Why do I see mixed results in tax lab?

Tax Lab provides four ways to evaluate a withdrawal strategy.

1. Average effective tax rate
2. Total taxes paid
3. Total net income
4. Total net legacy

While #1 and #2 will move together (if one is better or worse, the other will be too), #4 can sometimes move in an opposite direction, especially when running a "How can I spend $X, net of tax?" plan. You may see this in the Tax Lab > Compare > Statistics section of the software, as in this example, which compares an aggressive Roth conversion strategy (targeting the 35% Federal ordinary income tax bracket) to a Taxable, Tax-Deferred, Tax-Free ordering of withdrawals (with no Roth conversions).

The first question is, how should this be interpreted? It looks like the Roth conversions save on total taxes but actually produce a loss in legacy. In interpreting the estimated results of a withdrawal strategy, it's important to remember that, while #1 and #2 are helpful and worthwhile to know and evaluate, all measurable dollar advantages to a strategy find their way to #3 and #4. So, in this case, the worse net legacy for the Roth conversion strategy counts against it, even though it is produced with lower taxes along the way. In other words, it doesn't look like this is a good strategy. (In this example, there is no difference in total net income because this is a "How can I spend $X, net of tax?" plan. In a plan like this, net spending is held constant, no matter the withdrawal strategy.)

Still, we might wonder how this could happen. How could lower taxes lead to a worse net legacy? The answer here is that the Roth conversion strategy is too aggressive. Yes, it saves on overall taxes, but in paying those taxes early in the plan, it deprives the plan of the growth of the assets that are used to pay the taxes. Over time, that's enough to tip the scales against these aggressive Roth conversions. 

The asset level at the end of the plan is lower than it would have been if more taxes had been paid over a longer period in the plan, but more assets had been left to grow. This is true even though, in the Roth conversion plan, all plan assets are received without tax. The other plan has a higher estimated net legacy, even though some of the assets are in an IRA, and so result in quite a high tax bill to the heirs. This sort of analysis is quite complex, because it requires accounting for taxes paid, RMDs, and much more.

It turns out that with this plan, Roth conversions can provide value, but they need to be done less aggressively. Targeting the 24% Federal ordinary income tax bracket results in less of a tax savings during the plan, but a much higher estimated net legacy - swing of over $1million.

The lesson here is that, while paying less in taxes is better, all things being equal, it's important to first focus on net income and net legacy in evaluating strategies, because those are the places where money can actually be spent.