The process of doing a Roth conversion is not particularly complicated. What CAN be complicated is the decision about whether or not to do one and how much to convert.
How to Do a Roth Conversion
Step 1 – Transfer money from your traditional IRA to a Roth IRA.
Step 2 – Pay taxes on that money.
That's really all there is to it. Simple, no? There are a few variations. For example, you can transfer money directly from a 401(k) to a Roth IRA (and then pay taxes.) You can also, if the plan allows it, transfer money from a 401(k) to a Roth 401(k) or a 403(b) to a Roth 403(b) (and then pay taxes.)
Benefits of a Roth Conversion
There are a number of benefits of a Roth conversion.
- That money will never be taxed again (although estate or inheritance taxes could apply)
- No required minimum distributions on that money (not true in a Roth 401(k) or 403(b))
- If left to heirs, no income taxes for them either (better to inherit a Roth IRA than a traditional IRA)
- Assuming you're using a taxable account to pay the taxes, you are getting more money, on an after-tax basis, into a tax-protected and asset-protected accounts. In essence, you're transferring money from taxable to tax-protected.
- Done properly, you may be lowering your overall lifetime tax burden
- Smaller Required Minimum Distributions after age 72.
- May reduce estate/inheritance taxes due by removing “the government's portion” of retirement accounts from the estate.
The Downside of a Roth Conversion
There is really only one downside of a Roth conversion
- You pay taxes on it.
Did you get that? This isn't like a backdoor Roth, where you're comparing a taxable account to a Roth account. The Roth account always wins in that scenario. In this scenario, the Roth DOES NOT always win. In fact, it can be a pretty complicated decision.
When To Do A Roth Conversion
The idea behind a successful Roth conversion is that you want to prepay taxes at a lower rate than you would pay them later. Sometimes, there is another benefit, such as the ability to do a backdoor Roth IRA going forward (this occurs in situations where you cannot roll a SEP-IRA or traditional IRA into a 401(k) of some type.) So when are good times to do a Roth conversion of tax-deferred assets?
- As a student, resident, or upon residency graduation.
- During a sabbatical or other low-income year.
- While temporarily disabled (assuming disability income is tax-free).
- While in the military.
- After cutting back to part-time.
- In early retirement, before receiving Social Security.
- When you have a particularly low Roth to tax-deferred ratio and desire more tax diversification.
Basically, any time it would make sense to make Roth 401(k) contributions, it probably makes sense to do Roth conversions.
When are bad times to do Roth conversions?
- During peak earnings years (not always, especially for supersavers and those expecting to be in the top tax brackets in retirement)
- When you are converting money you would give to charity anyway.
- Using money you would give to heirs who are in a low tax bracket.
- When you don't have taxable money you can use to pay the taxes (not always, in fact this only slightly decreases the value of a Roth conversion)
- When you don't have much of a tax-deferred account.
Remember that in retirement, especially early retirement, you want to have enough taxable (i.e. tax-deferred account withdrawals) income to fill the 0%, 10%, and 12% brackets. So it's usually silly to convert anywhere near ALL your tax-deferred money to Roth money.
How Much Should I Convert?
The general rule is that you convert up to the top of a certain tax bracket. That might be the 12% bracket or perhaps even the 22% bracket in 2020. Generally doing conversions above this amount isn't advised, unless you expect a great deal of taxable income in retirement (and would be paying 24%+ on retirement income.) Practically speaking, what does that mean?
Consider this example.
Doctor Jones is 55 years old and has $2 Million in tax-deferred assets, $700,000 in taxable accounts, and no Roth accounts. He has cut back to part-time and now makes $80,000 per year. This year he will begin maxing out a Roth 401(k) and personal and spousal backdoor Roth IRAs. His spouse does not work and they will be taking the $24,800 standard deduction now. He thinks a Roth conversion is a good idea for him, but is unsure how large of a conversion to do this year.
If you think it looks challenging to climb up, you should try skiing down!
Let's assume his tax-deferred assets grow from $2 Million to $2.5 Million at the time of his retirement. Let's also assume that between him and his wife, they'll get $50,000 a year in Social Security, 85% of which will be taxable. Assuming the $24,800 standard deduction, his taxable retirement income will be around $122,000, squarely in the 22% bracket. Thus, it probably does NOT make sense to pay taxes at more than 22% now in order to do a Roth conversion. 22% makes sense for his situation (no Roth and plenty of taxable to pay the taxes.) 12% is a great deal.
His current taxable income of $55,200 is well within the 12% bracket. The first $25,050 he converts this year will be done at 12%. That much is a no-brainer. It would probably be advisable for him to convert another $90,800 (filling the entire 22% bracket) this year as well. That conversion will cost him $25,050*0.12 + $90.800*0.22 = $22,982. He can certainly afford that given the size of his taxable account.
