Roth IRA Calculators
Using VeriPlan to evaluate Roth retirement account contribution and conversion trade-offs
This is the third part of a three-part article on Roth conversions and Roth IRA contribution calculators. The first part discusses the Roth account investment and asset conversion decision and the need for a sophisticated lifetime financial planning software tool to enable informed decision-making about Roth investment strategies.
The second part discusses additional considerations when evaluating a conversion of traditional IRA accounts into Roth IRA accounts. This third part discusses what VeriPlan can do for you and how to use VeriPlan to evaluate Roth investing decisions related to Roth accounts within the context of your family’s comprehensive lifetime financial plan.
Introduction to VeriPlan and its Roth analysis functionality
To understand the Roth functionality of VeriPlan, as well as, its sophisticated and automated lifetime financial planning capabilities, the inexpensive VeriPlan CD provides three software files that you can chose from. You could start by building a lifetime financial planning model for your family from scratch using the core product. This direct approach will get you well on the way to developing and fine tuning a baseline financial plan for your family and then making a well-informed decision about Roth account investments for your family.
Any change that you make anywhere to any plan developed in VeriPlan is fully integrated with all of its other functionality, including the Roth analysis functionality. Just open separate instances of your current VeriPlan model, and keep one of these instances as your comparison model. Then, with the alternate VeriPlan test case model, begin to change one, two, or dozens of data points and assumptions — as many as you need to model an alternative financial decision for your family. Then, simply compare future total asset values at the same arbitrary future age, e.g. 55 years of age, 95 years, etc. You can make these comparisons at any future age through age 100.
Such comparisons will indicate whether the alternative strategy enhances or detracts from your current plan and by how much. If you like the new financial plan revisions that you have made, then simply adopt the revised planning model as your “baseline” financial plan. Repeat as necessary to fine tune your plan. Move on to the next financial decision you want to consider.
If one decision impacts another, make as many changes as you want. VeriPlan’s robust automation and this iterative planning process allows you to converge quickly on a comprehensive family financial plan that will simultaneous reflects all of your financial decisions in a fully integrated manner.
Comparisons between projection models can be made quickly and easily. All standard output graphics have supporting data tables and all are formatted for printing. There is no waiting between projection scenario revisions. Revision performance has been optimized to achieve sub-second response times on PCs with less than average speed and systems resources.
Your Roth account investment decision could involve current Roth conversions and/or a series of future annual Roth account contributions. The opportunity to convert into Roth IRA assets is just one slice of the overall Roth investment puzzle. The viability of your Roth investment strategy decision will depend upon your lifetime income, expenses, debts, asset appreciation, investment costs, and a wide range of taxes related to your income, investments, and properties.
Therefore, you should solidify your decisions about other goals and objectives in your lifetime financial plan first. In effect, a proper Roth decision is a tax optimization built upon a developed lifetime financial plan. Interim financial planning decisions, such as home purchases, consumption management, early retirement, and many other family financial planning factors can dramatically affect the wisdom of your lifetime Roth tax optimization decision. Any financial planning analysis performed that disregards these other factors is dubious at best.
Using VeriPlan to understand VeriPlan’s Roth investment calculator capabilities
Some people like to learn VeriPlan as they go by working directly on their own family financial plan. They dive right into VeriPlan by loading their financial data, reflecting their future financial plans in their model, playing with alternatives, and converging on a refined lifetime personal finance plan for their families. Others want to study and learn a bit before starting on their own plan. Either approach is valid.
If you want to dive right in, just use the core VeriPlan product file without any data or parameter adjustments. All instructions and documentation are embedded within VeriPlan at the point that you need the information. Links at the top of every input page tell you which sections need “required” or “optional” inputs from you and which sections are solely informational.
Your lifetime annual Roth retirement contribution strategy
Before I describe how to model a traditional IRA to Roth IRA conversion of retirement assets that you already own, let me quickly summarize VeriPlan’s fully automated annual Roth contributions facilities in the next two sections. VeriPlan fully automates the lifetime projection process for traditional versus Roth contributions into IRA, 401k, and 403b plans during your working years.
VeriPlan provides a very easy to use tool that allows you to vary the percentage of your potential future contributions that you would make to traditional and/or Roth retirement plans. All you have to do is to set the percentage from 0% to 100% of your total annual tax-advantaged retirement account contributions that you would contribute to Roth accounts.
