Originally Posted by
Forgotmyhat
A clarification. The circumstances forcing the $29,365 to be paid to tax is due to the fact that you choose to pay the tax “out-of-pocket” (as indicated in a previous post), in which case tax has already been paid on that amount, so the $29,365 doesn’t get taxed again.
29,365 is the tax due on 79,365 in W2 income. In the example 79,365 was earned and taxed at an amount of 29,365 leaving 50,000 to grow tax free in a Roth. At 8% over 20 years, that is $233K of spendable cash.
This was the alternative to deducting the amount from the converted funds. In which case, in your example, it would reduce the “principle” by the tax due, thus reducing your basis and hence growth.
We are not talking about converting an IRA, we are talking about contributions from earned income into a Mega Back Door Roth via 401a After Tax contributions. Reread the example and feel free to run it in your own spreadsheet. Yes the amount of invested principle is lower, resulting in a lower gross amount in the account. The net spendable amount after income taxes and capital gains taxes is higher.
Furthermore as part of an estate planning tool, the prepaid taxes of a Roth account create a lower amount of gross estate value potentially subject to inheritance tax. It provides a larger amount of net spendable cash even though it is a lower amount than a traditional account.
BUT, you must do one or the other. Thus, if you pay the tax “out-of-pocket”, there is no choice as to whether you keep the $29,365 or if you “would have” invested it or not. There is no alternative...it’s gone. Had you not paid out-of-pocket, again there is no choice, the $29,365 on top of the converted amount doesn’t exist. The very fact that we are talking about the $29,365 is because you chose to do a back door Roth.
This entire thread is about MBDR, but I think you are confusing it with a Roth conversion.
79,365 of W2 earnings = 50,000 MBDR Roth annual contribution
79,365 of W2 earnings also equals 50,000 Traditional plus 18,500 (29,365 minus taxes) for hookers and blow or a taxable investment account.
As for Roth conversions, the tax similarities still apply. If you have the money to pay the taxes vs reducing principle in the Roth account post conversion, you will have more spendable money. A 50K Roth conversion yields a tax liability of 18,500.
50K in a Roth account becomes more spendable money than 50K in a Traditional PLUS 18,500 in a taxable. The math is clear, but setting up the problem correctly can be problematic.