Some Notes on Roth Conversion

Converting non-Roth IRA money to Roth has no income limit, which is why it’s often called a “back-door-Roth” — in effect, it has the same outcome as contributing to a Roth, but high income earners can’t directly open a Roth… so this is basically jumping through hoops to get a Roth when your income is too high — but if you already have pre-tax retirement money, any conversion will require you to come up with some cash to make it happen.  So, should you do it?

Brief Review

Roth = post tax account.  never taxed again

Traditional = take tax deduction now, pay tax upon withdrawal when you are old

Roth conversion = paying tax on a traditional account to convert it into a Roth (i.e. avoid paying taxes when you are old).  If you have no retirement accounts, then this is free.  But if you have pre-tax accounts, you will need to come up with cash to pay the taxes to do the conversion.

Reasons to do it:

– You’re young and you pay very little tax.

– You have many years before retirement and a relatively small sum to convert (i.e. < $100k).  Still worth it for more, but you have to come up with $25k+ cash to do it, and that’s hard for most people.

– You’ve already maxed your pre-tax contributions for the year, and you want to shove even more money into super profitable tax-free growth.

–  You make a high amount of money and you want to shove the absolute maximum into tax-free growth.  You want to max your retirement contribution limits for the rest of your career (in this scenario, a Roth conversion is a no brainer).  The tax free growth of retirement accounts is pretty great, so maxing it makes a lot of sense.  Unless you’re planning on starting a business or something, you’re not going to find a better investment vehicle for that money.  Especially if you don’t have access to a 401k or 403b, Roth conversion is, in effect, a contribution to your retirement account, so if you’ve hit the $5500 traditional IRA contribution limit (Roth is the same limit, but you wouldn’t bother w/ a conversion if your income allowed you to contribute directly to a Roth…) and you have no other vehicles for tax free growth, the conversion in effect is shoving more money into tax-free growth by removing the possibility that the government will take your tax free gains.

– You’re early in your career and you have the cash to do it (since doing the conversion w/ outside cash is essentially a contribution to your retirement account, the younger you are, the more time that extra contribution will grow and the more it will benefit from the tax free growth).

– You believe you will be in a significantly higher tax bracket later in life, so you want to pay the lower taxes now.

– You don’t think there will be a big difference in taxes, and you just like the idea that you won’t be taxed on it in the future.

Reasons not to do it:

– you believe your tax rate will be lower at retirement, either b/c the US lowers taxes or because you realize less income (i.e. spend less, have fewer obligations)

– You are close to retirement and you don’t have a bunch of cash lying around to pay the taxes.  In this case you’d have to withdraw money to pay the taxes, and that money would therefore be unplugged from tax-free growth, which would be bad.


Let’s keep the numbers simple.  Let’s say you work at a small startup without a 401k program, so all you can do is put money into an IRA.  Let’s look at the $5500 case, where we max our IRA contribution for a year (this is the max regardless of if the contribution is traditional or Roth).  Let’s assume income tax is 25%.  Let’s assume that over the course of 30-40 years, your investments would grow 10X, so you start with $5500, but you end with $55,000.  We’re going to ignore inflation, which impacts Roth and traditional accounts exactly the same.


Start: $5500, Tax: $1375

End: $55,000, Tax: $0


Start: $5500, Tax: $0

End: $55,000, Tax: $13,750 (25% of $55000)

Okay, so you see you’re paying much more tax w/ the traditional IRA.  *BUT* the clever person will say, the time value of that $1375 you had to pay w/ the Roth was really big, because if you had invested in, it would also have grown a bunch over the course of 30-40 years.  Yes, that is correct, *but* several things to note:

1)  The probability you would’ve invested the $1375 is pretty low.  Behaviorally, people suck with money.  So one way to win with it is to admit that you suck it, and to chuck it into retirement before the Apple Watch is released.  If you don’t invest the $1375, you end up with a big fat 25% relative loss in your retirement account, and then whatever benefit you got from spending the $1375 at the earlier age.  Unless you’re spending the $1375 on something that seems like it’ll generate > $13k in the future, it seems like it’s better to chuck it towards a Roth conversion.

2)  In the traditional scenario, since you’ve already maxed your retirement accounts, even if you did invest the $1375, you’d be investing it in non-tax-free-growth investments, which are subject to capital gains tax (long term: 15%-20%, short term: 35%).  This is going to be charged when you sell a fund and realize the income at retirement.  This is also going to be a drag to growth along the way as various funds change the composition of their portfolios, buying and selling stocks.  The result is that this non-IRA investment will definitely do worse than your IRA investments, even if they were invested in the same assets (I’m going to ignore tax free municipal bonds since maximum profit comes from equity markets over a 30+ year span, and 30 years is enough that the volatility of equity markets is less of an issue).  So even if you invested the $1375, which again you’re unlikely to do, it would only grow maybe 7X in the same time period (the longer the investment period, the worse the relative performance… I’m pretty sure I’m being generous w/ 7X… it’s probably more like 5X), so now we’re looking at the Roth account having $55,000 and the traditional account having ($55k – $13.75k tax + $9625 outside growth) = $50,875, a loss of around 9% b/c you didn’t use the Roth, and that’s the absolute best case scenario.  If you spend the $1375 on hookers and blow, it’s a 25% loss.

