Jump to content

How much would you pay for $1000 in a Roth IRA?

Recommended Posts

If you could somehow trade some amount of cash for $1000 in a Roth IRA, how much would you be willing to pay to do that?  Since longevity would play a big role in the calculation, let's assume you have at least 40 years before you would start to take money out.  I am also assuming you have maxed out any easy mechanisms to get money into a Roth, so this would be to add more on top of your already capped contributions.

I would think at an absolute minimum the value should probably be based on the long-term capital gains rate, which is currently 23.8% for high earners but could conceivably go much higher.  Even if you decided to hold an incredibly tax-efficient asset like Berkshire, then given enough time to compound you would approach the point where you would be indifferent to having $1000 starting balance in a Roth IRA vs. $1312 in a taxable investment account.  The reason being that all the gains compounded from that extra $312 would be lost to the 23.8% tax rate (1000/.762 = 1312, so every 1312 you make is the same after tax as 1000 made in the Roth). That's not a perfect example as the initial principle wouldn't be taxed, but over long enough periods and high enough compounding rates that becomes much less of a difference.  After 24 years of compounding at 8%, you would be better off starting with $1000 in a Roth than $1250 in a taxable account.  In the real world you might want to sell earlier and incur capital gains tax sooner, or get dividends, or the tax rate could go up, and then you should be willing to pay even more to start with a Roth. 

If a 23.8% tax rate occurring only once is the bottom end of value calculation, then the upper end would be a situation where all the gains are taxed at annually and at ordinary rates (interest, non-qualified dividends, or short-term capital gains). Here the tax rate could easily hit 40.8% (37% top tax rate + 3.8% surtax for investment income).  Here it would be like compounding 8% in the Roth versus (.08 x .592) = 4.7% in the taxable account, and there after 24 years you would have rather started with 1000 in the Roth instead of 2000 in the taxable.  You could even go wild and compare 40 years compounding at 10% in the Roth vs. 5.92% after tax in a taxable, in which case $1000 in the Roth is worth more than $4000 in the taxable.  I'm thinking for me the answer is probably somewhere in between $1300-$2000 if my reasoning is correct.

The reason why I bring this up is I think I undervalued tax-deferred accounts in the past, and I just took what options were easily available instead of jumping through some hoops to create opportunities to put more cash into retirement accounts.  As it is, about 80% of my investments are in taxable accounts, with the balance being about equally split between Roth IRA and a rollover IRA.  Over the years, I probably could have taken some steps to dramatically increase my contributions, such as incorporating a side-hustle, paying myself a W2, and starting a solo-401k with the maximum 25% employer contribution, and finally paying to convert the pre-tax money to Roth.  It probably would have cost something like 30% of the amount in cash payroll taxes and other fees to get the equivalent dollar amount in a Roth IRA as opposed to a taxable investment account, but based on the above calculation that might easily have been worth it.  I think I should definitely consider that going forward.  I have even heard about options to create a defined benefit plan where I could maybe put in up to 200k per year if I really want to move aggressively on this.

I’m curious what other people think about this.

Edited by aws
Link to post
Share on other sites

Instead of hypothetical question, the real question is: is it worth converting from traditional IRA (401(k)/Rollover IRA/etc.) to Roth assuming (close to) top tax rate?


I played around and IMO conversion is only marginally better for most scenarios - unless you assume high returns (15%+) and (very) long timeframes.

For your hypothetical question if you had to pay more than what you pay for traditional to Roth conversion to get money into Roth, it's very likely not worth it.


One observation that applies to both your hypothetical question and my real question: there is non-zero chance that Roth IRA will be taxed at some point in the future. How much "non-zero" is tough to estimate. Also, almost everyone has been expecting higher tax rates since (before) 2000. So far tax rates have not gone up, so most scenarios from 20 years ago were wrong. Whether taxes will go up in the future and how much are IMO quite unknown quantities (that possibly are also political and should not be discussed here).

Link to post
Share on other sites
Posted (edited)

The conversion is really a separate issue.  This is more of the incremental value of a tax-deferred or tax-free retirement account vs. an equivalent amount of cash.

Given a long enough time frame you might rather have $1 in a traditional IRA (which will be taxed when you take it out) to achieve the benefits of tax free compounding, instead of $1 of already taxed cash, although it would depend on how tax efficient your investing is.

In my scenario I am pretty well set on Roth being superior as if you assume constant or rising tax rates, then a Roth is better, especially because you can effectively put so much more in a Roth.  If your funds were limited and you had to choose between $1500 in a traditional to yield a $500 immediate tax benefit, or $1000 in a Roth, you wouldn't care which you had if the tax rates were constant now and in the future.  But if you could max out the Roth then you end up effectively putting more of your cash to work in the retirement account.

My question is would it be worth it to pay 30% in payroll taxes and fees (on top of the income tax due on the conversion) to get extra money in a Roth.  The scenario wouldn't really change if you considered it a traditional IRA instead.  For that situation I would pay the 30% in payroll taxes and fees and get a tax deduction this year for the full amount, but all the money would be in a traditional IRA and taxable when withdrawn.  I prefer the Roth because of the bigger effective size of the contribution, but in either case it just boils down to would you pay those big extra payroll taxes and related costs to issue yourself an unnecessary W2 in order to open up the window to a much larger contribution?

Edited by aws
Link to post
Share on other sites
  • 2 months later...

You could do what i did a few years back. Have a purposely very low income year, I went and traveled and captured zero gains one year. Then I converter from sep to roth up to the marginal rate of 40k (or wherever the change was then) plus standard deduction paying 12% tax on the converted portion.... that was at age 37. 


However to answer your question, imo, what I did is the only time where it clearly makes sense. 

Link to post
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
  • Create New...