Between his Roth 401(k) contributions, his backdoor Roth IRA contributions, and his Roth conversions, (and probably spending some of the taxable money) he will rapidly be converting taxable assets to Roth assets, a great financial move. If he does this sort of thing 5 years in a row or so, he will have pretty nice tax diversification throughout retirement due to a sizable Roth account.
In short, Roth conversions can be a great tool, but run the numbers first. Roth does NOT always win this competition.
What do you think? Have you done a Roth conversion? Why or why not? Do you anticipate doing some in the future? Comment below!
Excellent post on an important topic. It is difficult to apply the concepts to individual scenarios for many of us. It isn’t intuitive for most of us to do it in our heads. Web resources such as this one helped me:
https://calcsuite.fidelity.com/rothconveval/app/launchPage.htm
I saved 250k in tax (lifetime) by converting based on my best assumptions about my future.
Great post! This is a strategy I believe many investors would benefit from but in my experience, very few take advantage of it. The classic example I see is someone that retires early and is strictly living off taxable investments. They haven’t yet taken social security and don’t really have any other taxable income sources. Often they are in a very low tax bracket even with sizable wealth. This is a fantastic time to consider Roth Conversion but unfortunately many miss the opportunity. It’s rare that I hear of someone making this decision based on the numbers they ran for their situation – which as you point out should be how the decision is made. These are the irrational reasons I see people NOT doing them…
1) Bad Accountants (especially accountants that don’t do any planning – which is most) tend to discourage this strategy for everyone. They error on paying the least amount possible each year.
2) More Taxes – Many people don’t like intentionally causing more taxation now (even if the long term benefits outweigh the cost)
3) Crappy Financial Advisors – They work with crappy financial advisors that are more concerned about selling product and managing assets than strategic tax planning. OR maybe they work with one of the good guys that suggests this strategy but this advisor has too many conflicts to become more trusted than the accountant – so people default back to #1.
4) The Government – They don’t trust the government and genuinely believe they will eventually tax Roth IRA’s.
5) They don’t know it exists.
“When you don’t have much of a tax-deferred account” and you are old. Not having much savings is also a symptom of being young which would be a great time do it.
My husband and I are currently paying 46% marginal, and 4 years from complete retirement. I asked our accountant to run projected returns for retirement years using the two extremes of drawing from 1) cap gain/AMT, or 2)qualified tax deferred accounts. He projected effective rates of 1) 14%, and 2) 22%.
Firstly, I’m stunned at how low these tax rates will be to provide an after tax revenue of $200k/yr.
My premise is that in retirement, effective tax rates trump marginal rates for planning.
Thusly, I can see using the early retirement years to make Roth converts to 15%, but not to the 25% bucket.
Am I wrong on this?
Most people are stunned the first time they run those numbers. That’s why tax-deferred retirement accounts are such an awesome deal for most docs.
If you have an existing Roth IRA and convert a 401k or 403b to a Roth IRA, are you converting into the old one (so still just one Roth IRA) or do you now have two separate Roth IRAs?
I commingle my Roths and it seems to have no effect. I have not withdrawn any income from my Roths, however. Because there is a five-year (I think) waiting period before you can withdraw from a Roth, there might be a problem identifying which funds had been there for five years or more. Your tax man should have the answer.
You can put it all in one. Bear in mind the 5 year rule, which might be one reason to keep them separate. But I wouldn’t worry about it much.
jz, The effective rate is important to determine your total expected tax bill but it doesn’t really tell you how much tax you will pay on marginal adjustments of income like spending from your IRA or Roth Conversions now vs. later. When considering a roth conversion, I would compare marginal in the year of the potential conversion vs. marginal in the year you anticipate spending it. This should provide a better estimate of actual taxes paid.
I’ll preface this by saying that I don’t wear a white coat and my engineering income isn’t as high as a typical white coat. But I learn as much from this blog as any I read. Thanks, WCI!
We would love to contribute more to our Roths or do a Roth conversion on an old 401k that has since been rolled over to a tIRA at Vanguard. Our situation is that if I max out both my HSA & 401K, and contribute just a bit to our Roths, we are just barely able to get a small retirement savers tax credit from Uncle Sam at tax time. This places our family solidly in the 15% marginal tax bracket. I’d need a huge raise or do almost 75% Roth 401k before I’d hit the 25% bracket.
My question is, when does it make sense to forgo the $400 tax credit to do a conversion or contribute more to our Roths instead of traditional? At this point, I haven’t been able to give up the free money from Uncle Sam…
I suspect that this question on when to give up the saver’s credit also has implications for lower earning residents. But maybe with my lower earnings, we could stay in the 15% bracket forever and it doesn’t matter for me like it would a resident who may eventually end up in a much higher bracket.
This isn’t an area I spend a ton of time thinking about given the income of most of my readers. However, the best way to look at questions like this is to use tax software like Turbotax. You can change the variables in seconds and it’ll spit out a unique answer just for you.
Your question is a little more complicated than that, since it requires you to look into the future and estimate your personal future tax rates. The accuracy of your forecast will obviously be a pretty important variable.
