Now that all of my IRAs are at Vanguard, I can decide whether to convert my $5,000 Traditional IRA to combine with my Roth IRA. After reading up on some pertinent articles at Fool.com and Fairmark.com, here are my thoughts.
Right now I am currently eligible to convert, as my modified adjusted gross income (MAGI) is less than $100,000, after reading this article on eligibility. This will probably not be the case in the future. Also, I have the cash available for the taxes that I will have to pay during the conversion. That way, I won’t have to take the money out of the Traditional IRA, and the $5,000 will then be post-tax instead of pre-tax. Finally, I don’t intend to contribute any more money to a Traditional IRA in the foreseeable future.
Much of the talk about Traditional vs. Roth IRA is about whether you tax bracket will be higher or lower when you retire. However, since that is about 40 years away, who know what the taxes will be by then? Some people even say that earnings on Roth IRAs may be taxed as well later on. I personally like the thought of having all of my non-401k retirement funds in a post-tax account, to hedge my bets between pre-tax and post-tax scenarios.
Finally, it’s time to do some math. There are numerous calculators out there, but the math isn’t hard, so let’s get to it.
Annual investment rate of return (pre-tax) – 8%
Annual investment rate of return (post-25% tax) – 6%
Current Tax Bracket – 25%
Retirement Tax Bracket (best guess) – 25%
Time until retirment – 35 years
Scenario #1: Stay with Traditional IRA
$5,000 x (1.08)^35 = $73,927 (pre-tax)
After taxes, I would end up with $73,927 x 75% = $55,445
However, I would be saving the amount to pay the tax on the potential $5,000 Roth conversion ($5,000 x 25% = $1,250), which could have been saved in another taxable account and invested:
$1,250 x (1.06)^35 = $9,608.
So my total amount of money post-tax would be 55,445 + 9608 = $65,053.
Scenario #2: Convert to Roth IRA
$5,000 x (1.08)^35 = $73,927 (post-tax)
So according to my calculations, I would end up $8,874 ahead in the end if I convert to a Roth. Of course my calcs may be wrong or I may be missing something (If so, please tell me!). I’ll ponder it a bit longer, but I will probably initiate this conversion by the beginning of next week.