California E&S Insurance

Why I converted 100% of my pre-tax accounts to Roth for FIRE Reading /u/PayDBoardMan's post on [The mathematical benefits of Roth accounts](https://www.reddit.com/r/financialindependence/comments/116f0h3/the_mathematical_benefits_of_roth_accounts/) inspired me to write this post. Over the course of a few low income years I converted 100% of my Pre-Tax accounts into Roth accounts, in the 0% to 22% brackets with around an 18% effective tax rate of federal only taxes moving to a income-tax-free state. My marginal contribution rate was 35%+ fed taxes and 9.3%+ CA tax brackets for a 44-50%+ marginal rate. Edit: I'm not recommending to convert up to 22%. It made sense in my case as I'm permanently disabled and receiving SSDI. Most people are best with 12% conversions. I made 100% pre-tax contributions to my 401k and back-door roth contributions (too high income for T-IRA contributions.) I strongly think it's optimal for FIRE focused people to contribute 100% to pre-tax (unless in low tax bracket with higher expected tax brackets - ie Medical Doctor Residents), then try to aggressively Roth-convert as much as possible in low income years. I converted to 100% roth for all the reasons /u/PayDBoardMan listed, which I won't repeat here. I'll add my own unique reasons: # Roth Conversions with taxes paid from outside sources = additional Roth Contributions mathematically! Many people overlook this weird math quirk - if you pay the conversion taxes from a taxable account, it's **equivalent** to investing that money in the Roth IRA! I've greatly expanded my tax-advantaged space by performing Roth Conversions! Math: $100k converted, $18k taxes owed (my case). Assumptions: Effective tax rate the same in retirement, 15% LTCG. Pay taxes out of conversion: $82k aggressively invested over 30 years at 7% daily compounded real rates = $669k $100k aggressively invested over 30 years at 7% daily compounded real rates = $816k Roth or Pre-tax Value. Pre-Tax After Tax Value is $816k * (1-.18) = $669k. $18k tax cost invested in taxable is $146.9k. After tax value = $127.5k 669k + $124.68k = $796.5k. $816k Roth Value > $796.5k pre-tax after-tax value. Therefore: Paying conversion taxes outside of the Roth Conversion = equivalent to investing the taxes in the Roth account! Note - I **did not** model average 0.5% tax drag for the $18k taxable investment either! If I model that then the taxable return is 6.5% per year and it's $126k before taxes, with a $109.8k after tax value! Even if we're all 0% LTCG for this example, pre-tax would be $815.9k, and $816k >>> $778.8k pre-tax-after-tax value so you're still getting a huge "invisible" investment benefit by paying the taxes with outside funds! Given my personal finance situation it's very unlikely at retirement I'll be less than 18% effective tax rates barring huge political changes/etc. Then if you can grow the roth even better where you'd be well 30%+ effective retirement rate were it a pre-tax account still then you've scored big by converting. #Crazy Flexibility to move to any state of my choice Now that I'm 100% Roth I can move to any state of my choice and not worry about taxes! I could decide to move back to CA if I want to, or another state with high income taxes. I can't imagine withdrawing on pre-tax anything living in California when it's only [$66k to trigger the 9.3% state tax bracket](https://www.nerdwallet.com/article/taxes/california-state-tax) Being 100% roth with an 18% effective rate "locked-in" is really nice for flexibility to move around in the future. #Roth accounts encourages optimal investing - no diminishing returns As we saw in the above example living in a state like California, and federal taxes in general, makes most people not want to push for optimizing their investing strategies. If you build your account to the point where the government is taking more than 50% combined you lose a lot of incentive to keep putting in effort for diminishing returns. There is no diminishing returns to Roth accounts! If you get really lucky and make $1 billion in a Roth account it's not going to be valued only at $500 million after taxes if it was in a pre-tax account. You're a lot more incentivized to optimize your investing strategy with a Roth account vs a pre-tax account. #Pre-tax income interacts badly with Long-Term Capital Gains Brackets and Social Security Taxation In my case for investing for FIRE in my career I was already making substantial taxable account investments. Under the current tax laws ordinary income pushes out the 0% long-term capital gains tax brackets. However, being 100% roth I can have 0% taxed qualified dividends to [$41k per year single, $83k married](https://www.nerdwallet.com/article/taxes/capital-gains-tax-rates), and **really lower my taxes.