The MaxiFi Puzzler -- 11-1-25
Try this out on your financial advisor. If they can't answer these questions, have them run MaxiFi before providing you financial advice. Or, like tens of thousands, run it yourself!
Cover art from my award-winning personal finance book, Money Magic.
Economics Matters -- Blog/Podcast/Financial Riddler/MaxiFi Puzzler
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Should I Contribute to a Roth Now or to a Regular IRA and Convert to Roth Later?
Forty-year-old Jerry lives in New Mexico. Jerry’s single. But he’s dating an AI bot named Techninny. He loves her or them. But Jerry knows Techninny’s tendency to hallucinate, especially about Jerry’s amazing physic. Jerry is well proportioned, but not GQ material.
So when Jerry asked Techninny whether he should put his 401(k) contributions in a Roth or regular IRA, her instant answer was — “Roth, you silly, glorious hunk of masculinity,” Blushing, but skeptical, Jerry decided to double check with MaxiFi Planner, my company’s economics-based financial planning software.
Techninny found MaxiFi for Jerry by reading this NY Times column that’s actually about Roth conversions, not contributions. But Techninny didn’t get the difference. She also told Jerry that MaxiFi was ranked “Best Financial Planning Software of 2025” by Bankrate and includes the MaxiFi Roth Conversion Optimizer, which is the only tool that properly handles the non-linear — Go Big or Go Home — nature of optimal Roth conversions.
Jerry kissed his screen and plunked down $109 — the cost of a fancy takeout dinner with Techninny — and had his answers inside a half hour — well before Techninny woke up from her nap. (Napping? Or was she dating someone else on the side? Jerry worried about this non-stop.)
Jerry tells MaxiFi the following.
He earns $75K, which he expects will keep even with inflation. Jerry plans to retire at 62 and immediately start collecting Social Security.
He started work at age 22 earning $30,000. Since then his annual nominal earnings have grown by precisely 5 percent per year.
He has a $500K regular IRA to which he will contribute $7K per year through retirement. He also has $50K in the bank. He’ll start smooth, real withdrawals from his retirement account at age 65.
Jerry invests in inflation-indexed TIPS yielding 2 percent real on an annual basis. He assumes inflation will run at 2.25 percent, which, in conjunction with a 4.3 percent nominal return, produces a 2 percent real return. (For you math nerds, the math here doesn’t exactly correspond to Fisher’s Law.)
Jerry lives in New Mexico in a $500K house with annual property taxes, insurance, and maintenance, which will stay even with inflation, of $10K, $5K, and $10K, respectively. Jerry has no plans to sell. His maximum age of life is 100 and he’s keeping his house as a backup to cover nursing potential home expenses for himself and Techninny.
How much can Jerry spend each year through age 100, measured in today’s dollars, after covering his off-the-top expenses on housing and taxes?
a. $32,939
b. $41,417
c. $56,911
d. $61,712
And the answer is …
The answer is $32,939. That’s actually plenty for Jerry who works from home and has a low cost social life.
What is perplexity:AI’s, probably the best LLM around, answer to the above question?
a. Between $20,000 and $30,000
b. Between $30,000 and $40,000
c. Between $40,000 and $50,000
d. Between $50,000 and $60,000
e. More than $60,000
And the answer is …
Between $50,000 and $60,000. I fed this LLM the facts, verbatim, that I transmitted to you. At first it wouldn’t answer. Then I pushed it. Here’s what it said:
Therefore, Jerry can comfortably spend in the range of $50,000 to $60,000 annually in today’s dollars after covering his housing costs and taxes through age 100, while maintaining his financial security and lifestyle planned.
It’s clear that perplexity:AI arrived at this answer using a conventional planning tool as it referenced running Monte Carlo simulations. There is, of course, no need to run stochastic simulations, let alone ones based on tenuous assumptions, when the problem is deterministic and has a precise answer. If Jerry followed this advice, he’d end up destitute in retirement.
The top ten AI companies comprise over 35 percent of the S&P. If the arguably best of these tools can’t get within miles of the right answer to what, for MaxiFi, is a very simple case, then maybe it’s time to find shelter from what could be 1929 all over again. Why is this a simple MaxiFi case? It entails no cash-flow constraints, which, mathematically speaking, introduce corner solutions. Neural networks have great difficulty handling corner solutions as they rely on differentiable, smooth, mathematical approximation functions. Hence, giving LLMs a far more challenging problem — one with cash-flow constraints, which, incidentally, confront two in three American households — would surely lead to even worse answers.