This math is why in this scenario, the Roth is an easy choice, and it only gets better the younger you are, which is a reason to start using Roth or Roth yearly “back-door-Roth” / Roth conversion ASAP.

Obnoxious IRS Rules

If you have pretax retirement assets, you can’t tell the IRS you’re only converting the $5500 from *this* year.  It would be nice if you could b/c you could then pay $0 in taxes b/c there wouldn’t be any growth yet.  But sadly, the IRS doesn’t care.  To them your retirement is a big pile of money, and they will tax you proportionally to your different asset types.

As I’ve probably mentioned before, if you have the cash, definitely do your Roth conversion all at once.  I think you’re only allowed to do 1 Roth conversion per year, so make it count.  It makes the accounting easier from then on because you end up just having 1 big bucket of post-tax Roth money instead of separate pretax and post-tax buckets.  If you do any Roth conversion, the government will force some of that conversion to be on pre-tax assets if you have any… which means you will need cash to pay the taxes.


Say you have have contributed $40k pretax to retirement, and the accounts have earned $10k, so now you have $50k of pre-tax money.  Then, this year, you fund a traditional IRA with $5500 from your take home pay (i.e. this $5500 has already been taxed via payroll).   Your tax rate is 25%.  The accounting will look like this:

$50k pretax retirement account stuff, $5500 post tax retirement stuff from this year (post tax b/c tax was already taken from payroll… normally you’d claim a deduction at tax time for this, but b/c want to do Roth conversion, we won’t, so it is therefore “post tax”).

You say you want to convert $5500 of this to be Roth.

They will then say that of that $5500 that you want to convert,

(50,000 pretax assets /55,500 total non-Roth assets) * $5500 [conversion amount] = 4954.95 of the conversion will be taken from your pretax retirement account

$545.05 of the conversion will therefore from your contribution this year, and you won’t have to pay tax on it b/c you already did when payroll took out taxes.

So you will be taxed on 25% of $4954.95, which is $1,238.74.

If you want to convert the whole damn thing, we’re looking at paying $12,500 which is 25% of $50k.  Another way to look at the total amount is $55,500 * .25  = $13,875 minus the payroll taxes you already paid ($5500 * .25= $1375), which also comes out to $12,500.

Consult a CPA for all of this, of course.  😉

In other words, if you have pre-tax retirement assets, you can’t do *any* Roth conversion without paying *some* tax.  How much tax you pay depends on how much pre-tax assets you have.  *BUT*  I will say that even if you are paying tax, it is just (in essence) increasing the amount money you have that is growing tax free, so even if it’s painful to see that liquid cash going away, you’re putting into a kick-ass retirement vehicle, so it’s long-term smart.


Economic Outpatient care,-122.242242,37.454175,-122.247494_rect/17_zm/1_fr/?view=map

Recently, a friend posted that he needed a room mate for his house.  This friend graduated with a communications degree, is younger than me, and doesn’t have as many technical skills.  The house was purchased in 2015 for $1.76M (listed at $1.375M).  That’s over 10X the price I paid for mine… and there’s no way he makes 10x more than me.  His dad is a VC, so definitely this is family money.  I paid $195/sq. ft., a ridiculous amount compared to Georgia (~$65-$100 / sq. ft.).  His dad paid… $983/sq. ft…. 5X what I paid per sq. ft….

I wanted to estimate the financials to show you how it’s a bad idea to buy a $1.76M+ house for you kid when they don’t make that much income.  $25k a year in taxes alone.  $1500 a month even if you include the tax deduction.  On a $125k tech salary, that’s a fixed 23% loss every month.  Barf.

ugh and holy crap.  i wonder who owned this: []

Monthly Gross Pay $8,333.33
Federal Withholding $1,702.27 – about 20.4%
Social Security $516.67 – 6.2%
Medicare $120.83
California $590.12 – 7%
CA SDI $75.00
Net Pay $5,328.44

Monthly Gross Pay $10,416.67
Federal Withholding $2,285.61 about 22%
Social Security $645.83 – 6.2%
Medicare $151.04
California $803.24 – 7.7%
CA SDI$93.75
Net Pay $6,437.20

It feels like the tax on that next $25k is pretty disgusting.  The difference in net pay per year is $13305.12.  That’s about a 47% tax rate on that $25k. WTF.  Fuck you America.  If you want to make over $100k, we’re taking half your money.  You get to be a slave half the time.

Anyhow.  Looks like the billing address for the taxes on this place is in Cupertino ($354k purchase in 1986… a lot for 1986…. probably $2M+ now….)… so almost for sure his dad owns it and he’s essentially just a tenant.  From an income tax perspective, that makes sense.

Self made Billionaires

Thus, the most encouraging results come from this year’s Forbes 400.  For the first time in our data set, we see the number of self-made billionaires who rose from nothing, and overcame various tough obstacles, outpacing those that just sat on their fortunes.  A total of 34 billionaires, or 8.5%, scored as 10s, or more than three times as many as in 1984.  The number of 100% inherited fortunes as a percentage of the total fell to 7%, with 28 billionaires in the 1 category, compared to 99 back in 1984.

While our self-made scores aren’t a perfect measure, they do shine a light on an interesting story: more and more, the richest people in the country have worked hard, in an incredibly difficult context, to earn a spot in the Forbes 400.  And while it is a known fact that the wealthiest have amassed a greater proportion of the nation’s output than the rest, the self-made scores demonstrate social mobility is indeed possible.