VeriPlan handles the rest automatically. For your traditional tax-advantaged accounts and your Roth tax-advantaged accounts, VeriPlan checks all the legal contribution limits related to projected minimum and maximum allowable annual income, the impact of qualified work plans on IRA deductibility, spousal contributions, over 55 catch-up contributions, etc. All of these parameters are user changeable, if tax laws were change in the future or if you wanted to test the impact of different limits and restrictions. VeriPlan automatically manages contributions taxation, asset growth, annual asset re-balancing, withdrawals taxation, etc. for these Roth accounts, as well as for all of your other cash, bond, and equity assets in taxable account and in traditional tax-advantaged accounts.
With this highly automated Roth contribution modeling tool, all you have to do is to set various percentages of Roth contributions and use the scenario comparison methods detailed in the section immediately following. Because this annual Roth contributions facility is so automated, you should use this facility to test the potential benefits of contributing none, some, or all of your available retirement plan contributions into Roth accounts rather than traditional retirement accounts.
Modeling Roth conversions will require you to do direct adjustments to your asset entries in VeriPlan. Therefore, VeriPlan’s automated annual Roth retirement contributions tool can be very useful to use first. The results may give you a preliminary, but very quick, indication of whether traditional IRA asset conversions into Roth accounts might or might not be attractive, as well. (However, for those whose annual taxable income exceeds Roth contribution limits, this tool will not provide such an indication. If you have relatively high income, then you may not be able to make annual Roth retirement contributions, but you still may be able to convert your current Roth IRA assets. (See IRS Publications 560 and 590.)
Specifics on how to model annual traditional and Roth retirement plan contributions with VeriPlan
This section provides specifics on how to use VeriPlan’s automated traditional IRA, designated 401(k), 403(b), and Roth IRA savings calculator functions for optimizing annual contributions with respect to taxes. First, refine your family’s baseline VeriPlan model to reflect all of your other important pre-retirement family financial goals, objectives, and plans. Then, use VeriPlan’s “Tax-Advantaged Plan Tool” to optimize your retirement contributions tax strategy to boost your available assets in retirement.
Go to VeriPlan’s “Tax-Advantaged Plan Tool” page to make your choices about future contributions into traditional versus Roth accounts. Set the percentage of your total allowable annual retirement plan contributions that you would like to invest in Roth accounts during your working years. If one or both earners are eligible to participate in designated Roth 401k or Roth 403b retirement plans, then just indicate the maximum contributions allowed. Also, enter any maximum matching dollar amounts that your employer might provide. If you do, VeriPlan will automatically model your future annual allowable contributions into designated Roth 401k and Roth 403b plans, with employer contributions, as well.
With VeriPlan, you can easily determine whether or not future Roth contributions are likely be advantageous to your family. You can tune these contribution proportions from 100% traditional contributions (and 0% Roth qualified employer retirement plan contributions) up to 100% Roth contributions (and 0% traditional qualified employer retirement plan contributions). Or, you can choose any percentage in between for an annual combination of traditional and Roth contributions up to allowable limits.
Everything is automated with this annual Roth contributions projection facility. Just set the parameters and everything else will just ripple through your fully integrated VeriPlan model. Such integrated and automated computations would include future year-by-year asset deposits and withdrawals as required between various account types; asset allocations and rebalancing; asset taxes; investment costs; etc. VeriPlan would quickly execute projection calculations for all model factors affected by your choice between traditional and/or Roth account annual contributions over your lifetimes.
Try as many alternate scenarios as you wish and compare total projected future asset values at arbitrary future ages. Note differences in scenario asset values. Note their magnitude. View the Tax Assets graphic for the proportions of financial assets projected in taxable, traditional tax-advantaged, and Roth accounts over the years. View the Transactions graphic to understand net annual flows between your taxable and traditional and Roth tax-advantaged accounts.
If your total projected financial assets would be exhausted before you are 100, carefully note the age at which this is projected to occur. (Note that financial assets are your cash, bonds, and stock assets in taxable, traditional retirement accounts, and Roth retirement accounts. Financial assets do not include your real estate and other assets.)
Compare the projected age that your financial assets would be exhausted, between the two scenarios. Your choice of traditional versus Roth assets could significantly impact how long your financial assets would last, one way or the other. Keep in mind that the age that your financial assets are exhausted is an important indicator of your optimal retirement tax strategy.
Also, obviously if and when you run out of financial assets, you would need to have other assets, such as real estate equity or property than could be accessed or sold, to cover your living expenses. Otherwise you would be destitute. VeriPlan automatically projects the anticipated growth of your real estate and other property assets and graphs their value in layers on top of your cash, bond, and stock financial assets.