I retired late and began taking Social Security before full retirement, so did not have the option of doing Roth conversions early, although I had a pre-existing Roth IRA. However, I found myself in a pretty low tax bracket, so did conversions gradually over several years. My intention was (and is) to shift a significant amount to Roths and use them like an annuity for my daughter. Worked well, but be warned that you should estimate the extra tax you will pay on the amount converted — if it is too big, it can drive up your tax bill fast. This is especially true if you are below the level where you pay tax on 85% of your Social Security. The way the tax on SS is structured, you pay a marginal rate of about 50% on the additional amount of Social Security benefits taxed. Ouch! The only good part is that you have until Oct. 15 of the year after the conversion to undo it by “recharacterizing” all or part of the conversion. I did that and got a substantial refund of last year’s taxes. Will not make that mistake again.
Another calculation to consider is the capital cost of tax conversion versus the advantage of lifetime beneficiary(inheritance) IRA. Your daughter has the option of opening a beneficiary IRA and taking lifetime RMD distributions on her life…a small amount each year if she is young. Also need to consider daughters income of course.
Fortunately or unfortunately, most readers of this blog won’t have to deal with this issue. I cannot imagine a scenario where my Social Security benefits are not maximally taxed. That really doesn’t allow for very much taxable income at all. We’re talking about $34K of taxable income ($44K joint). I hope most of my readers have more taxable income than that in retirement.
I would recommend this book. It is technical but definitely a good read. As a disclosure, I am a CPA but read this book for my personal financial planning.
http://amzn.to/1KhBlRw
I appreciate putting this idea in the context of scenario (happens to be similar to what our family has going on near late career)…would appreciate any thoughts on these issues.
-At age 55, the couple making $80000 is under the IRA phase out limits (96k/181k depending on 401k access). They are also at age for IRA catch up contributions, they can have own IRA and spousal IRA $13000 deduction of current taxes and possibly bring them down a tax bracket. I don’t see how they can do a “backdoor ROTH IRA”, if they elect to convert they are in essence paying the tax burden on this up front. It becomes a decision whether lowering taxable income by $13k is preferential to holding ROTH space.
-Another consideration of IRA vs paying tax on ROTH conversion. At some point if they know their retirement is well funded, is it worth considering holding stock in taxable assets for step up basis and prevent need for RMD?
Thanks,
Michael
If you’re under the traditional IRA deduction income limit, then you’re choosing between Roth and traditional. That’s not backdoor Roth territory, where you’re choosing between taxable and Roth. A different decision for sure.
Re: Your other consideration.
If you’re talking about money for your heirs, there are benefits both ways of leaving a Roth IRA versus leaving a taxable account. The taxable account gets a step-up in basis, but the Roth IRA can be stretched. You’d have to run the numbers but basically, the higher the return, the less tax-efficient the investments, and the younger the heir the better the Roth IRA would be. And if it is a traditional IRA instead of a Roth IRA, then you have another variable- the RMDs to contend with. And that’s not even factoring in the benefit of you getting the tax break.
Great article. My takehome is I might need to prioritize building up my taxable account a little more to find the large Roth conversions I plan to do from age 60-70 in low income years between retirement and SS/RMDs.
I am graduating fellowship June 2016 and have the typical fellow income ($55,000). Considering my income is about to go up, it would make sense to do the conversion now. Currently my 403B has $26,000. If I were to convert this to a Roth 403B, would the taxes come out of this account? Or do I have to have the cash on hand to pay for the conversion?
You would want to come with cash that is not included in the conversion. If you pay with money in the account I think you are subject to the penalty on that portion. Additionally, you want as much in the ROTH as you can so you wouldn’t want to do this. I also think someone mentioned the Oct 15th waiting period which you can use to time as much gain as you can… which I would do but it adds more complexity.
If I wait to do the conversion in December of 2015 then I will have the maximum in the 403B to convert to a Roth 403B. This allows it to be taxed at my lower fellow tax rate before I start making attending level salary in 2016. The key of course if having the cash to cover the taxes. Does that sound like a reasonable plan?
use an online calculator: https://turbotax.intuit.com/tax-tools/calculators/taxcaster/ to estimate your 2015 taxes, assuming you are able to convert all that you have in your 403b by end of 2015.
put in all your info (+spousal, if married). see what your taxes would be – see if you would have enough money to pay them by april 2016. i’ve not done a conversion within a plan, only when transferring money out (rollover from 401k/403b into Roth) – i paid money on conversion during the time of tax return several months later. if you are having trouble saving the extra money to have it by April 15th, consider increasing your withholdings for Fed taxes from paycheck (for Sept-Dec 2015) to account for the extra taxes due in April.
do not have your plan withhold money for taxes from your conversion – it complicates things. when IRS sees that not all the money that is being converted “made it” into the receiving account, it starts assuming that you took a distribution, which is an early distribution, and it’s subject to penalties and taxes.
i don’t know how it works for you with doing the conversion while money is still within the 403b – sometimes not all the options are available with 401/403 plans (sometimes the plan requires to withhold taxes for you – this may have been the only option several years ago) – but it is preferred to never spend any of your conversion money on taxes. after you separate from your current fellowship, you definitely would have all options available.