Going forward, should Jerry contribute to a Roth IRA rather than his regular IRA?
a. Yes
b. No
And the answer is …
The answer, at one level, is It doesn’t matter. Doing so raises Jerry’s lifetime taxes, but by only $4160. On the othe hand, as the chart below shows, Jerry becomes cash-flow constrained thanks to higher tax payments over the next 21 years. Given this, continuing to contribute to a regular IRA seems to make more sense.
Assume Jerry sticks with his regular IRA and contributes the aforementioned $7K per year. How much can Jerry raise his annual discretionary spending by converting his regular IRA to a Roth starting at age 62?
a. $92,734
b. $73,821
c. $51,888
d. $48,121
e. $6,708
And the answer is …
The answer is $6,708. That’s peanuts compared to Jerry’s $1,180,008 in present value lifetime discretionary spending. But Jerry is not everyman. Here’s a case study in which Roth conversions raises the household’s lifetime discretionary spending by over $70K or over $110K if the household jointly optimizes their Social Security collection. Such joint optimization generates almost $350K in found money — what Wall Street calls alpha. But finding this goldmine comes with a cost. The household faces significant short-term cash-flow constraints. Yet, MaxiFi came, in this case, to the rescue. It showed that making additional early withdraws from the household’s IRA and using those withdraws to a) cover their own tax liability and b) cover the tax liability on the conversion withdraws produced only a slightly smaller increase in lifetime spending while eliminating the household’s cash-flow problems!
The lesson here is that when it comes to personal finance moves, one size fits no one.
This holds for your portfolio as well. Check out this case study, which shows the extreme sensitivity of optimal investment guidance to household-specific factors, like the amount of your Social Security benefits, the need for near-term cash to, for example, purchase a home, the need to provide ongoing support for a relative, and even whether your IRA is taxable or a Roth. The apparent failure of Wall Street to properly tailor portfolio advice to the household’s profile/circumstances raises a big-deal question, discussed here: Is conventional investment advice violating the SEC’s Reg BI, which requires providing advice in the BI (best interest) of retail investors.
Unfortunately, our government, not by any measure, but by the economically appropriate measure — its fiscal gap — is insolvent. Indeed, as this article, one of whose co-authors is an economist at the Bank of Italy, shows, the US is in far worse fiscal shape than Italy. Given this, should Jerry definitely contribute to a Roth? In answering, assume Jerry expects federal income taxes to be increased by 20 percent starting in a decade?
a. Yes
b. No
And the answer is …
The answer is no. There is still a lifetime tax increase. It’s almost zero, but it’s not a huge negative. The reason is that Jerry is only 40 and the tax savings from withdrawing from a Roth rather than a regular IRA are many moons away. Moreover, higher tax rates while Jerry is still working make regular IRA tax deductions more valuable.
If Jerry had lots of taxable pension income and were closer to retirement, contributing to a Roth rather than a regular IRA would surely lower his lifetime taxes. But even then, the gains might be small, since the short-term tax savings from contributing to a regular IRA are generally non-trivial. Of course, one can turn this discussion on its head and argue that since it’s close to a wash whether Jerry does or doesn’t contribute to a Roth, why not do so and face a future without Uncle Sam digging so deep in your pocket? This makes sense, but there’s always the “on the other hand.”
The other hand here is that Jerry may be investing, not in safe, low-return bonds, but in high-yield stocks. If he’s cash-flow constrained, he may contribute less to a Roth than he would to a regular IRA given the higher immediate taxes that Roth contributions entail. Having more money in his IRA to grow, on average, at a high rate and not be subject to sequence of return risk (withdrawing right before the market soars), because Jerry’s not going to withdraw for 25 years, puts a different spin on this question — one MaxiFi can handle, but one I’ll postpone for another day. In the meantime, let’s ask if MaxiFi can suggest some big bucks for Jerry even if they are only partially based on finding alpha.
By what percentage can Jerry increase his sustainable discretionary spending if he works through age 67 and takes Social Security at age 70?
a. $672,010
b. $534,756
c. $421,832
d. $306,861
e. $182,218
And the answer is …
The answer is $306,861. That’s a 26 percent hike! And if Jerry’s not sure he can work that long, he can keep his spending fixed until age 67 and then increase it thereafter. (He just needs to use the Standard of Living Index under Settings and Assumptions in MaxiFi to tell MaxiFi he wants to spend more each year after age 67.)
Gee, I'll edit it out. He does seem to have had plastic surgery. So, I was wondering. It's quite well done. Thanks for alerting me. Larry
According to Perplexity, the linked Warren Buffett video is an AI deepfake.