** Pull up [TurboTax Tax Caster](https://turbotax.intuit.com/tax-tools/calculators/taxcaster/) and put $40k of short-term capital gains, then compare $40k of long-term capital gains as a single person. $40k STCG is $3k in taxes. $40k LTCG is $0 in taxes. If you have both $40k STCG and $40k LTCG - $6.8k in taxes - your pre-tax withdrawals are pushing out your LTCG advantages! If you need $80k of LTCG and pre-tax withdrawals to live off of - you only need $73.2k of roth + LTCG instead, greatly helping you **minimize expenses** in retirement. It's the difference between a $1.8m portfolio and a $2m portfolio @ a 4% Safe Withdrawal Rate. Now imagine ordinary income pushing Social Security income to be taxable on top of the LTCG! Ouch! You can have as high as a [55% marginal tax rate](https://www.bogleheads.org/wiki/Social_Security_tax_impact_calculator) with all 3 sources of income interacting together! This is known as ["The Hump"](https://www.bogleheads.org/w/images/9/98/Single63K.jpg) for social security tax calculations. Per the Boglehead's wiki: >If you can convert funds at 25% or 28% today to avoid the 46.25% or 55.5% marginal brackets in retirement your financial gains will be substantial. I really want to revisit /u/PayDBoardMan's burger analogy here - by being 100% roth you just got access to an exclusive restaurant that lets you buy 40 burgers for free instead of 5 burgers for free by avoiding all these bad tax bracket interactions! #There are plenty of ways to fill up your ordinary income tax brackets besides pre-tax withdrawals or Roth Conversions! Speaking of STCG taxes - if you want to fill up ordinary income brackets instead - you can pursue more lucrative "hands on" trading or unique investment strategies that's only really available in taxable accounts! For instance, you could: * Sell options using margin/portfolio margined accounts to create excess returns. You can only sell cash-secured/spreads in retirement accounts! (You can sell future options with leverage in retirement accounts.) * Invest in investments that *initially* generate K-1 losses, but later generate substantial ordinary income (real estate syndicates, etc.) * Day trade with 4x intraday margin relief. * Converting taxable assets into charitable remainder trusts which spit off ordinary income but saves you from realizing substantial LTCG. * Annuitize by buying immediate annuities with taxable assets which the interest spits off ordinary income * Move your bond allocation to taxable and stock allocation to your roth account so it grows the most. * And many more ideas! I've been profitably trading options for several years now. I'm really glad my retirement account is 100% roth now. I have so many options at my disposal to fill my lower ordinary-income brackets now instead of making pre-tax withdrawals. # Estate planning /u/PayDBoardMan already touched upon the issue of a widow getting a pre-tax account and being in single brackets. That is a huge downside of Pre-Tax accounts. However there are more reasons why Roth IRAs are still the superior tool for estate planning purposes (unless you have a huge charitable bone.) The lifetime stretch is STILL possible instead of a 10 year stretch for these cases: * A surviving spouse - that's still really nice. * A person who is not more than 10 years younger than the IRA owner * A minor child of the IRA owner (until turning 18/21/26 based on circumstances) * A disabled person * A chronically ill person (unable to perform 2 or more ADLs or has a severe cognitive impairment) Even if it does go to a heir where they have to drain it in 10 years, it's still much nicer to inherit a Roth IRA and stretch it than deal with the heavy income taxes of a pre-tax account. What if your heir gets a lucrative job and are in really high tax brackets by year 10 stretching a pre-tax account? Ouch! Then if you do have charitable purposes - chances are it'd be well past what your spouse needs to live off of anyways, and taxable accounts are still great to donate, along with HSA accounts! So you're less likely to be donating to charity in your inheritance plan being lower net-worth. # Everyone forgets about HSA accounts There is no Roth version of the HSA account as it's already triple-tax advantaged for qualified medical expenses. This is another pre-tax retirement income source if you haven't been saving receipts for years or if the IRS/Congress changes the rules later on. Inheriting HSA accounts really sucks - zero stretch, all income is due in the year of death for inheritance. Ouch! Well, guess what the other nice benefit of HSA accounts are? 100% complete investment control! Your 401k plan probably has crappy investment options. You can transfer HSA funds from your payroll HSA custodian to Fidelity at any time and then invest in leveraged ETFs. You can pursue the most risky/speculative strategies (say Hedgefundie's Excellent Adventure) in the HSA first and with $3k~ single contribution limits per year - either have a really amazing HSA that could grow to millions or worst case $0. Hell, $3k/year lost to HFEA is probably not going to change anyone's FI plans, and if it pays off it'd be freaking amazing to have a $1 million+ HSA account. I have a HSA account, I maxed it out every year, and despite the recent brutal drawdown, it still has a great chance of hitting $400k-$900k in 20 years being invested in HFEA. I'm still on track to hit $6m - $14m by the time I'm 65 in it with HFEA. # Lower Medicare