You want to have the cash on hand to pay for the conversion. The best time to do it is 2015 (maybe you can get a signing bonus or something to use to pay for it.) The second best time is 2016.
Does your fellowship plan offer a Roth option? If so, I would switch over to doing Roth contributions for the rest of the year instead of pre-tax and then you won’t need to convert them.
You would also need to check if your plan allows for “In-Plan Roth Conversions” so that you can do this in 2015. Not all do.
For the 21,010 in your example above, what about the opportunity cost of paying that money? If you don’t convert, and keep the 21,010 in a total U.S. stock index fund, won’t the money grow such that it will outweigh the tax benefit? Don’t forget, you are only taxed on money that is required to be distributed from the non-roth tax deferred account. The rest continues to grow tax deferred. Will the growth of the 21,010 outweigh the benefits of the conversion?
Dear WCI,
Do the traditional $5500/year limits still apply? So if I contribute $5500 to my roth, am I still allowed to convert money from my 403b or can it only be 5500 total?
No limit on conversions, only contributions.
This probably won’t apply to most of your audience, but here’s another benefit: during early retirement or a dyi sabbatical year, one could use Roth conversions to manage one’s MAGI to hit the sweet spot for ACA premium and cost sharing subsidies.
Good point. Love how government keeps making these decisions more complicated.
One more situation that I don’t believe was discussed above: I had a 401K at work that included both pre-tax and after-tax contributions. The rules changed last year to allow rollover of the after-tax money into a Roth, but the pro-rata rule would still apply, so in order to take full advantage of this opportunity I had to roll all the money into IRAs, and not just the after-tax money. I rolled the the pre-tax into a traditional IRA, and the after-tax into a Roth. Unfortunately, the appreciation of the after-tax money, which was about 100%, had to go into the traditional IRA.
That’s similar to what I did with my TSP when I left the military. You isolate the basis, then convert it.
Perhaps a waste of time, but I’m in med school with a family, wife is a stay at home mom, so our income is $0 per year. I have a 401K from before med school with <10k in it that I've actually been thinking about rolling into a vanguard roth ira. Just wondering if it would make more sense to do it now or do it in residency. I figure that with my current (lack of) income, I'd probably get most of the taxes I pay on the conversion right back. Any thoughts on when this conversion would be most advantageous?
do the conversion now. it may even be free. use this: https://turbotax.intuit.com/tax-tools/calculators/taxcaster/ put in your numbers, and it would tell you if any taxes are due. your <10k conversion would probably be negated by the standard deductions for you/wife/dependents, with zero tax due.
if you wait till residency, you will have residency income, and you will be in the higher bracket, your conversion will get taxed at your marginal income tax rate.
Now.
Austin: You might be able to do it now for free. As a student paying tuition (even from loans) you get a $2,000 lifetime learning credit towards your tax bill in any year you pay over $10,000 in tuiton (from your 1098-T). This $2,000 credit would probably entirely wipe out the tax bill on your Roth conversion. In any event, with a wife and kids your tax bill on $10K in income would be negligible. Please try it in turbotax or double check with an accountant first, though.
Great post. One other point I’d make is that when your investments are down big (like 2008-2009), that is an opportunistic time to do a Roth conversion, as you’ll be paying lower taxes on a lower portfolio value.
Great point. Lots of ways to time the market!
Not totally related to your post, but, how would I figure out if its more beneficial to put my $5500 into a Roth IRA, OR put that money into paying our $350,000+ debt? We are PGY-1 of 3. thanks!
This is such a complex question because there is a lot of information wrapped up in that 350k number. Is most of it private? Did you refinance to DRB or another program that has $100 or less payments during residency? Is most of it federal? Are you doing PAYE/IBR? These questions determine your fixed costs during residency.
If you have low fixed costs then taking advantage of your roth space would be ideal from a math perspective. It would also be a great time to invest to learn about how the process works. The only thing I would caution is if you were to take this approach, you need to follow WCI’s advice and live like a resident for few years to pay off student loans since you will have gotten such a late start.
We are in a similar situation to you, but we refinanced our private debt and will enter PAYE/IBR in a month. I feel a little guilty pushing off student loans until my wife becomes an attending, but we will have a very large roth account after these four years. We also plan to have income above and beyond what we put into traditional accounts when she is an attending. Instead of investing in taxable accounts we will be investing in paying off student loans.
It would require a crystal ball (or at least a heck of a lot more info than you’ve provided) to know for sure. But this post will probably help:
https://www.whitecoatinvestor.com/student-loans-vs-investing/
Work just started a Roth 403b option but my wife and I make combined $450k+. Should I do the Roth 403b and let her do the regular 403b (we work at different hospitals)? Should I do my 457b deferred comp? Not sure how long I’m gonna be here and I am nowhere near 59-1/2 years old. So far I’ve opted not to, just been doing back door Roths for each of us up to the $11k max. Thanks!
