Married ED Docs, just finished residency - Convert 403b to Roth or not?

[soundbyte]

Wife and I are both physicians who just finished our residencies. This year, we anticipate our collective income to be around $350k (5 months attending salary + 6 months of resident salary) this year (so 33% marginal tax bracket). We each have about $19k in 403b accounts, so approximately $40,000 total. Is rolling over these accounts in our Roth IRAs the best logical move? In running the math, it seems like given the small amounts, the growth in a Roth vs Non-roth may be a wash, considering taxes. However, rolling over directly into a Roth allows us the options in the future to contribute more through the Backdoor Roth while avoiding any pro-rata issues.

I think the option of avoiding any pro-rata issues with regards to a backdoor roth in the future makes converting to a Roth now the best move.

[jfoxcpacfp]

Do you have the savings to pay the taxes? Will you be able to meet other commitments if you convert (i.e. student loan payments)? If the answer to both questions is "yes", I would probably recommend converting this year. If you are both relatively young (early 30s), the growth won't be a wash over the long term - you'll come out ahead. And that's not even considering the ability to do a backdoor Roth.

[litovskyassetmanagement]

Not everyone would recommend converting while you are in a 33% federal bracket (and state bracket matters too). Rolling that amount into a retirement plan (if these plans have index fund lineup) would probably be a good idea as well.  However, I'd say that converting to Roth won't necessarily be a bad idea if you can also contribute a decent amount to retirement plans, and if you reasonably believe that you will not be in 33% bracket going forward until near retirement.  Also, don't forget the 1099 income loophole - then you'll be able to open your own individual 401k and roll over any traditional IRAs into it (but you have to be careful about the combined 403b + 401k maximum).

EDIT: I guess I missed that the money is in a 403b already, not in an IRA.  So you won't have an issue with backdoor Roth at all.

[soundbyte]

We are both 29 (turning 30 Ina few months) and we do have the personal savings to pay the taxes on the conversion come April.
We recently moved to VA for our jobs, and with full time attending salaries, our combines income will be greater than $600k. The only other wrench to consider would be if my wife eventually goes part time in 4-6 years for child care reasons. However, even if she works 50%, I anticipate our taxes would still be higher in the future than they are this year.

[jfoxcpacfp]

soundbyte wrote:

We are both 29 (turning 30 Ina few months) and we do have the personal savings to pay the taxes on the conversion come April.
We recently moved to VA for our jobs, and with full time attending salaries, our combines income will be greater than $600k. The only other wrench to consider would be if my wife eventually goes part time in 4-6 years for child care reasons. However, even if she works 50%, I anticipate our taxes would still be higher in the future than they are this year.

Click to expand...

Over the long term, with an appropriately-diversified equity mutual fund portfolio in your Roth IRAs, you will far overcome the taxes paid today. You've got 30+ years of growth; equities (again, appropriately diversified) have averaged 10-12% returns since 1926.

[litovskyassetmanagement]

jfoxcpacfp wrote:

soundbyte wrote:

We are both 29 (turning 30 Ina few months) and we do have the personal savings to pay the taxes on the conversion come April.
We recently moved to VA for our jobs, and with full time attending salaries, our combines income will be greater than $600k. The only other wrench to consider would be if my wife eventually goes part time in 4-6 years for child care reasons. However, even if she works 50%, I anticipate our taxes would still be higher in the future than they are this year.

Click to expand…

Over the long term, with an appropriately-diversified equity mutual fund portfolio in your Roth IRAs, you will far overcome the taxes paid today. You’ve got 30+ years of growth; equities (again, appropriately diversified) have averaged 10-12% returns since 1926.

Click to expand...

Sorry, but that's just not true.  It depends when you invested and when you withdrew.  Promising 10%-12% returns is just not a good idea, regardless of how long one holds.  What you did not mention is the likelihood of getting these returns, and that's where it helps providing a bit more context (attached).  The range of returns is actually quite large, and while you won't necessarily experience a below zero return when holding 30+ years, you can definitely experience a negative real return (which is all that matters).

 

[PhysicianOnFIRE]

My vote is to leave it alone. Lat year would have been a great time to convert, but your income and tax bracket have already climbed dramatically.

As Kon points out, as long as you don't hold a tax-deferred IRA in your name, you're good to go with the Backdoor Roth. If you do have an individual IRA, you might be able to roll it over into the 403(b).

For many, taxes will be dramatically lower in retirement, at which point you may be able to do Roth conversions while paying little or possibly no federal income tax. If you accumulate great wealth in tax-deferred accounts, and draw heavily from them to support an extravagant lifestyle, you could be in a higher bracket than you are this year. Of course, it's impossible to know what the tax brackets might look like when you eventually access your tax-deferred accounts.

