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Questions for you Mega-Backdoor Roth'ers...

Old 01-05-2021, 06:59 PM
  #181  
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Originally Posted by Forgotmyhat View Post
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.
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Old 01-05-2021, 07:06 PM
  #182  
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Originally Posted by Forgotmyhat View Post
Seems to me the back door Roth is the vehicle to use if you say, take a leave of absence and significantly reduce you income in a particular year. THAT would be the time to do it.
Or if you were displaced to a lower paying seat and won't get a fat profit sharing check next month. Or if you have huge depreciation deductions from your real estate investments. Or if you took accelerated depreciation on business assets. Or if you are expecting to remain in your current tax bracket in retirement. Or if an inherited Roth IRA is part of your estate plan. Or you just want to do what the cool kids are doing. Or any number of possibilities that fit your situation.

Last edited by Gunfighter; 01-05-2021 at 07:17 PM.
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Old 01-05-2021, 07:22 PM
  #183  
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Originally Posted by Gunfighter View Post
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.
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.

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.

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.
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Old 01-05-2021, 07:28 PM
  #184  
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Originally Posted by Gunfighter View Post
Or if you were displaced to a lower paying seat and won't get a fat profit sharing check next month. Or if you have huge depreciation deductions from your real estate investments. Or if you took accelerated depreciation on business assets. Or if you are expecting to remain in your current tax bracket in retirement. Or if an inherited Roth IRA is part of your estate plan. Or you just want to do what the cool kids are doing. Or any number of possibilities that fit your situation.
Yes, I get all that. I own commercial real estate and understand all the deductions and depreciations. And I get that everyone’s situation is different. But after 18 pages in the thread, those specifics haven’t been mentioned. It seemed like the back door Roth is the thing to do, just for the sake of doing it. I was wondering what I was missing. But based on the responses, it turns out I wasn’t missing anything.
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Old 01-05-2021, 08:12 PM
  #185  
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Originally Posted by Forgotmyhat View Post
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.
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Old 01-05-2021, 08:36 PM
  #186  
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Originally Posted by herewego View Post
Mathematically if one were to invest $10000 now without paying 37% taxes on it it vs taking the same $10,000 and giving $3700 to the Tax man and investing the remaining $6300 the real dollar value of the withdrawals depends on the taxrate at withdrawal. Say the investment grows 10 times between deposit and withdrawal: the $10,000 becomes 100,000, but then is taxed 37,000 and you end up with $63,000 to spend. the $6300 invested becomes $63,000 so you end up with the same equivalent money. If tax rates go up (a most likely scenario given the huge amounts of government overspending lately) that $100,000 gets taxed to 50% and you are screwed.
The trick is to Invest the 37% pretax savings, but withdraw taxable money from that or the company contribution funds taxable only to a 24% tax bracket, the take any remaining spending needs from tax free Roth money.
Unconstrained by contribution limits, your above comparison works. Suppose the tax man sets a maximum contribution of 6,300 and the remainder is in a taxable account. Your 10,000 option now becomes 6,300 in the tax deferred account, pay income taxes on the remaining 3,700, then invest 2,331 in a taxable non-retirement account. The answer is 58,070 traditional vs 63,000 Roth.

Scale the limit from 6,300 up to 19,500 and you have a real world comparison to 401k vs Roth 401k.
Scale the example up to 58,000 to be in sync with IRS 415C limits and you see where the MBDR becomes appealing.

Last edited by Gunfighter; 01-05-2021 at 09:02 PM.
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Old 01-05-2021, 09:07 PM
  #187  
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Originally Posted by Forgotmyhat View Post
Yes, I get all that. I own commercial real estate and understand all the deductions and depreciations. And I get that everyone’s situation is different. But after 18 pages in the thread, those specifics haven’t been mentioned. It seemed like the back door Roth is the thing to do, just for the sake of doing it. I was wondering what I was missing. But based on the responses, it turns out I wasn’t missing anything.
The biggest thing we are all missing is that commercial real estate investments are a better retirement vehicle than anything being discussed on this thread. Forget the Roth and double down on CRE.
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Old 01-05-2021, 09:17 PM
  #188  
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Originally Posted by Gunfighter View Post
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.
Ah, you are correct, I am thinking straight conversion, not MBDR. As to your second point, I’ll have to play around with the numbers.
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Old 01-05-2021, 09:21 PM
  #189  
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Originally Posted by Gunfighter View Post
The biggest thing we are all missing is that commercial real estate investments are a better retirement vehicle than anything being discussed on this thread. Forget the Roth and double down on CRE.
Totally. That’s plan A! Also the key to early retirement.
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Old 01-06-2021, 04:03 AM
  #190  
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Originally Posted by Gunfighter View Post
Unconstrained by contribution limits, your above comparison works. Suppose the tax man sets a maximum contribution of 6,300 and the remainder is in a taxable account. Your 10,000 option now becomes 6,300 in the tax deferred account, pay income taxes on the remaining 3,700, then invest 2,331 in a taxable non-retirement account. The answer is 58,070 traditional vs 63,000 Roth.

Scale the limit from 6,300 up to 19,500 and you have a real world comparison to 401k vs Roth 401k.
Scale the example up to 58,000 to be in sync with IRS 415C limits and you see where the MBDR becomes appealing.
But then you have to look at your tax rate upon withdrawal.
Assuming over 65 with a total retirement fund of $5M that you invested less than that amount at the marginal tax rate of 37%. you can safely withdraw 4% or $200,000 yearly
TaxYear2020 over 65 has a married standard deduction of $26,450
so you now have $173,550 being taxed
the first $19,750 is at 10% or $1,975
up to $80250 is at 12% or $7260
Then to $171050 is 22% or $19,976
And the final $2499 is now at 32% or $800
for a total tax bite of $30,011 on that annual $200,000 withdrawal or 15%

I admit my analysis comes from a Regional Pilots perspective who is only a 5%er without working with a tax advisor, so the Standard "Your mileage will vary", "everyone's situation is different" "consult a professional" comments hold true.
IMHO the best way is to contribute the maximum to Roth accounts when you're in the 0-12% brackets, and move to investing pretax money (max $26000 over 50, but $58000 with company plan"X") as you get into the 24% and higher brackets. That way in retirement desiring a $200,000 expense account, you can withdraw $106,700 from the accounts that are taxed, with the remaining $93,300 from the Roth accounts.
Better yet is to invest those pretax dollars when you live in a high tax rate state like California, then move to Texas or Florida in retirement and not have to pay state income taxes on the withdrawals. on second thought, if you're from California move to Washington instead of Texas
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