Hi. There is nothing magical about Roth. Take all of your deductions while you can. These deductions are the only sure thing you will get, everything else, regardless if it is in Roth or not depends on the market. Depending on your home state, additional investments, you will pay around 40% in taxes. Max out yours as well as spouses 401K, as well as 457b if you will stay at this job for few years, by high deductible health insurance and open HSA, and every year make contribution to nondeductible IRA and few days later confer to Roth without paying any taxes (over time this will add up for both of you.
With the money you safe in tax deductions you can buy second home or rental property, contribute to 529 education accounts (if you have kids or nephews / grand kids etc), buy some gold every year (while still cheap), open brokerage account and take advantage of low rates on dividends / capital gains and enjoy benefits of tax loss harvesting (powerful tool for those in the know). Get enough traditional life insurance to cover you working years, and then buy whole life insurance (I maybe wrong, but over 30 – 40 yrs buying whole life insurance maybe the best decision you make as far as your SAFE MONEY investment decision is concerned).
Nothing magical about Roths except having money grow tax free for generations with minimal expenses and total control? Please quit plugging gold and whole life. It’s crap investments for the paranoid.
Long term business growth + Dividends + change in price/earnings + inflation determines the value of the stock market. Real companies that employ real people. They are going to be around for a long time.
Mr. Arkydore, please read Sam’s post fully and reflect on what he is saying before you have a spasm. Sam, I agree with you 100%, ROTH is OK for some, but if you convert it by patying taxes upfront then it could be a bad idea. He is not pushing anyting. Througout history, gold has proven to be excellent investment again and again. People in china, greece, russia and middle east would love to have most of thier assets in gold at this point due to current devalaution issues (In my humble opinion no more then 10%)
Whole life insurance is exceelnt way to diversify and very impotant tool for you safe money, but in moderation.
Trust me, I read it. The answer to full Traditional accounts is taxable not gold or whole life. They are not good investments. I’ll take SP500 over gold any day of the week. You might be lucky to get 1-3% real out of gold and that is with holding it for long periods of time. Whole life is a bundle of complexity. Insurance company will be taking a profit from the sale. No free lunch.
I’d expect 0% real out of gold long-term. 2-5% nominal out of whole life held for the long-term.
While I don’t hold gold or whole life, if you limit both to 10% or less of your portfolio, you’ll probably do just fine.
I disagree that gold has proven to be an excellent investment. It doesn’t pay dividends, it is taxed at the higher “collectible” rate, and it has only kept up with inflation over millenia, rather than outpaced it. An ounce of gold centuries ago bought a nice man’s suit. Same thing today. I think it would be more appropriate to call it a store of value or a bit of insurance against certain scenarios than an excellent investment. That suggests to me high returns, which gold clearly has not had when compared to good businesses (stocks) and real estate.
If you read WCI, you should not be paying 40% in taxes…
https://www.whitecoatinvestor.com/doctors-dont-pay-50-of-their-income-in-taxes/
Mr. KC. Depedning on your income, which state you live in and how much you want to convert, some people will definately pay 40% or higher, not to mention impact of obama care tax (too many issues to discuss). But, to each his own. People, my good people (being little biblical) dont forget that Roth in the end will only retun what the markeet gives you, so take the decuctions while you can (only free lunch given by the government)
Also, to advocate of Roth IRA, please look into concept of stretch IRA
In most decades I too prefer SP500, but in many decades it is good to have gold on hand. All depends on when you need the money.
Whole life insurance is only complex is you make it complex. If not for tax deductions, i would not put a peeny in 401 or roth IRA’s and put most of my safe money into whole life and I can tell you without hesitation that taxed brokeraged accounts for stocks are pretty good tax havens already (low tax on dividends / gains and abiilty to harness tax losses as you or someone else pointed out in another post)
But, to each his own
It’s interesting that you cannot predict the future in regards to Roth accounts, but you can predict the future in terms of gold and whole life. I do not claim either.
My argument comes down to this – SP500 has a proven track record of 7+% real returns over 10+ year periods. Gold and whole life do not. If you want to invest in them, great, more power to you. Just do not try to convince others that there is a historical basis for your assumptions.
Stock returns are lumpy. Good and bad peeriods. In the long run over decades markeet will give you good returns. But stock markeet is not alive, it doesnt have kids, stock markeet doesnt have illness or tuition to pay or bills due etc.
Lets just look at recent history, if you relied on stock to pay for expense during early 2000’s nad late then 2008 – 12, you were in big trouble. Gold wold have helped. Whole life insureance was wonderfull (bought two rental properties with cash, and still making out like a bandit). Even with all of my assetts and income, banks wouldn’t give me loan to purchase investment property.
Anyway, in the end it is up to each individual.
P.S. Sam, could you please make a comment (are you sill alive?)