IRMAA in Retirement too Everyone is focused on the ACA subsidies. You also get [taxed extra based on your AGI](https://www.socialsecurityintelligence.com/the-2023-irmaa-brackets/) when you're on Medicare as well! $97k or less you only pay $164.90/mo for part B. $183k+ its $527.50/mo, a $362.60/mo increase, or $4,351.20 a year. It's an additional 2.3% effective tax and a 5% higher marginal tax. Roth withdrawals avoids IRMAA increases. # Emergency Fund Tax Safety I really like /u/PayDBoardMan's example that spending isn't consistent in retirement. I don't really think the car example hit home enough with me though, I really think that $40k could be $4k a year withdrawn as a car isn't going to die suddenly in year 10, ignoring auto accidents which insurance covers. Still - it's $4k extra withdrawals you probably weren't thinking of at first at your retirement marginal tax rate! What does hit home with me though is emergency house repair stuff. If you're a home owner you could get hit with a ton of surprises that requires unexpected high payments - $40k for a new roof you thought you still had 10 years of life left, etc. Or maybe you got hit with a 100-year flood, weren't in a flood zone and weren't required to buy flood insurance, but it's going to be $40k of repairs regardless. Even if it's a situation that you're likely covered under insurance - it might be better to get that $40k of work started now and contractors paid and deal with the insurance adjuster later. Being 100% roth gives me a lot of flexibility with all of this without getting hit extra hard on taxes + agi increases + health insurance (ACA/medicare) premium increases. # Medicaid Spend Down Planning Life fucking sucks. You might be in a position where you have to go in a nursing home that's $500-$600 a day or $200k annual spend but your FI budget is only $100k, and you didn't buy long-term-care insurance to cover it. Maybe you only have a $2.5 million portfolio and those 5 years are going to suck $1m leaving $1.5m. After consulting with a well-qualified Elder law attorney the choice is made to pay the nursing home for 5 years, give away the rest of the assets after the [Medicaid Look-Back Period has passed](https://www.medicaidplanningassistance.org/medicaid-look-back-period/) and you preserved the remaining assets! You're now in a upscale nursing home that can't legally kick you out or legally reduce your quality of care with Medicaid footing the bill. Draining a substantial sized pre-tax account is really going to hurt badly tax wise. With a Roth account - not a dime of taxes are owed. [IRAs and Medicaid is a really thorny subject](https://www.irahelp.com/slottreport/can-you-lose-ira-medicaid) Too large of a pre-tax IRA = RMD income may never be qualified for Medicaid. Medicaid can attach to the RMDs. Likewise since a Roth never has RMDs all the assets are available to Medicaid. Most advice is clear though - generally, and I'm not a lawyer, but the best advice is to just spend it down per the above websites: >The simplest and safest way to do this is by transferring funds to others more than 5 years (60 months) before applying for Medicaid benefits. Such transfers escape Medicaid claims entirely. For my comfort zone, I much rather be 100% roth if I'm ever facing having to deal with a Medicaid nursing home situation. I'm really glad I'm 100% roth :). # Pre-Tax Advantages I gave up I want to conclude this post by listing some of the advantages pre-tax accounts have that I willingly gave up and alternative ways to deal with it for my situation: **Unable to withdraw earnings tax & penalty free until 59½** This is the biggest drawback for FI purposes for a Roth account is locking away your money where if you need to tap the Roth IRA it's treated as a Pre-Tax account. How I'm dealing with it instead - It's not as bad as people think! First of all, retirement accounts are the absolute LAST resort to touch regardless of needs. My taxable account is substantially larger than the Roth account. So any early year withdrawals will be low capital gains impact. You first withdraw your contributions from your Roth IRA, then conversion in the order of the conversion year. Backdoor roths are ALWAYS tax and penalty free, and taxable conversions are always tax free and penalty free after 5 years. You're only taxed on earnings for pre 59 1/2 withdrawals, [unless if they're qualified](https://www.irs.gov/publications/p590b#en_US_2021_publink100089543): >1. It is made after the 5-year period beginning with the first tax year for which a contribution was made to a Roth IRA set up for your benefit. >2. The payment or distribution is: >a. Made on or after the date you reach age 59½, >b. Made because you are disabled (defined earlier) >c. Made to a beneficiary or to your estate after your death, or >d. One that meets the requirements listed under First home under Exceptions in chapter 1 (up to a $10,000 lifetime limit). If you were affected by a qualified disaster, see chapter 3. (TL;DR of qualified disasters is earnings are still taxable with no 10% early penalty but you can spread the income over 3 years which greatly