This document is an addendum to the Roth IRA Conversion Analyzer User Manual. This addendum should help you understand how the program calculates data and arrives at its results. The listed items refer to the column headings of the various reports generated by the program.
No Conversion: Asset Analysis
This report shows an analysis of your client’s assets, assuming no conversion to a Roth IRA occurs.
Ordinary IRA Beginning Value
In the first year of the analysis, the starting value of the IRA is the same as the IRA Balance entered on the main input screen. In subsequent years, it equals the previous year’s ending value. This value does not appear in the report.
Ordinary IRA Ending Value
This is the balance of the Ordinary IRA at the end of each year. It assumes distributions are made at the end of each year. The ending value of the Ordinary IRA is calculated as follows:
Ending Value = Beginning Value + Contributions + Growth - Distributions – Conversion Amount
Ordinary IRA Growth
Growth in the Ordinary IRA is tax-free. It is calculated using the growth rate entered on the main input screen. Because distributions, contributions, and Roth IRA conversions happen at the beginning of the year, the growth is applied to the balance after these amounts have been taken into account. The formula, therefore, would be
Growth = (Beginning Value – Beginning of Year Distribution + Contribution – Conversion Amount) * Growth Rate
The Ordinary IRA Growth value does not appear in the report.
Other Assets Beginning Value
The beginning value of the Other Assets in the first year of the analysis is the same as the Other Assets value entered on the main input screen. In subsequent years, it simply equals the previous year’s ending value. In cases where taxes are paid from Other Assets, but no Other Assets are entered, the program sets the Other Assets beginning balance as the minimum amount of money required to pay the conversion taxes. This value does not appear in the report.
Other Assets Ending Value
Any IRA minimum distributions not being used to pay desired income are reduced by income taxes (if appropriate) and reinvested in the Other Assets. This happens at the beginning of each year. For the purposes of the following formula, we’ll refer to this distribution amount as "Net IRA Distribution".
Ending Value = Beginning Value + Contributions + Growth + Net IRA Distribution –Distributions + Tax Savings from IRA Contribution
Other Assets Growth
The Other Assets grow at the growth rate specified on the main input screen, and the growth is taxed. The program only reports the net growth value, not the pre-tax growth. Growth is calculated based on the balance at the beginning of the year, plus any contributions made at the beginning of the year, minus any distributions made at the beginning of the year.
Growth = (Beginning Value + Contributions + Net IRA Distribution – Beginning of Year Distribution) * Growth Rate
The Other Assets Growth value does not appear in the report.
Contributions to Other Assets
When you indicate contributions to IRAs at a time when those contributions are not possible, the contributions are made (at the beginning of each year) to the Other Assets. The specific value is not shown in the report.
Present Value of Future Distributions
The Asset Analysis report assumes the owner and spouse have both died by the end of each year. In most cases, the remaining non-spousal beneficiary does not have to take the IRA Assets out of the plan all at once, but instead can take them out slowly over his or her remaining life expectancy. The program assumes that the remaining non-spousal beneficiary takes full advantage of this deferral when you check "Adjust After-Tax Assets for Growth after Death" (which is recommended). To include this value in the Net After Tax Assets result, the program replaces the IRA Ending Value with the present value of all the future distributions that the remaining nonspousal beneficiary will take (the Present Value of Future Distributions).
The Present Value of Future Distributions is calculated by projecting that the plan will continue to grow, and that distributions will be taken as slowly as possible until the plan balance is entirely consumed. The distributions are calculated by using the minimum distribution method. Each distribution amount is then netted for income taxes. Finally, the program adds the present value of each net distribution together. The present value calculation is done using the Discount Rate that you enter on the main input screen.
Estate & Inheritance Taxes
Estate Taxes are calculated using the current estate tax tables. The program does incorporate the latest changes from the Taxpayer Relief Act of 1997. The Taxable Estate is assumed to be:
Taxable Estate = Other Assets Ending Value + Ordinary IRA Ending Value – Spousal Credit
If you have a non-spousal case, or have unchecked Adjust Taxable Estate for Marital Trust on the Taxes Window, the Spousal Credit will be assumed to be $0.
Net After-Tax Assets
For a spousal case, this is the value that the spouse’s beneficiary would receive assuming the IRA owner and the owner’s spouse were to die by the end of each year. For a nonspousal case, this is the value the beneficiary would receive assuming the IRA owner were to die by the end of each year.
If "Adjust After-Tax Assets for Growth After Death" is checked, the equation for the Net After Tax Assets would be:
Net After Tax Assets = Other Assets Ending Value + Present Value of Future Distributions – Estate & Inheritance Taxes
If "Adjust After-Tax Assets for Growth After Death" is not checked, the equation would be:
Net After Tax Assets = Other Assets Ending Value +Ordinary IRA Ending Value – Income Tax on Ordinary IRA – Estate & Inheritance Taxes
Tax Savings
When you indicate (in the Taxes Window) that Ordinary IRA contributions generate tax savings, the program invests the amount of taxes that would have been caused by any IRA contributions in Other Assets. These savings are treated as end-of-year contributions to the Other Assets. The specific value of these savings is not on the report.