You are picking time periods that suit your results. I am picking any moving 10 year period. They are not comparable.
Take a look as to what happend to stocks in 30’s, 40’s and then in 60’s and 70’s. Lets not forget the recent lost decade. Now 80’s and 90’s and last 7 yrs have been dynamite as far as stock are concerned. Since neither me, you or man behind the tree can predict what will happen tomorrow, then it is best to be diversified. Just sayin
Yes, still alive and kicking. I just don’t spend much time on blogs. I pretty much agree with your philosophy
Arkydore feller sound pretty young and inexperienced. After few decades of investing and savings he will have different perspective
I love when people act like age or education (in an unrelated field) make them better investors. All we have to go on is previous history. If you want to decrease volatility at the expense of growth, it is your choice. Just do not think you are getting a free lunch by investing in gold or whole life.
No such thing as free lunch. Gold 5 – 10% of portfolio.
Whole life does offer free snacks though: professionally managed portfolio (bonds, RE, private equity, acturail spread, and option ivestment) that out performs bonds, CD’s (and at time even stocks) with ability to access money tax free and death benefit to boot.
Stocks have a role. But for people who need money for education and retirement are down right maverick if they have most of there money in stocks.
Good golly. That’s a sales presentation if I ever heard one. Free snack?! Sheesh!
Let’s dissect this:
Professionally managed- Okay. But so are 2% ER 5.75% load actively managed mutual funds. Doesn’t mean you want to buy them.
Outperforms bonds- Not actually true. if you look at the returns of 30 year treasuries and a whole life policy over the last 30 years, guess who won?
At times even stocks- At times burying your money in the backyard outperforms stocks. Actually, for the first ten years, that outperforms whole life too.
Ability to access money tax-free- But not interest free. In fact, borrowing against insurance cash value is just like borrowing against your stock or real estate portfolio. It’s all tax-free. Borrowing always is.
Down right mavericks – Thus far the historical data is clear, the mavericks are still winning.
Money you need to pay bills soon shouldn’t be in the stock market or your whole life policy. That’s investing 101.
Although it is easy to pay 40%+ on a Roth conversion, since it is all done at one’s marginal rate. If I did a Roth conversion I might be doing it at close to 48%. (Thus the reason why I’m not doing one this year.)
I agree that you may be wrong on that point. Maybe it’s right for you (maybe not) but if so you represent a very small percentage of docs on that point.
Hard to say as you haven’t provided enough info. But the general rule is that you do tax-deferred during peak earnings years. If you expected to have a $5M+ tax-deferred account at retirement, that might change things.
Jeff, Mr. White coat reminds me of one of those financial advisors who told you to sell your kids and invest the difference in the stocks before every crash, saying it is the best way to retire. Once stocks crash, then they tell you the best way to prepare for retirement is to SAVE more and postpone your retirement (aint that a kick right where sun don’t shine).
Not smart or intelligent, but seasoned veterans know that saving is good, but saving and then investing most of your money in stocks ain’t no saving.
The issue with saving with whole life insurance instead of riskier assets like stocks and real estate is that you have to save a ridiculous percentage of your income to reach your goals with those lower returns. https://www.whitecoatinvestor.com/the-reason-you-take-market-risk/
If I bought a whole life policy today, I’d expect a long term over the next 50 years of something like 4% (1-2% real) As you can see from that post, if I want to replace 50% of my income in 20 years, I’d need to save 50-56% of my gross income for retirement. Nobody likes volatility, but the alternative may be worse.
I find it sad that I argue for hours with agents about whole life insurance in the comments sections of posts like this, but then I go check my email and I find emails like this one (details slightly changed to protect the innocent):
This is who is being sold these lousy policies. It’s not the financially astute who has all his ducks in a row, already maxed out his retirement plans, and now has extra money. It’s the doc who is buying these things from a “friend” trying to make a commission when he hasn’t maxed out his 401(k), saved up in 529s, paid off his student loans or mortgage, ever heard of a backdoor Roth IRA etc etc etc. This guy’s even got some credit card debt. Yet he has 5 whole life policies. There’s only one reason he has 5 whole life policies and that’s because his “friend” wanted to make some money. You think that friend did this doc (who is now going to surrender one or all of these policies after less than 20 years) a favor? Heck no. This is what is happening out there in the real world. I’m glad you like your policy and that it has worked out well for you. But you need to realize how rare your situation is.
Above post say nothing to me. How much was the premeiums, what was face value, were they efficient policies as far as cash build up is concerned, were they mutual companies etc.
If he only contiributed 30 thousends and took out 50 K then he might have done even better then the stock markeet. With tec tech bubble and great recession over past 15 yrs.
Money you dont need for 10 – 15 yrs you put in stocks. For other money, money for anticipated expenses such as college education, whole life if pretty darn good.
It might not say anything to you. To me it says someone was sold 5 separate whole life policies without him knowing it would cost him 5.5% to borrow his own money out. It says someone sold his friend 5 whole life policies while having credit card debt. He now has premiums due he cannot afford to pay. He also was sold a whole life policy to pay for college, a particular dumb use given the length of time it takes to break even on the policies.
