Path to Prosperity with Walter Pardo: Roth Conversions - Why the opportunity cost argument is invalid. 

Some people believe that there is an opportunity cost by doing a Roth conversion, that the funds used to pay the conversion tax could have been otherwise invested, and that investment return opportunity is lost.

FALSE! It’s all about the tax rates. 

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There is no opportunity cost in terms of lost investment gain - if the tax rates are the same both at conversion and later at distribution.

Let’s look at the math -- 

Let’s assume your savings account balance is going to double over time.

Without a Roth Conversion, a $100,000 in a Traditional IRA will grow to $200,000. Now, subtract a 30% tax liability, which leaves you with a balance of $140,000.

With a Roth Conversion, you start with a $100,000 Traditional IRA Balance. After conversion and paying a 30% tax liability, you’re left with an account balance of $70,000.

Now again, assuming your balance doubles over time, your net balance is $140,000. The net return is the same in both examples… IF tax rates stay the same.

However, if taxes increase, growth of the ROTH IRA account is tax exempt using the ROTH IRA strategy.

As the great Ed Slott said, “When tax rates increase, anything tax-free becomes immediately more valuable.”

 

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