Best,

-PoF

[soundbyte]

Do you mean leave it alone as in just leave it as the 403b with my old employer? I'm not a fan of the funds there, so if I didn't convert to Roth, I would move it into Vanguard as a Rollover IRA. But this would impact my future ability to do a back door Roth, correct?

[jfoxcpacfp]

Kon Litovsky wrote:

jfoxcpacfp wrote:

soundbyte wrote:

We are both 29 (turning 30 Ina few months) and we do have the personal savings to pay the taxes on the conversion come April.
We recently moved to VA for our jobs, and with full time attending salaries, our combines income will be greater than $600k. The only other wrench to consider would be if my wife eventually goes part time in 4-6 years for child care reasons. However, even if she works 50%, I anticipate our taxes would still be higher in the future than they are this year.

Click to expand…

Over the long term, with an appropriately-diversified equity mutual fund portfolio in your Roth IRAs, you will far overcome the taxes paid today. You’ve got 30+ years of growth; equities (again, appropriately diversified) have averaged 10-12% returns since 1926.

Click to expand…

Sorry, but that’s just not true.  It depends when you invested and when you withdrew.  Promising 10%-12% returns is just not a good idea, regardless of how long one holds.  What you did not mention is the likelihood of getting these returns, and that’s where it helps providing a bit more context (attached).  The range of returns is actually quite large, and while you won’t necessarily experience a below zero return when holding 30+ years, you can definitely experience a negative real return (which is all that matters).

 

Click to expand...

I think your chart proves my point. I'm talking about investing in an appropriately-diversified equity fund portfolio over the long term, not holding bonds. I'm not talking about trying to pinpoint years when the stock market has reached a "high", but investing according to an actual financial plan, lived out between today and dead. As your chart depicts, the average return between 1926 and 2014 was, indeed, 10.2%. A portfolio invested to mirror the market can only achieve market returns if managed according to the dictates of a financial plan. A portfolio invested and managed without a true financial plan in place (i.e. by an investment manager) will be limited to the specific investment manager's research.

As you know, permanent loss in a diversified equity portfolio is always a human achievement, of which the market is incapable.

As for taxes, see my example on page 11 of Guide for Established Attendings under "Use Bear Markets to Convert to Roth IRAs". This example depicts the very short term in which some have recouped their taxes paid on a large conversion. There will be plenty more opportunities and I would strongly advise against waiting for "low" tax rates in retirement, given today's opportunities. There is NO guarantee that Roth IRAs will be available for conversion or contribution when today's 30-something doc's retire.

[jfoxcpacfp]

soundbyte wrote:

Do you mean leave it alone as in just leave it as the 403b with my old employer? I’m not a fan of the funds there, so if I didn’t convert to Roth, I would move it into Vanguard as a Rollover IRA. But this would impact my future ability to do a back door Roth, correct?

Click to expand...

Yes, that would prevent you from annual tax-free backdoor Roth IRA conversions.

[PhysicianOnFIRE]

soundbyte wrote:

Do you mean leave it alone as in just leave it as the 403b with my old employer? I’m not a fan of the funds there, so if I didn’t convert to Roth, I would move it into Vanguard as a Rollover IRA. But this would impact my future ability to do a back door Roth, correct?

Click to expand...

I didn't know you had crummy funds there. Do your new employer(s) offer tax-deferred plans (such as 401(k), 401(a), 403(b))? If yes, how are the fund options there? Often, you can roll funds over into them if your current employer offers them.

I had a Vanguard SEP-IRA that I rolled over into my current employer's 401(k) plan, which offers Vanguard institutional funds. I previously made a Mega Roth conversion with the SEP-IRA in 2010, but I probably wouldn't do it again knowing what I know now.

 

Best,

PoF

[Zaphod]

Returns may not be 10-12% but it doesnt matter. Its not as if they actually had 10-12% annual purchasing power increase. Inflation was higher and so were taxes, costs of investing, frictions, etc...that dramatically reduced your actual real, real return. I expect the nominal number may be lower, even dramatically, but in reality dont expect much of a difference.

[litovskyassetmanagement]

jfoxcpacfp wrote:

Kon Litovsky wrote:

jfoxcpacfp wrote:

soundbyte wrote:

We are both 29 (turning 30 Ina few months) and we do have the personal savings to pay the taxes on the conversion come April.
We recently moved to VA for our jobs, and with full time attending salaries, our combines income will be greater than $600k. The only other wrench to consider would be if my wife eventually goes part time in 4-6 years for child care reasons. However, even if she works 50%, I anticipate our taxes would still be higher in the future than they are this year.