If you think his friend did him a favor by selling him these policies, I guess I’m not surprised you’re such a proponent.
I take it that you are using the word friend loosely.
5.5 % rate is very cheap compared to personal loans/credit cards, and if he had the right policy he would still get dividends on his cash value as thoug he never took the laon (difference b/ participating and non participating companies)
I still believe that whole life policy is good option, even for middle class individuals for saving purposes such as education. For my kids tuition I did pretty good in mid 2000 with stocks, and not so good later on so whole life was beneficial.
Please do not forget about risk tolerance as others have mentioned before, you got a be nuts to have too high of an allocation to stocks if you need the noney in few years. I can tell you that bond portion of your funds will do better in whole life. Should you die, then not only will family get proceedes from terma life, but also from whole life. Not to mention that many people who have kids late, or start second famalies CANNOT have difficulty affording premeiumns for term life.
My issues with you is that even if a person agrees with you 99% and says do this and taht, max out this befort that, and with money left over buy whole life, you go crazy. But, I tell you, it is a damn good product, and I couldn’t care less if 99.99% of people dont buy it. I as well as millions other as satisfied with whole life.
Glad you’re happy with your policy.
Friends don’t sell friends whole life insurance.
I disagree with much of what you’ve written, but can’t spend all day arguing with the dozen insurance agents currently posting comments on dozens of threads on the site, including those NOT about whole life insurance. The only way to come out ahead arguing with an insurance agent is to stand up and walk out of their office. Only an agent could even think about defending what has been done to this doc by his “friend.”
The old reliable trick,call them “insurance agents”
I am not an insurance agent. I am a physician, and now in my 60’s.
Friend probably should not sell whole life insurance or in my opinion any product to friends or family. Especailly if they value them.
I too no longer want to carry on this disucssion. Good luck with your investments.
Sorry, hard to keep track of everyone who wants to argue anonymously on the internet with me about whole life insurance. I agree it isn’t a profitable use of time for either of us. Good luck to you as well.
Dear Jim,
Long time reader and subject in your book here. Looks to me like Jeff and Sam (if they are not the same) are spammers pushing gold and whole life for some reason. You’re very patient- I think I’d cut their comments or at least the repetitions and consider banning them just because they waste your time (and that of us readers as well). Most valuable of course are your responses as to why their arguments are not that good.
Best wishes, Jenn
Maybe they are, maybe they aren’t. You gotta go a lot further for me to ban you. Most of the time I have to ban people it’s for persistent ad hominem attacks, although I blocked one recently just for being fixated on whole life with dozens of comments a week about it. It was wasting both of our time. People sometimes mistake my website for a public forum.
Roth conversion in not necessarily a good thing. I would definitely contribute maximum allowed to nondeductible traditional IRA and then convert it to Roth without any tax.
I would personally take every taxable deduction now, knowing very well that if I retire at 65, I will have over 20 yrs to stratrgically withdraw my money, including delaying my social security benefits, while it grows tax deferred. You gonna feel silly if you do a Roth conversion or invest in Roth 401 and then move from high tax state to a low tax state.
The ONLY sure thing these retirement accounts offer you are tax deductions, so take them while you can. There is no guarantee that after paying close to 40K on 100K roth conversion (my scenario) you will be able to earn this money back. Especially as you decrease your risk tolerance. Based on recent developments Bonds real return won’t be too good.
Rather then to pay upfront in taxes for Roth, I would keep that money and do the following:
1. pay down non deductible debt
2. Put the money in 529 education fund for kids / grand kids
3. Buy stocks / mutual funds and take advantage of low rate on dividends/capital gains (keep bonds/REITS/MLP’s and sell options in IRA/401)
4. Buy some Gold coins
5. Buy whole life insurance (I know, I know, I know all the arguments against it). If you are on this board, then you need whole life. Especially for safe portion of you retirement funds. Nothing and I mean nothing else offers you the safety, tax free accessibility, along with inheritance planning. Additionally, as interest rates rise, bond returns fall, you are going to wish you had whole life insurance. Insurance companies do well / better during rising interest rates.
Look, why do you think IRA allows all the Roth IRA conversion you can stomach, but limits/regulates deductible IRA/401 K and whole life insurance.
Here you have it, life time of experience in few short paragraphs.
Best of luck
This is the second post you’ve made a statement that docs on this board need whole life without stating your reasoning for that recommendation, which I generally recommend against and have written a dozen or more posts explaining why.
You briefly allude to some benefits such as
Safety- You say nothing else offers you safety. I think you’re overselling this benefit. Treasuries are at least as safe. Most cash value for a large policy is backed by a single company since it exceeds the amount backed by a state guaranty corp.
Tax-free accessibility- You can borrow against stocks and real estate “tax-free” just like you can borrow against the cash value of a life insurance policy. And, the “death benefit” is just as free thanks to the step-up in basis.