If you see that VeriPlan projects that you would have financial assets remaining at age 100, then this really becomes an estate planning subject, and future estate planning and estate taxes on your residual assets are highly uncertain. In fact, VeriPlan’s projections act as an annual estimator of your gross estate at any age.
You probably do not wish to predict/plan the date of death for you and your spouse, and VeriPlan does not require you to do so. Regarding your accumulated excess assets at any age, just realize that VeriPlan will automatically project everything for you through age 100. For example, VeriPlan will automatically transfer the RMD each year out of your traditional retirement plan accounts and will apply the appropriate federal, state, and local income taxes. If your annual taxable “required minimum distribution” (RMD) from your traditional retirement accounts exceeds your annual living expenses plus RMD taxes and other taxes, then any excess will be transferred automatically into your taxable financial asset accounts. Otherwise, if your living expenses and taxes exceed the RMD, VeriPlan will automatically draw down your taxable accounts (and then Roth accounts, if your taxable financial assets are exhausted) to make up the difference.
Using VeriPlan to evaluate a one-time traditional IRA retirement account to Roth IRA conversion
Concerning the evaluation of one-time Roth IRA conversions, again, keep one model instance open as your comparison baseline. Then, open another instance of the same VeriPlan file, and go to any of the cash, bond, or equity assets on the corresponding input tables. In developing any VeriPlan financial projection planning model, all current cash, bond, stock, property, and other asset holdings information would already have been entered into the appropriate financial data entry pages.
Decide on the amount to be converted from any of the traditional tax-advantaged plan cash, bond, or stock assets that are already entered into the model. Which type of financial asset or the particular financial asset you choose is not very relevant, for testing purposes. This is the case, because VeriPlan will automatically rebalance your asset portfolio at the beginning of the second projection year and the beginnings of all subsequent projection years up to age 100, according to your settings in one of the five flexible and automated asset allocation models that VeriPlan provides. However, if you are seriously considering a conversion, then select the account that you intend to convert. Note that VeriPlan is user up-datable over time, and you can use it to model the future value of your portfolio, and you can update your portfolio in VeriPlan to reflect asset acquisitions and disposals.
If you want to convert the full asset value of a single retirement account or several accounts to a Roth IRA, just change the “0” (for traditional tax-advantaged assets) to a “2” (for Roth tax-advantaged assets) in the asset tax-ability column. If the conversion would be just a portion of the assets in that financial account row, simply make a new row for the same asset account. Then, apportion the current asset values between the two rows — one row with a “0” in the asset tax-ability column (for the remaining traditional tax-advantaged assets) and the other row with a “2” in its asset tax-ability column (for the Roth tax-advantaged assets that would be converted).
Now, choose how to pay the conversion taxes. If your total taxable cash holdings exceed your preferred minimum emergency cash reserves, then just reduce those amounts in VeriPlan to reflect the federal, state, and local taxes that you would need to pay. Otherwise pick the taxable bonds or stocks you would sell to pay the taxes on the Roth IRA conversion.
While Roth conversions funded by existing taxable assets are obviously much more preferable, if taxable assets are inadequate to fund the total taxes due, then some traditional tax-advantaged account assets could also be sold instead. If Roth conversion taxes were to be funded from existing traditional tax-advantaged retirement asset accounts, then these adjustments would simply be made to traditional tax-deferred account assets rather than taxable assets in VeriPlan. Remember to allow for some additional withdrawal amount to cover the taxes that would be due on these retirement account withdrawals.
While not necessarily prohibitive, note that having to withdraw additional traditional retirement assets is a potential red flag related to the wisdom of such a conversion. Of course, you can use VeriPlan to evaluate the trade-offs, but withdrawing traditional retirement assets to pay Roth IRA conversion taxes will raise the payback hurdle at the front-end that you would need to overcome to justify the conversion. Furthermore, not only do the increased taxes up front raise the hurdle, these withdrawals also reduce the amount of assets you have in your traditional retirement plans. In turn, fewer traditional retirement account assets would mean less appreciation, lower RMDs in retirement, and fewer taxes related to these smaller RMDs. This would reduce the future benefit of tax avoidance and lessen the value of doing a Roth IRA conversion.
Finally, note that if you are under age 59 and 1/2 then and additional 10% early withdrawal penalty might be due on IRA withdrawals that were not rolled over, but instead, were used to pay Roth conversion taxes. Also, a few states assess additional early withdrawal penalties. For example, California adds a 2.5% penalty. Obviously, early withdrawal penalties would significantly raise total front end taxes and reduce the appeal of doing a conversion. Nevertheless, you can still model these early withdrawal penalties in VeriPlan in the manner described above.