No Conversion: Distributions
This report shows an analysis of the distributions coming out of the Ordinary IRA, assuming no conversion to a Roth IRA occurs.
Ordinary IRA Beginning Value
In the first year of the analysis, the beginning value of the IRA is the same as the IRA Balance entered on the main input screen. In subsequent years, it equals the previous year’s ending value.
Life Expectancy
This is the life expectancy number used by the program to calculate the required minimum distribution from the Ordinary IRA. Before the assumed death of the client, this calculation is based on the ages of the client and the beneficiary (if there is one). For spousal cases, the ages of the spouse and child (if there is one) are used after the date of the assumed death of the client. For more details about this calculation, please see the description of the Minimum Distributions Calculations in the user manual.
Ordinary IRA Distribution
The Ordinary IRA Distribution is never smaller than the required minimum distribution. The required minimum distribution is calculated by dividing the Beginning Value by the calculated Life Expectancy. When you indicate that Desired After-Tax Income is paid out of the Ordinary IRA, the distributions are calculated large enough to pay the specified distribution plus any taxes on that distribution. Minimum distributions and distributions to pay income are taken at the beginning of the year. Distributions needed to pay Conversion Tax are taken at the end of the year. In conversion cases where there is a distribution needed from the Ordinary IRA in 1998, the program makes this distribution before converting the Ordinary IRA to a Roth IRA. This value will only appear if such a distribution is needed.
Income Tax
The income tax on the Ordinary IRA Distribution can be calculated using either a tax rate or a calculated AGI (depending on the Method of Calculating Income Taxes selected on the Taxes Window). If a tax rate is used, the income tax equals the entered Income Tax Rate multiplied by the taxable portion of the Ordinary IRA Distribution. If the AGI method is being used, the income tax is calculated as the amount of tax generated by the taxable portion of the Ordinary IRA Distribution. See the discussion of Calculating Income Tax using the AGI below for more details about this approach.
In many cases, the entire Ordinary IRA distribution will not be taxable. If there is a nondeductible balance in the IRA, only a portion of each distribution will be taxable until that nondeductible balance is entirely distributed. The total amount of nondeductible contributions is entered on the Taxes Window. To calculate the taxable portion of the distribution, use the following formula:
Taxable Portion = Distribution * [1-(Balance/Nondeductible)]
Federal Estate Tax is taken upon the death of the IRA owner (or spouse in a spousal case). When this happens, another deduction is created for the amount of Federal Estate Tax attributable to the Ordinary IRA balance. This additional deduction further modifies the formula as follows:
Taxable Portion = Distribution * [1 - (Balance/Nondeductible Balance)] * [1 - (FET Attributed to IRA/ Balance at Death of Owner)]
Distribution From Other Assets
There are no required distributions from the Other Assets. Instead, money is only distributed to pay taxes and income. Income is taken at the beginning of each year. Conversion taxes are paid at the end of each year. Money taken to pay the estate tax is taken at the beginning of the year following the deaths of the owner and spouse.
Net Cumulative Distributions
This is the total of all after-tax IRA distributions made through each year. If you are viewing inflation-adjusted results, this number is the total present value (after-tax) of all IRA distributions made up to this point.
Roth IRA Conversion: Asset Analysis
This report shows an analysis of your client’s assets, assuming a Roth IRA conversion has occurred.
Roth IRA Beginning Value
The Roth IRA always starts with a $0 beginning value. In subsequent years, it simply equals the previous year’s ending value. This value does not appear in the report.
Roth IRA Ending Value
This is the value of the Roth IRA at the end of each year. The ending value of the Ordinary IRA is calculated as follows:
Ending Value = Beginning Value + Contributions + Growth Conversion Amount – Distributions
Roth IRA Growth
Growth in the Roth IRA is tax-free. It is calculated using the growth rate entered on the main input screen. Because distributions, contributions, and Roth IRA conversions happen at the beginning of the year, the growth is applied to the balance after these amounts have been taken into account. The formula, therefore, would be:
Growth = (Beginning Value – Beginning of Year Distribution + Contribution + Conversion Amount) * Growth Rate
The Roth IRA Growth value does not appear in the report.
Other Assets Beginning Value
The starting value of the Other Assets in the first year of the analysis is the same as the Other Assets value entered on the main input screen. In subsequent years, it simply equals the previous year’s ending value. In cases where taxes are paid from Other Assets, but no Other Assets are entered, the program sets the Other Assets beginning balance as the minimum amount of money required to pay the conversion taxes. This value does not appear in the report.