Inheritance planning- Life insurance can be a great tool in certain scenarios, but these are unlikely to be needed by the vast majority of physicians, who not only have an estate that falls well below the federal exemption limit, but is also generally quite liquid already.
Insurance companies are buying the same bonds you and I are. Don’t believe me? Take a look at their portfolios. Same old stuff.
However, I do agree with your main point that paying a 40% rate on Roth conversions is probably a mistake most of the time.
Hi,
Treasuries – safe but very poor returns, even before 40% tax (I won’t even go into obama care impact). I say no thank you to treasuries. Plus treasuries don’t have death benefit.
-Security based borrowing rate as of today 9 – 11% (let not even talk about what happens if stock value goes down)
-Real estate – at times its good and other times you aint got no equity. I do not want to go into recent market crash (in fact I bought 2 houses with cash with money borrowed from whole life in 2009 and 2010).
-Insurance companies invest in bonds, real estate, private equity, and they also use portion of interest to buy stock options to generate additional income. Lastly, life insurance actuaries profits, unless flu forget, they are in the business of underwriting risk.
I do not know your age, but as you advance in years and you need money for mortgage, kids education, weddings, taking care of parents, you won’t be able to stomach the volatility of stocks. Naturally as you age, your asset allocation will change and you have less time to recover from bear markets. Honestly, in retrospect I would have bought so much more whole life, and am now convinced that it is a superior product then investing in stocks. You will agree with me once you realize that stock market results and compounded returns are mutually exclusive.
I understand you say no thank you to treasuries. My point is that treasuries are safer than whole life. If you want safety, treasuries can do that.
9-11%? It’s sub 1% at Interactive Brokers. But yes, let’s talk about what happens when stock value goes down. If you borrow out as much as you possibly can, your margin call may cause you to have to sell stocks at a low. How can you avoid that? Well, the easiest way is to avoid borrowing out as much as you possibly can, which is probably a good idea with real estate and life insurance too. And yes, real estate and stocks are more volatile than life insurance cash value. That’s why you make so much more investing in them.
I love how you think you understand my future risk tolerance for me. That’s very perceptive of you. I’m 40 years old. Weddings-paid for. School-paid for. Mortgage- will soon be paid for. Parents- covered. Medicine paying me 4 times as much as I need. Side income paying me 3 times as much as I need. I think I’ve got pretty good capacity to take risk, and having passed successfully through the worst bear market since the Great Depression, I’ve got plenty of ability to do so. I will likely continue to have a significant portion of my portfolio in stocks until the day I die, but it is unlikely that I will ever purchase a whole life policy again.
You have done well for yourself. Keep it up.
White Coat – there is also a benefit on death with the ROTH and the RMD’s your beneficiaries are required to take. I can get specifics if anyone wants them but it allows your decedents to let the tax deferred compounding happen longer.
Also, I wish I would have converted all my Traditional IRA’s when I had the chance but not sitting at a higher tax bracket it is a tough decision based on what modeling I use. Anyways, this is a great topic.
I am doing research on ROTH IRA for kids and how to do it though business (modeling in your older posts) or actually household items where you can avoid the self employment tax. I think it actually might be a better college savings vehicle (or in combination) than 529 since you can take the principal out tax free.
David, open custodial accounts for all of your kids, take advantage of kiddie tax up to around $2000K anually. You can use the earnings/ money in custodail account NOW vs. later, for most anything (read the rules though).
Depending on how much money you have and you financial apititude then you can decide 529 vs. roth for your kids.
Please also look into possibility of whole life insurance for your kids depending on your goals (it is not right for 95% of the kids, but excellent financial tool for cerarain families)
I have custodial accounts with dividend income for the kiddie tax but that is outside the ROTH idea since it deals with passive income. I need to create SE income to fund a Roth but more importantly get around the self dealing rules to justify the income.
I am not getting whole life insurance for my kids.
One of my kids custodial account is in lending club, and other two with prosper. Lending club avg return around 8.3% and prosper around 8.7% witout volatility (I invest in moderate risk rang). Returns were much higher in early years (around 13%) but they do decline as portfolio matures / defaults rack up (this is advertised before hand, so this is to be expected). Dividend stocks are good option if you dont mind the volatility, and bonds aren’t too attractive these days.
Fine, dont buy whole life for your kids, but instead buy it for your self. Just kidding. Whole life is not appropraite for most people.
self employment income – pretty much anything that is not passive.
I think 5% is probably a dramatic overestimation. I’m still waiting to see an example where whole life insurance purchased on children was better than the available alternatives. I’m sure there is one out there somewhere.
You’re talking about stretch Roth IRAs, another great benefit of a Roth. https://www.whitecoatinvestor.com/the-stretch-ira/
Not sure I’d burn a kid’s Roth IRA on college. I’d leave that for their retirement if I were sneaky enough to get some money in there early.
David, what is SE income
Jeff, I used some of your lines to answer a question. I hope you don’t mind.