To convert or not to convert to a Roth
I have a client that is 67 years old with close to $1mm in his 401(k) plan. He mentioned to me that he was interested in converting the 401(k) to a Roth IRA and then just invest it in a CD. Can you give me direction on whether or not that is wise and what the better alternatives would be. Thanks
Permalink Submitted by Alan Spross on Tue, 2008-09-30 20:01
It certainly would not be wise to convert such a huge amount in a single year since that would inflate his tax bracket and probably result in the tax bill being greater than his average tax rate in retirement. Is he retired, and is there an after tax balance included in the 401k?
Permalink Submitted by Larry Deatherage on Tue, 2008-09-30 21:19
Yes he is retired. I believe there is a small balance in after tax.
Permalink Submitted by mk foss on Tue, 2008-09-30 22:00
The FDIC limit for retirement accounts is $250k of coverage. As Alan implied you normally would convert such a large amount to Roth over a number of years to make use of some of the lower tax brackets.
Permalink Submitted by Alan Spross on Tue, 2008-09-30 22:42
There are many variables to consider, more than can be covered here, but generally, if he has no or minimal Roth assets now, and the total of his retirement assets are in the 401k, he should convert incremental amounts over several years. For example, he might want to only convert the amount that can be contained within his 15% bracket each year, therefore his tax situation would have to be estimated to determine what that might be. This all depends on what other income he has such as pension, SS, rentals, and other after tax investments.
His plan should also be contacted to see if they will directly transfer the after tax amount to a Roth IRA as well as a doing a direct rollover of the balance to a TIRA. This gets the after tax assets into a Roth faster and without pro rating with TIRA assets. But some plans will only do one transfer. If his plan will only do one transfer, he should use it for the pre tax amount and receive a check for the after tax amount and then roll the after tax amount directly to a Roth IRA.
For 2008 and 2009, he can only convert to a Roth if his modified AGI is not over 100,000. After that the income limit disappears.
Once he reaches the year in which he turns 70.5, he will have to take his RMD prior to converting to a Roth, and he can only convert amounts in excess of the RMD. He cannot convert the RMD itself.
Other considerations:
He should be able to pay the additional income taxes from non IRA funds.
His estate plan should be considered. Does he want his beneficiaries to inherit a Roth or a TIRA. Lower bracket beneficiaries can receive TIRA assets as they may in a lower bracket than the client.
Whether he has LT care insurance is another factor. Convert less if he has coverage than otherwise, since LT care expenses are deductible.
These are not necessarily all of the factors. It is possible to convert too much just as it is to fail to take advantage of conversions as a hedge against future tax increases. Conversions basically hedge against the cost of success and lesser conversions hedge against financial setbacks such as losses and a long bear market. There is no single right or wrong answer, and subjective assumptions must be made each year. There can be a long range conversion plan, but it should be re visited each year.
Permalink Submitted by Bruce Steiner on Thu, 2008-10-02 02:01
A forum such as this can be useful for general information. But someone with a $1 million IRA should consult with his/her own lawyer, who can give him/her specific advise based upon the particular facts, and his/her objectives.
Permalink Submitted by Al Fry on Thu, 2008-10-02 03:54
Bruce – glad to see we are on the same wavelength. I’ll be in NY tommorrow night (abeit Rochester) to do a seminar Friday am on “The 25 Planning Mistakes with Annuities; and how to resolve them”.