Here is my question.I want to convert IRA money this year (and pay ordinary income tax on it), into a Roth IRA where it will never be taxed again.If I take $1,000.00, as an example, and convert it this year, I will pay $35.00 tax on it leaving $65.00 left to work in the Roth IRA with no future tax. If I figure the future tax rate on regular IRA withdrawals will be 50%, should I do it assuming a pretax return on my money is 8% and a period of time 15 years compounded monthly.I have an HP Financial Calculator (12C) that can do the work if I know which of the above fall into the category of PV, PMT, FV, Interest, etc. I want to learn how to enter the scenarios vs just getting an answer in the example.
Country/State/Province of question: California
Trying how to remember how to use the financial calculation features of the 12C.
Here is a link to a calculator that may do what you are asking about. http://www.calcxml.com/do/qua04
Now, the first thing I noticed is that you are assuming that you are using the IRA money to convert to the Roth and investing the net $650. You can't do this without incurring a tax on the withdrawal (in your situation, the 35% is considered withdrawn from the traditional IRA during the conversion process), IN ADDITION to paying the tax on the gross amount considered to have been converted ($1000). In other words, in order to avoid an additional tax on the amount withdrawn from the traditional IRA (plus penalties if you are under 59 1/2), you have to pay the tax on the conversion with assets other than those coming out of the Traditional IRA during the rollover process.
Taking into account your loss of income and growth on the other assets is a complicating factor.
I don't know if 8% is a reasonable rate of return in this market environment, and I certainly would not compound it monthly. However, if you did as you are suggesting for the traditional IRA:
PV= -$1000 (i.e. a minus number)
PMT=0 (you are not adding to or subtracting from the account)
i=8/12 (this is 8% compounded monthly)
n=180 (15 years with 12 months/year)
Then you get your FV of the Traditional IRA in 15 years. I suppose you could then apply the 50% rate to the gross amount of the Traditional IRA 15 years hence, assuming that you take all of the money out in year 15, vs. what the after-tax Roth number will be, starting with the lower $650 balance. This would sort of tell you if doing the conversion would make sense over a 15 year time frame.
There is a lot that you leave unsaid (i.e. if you will be taking withdrawals from the account each year in the future, which could complicate this question a lot). My sense is that you are trying to compare what you would have in 15 years on the Traditional vs. Roth accounts, but you are asking how to use the HP, and that is a different question.
I hope that this helps.
Investment Advisor for over 25 years. Former Big 8 Public Accounting Firm Auditor.
Hello Anita,I did not know that the methodology would be so simple, but I agreed to your fee, so THANKS for the thorough and excellent answer. (-:I had planned to take the Tax money (ex.35%) from other funds, and, since I am 68, have no withdrawal penalties. I will not need the Roth money, and will probably will it to my two children.I agree that annual compounding would be more realistic, but what would be your crystal ball estimate on stock market return during the next 15 years?Thanks againHolland
Hello Anita, - one more thing! I can now solve the problem in my HP 12C, since you framed the numbers into proper variables (i.e. FV, PMT, etc.) for me. Thnx again.I did not know that the methodology would be so simple, but I agreed to your fee, so THANKS for the thorough and excellent answer. (-:I had planned to take the Tax money (ex.35%) from other funds, and, since I am 68, have no withdrawal penalties. I will not need the Roth money, and will probably will it to my two children.I agree that annual compounding would be more realistic, but what would be your crystal ball estimate on stock market return during the next 15 years?AlsoThanks againHolland
Prognosticating the stock market is always perilous.
I read a book by Benjamin Graham, the father of value investing, over the weekend, and he suggests that rather than guessing where the stock market is going, you should instead strive to purchase stocks with a "margin of safety" built in...in other words, use value investing. Graham is the one who hired Warren Buffett when he was a youngster and made him into the legend he is today...
However, if you look at 2011 estimated earnings, stocks are trading at about an 11 P/E multiple, which is fairly inexpensive compared to the recent past. And compared to bond market yields, the stock market looks like a bargain.
Over the last two years, I have been purchasing stocks of well-known companies that have large dividend yields -- Utility stocks, Energy stocks, some large Pharmaceutical stocks..some have 6% dividends or more. I reinvest the income as it comes it to further diversify my clients' portfolios.