As summarized in earlier sections, to analyze the trade-offs, all you would need to do next is to compare the projected total financial asset values of the different scenario models at the same arbitrary future age, e.g. 80 years, 95 years, etc. Note differences in scenario asset values. Note their magnitude. Compare the age at which your cash, bond, and stock financial assets would be exhausted, if your cash, bond, and stock financial assets would run out prior to age 100.
If you want to adjust the long-term tax rates for federal taxes, for any state taxes, or for any locality, just make the changes on the “Your Taxes” page. All income, expense, debt, tax, and asset modeling assumptions are user changeable. All documentation is fully integrated within VeriPlan.
VeriPlan’s financial data and parameters are all user adjustable. No black box — no rigid, one size fits all assumptions.
If VeriPlan indicates that a Roth IRA conversion could be attractive, run proforma tax returns to verify your assumptions about taxes due
A traditional IRA conversion to Roth retirement account conversion requires a reasonably accurate estimate of the taxes that would be due related to the conversion. While you can model a guesstimate of the taxes due in VeriPlan by reducing your current asset as described in the prior section, you should do pro forma tax returns before doing a conversion.
The more involved part of the Roth IRA conversion analysis is separate from the internal logic of VeriPlan. Since the up-front tax payment is the disincentive to convert to a Roth account, it is important to carefully evaluate the taxes due for the current year (or over two years, if splitting tax payments over two years is available to you). There are several ways to do this, but all of them essentially imply that you do a proforma draft of the tax returns that you would file in the springtime.
Whether or not you have decided to use VeriPlan, some free Roth conversion tool on the Internet, or the modeling software that a financial adviser has, getting a proper estimate of taxes due is one of the first orders of business. If you decide to go ahead with a Roth conversion, it will involve some retirement account paperwork to implement the conversion. Eventually you will need to file your tax returns anyway. If you decide later on that doing the conversion was not what you really wanted to do, then you may be able to reverse (re-characterize) the transaction before your tax returns are due. However, to reverse a Roth IRA conversion will require some more time-consuming paperwork.
So, why not just draft your proforma income tax returns before you make a final decision and start the conversion paperwork process? If you have a good understanding of income tax laws, you can estimate how much total tax would be due related to the amount of Roth assets that you want to convert. This is even easier, if you develop your own tax returns using a home tax return program such as TurboTax.
If you are not comfortable with doing this yourself, then your friendly CPA would probably be happy to run some tax estimates for you. Your tax accountant probably would be trilled to do this for you, if you asked for this analysis when it was not in the middle of peak tax filing season for real income tax returns.
While you should consult IRA Publications 560 and 590 (see the links in Part 1 of this article), make sure that your current year tax estimate reflects any federal, state, and/or local taxes due on the conversion amount less any proportional tax basis that you may have across your various traditional tax-advantaged retirement accounts for IRAs.
Attention should also be paid to any asset tax basis which might be associated with the tax-advantaged asset holdings. Appropriate decrements for any proportional tax basis should be taken out. (Note that VeriPlan supports lifetime asset tax-basis modeling as a fully automated background process.)
VeriPlan is the most cost-effective way to evaluate Roth retirement account contribution and conversion strategies
VeriPlan is marketed on the Internet from the front page of this “My Financial Freedom Plan” (http://www.theskilledinvestor.com/VeriPlan/) website. Do-it-yourself end users can purchase the VeriPlan CD and a household license for a very inexpensive price. There are no support charges, and there are no forced future upgrades. VeriPlan is a mature, robust, and highly functional comprehensive lifetime financial planning application and retirement planning calculator. All functionality is exposed and all projection model assumptions are user update-able. Therefore, future upgrades are simply unnecessary.
Financial planning advisors also can obtain VeriPlan for use with their clients. Financial planners can:
• incorporate VeriPlan into their service offering,
• develop comprehensive models and unlimited scenarios,
• use it live with clients for informed scenario planning and financial decision-making,
• incorporate VeriPlan’s output into their printed financial plans for clients, and
• provide the VeriPlan product and customized models to clients for use at home.
For advisors, volume pricing is available starting at five units of VeriPlan. Financial advisors will find VeriPlan to be an excellent new tool to model the Roth conversion puzzle within the context of each client’s particular comprehensive financial planning situation. At the same time, advisor will also be able to see how VeriPlan can meet a myriad of other requirements for comprehensive, integrated, and automated financial planning decision support software.