reduces the tax hit.) So yes, sadly the earnings portions of SEPP withdrawals of the Roth IRA will be taxed, so you might want to do a [Roth Conversion Ladder](https://www.investopedia.com/how-roth-conversion-ladder-works-5214808) until your desired income gets you to age 59½. Then past 59 1/2 you'll want to convert as much to a Roth as possible, perhaps going well past the $50k example the article has, before you start taking Social Security Retirement Income. **Qualified Charitable Distributions** Pre-Tax accounts can donate up to $100k directly to one or more charities to meet their RMD requirements. How I'm dealing with it instead - I'll be donating appreciated shares from my taxable account. Donating appreciated shares is mathematically superior already. You can donate up to 30% of AGI of long-term holdings AND you avoid incurring LTCG by doing so. It's win-win. Also my options trading gives a ton of STCG too! I plan to trade options until I become senile, so in my mind I can donate $100k of STCG anyways and get the identical tax benefit. I don't see the Qualified Charitable Distribution bonus to be compelling enough to keep a pre-tax account around in my situation. **Optimal Inheritance for Charities** No argument, Pre-Tax accounts are optimal to donate to charities. No federal taxes are due for charitable donations of pre-tax accounts at death AND no estate taxes! How I'm dealing with this instead - I still have my HSA pre-tax account. That is marked for charities. I'm investing it the most aggressively to optimize it. At the end of the day charities get just as huge as an impact from a taxable account donation and Roth IRA donation. I'm also doing all my giving while I'm living, which I've already shown above the taxable account is the optimal donation vehicle while alive. Yeah the step-up in basis reduces the benefits of taxable donation inheritance but it still lowers any estate taxes due. One can establish charitable remainder trusts of various kinds with taxable accounts that turns it into ordinary income and the charity gets the remainder! Likewise you can dodge incurring capital gains by gifting appreciated shares into the remainder trusts and getting a % donation impact based on actuarial values of how much the charity is expected to get in remainder. **Foreign Nations treat Roth IRA accounts as a Pre-Tax Account** This one really sucks. It's true - many foreign nations double tax Roth IRAs. How I'm dealing with it instead - I've done some excessive digging on this and for a few nations with a really competent local tax lawyer that's both versed in USA and the foreign nation law they might be able to reach an agreement with the foreign tax authority to treat Roth accounts as taxable accounts instead. So worst case is any sales will incur capital gains instead of distribution being taxed. There is a reason why TD Ameritrade and other brokerages keeps cost basis records of Roth IRA accounts and it's for reasons exactly like this! So keep really good records, and if I plan to move to a foreign country I plan to sell and re-purchase all my investments in my Roth before establishing tax residency! I also really don't see myself moving outside of the USA or living outside of the USA. I think with Roths becoming more and more common we might have more tax treaties in the future to fix these issues too. Be sure to write your senators if you really want to live abroad! Only The President along with 2/3rds Senators can establish and modify new treaties. Then people overlook one huge benefit of doing Roth conversions - if you renounce your USA citizenship after 59½ the [Roth IRA is tax free for exit taxes.](https://www.expatriationattorneys.com/roth-ira-expatriation-tax-exit/) Having a huge pre-tax account can also REALLY limits your flexibility to move abroad if people want to renounce USA citizenship to escape being taxed on your global wide income. Worst case a pre-tax account might be treated as all taxable income in the year you renounce your citizenship if the exit tax applies to you, which it does for $2m or more of net worth. My original FIRE target years ago was $2.5m net worth. On the other hand by now being 100% Roth I have a ton of expected tax free income - greatly lowering my tax burden. I really don't see any reasons to renounce my citizenship for tax reasons and a crap ton of disadvantages if I do! I love living in the USA, I love the travel flexibility of our passport, and we have the [7th most powerful passport in the world.](https://www.cnbc.com/2023/01/19/most-powerful-passports-henley-passport-index.html) If you really think about it we have [186 visa free destinations](https://en.wikipedia.org/wiki/Henley_Passport_Index) and Japan tops the most at 193. I don't really see any reason to get a Japan passport just to visit 7 more countries without paperwork! Those countries are: Venezuela, Bolivia, Belarus, Bulgaria(Americans just pay a fee on arrival, Japanese arrive no fee), Turkey(probably not a good time to visit), and a few Asian countries that Americans just pay fees/get e-visas/or visa on arrivals for. The USA also gets a few visa free