Roth Conversion: Single, Age 62 with $1,500,000 of assets
This case illustrates the advantage and disadvantage of making the right decision about whether to convert and how much to convert to a Roth IRA each year.By intelligently managing a series of Roth Conversions, this person would be able to extend their portfolio’s longevity by more than five(5) years.
$1,000,000 in 401(k)s
$500,000 in regular taxable accounts
Andrea, Age 62 with $1,500,000 of assets
She plans on retiring this year. She wants to know how long her financial portfolio may last if she spends $79,700 after taxes in the first year and an inflation-adjusted equivalent amount each year thereafter.
Option 1: She converts the $1 million 401(k) into a Roth IRA in the current year.
Option 2: She never converts funds to a Roth IRA.
Option 3: Each year she considers a Roth conversion and may convert some or no funds. In years when there is a partial conversion, the amount converted varies from year to year.
In all three Strategies, she is assumed to begin Social Security at age 68. In addition, with the exception of the amount, if any, converted to a Roth IRA each year, we assumed each Strategy withdrew funds tax efficiently from the 401(k) and taxable account. We assumed she maintains a 50% stocks-50% bonds after-tax asset allocation with stocks earning 7% per year and bonds earning 3%, both historically conservative assumptions.
In Strategy 1 of the Figure, she converts her $1 million in a 401(k) to a Roth IRA in 2010 and her portfolio runs out of money by the end of 2039.
In Strategy 2, she never makes a Roth conversion and her portfolio runs out of money after providing some of her spending needs in 2045.
In Strategy 3, she makes a partial Roth conversion in some years and no conversion in others. Her portfolio provides all funds needed for 2045 and about $2,000 for 2046. Strategy 1 shows that she should not make a complete Roth conversion in 2010. Comparing Strategies 2 and 3 shows that partial Roth conversions adds longevity to her portfolio. Moreover, Strategy 3 would extend her portfolio’s longevity by more than five years compared to the complete Roth conversion (Strategy 1) and by about one year compared to never making a Roth conversion (Strategy 2). Additional longevity could be provided by judicious choice of the Social Security starting date.
By intelligently managing a series of Roth Conversions, Andrea was able to extend the portfolio’s longevity by more than five(5) years.
Assumptions: She maintains a 50% stocks-50% bonds after-tax asset allocation with stocks earning 7% per year including 2% dividend yield and bonds earning 3% interest per year. For the stocks, 20% of capital gains are realized each year with all gains being long term. The original cost basis of assets held in the taxable account is set at the market value. Her Primary Insurance Amount for Social Security is $2,500 a month and her Full Retirement Age is 66. Both strategies allocate stocks to the taxable account and bonds to the 401(k) to the degree possible while maintaining the 50% stocks-50% bonds after-tax asset allocation. Based on today’s Tax Code, she will usually be in the 25% tax bracket in retirement. She takes the standard deduction, and tax brackets, standard deduction amount, over 65 tax exemption amount, and personal exemption amount rise with inflation at 3% per year.