Newsletter introduction

By Chris Cassidy

WHEN I FIRST BEGAN my career at Trust Company of Vermont, I made contributions each year to a Traditional 401(k) retirement savings plan. Contributions to a Traditional 401(k) are made with pre-tax dollars, but whenever the money is distributed, the distributions are taxed at ordinary income tax rates. At the time, I thought that when I retired and was no longer earning an income, my tax rate would be very low, and I could then take the money out without paying too much in ordinary income taxes. 

Before 2010, only those individuals with an annual adjusted gross income (AGI) of $100,000 or less could convert a Traditional IRA to a Roth IRA. However, this rule changed in 2010, and Trust Company of Vermont began helping clients with Roth conversions. As a result, I reconsidered my own contributions and decided to stop making Traditional 401(k) contributions, opting instead for a Roth 401(k). With a Roth 401(k), contributions are made with after-tax dollars, withdrawals are entirely tax-free, and there are no Required Minimum Distributions (RMDs). 

Even though I have not contributed to my original Traditional 401(k) since 2010, due to a fantastic stock market, the value of that once tiny account is now $175,000. While I am not thrilled about the idea of paying a large tax bill to convert those funds to a Roth 401(k), I believe it makes a lot of sense to do so in my situation. 

While nobody knows for sure how long they will live, when I look at life expectancy tables, there is a reasonable statistical chance that I will live 40 more years. Since my wife is younger than I am and women, on average, live longer than men, there is a reasonable chance that she will survive me by 10 years. 

From a family inheritance standpoint, one major benefit of a Roth IRA is that it grows tax-free for the lifetime of the owner, the lifetime of the surviving spouse, and an additional 10 years for the inheritor. In my case, that could be 40 years of tax-free growth for me, 10 years for my wife, and 10 years for my daughter. According to the rule of 72, if my account were to earn 7.2% annually, it would double in value every ten years. That would mean that upon my death, it would be worth $2.8 million. Upon my wife’s death it would be worth $5.6 million and by the time my daughter withdraws the funds, it could reach $11.2 million. 

Although I cannot predict future tax rates, I do know that right now tax rates are at some of the lowest levels in history. I also know that paying ordinary income taxes today on $175,000 will likely result in a much lower tax bill than if my daughter were paying it on $11.2 million in 2084. The thought of my daughter cursing me in sixty years because I failed to do a conversion and instead left her with a large tax bill may just be enough to get me to convert this year. 

Many of us have Traditional 401(k)s and Traditional IRAs from years of contributions. Devon Walsh has written a very helpful article on what to consider when deciding if a Roth conversion makes sense. It is a good guide to use when trying to make this decision.