Other Assets Ending Value
Any IRA minimum distributions not being used to pay desired income are reduced by income taxes (if appropriate) and reinvested in the Other Assets. This happens at the beginning of each year. For the purposes of the following formula, we’ll refer to this distribution amount as "Net IRA Distribution".
Ending Value = Beginning Value + Contributions + Growth + Net IRA Distribution - Distributions + Tax Savings from IRA Contributions
Other Assets Growth
The Other Assets grow at the growth rate specified on the main input screen, and the growth is taxed. The program only reports the net growth value, not the pre-tax growth. Growth is calculated based on the balance at the beginning of the year, plus any contributions made at the beginning of the year, minus any distributions made at the beginning of the year. This value does not appear in the report.
Growth = (Beginning Value + Contributions + Net IRA Distribution – Beginning of Year Distribution) * Growth Rate
Contributions to Other Assets
When you indicate contributions to IRAs at a time when those contributions are not possible, the contributions are made (at the beginning of each year) to the Other Assets. This value does not appear in the report.
Present Value of Future Distributions
The Asset Analysis report assumes the owner and spouse have both died by the end of each year. In most cases, the remaining non-spousal beneficiary does not have to take the IRA Assets out of the plan all at once, but instead can take them out slowly over his or her remaining life expectancy. The program assumes that the remaining non-spousal beneficiary takes full advantage of this deferral when you check "Adjust After-Tax Assets for Growth after Death" (which is recommended). To include this value in the Net After Tax Assets result, the program replaces the IRA Ending Value with the present value of all the future distributions that the remaining nonspousal beneficiary will take (the Present Value of Future Distributions).
Roth IRA Taxes At Death
This is the amount of income tax that would be due if the owner and spousal beneficiary (if applicable) were to die by the end of the current year. The Asset Analysis Report and the Net After Tax Assets result assume that the client and spouse both have died by the end of each year. In this case, there may be taxes due on the Roth IRA balance. If the owner dies during the four-year spread out of the Roth IRA taxes, the rest of the taxes are immediately due. Also, if the Roth IRA balance is being distributed (because you did not check "Adjust After-Tax Assets for Growth After Death" on the main input screen) during the first five years of a conversion, the Roth IRA Growth up to that point gets taxed. See the description of Roth IRA Conversions in the Calculations section of the user manual for more details on the calculation of income tax on Roth IRA Growth.
Estate & Inheritance Taxes
Estate Taxes are calculated using the current estate tax tables. The program does incorporate the latest changes from the Taxpayer Relief Act of 1997. The Taxable Estate is assumed to be:
Taxable Estate = Other Assets Ending Value + Ordinary IRA Ending Value + Roth IRA Ending Value – Spousal Credit
In the case of 100% Roth IRA Conversion, the Ordinary IRA Ending Value is $0. Finally, if you have a non-spousal case, or have unchecked Adjust Taxable Estate for Marital Trust on the Taxes Window, the Spousal Credit will be assumed to be $0.
Net After-Tax Assets
For a spousal case, this is the value that the spouse’s beneficiary would receive assuming the IRA owner and the owner’s spouse were to die by the end of each year. For a nonspousal case, this is the value the beneficiary would receive assuming the IRA owner were to die by the end of each year.
If "Adjust After-Tax Assets for Growth After Death" is checked, the equation for the Net After Tax Assets would be:
Net After Tax Assets = Other Assets Ending Value + Present Value of Future Distributions – Roth IRA Taxes at Death – Estate & Inheritance Taxes
If "Adjust After-Tax Assets for Growth After Death" is not checked, the equation would be:
Net After Tax Assets = Other Assets Ending Value + Roth IRA Ending Value + Ordinary IRA Ending Value – Income Tax on Ordinary IRA - Unpaid Roth IRA Taxes at Death – Estate & Inheritance Taxes
In the case of 100% Roth IRA Conversion, the Ordinary IRA Ending Value is $0. Also, the Income Tax on the Ordinary IRA value is $0.
Tax Savings
When you indicate (in the Taxes Window) that Ordinary IRA contributions generate tax savings, the program invests the amount of taxes that would have been caused by any IRA contributions in Other Assets. These savings are treated as end-of-year contributions to the Other Assets. This value does not appear in the report.
Roth IRA Conversion: Distributions
This report shows an analysis of the distributions coming out of the Roth IRA, assuming a conversion to a Roth IRA has occurred.
Roth IRA Beginning Value
The Roth IRA always starts with a $0 beginning value. In subsequent years, it simply equals the previous year’s ending value.
Roth IRA Ending Value
This is the value of the Roth IRA at the end of each year. The of the Roth IRA Ending Value is calculated as follows:
Ending Value = Beginning Value + Contributions + Growth + Conversion Amount – Distributions
The Roth IRA Ending Value does not appear in the report.
