A traditional IRA balance overstates true wealth because every withdrawal is taxed as ordinary income, meaning the government owns a portion of every dollar on the statement. Converting $40,000 annually at 12% using outside funds beats a $730,000 traditional IRA balance taxed at 22% on withdrawal, leaving the converter with more spendable money. Roth owners avoid required minimum distributions, Medicare IRMAA surcharges, and pass tax-free balances to heirs.
These advantages hold regardless of future tax rates. Two retirees, same $1 million, same 4% rule, buy one finished with $1.4 million, the other hit $0 in 12 years. Our free reader guide explains the flaw that separated them, and the income-first method built to avoid it.
Two brothers, same starting balance of $450,000 in a traditional IRA, same age, same market. Imagine that one spent a decade moving $40,000 a year into a Roth, paying tax on each conversion at the 12% federal rate. The other brother did nothing and watched the balance climb to $730,000.
On paper, the second brother looks like he came out ahead. In practice, he owns less of what his statement says than his brother owns of a smaller one. A traditional IRA balance is money on which no federal income tax has ever been paid.
Every dollar withdrawn is taxed as ordinary income in the year it comes out. If the eventual tax rate is 22%, then twenty-two cents of every dollar on that statement belong to the Treasury. The account holder is a custodian for a share he does not own.
A Roth statement works differently. Tax has already been settled. Qualified withdrawals in retirement come out untaxed.
Extract — continue reading at the source.
