I'm trying to decide a simple (not really) question. Whether or not to invest in a Roth IRA.
The devil is in the details, so let me set it up. It's more than an academic question for me, but I'm going to set it up with clean variables to avoid alternative suggestions that might not be applicable.
I am confident I have already saved enough for MY retirement. Whatever I put in this IRA will be money that will ONLY be used to pass down to my son after I die. I am not married and there are no other heirs. Let's say I'm 60 years old and I expect to live to 80, but of course that's just a guess. I understand the criteria for IRA contribution, but to keep the numbers easy, let's say I'm considering whether or not to contribute $10,000 all at once into a Roth account. (Pretend it's a Roth 401K or that I'm actually married and we're able to invest 10k all at once between the two of us. Doesn't matter. Again, just trying to keep the numbers easy to work with). I'm retiring soon and I can't put this decision off much longer.
I am currently in the 22% income tax bracket, putting me in the 15% capital gains tax bracket. I have a pension and I will always remain in this same tax bracket after retirement and until the day I die. My "estate" will never be high enough for my heir to be subjected to inheritance tax.
Important to this calculation is knowing where the contribution money is coming from. I own $20,000 worth of shares in the VTSAX index fund. This fund is held in a taxable account. All shares inside this account are uncovered and the cost basis method was locked in at "average cost basis" long ago and cannot be changed. Half of the value of this fund ($10,000) exists as a long term unrealized gain.
The ONLY way I can fund my Roth IRA is to get the money from the taxable VTSAX. I will need to take out $10,811 in order have enough to fund the Roth IRA and cover the the taxes. (50% unrealized gain means $5,405.5 is subject to capital gains tax at 15%, which comes to $810.83 in tax. Round that to $811 and that's how $10,811 comes to $10,000 I can use to contribute to the Roth IRA.)
BTW, should I fund the Roth IRA, I'll be investing in the exact same VTSAX fund.
So that's the setup. For simplicity, imagine I'm comparing $10,000 of VTSAX inside a Roth IRA account with $10,811 of VTSAX inside a taxable account. Half of the value of the taxable VTSAX fund is unrealized gain.
Now some hypotheticals. It's 2024. For the next 20 years, VTSAX will return 7% (until 2044). In ten years I die (in 2034). 20 years from now, in which scenario is my son better off? He (in magical hindsight) can choose between:
1) Taxable VTSAX,initially worth $10,811, which grows for 10 years at 7% and then has its cost basis reset, only to grow at 7% for another 10 years.
2) $10,000 VTSAX inside a Roth IRA which can be held for 20 years (10 years of the remaining years of my life + 10 years after I die) before it has to be cashed out.
Let's assume that when my son takes out the money from the taxable account he will also be in the 22% bracket and thus have to pay %15 on the capital gains.
For the sake of my son's inheritance, which is the better choice for me to make? 1 or 2?
I've run this a few ways using a spread sheet. For most intents and purposes, it doesn't seem to matter how long I live as the key factor is whether or not the investment will be allowed to grow for an additional 10 years inside a Roth IRA. The exception to this would be how much churn there is on VTSAX for those 20 years, considering that realized gains on taxes on churn will not affect gains inside the Roth IRA. The other factor is market gain. It seems that the better the market gain over this time period, the more the Roth IRA will be the favored choice.
In my example, the taxable VTSAX I'm drawing from is made up of 50% unrealized gains. Other scenarios I've run suggest that a lower % of realized gains favors the Roth option, while a higher % of realized gains tends to favor leaving it in the taxable account that can be reset upon inheritance.
The two above scenarios are pretty easy to setup on a spreadsheet and compare, but what I'm really looking for from the forum is concepts I may have missed, alternatives to the two options, or faults in how I've setup the hypotheticals. One of the variables I'm having a hard time locking down is what percentage to use for "churn" inside the taxable VTSAX. Running the above scenario with no accounting for churn, my results are, that after 20 years, the Roth IRA end value is about the same as the taxable VTSAX value after paying all taxes owed on it. Running the same results with some accounting for tiny realized gains from "churn" inside the taxable VTSAX makes the Roth IRA choice more favorable.
Other things to consider is that my son, upon my death would be able to change the cost basis method to "spec ID" perhaps giving him reason to want to hold the fund longer than 10 years beyond my death. Also worth considering is whether or not or the capital gains tax rate will be higher 20 years from now or whether or not Roth IRA withdrawals will be subject to taxation.
Well, there it is. Thanks if you've made it this far. Other than being a good academic exercise to see if you know your IRA and inheritance rules, it's not so crazy to think that some people (with pensions and uncovered shares locked in at average cost basis) might be facing this situation howbeit with larger amounts. (Think Roth 401Ks, married couples over 50 contributing to Roth IRAs, etc).
Thanks!