Click to expand…

Over the long term, with an appropriately-diversified equity mutual fund portfolio in your Roth IRAs, you will far overcome the taxes paid today. You’ve got 30+ years of growth; equities (again, appropriately diversified) have averaged 10-12% returns since 1926.

Click to expand…

Sorry, but that’s just not true.  It depends when you invested and when you withdrew.  Promising 10%-12% returns is just not a good idea, regardless of how long one holds.  What you did not mention is the likelihood of getting these returns, and that’s where it helps providing a bit more context (attached).  The range of returns is actually quite large, and while you won’t necessarily experience a below zero return when holding 30+ years, you can definitely experience a negative real return (which is all that matters).

 

Click to expand…

I think your chart proves my point. I’m talking about investing in an appropriately-diversified equity fund portfolio over the long term, not holding bonds. I’m not talking about trying to pinpoint years when the stock market has reached a “high”, but investing according to an actual financial plan, lived out between today and dead. As your chart depicts, the average return between 1926 and 2014 was, indeed, 10.2%. A portfolio invested to mirror the market can only achieve market returns if managed according to the dictates of a financial plan. A portfolio invested and managed without a true financial plan in place (i.e. by an investment manager) will be limited to the specific investment manager’s research.

As you know, permanent loss in a diversified equity portfolio is always a human achievement, of which the market is incapable.

As for taxes, see my example on page 11 of Guide for Established Attendings under “Use Bear Markets to Convert to Roth IRAs”. This example depicts the very short term in which some have recouped their taxes paid on a large conversion. There will be plenty more opportunities and I would strongly advise against waiting for “low” tax rates in retirement, given today’s opportunities. There is NO guarantee that Roth IRAs will be available for conversion or contribution when today’s 30-something doc’s retire.

Click to expand...

Actually, it says returns are NEVER average. The average range (8%-12%) was achieved in only 6 out of 89 years, which means that most of the time one gets below or above (with below being a clear winner).  Returns are never average and depend on the starting and ending point, so it does not matter what the average return was in such and such a period, what the investor experiences is exactly what's shown in the charts, which is a return with a SPREAD that is significant.  So the proper way to talk about returns is to say that there is an average return with a spread that we actually do not know, other than that it can be huge.  In 1999 S&P500 annualized return was nearly 14% for the previous 30+ years.  In 2008, return was about 9.5% for the preceding 40 years.  This is a huge difference that matters.  Making projection with 14% return vs. making projections with 9.5% return is like night and day with respect to the final value of one's portfolio.  So again, saying that one can expect 10%-12% return is misuse of statistics because you have to mention the standard deviation (at the very least) of those returns, which means getting 10% +/- X, where X can be as high as 5% or even more depending on what one is investing in.  Planning for a 10% return and getting 5% over 30+ years means only getting about 1/3 of the money, even after 30+ years.

[litovskyassetmanagement]

Zaphod wrote:

Returns may not be 10-12% but it doesnt matter. Its not as if they actually had 10-12% annual purchasing power increase. Inflation was higher and so were taxes, costs of investing, frictions, etc…that dramatically reduced your actual real, real return. I expect the nominal number may be lower, even dramatically, but in reality dont expect much of a difference.

Click to expand...

It actually does matter because taking excessive risks can lead to significantly LOWER returns.  The whole point is that if you are overexposed to the markets, your return will be at the mercy of the market, which means that your fortune will rise and fall by the market, and that's a terrible way to invest, especially if you are going to accumulate significant amount of money.  Understanding the statistics of the stock market is the first step before developing an investment strategy that should be robust to market risk.

[litovskyassetmanagement]

Zaphod wrote:

Returns may not be 10-12% but it doesnt matter. Its not as if they actually had 10-12% annual purchasing power increase. Inflation was higher and so were taxes, costs of investing, frictions, etc…that dramatically reduced your actual real, real return. I expect the nominal number may be lower, even dramatically, but in reality dont expect much of a difference.

Click to expand...

Also, when advisers state to their clients to expect 10%-12% returns, and that advisers know how to get those returns over the long term by 'properly diversified' portfolio, that's called malpractice.  No adviser can do any such thing.  They have no idea how to get returns, because markets deliver returns.  The only thing an adviser can do is decrease investment cost and manage risk, which is not something that can be done with 100% stock market exposure, diversified or not, especially in the long term.  This is why many clients drop advisers by the way - they think somehow advisers are supposed to produce returns, while they can do no such thing, and because holding over 30+ years is no guarantee that returns will be anywhere near historical averages.