Conversion Amount
The Conversion Amount is the total amount converted from the Ordinary IRA. Distributions from the IRA are taken before the conversion is done, so the Conversion Amount formula is:
Conversion Amount = (Ordinary IRA Beginning Balance – Beginning of Year Ordinary IRA Distribution) * Percent to Convert
Roth IRA Life Expectancy
This is the life expectancy number used by the program to calculate the required minimum distribution from the Roth IRA. There is no minimum required distribution until the death of the IRA owner. For more details about this calculation, please see the description of Roth IRA Conversions in the Calculations section of the user manual.
Roth IRA Distributions
The Roth IRA Distribution is paid out each year. The Roth IRA Distribution is never smaller than the required minimum distribution. The minimum distribution requirement starts on the owner’s (or the owner’s spouse, in the case of a rollover) date of death and is calculated based on the beneficiary’s life expectancy. When you indicate that Desired After-Tax Income is paid out of the Roth IRA, the distributions are calculated to be large enough to pay the specified distribution. Minimum distributions and distributions to pay income are taken at the beginning of the year. Distributions needed to pay Conversion Tax are taken at the end of the year.
Distributions From Other Assets
There are no required distributions from the Other Assets. Instead, money is only distributed to pay taxes and income. Income is taken at the beginning of each year. Conversion taxes are paid at the end of each year. Money taken to pay the estate tax is taken at the beginning of the year following the deaths of the owner and spouse.
Conversion Tax
When the Conversion Tax is spread out over four years, as it can be for 1998 conversions, the tax in each year equals the amount of tax charged on one fourth of the taxable portion of the conversion. The taxable portion of the conversion is calculated in the same manner as the taxable portion of an Ordinary IRA distribution. If additional money is taken out of the Roth IRA during the four years of the spread out, the payment of conversion taxes is accelerated.
Penalty on Distribution, Income Tax
For details, see the description of Roth IRA Conversions in the Calculations section of the user manual.
Net Cumulative Distributions
This is the total of all after-tax IRA distributions made through each year. If you are viewing inflation-adjusted results, this number is the total present value (after-tax) of all IRA distributions made up to this point.
Comparison Report
This report shows a comparison of not converting the Ordinary IRA and converting some or all of it to a Roth IRA. The report is broken into two sections, No Conversion and 100% Roth IRA Conversion.
No Conversion
Net Cumulative Distributions
This is the total of all after-tax IRA distributions made through each year. If you are viewing inflation-adjusted results, this number is the total present value (after-tax) of all IRA distributions made up to this point.
Net After-Tax Assets
For a spousal case, this is the value that the spouse’s beneficiary would receive assuming the IRA owner and the owner’s spouse were to die by the end of each year. For a nonspousal case, this is the value the beneficiary would receive assuming the IRA owner were to die by the end of each year.
100% Roth IRA Conversion
Cumulative Distributions
This is the total of all distributions made from the IRAs through each year. If you are viewing inflation-adjusted results, this number is the total present value of all distributions made up to this point.
Increase in Distributions
This is the percentage increase in the amount of cumulative after-tax distributions received caused by converting to a Roth IRA in 1998.
Net After Tax-Assets
For a spousal case, this is the value that the spouse’s beneficiary would receive assuming the IRA owner and the owner’s spouse were to die by the end of each year. For a nonspousal case, this is the value the beneficiary would receive assuming the IRA owner were to die by the end of each year.
Increase in Net Assets
This is the percentage increase in the net after-tax assets caused by converting to a Roth IRA.
Calculating Income Tax Using the AGI
The tax due on a particular amount of income is calculated by subtracting the tax that would have been paid if that income did not exist from the tax that would be paid with that income. The result of this subtraction gives us the amount of income tax generated by the amount of income in question. When doing this calculation for several sources of income, it is important to apply the income in the same order to the AGI – otherwise income will be taxed at incorrect brackets.
For example, assume your base AGI is $100,000 and you are trying to find the tax caused by an additional $30,000 in income from an Ordinary IRA, and an additional $50,000 in income coming from a paycheck. Your total AGI is $180,000. The income tax on the first $30,000 could be expressed as "Tax on $30,000 = (Tax on $130,000 – Tax on $100,000)" and the income tax on the $50,000 could be expressed as "Tax on $30,000 = (Tax on $150,000 – Tax on $100,000)" – but this would be incorrect. Doing the calculation in the above manner would result in the $50,000 being taxed at a tax bracket which is too low.
The correct calculations would be:
Tax on $30,000 = (Tax on $130,000) – (Tax on $100,000)
Tax on $50,000 = (Tax on $180,000) – (Tax on $130,000)
Doing the calculations in this manner would result in the correct tax amounts.