Tax Penalty for Roth Withdrawals

This was a message to my accountant. I was making sure they have my basis in my Roth IRAs accurate so I can do penalty free withdrawals before retirement equal to the contributions, conversions, and rollover basis. I also said I didn’t mind potentially exceeding that later and doing penalized withdrawals. This email shows my reasoning and I wonder if anyone sees something I am missing.

I hear you! I love the Roth IRAs and will continue to cram as much into them as I can and avoid spending out of them. I would only spend out of them if I have run out of income or taxable funds. I think we are on the same page there. However, I think we could potentially get into a scenario some years where we have spent our taxable funds down to zero. So I want to make sure the basis is clean and usable.

All that said, the leveraged ETF algorithms I do with high turnover strategies benefit so much from the Roth IRAs that it still makes more sense to use the Roth and have withdrawal penalties than to use a taxable account. Over the last 4.5 years or so I have had an annualized return of about 30%. Hopefully I can still get high returns in the future, but the math seems to still work even assuming a 10% return.

For example, I’m going to assume a tax rate of 25%, a portfolio turnover per year of 100%, and an annualized rate of return of 10%. Funds held in a taxable account would have a net tax drag of about 2.5% per year on the portfolio (25%*10%). In a roth it would be 0%. However, say I did want to spend 4% of the portfolio some years. That would be a drag of 1.4% tax but only on the years a withdrawal is made (4%*10% +4%*25%). Of course that is super simplified but maybe that helps explain my thinking. If you do see something I’m missing by all means I want to hear it.

Seems to make sense, following to hopefully hear from someone who’s done this or knows exactly.