countries Japan doesn't get Visa free access to. In all respects I love visiting and vacationing in tropical islands and the USA passport is actually stronger for that! We have Hawaii, Guam, Puerto Rico, the US Virgin Islands, American Samoa, and many foreign tropical islands don't require visas for US travelers but require visas on arrival for Japan. We also have visa-free and PASSPORT-FREE Palau access even though they're now a sovereign nation with proof of US Citizenship(drivers license + birth certificate), and no tourist visa required for US citizens visiting one year or less. So despite Japan being ranked as #1, for my interests I really value keeping my USA passport a lot more than switching it out for say a Japan passport. I love living in the USA. **Unable to rollover Roth-IRA assets to future employer 401ks/Solo 401ks** This is a huge drawback currently. Once in an Roth-IRA account you can never rollover it into a solo Roth-401k again or an employer Roth 401k plan. If the SECURE 2.0 act becomes law this issue is fixed. **Roth Future Tax Risks** Look - I can make the same arguments against pre-tax accounts. At one time we had a 70% upper federal tax bracket too. Boy that would hurt if you had to spend down assets for Medicaid at the time being. Pre-tax accounts also get hurt just as bad for sales taxes/VAT/so on if our government is greedy and DOESN'T reduce income taxes. Look at the EU/UK - its high income tax AND high VAT taxes! We can't predict the future. If you're worried about the tax future then 50% roth and 50% pre-tax is the only logical choice. However being FIRE focused, we are significantly living below our means. I'm living in a small home where property taxes is $4,000 a year and capped at 3% annual increases, AND property tax is computed on the home's replacement cost and not the market value of the home! My total housing payment WITH mortgage is $24k year, and FI for that is $600k which I'm already house-FI and lean-FI. In a worst case scenario I either pay off mortgage and live off $4k year + food costs, or relax with over 25 years of runway of cutting all other discretionary spending to the bone. I'm living by myself, I have 3 unused bedrooms and can get roommates at $500/mo/room. $24k spend just became $6k spend + food costs so lean-FI on $150k or less. Health insurance easily Medicaid or ACA subsidies, especially with being 100% roth. Paid off mortgage with 3 roommates = +$14,000 rental income each year. **I'm now FI just simply by owning a paid off home!** Seeking FIRE means you're adaptable and have a plan. We have tons of flexibility and privileges by being well off financially and being very financially and mathematically literate. We can handle any future tax issues that get thrown to Roth IRAs just fine. I feel really relieved having converted 100% of my pre-tax accounts to roth accounts. Look - if future proposed tax legislation bothers you - WRITE your senators. I wrote my senators about the above Roth IRA drawback of rolling over assets to future employer 401k Roth plans + Roth 401k RMD issues, and they were shocked as they were NOT AWARE of that drawbacks! They got it in the SECURE 2.0 act and will not forget this if it doesn't become law this year. I will not forget this issue either! I'm not afraid to give feedback about anything! I politely write people and things change - even my broker TD Ameritrade changes the % margin they take on various securities on Portfolio Margin as I ask them to review stuff as the percentage they're taking for margin isn't reflective of the actual risk! People are in the dark unless you appropriately communicate! :) **Roth 401ks are subject to RMDs** Just rollover it to a Roth IRA account. It was fixed in the secure 2.0 act should it become law where Roth 401ks will NOT be subject to RMDs. Again, I wrote my senators about this too! They could have made Roth IRAs subject to RMDs instead but they chose to align 401k plans instead, it's also a great sign that they really do care about preserving the tax benefits of Roth at this time! It's unlikely tax policy will drastically change in the next 10-20 years. That's why I don't feel stressed out about future taxes being 100% roth. **Fine grained taxable income control** On 12/31 every year you can know exactly to the penny your tax bracket is and make withdrawals from pre-tax accounts to optimize your tax brackets to the penny. How I'm dealing with it instead - Personally, I'm really freaking happy that I stayed in the 22% bracket and had an 18% effective tax rate doing my conversions. I'm personally happy to spend 12/31 with family instead of spreadsheets trying to squeeze every last penny of tax efficiency with "perfect" withdrawals/conversions! By finishing my Roth conversions I don't have to analyze it anymore **for the rest of my life.** I can't express enough how amazing it feels to have Roth converted everything! It's freed up so much analyzing for me and I'm just really happy living life instead! #TL;DR **I have zero regrets converting 100% of my pre-tax accounts to Roth accounts!**

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