after 37% income tax for a Mega Roth. After 20 years at 8% returns, that is now worth $233,048 with no taxes due. All $233k is spendable cash.
Your argument was to put $50,000 in a pre-tax account and invest the rest, rather than prepay taxes. The $50,000 pretax grows to the same $233,048, but income taxes are due on withdrawals leaving you with $146,820 in spendable cash. Your $50k pretax contribution leaves $29,365 that is taxed and reduced to $18,500. Assuming that the remaining $18,500 is invested at 100% tax efficiency (Unicorn ETF with no annual dividends, distributions or investment exchanges) and earned the same 8% return, the account is now $86,228, which is reduced to $70,312 after long term capital gains tax on the growth. $146,820 + $70,312 = $217,132 or LESS than $233,048 of spendable cash in the Roth account.
IF you could have invested ALL of your money in a pre-tax account the results would have been the same $233K of spendable cash. The problem is that the money you "saved" in taxes gets taxed and the earnings on that also get taxed.
Summary: This strategy works well for people who are limited by the IRS 415c limits. If you expect to remain in the same tax bracket at retirement, you are better off with a Roth.
This is just one basic example, there are numerous combinations and permutations of income tax and capital gains tax that can impact the numbers. Every investor has unique circumstances that will impact their decision.