My company's 401k plan is in something called a VIP account. There are different funds available to invest in and the VIP account can have pretax, after tax, and Roth money in it. I can perform a Roth conversion on any of those and it will stay in my VIP account. They literally just re-designate the converted amount as Roth, I’m given a statement and then I’m responsible for the taxes on the conversion at tax time. No changing of funds or anything. So, due to their low management fees and no other fees in terms of managing the accounts I’m probably going to leave all my money there.
I hadn’t ever really considered Roth conversions because it makes no sense while working, I’m in too high a tax bracket, and didn’t think it would work after retirement. Then I got exposed to various retirement planning tools such as Pralana and New Retirement. Thank you! NR is too much of a black box for my liking but it does get you in the ballpark.
So, I’m trying to investigate Roth conversions in Pralana and I’m struggling a little with how to set up the Asset Allocation page which uses my Asset Classes to determine an overall real ROR for each account. I’m trying to figure out how to translate my Boeing VIP account to Pralana’s Asset Classes and Asset Allocation pages. Knowing I’m doing a Roth conversion, I’m thinking I need to put something in the Roth column on the Asset Allocation page to get a reasonable ROR for the Roth account. When I first tried an optimization, I had nothing in the Roth column and the optimization routine always stated I should not do a Roth conversion. When I did make an entry in the Roth column, then all of a sudden optimization seems to be a good thing and a real eye opener as well. I can now see how this saves on taxes after my Social Security kicks in and in one scenario I tried, it eliminated my RMDs. Very interesting.
With that said, I’m basically unsure of the right way to model my VIP account in PRC and would appreciate some guidance.
In addition to that, I can’t say I know with 100% certainty that I know where those Roth conversions made through the optimization in the spreadsheet go. I’m thinking they end up being considered as “Regular” investments, like excess cash after the maximum cash limit, but it’s just a guess. And then my brain goes back to the Roth column in the Asset Allocation Table and I think something needs to go there.
My other, potentially related problem is the interactions between the Asset Class Table and the Asset Allocation Table. Maybe I’m trying to “over use” the tool but it allows for detail so I’m trying to be detailed as I’ve noticed that when planning 30 years out, small percentage changes can make a big difference. And I don’t mind detail. Can I get some guidance on the proper way to use these tables, including specification of management fees? The Asset Allocation Table only allows those fees to be entered at the account level but the management fees on my VIP Account are more at the asset level than the account level. So I’m not exactly sure how to enter everything other than doing some other math to average the management fees based on how much is in each account.
I suspect I just need my thinking straightened out but I need some guidance as to what the tool does for Roth conversions and what to enter for the percentages in the Roth column. Maybe they reflect the same that is entered in the other columns so the optimization rebalancing keeps the percentages in the right places? That would be assuming that’s what the optimization does…
The first thing is to realize that PRC cannot necessarily model the exact account structure that every user has in the real world. PRC is highly flexible but it’s a generalized model and you will have to do some translations to set it up so that it will model your specific situation. PRC models cash accounts, regular investment accounts, his and her tax-deferred (TD) accounts and Roth accounts, and so on, but there is definitely no such thing (in PRC) as an account that is both TD and Roth. So, you’ll need to model your Boeing VIP account as two separate accounts, one that’s TD and another that’s Roth. Each of those accounts will hold separate assets (things such as money markets funds, stocks and bonds). On PRC’s Financial Assets > Asset Classes (FA > AC) page you can define your asset classes and the associated rates of return (ROR). On PRC’s Financial Assets > Asset Allocation (FA > AA) page you can define how these assets are mapped to your TD and Roth accounts (i.e., what percentage of the account is allocated to each asset class). PRC will then use this information to calculate an aggregate ROR for each account and use it for making future projections.
You’re really asking about Roth conversions and are unsure of where the money goes when doing one, so let’s clear that up before proceeding any further. When you do a Roth conversion, you’re simply moving money from a TD account to a Roth account. This is a taxable event (all converted funds are taxed as ordinary income in the same tax year) but it will reduce your RMD’s (because of the reduced balance in the TD account) which are also taxed as ordinary income. So, there’s a trade-off between higher taxes at the time of the conversion and reduced taxes from then on due to lower RMD’s. Another consideration is that money in a Roth account has more spending power than money in a TD account because all money in a Roth account is after-tax money whereas all money (except for after-tax contributions) in a TD account is before-tax money. Evaluating that trade-off is fundamentally what PRC helps you do with its Plan Roth Conversions page.
With that said, though, for you to evaluate Roth conversions it is crucial that you specify the initial balance and the asset allocations for the Roth account. If you leave this blank, then your Roth account will have an effective ROR of zero and that will definitely not result in any good results from a Roth conversion (because it’s an apples vs. oranges comparison, as you observed in your experiments). As a simple starting point that will reduce the evaluation of Roth conversions to taxation differences, you should probably use the same asset allocations for the Roth account that you use for your TD account. This will result in the same ROR for each account and remove ROR differences from the evaluation of the Roth conversion.
You also asked for clarification on what the Roth optimization process does. It starts by establishing a projection baseline with no Roth conversions, and then (using the tax-bracket-restricted mode and both husband and wife TD accounts) automatically runs through every combination of % of account and maximum marginal tax bracket to determine which set of parameters yields the largest total savings balance at the end of the modeling period (i.e., the latest life expectancy). If this result is better than the baseline, PRC reports that a Roth conversion appears to be beneficial; otherwise, it reports that a Roth conversion is not recommended.
The final topic that you raised is management fees. PRC’s design puts management fees at the account level rather than the asset level. You’ll just have to do some math outside of PRC to select the best rate for that at the account level.