The devil is in the details, so let me set it up. It's more than an academic question for me, but I'm going to set it up with clean variables to avoid alternative suggestions that might not be applicable.
I am confident I have already saved enough for MY retirement. Whatever I put in this IRA will be money that will ONLY be used to pass down to my son after I die. I am not married and there are no other heirs. Let's say I'm 60 years old and I expect to live to 80, but of course that's just a guess. I understand the criteria for IRA contribution, but to keep the numbers easy, let's say I'm considering whether or not to contribute $10,000 all at once into a Roth account. (Pretend it's a Roth 401K or that I'm actually married and we're able to invest 10k all at once between the two of us. Doesn't matter. Again, just trying to keep the numbers easy to work with). I'm retiring soon and I can't put this decision off much longer.
I am currently in the 22% income tax bracket, putting me in the 15% capital gains tax bracket. I have a pension and I will always remain in this same tax bracket after retirement and until the day I die. My "estate" will never be high enough for my heir to be subjected to inheritance tax.
Important to this calculation is knowing where the contribution money is coming from. I own $20,000 worth of shares in the VTSAX index fund. This fund is held in a taxable account. All shares inside this account are uncovered and the cost basis method was locked in at "average cost basis" long ago and cannot be changed. Half of the value of this fund ($10,000) exists as a long term unrealized gain.
The ONLY way I can fund my Roth IRA is to get the money from the taxable VTSAX. I will need to take out $10,811 in order have enough to fund the Roth IRA and cover the the taxes. (50% unrealized gain means $5,405.5 is subject to capital gains tax at 15%, which comes to $810.83 in tax. Round that to $811 and that's how $10,811 comes to $10,000 I can use to contribute to the Roth IRA.)
BTW, should I fund the Roth IRA, I'll be investing in the exact same VTSAX fund.
So that's the setup. For simplicity, imagine I'm comparing $10,000 of VTSAX inside a Roth IRA account with $10,811 of VTSAX inside a taxable account. Half of the value of the taxable VTSAX fund is unrealized gain.
Now some hypotheticals. It's 2024. For the next 20 years, VTSAX will return 7% (until 2044). In ten years I die (in 2034). 20 years from now, in which scenario is my son better off? He (in magical hindsight) can choose between:
1) Taxable VTSAX,initially worth $10,811, which grows for 10 years at 7% and then has its cost basis reset, only to grow at 7% for another 10 years.
2) $10,000 VTSAX inside a Roth IRA which can be held for 20 years (10 years of the remaining years of my life + 10 years after I die) before it has to be cashed out.
Let's assume that when my son takes out the money from the taxable account he will also be in the 22% bracket and thus have to pay %15 on the capital gains.
For the sake of my son's inheritance, which is the better choice for me to make? 1 or 2?
I've run this a few ways using a spread sheet. For most intents and purposes, it doesn't seem to matter how long I live as the key factor is whether or not the investment will be allowed to grow for an additional 10 years inside a Roth IRA. The exception to this would be how much churn there is on VTSAX for those 20 years, considering that realized gains on taxes on churn will not affect gains inside the Roth IRA. The other factor is market gain. It seems that the better the market gain over this time period, the more the Roth IRA will be the favored choice.
In my example, the taxable VTSAX I'm drawing from is made up of 50% unrealized gains. Other scenarios I've run suggest that a lower % of realized gains favors the Roth option, while a higher % of realized gains tends to favor leaving it in the taxable account that can be reset upon inheritance.
The two above scenarios are pretty easy to setup on a spreadsheet and compare, but what I'm really looking for from the forum is concepts I may have missed, alternatives to the two options, or faults in how I've setup the hypotheticals. One of the variables I'm having a hard time locking down is what percentage to use for "churn" inside the taxable VTSAX. Running the above scenario with no accounting for churn, my results are, that after 20 years, the Roth IRA end value is about the same as the taxable VTSAX value after paying all taxes owed on it. Running the same results with some accounting for tiny realized gains from "churn" inside the taxable VTSAX makes the Roth IRA choice more favorable.
Other things to consider is that my son, upon my death would be able to change the cost basis method to "spec ID" perhaps giving him reason to want to hold the fund longer than 10 years beyond my death. Also worth considering is whether or not or the capital gains tax rate will be higher 20 years from now or whether or not Roth IRA withdrawals will be subject to taxation.
Well, there it is. Thanks if you've made it this far. Other than being a good academic exercise to see if you know your IRA and inheritance rules, it's not so crazy to think that some people (with pensions and uncovered shares locked in at average cost basis) might be facing this situation howbeit with larger amounts. (Think Roth 401Ks, married couples over 50 contributing to Roth IRAs, etc).
Thanks!
Statistics: Posted by bobsmith — Wed Aug 28, 2024 8:29 am — Replies 7 — Views 439