Advisability of traditional IRA conversion to Roth
I am a 71 year old retiree with a traditional IRA valued at approximately $500,000. My wife and I have adequate income to support us without using IRA money. Since the MRD is suspended for 2009 I thought it would be a wise move to convert about $20,000 to an existing Roth. I was told by a financial advisor that it would be unwise to do so because of the tax liability. I felt that the growth potential with stock levels so depressed, this would be an ideal time to do this. I am looking for the pros and cons; comments???
Permalink Submitted by Alan Spross on Tue, 2009-01-06 20:51
A thorough analysis involving many issues would be required in order to provide the best response.
A more superficial analysis focuses on your marginal tax rate for the conversion, including the affect of more SS dollars included in AGI, vrs your average future expected marginal rate. The future rate would be an educated guess based on both your personal situation and the future direction of tax rates, which are expected to increase after we get out of the current recession.
Another factor to consider is how much you currently have in Roth assets. Your first Roth dollars are the most valuable because they provide you with future distribution flexibility when you need it. They could be referred to a tax diversification. In addition, the increase in Roth vrs TIRA assets directly reduces your future RMDs which are taxable at your marginal rate.
This year is unique since you can convert without taking your RMD first, unless your first RMD was for 2008 and you have not yet taken it. In other years, the RMD must come out first before converting an additional amount. Also, without the approx 19,000 RMD, you are more likely to be in a lower bracket this year than in the future. Taxable interest will also be extremely low this year unless you have an older long term CD.
If you have tax software, you can work up your own scenarios for how much to convert, if any. If not, then your tax preparer can probably help you with crunching some numbers after entering your final 2008 tax data.
Permalink Submitted by Bruce Steiner on Tue, 2009-01-06 23:56
Assume a constant 30% income tax rate, and that you have an extra $6,000 that you could use to pay the tax on the $20,000 that you are thinking of converting.
Suppose you convert. You’ll then have a $20,000 Roth IRA. Over some period of time, it will double to $40,000.
Suppose you don’t convert. Over the same period of time, the $20,000 in your traditional IRA that you didn’t convert will double to the same $40,000, which you or your beneficiaries will withdraw, leaving $28,000 after tax. If the tax rate on the investment income and gains on your $6,000 in your taxable account were zero, that $6,000 would double to $12,000, so you would have the same $40,000 total. But since the tax rate on the income and gains in your taxable account is greater than zero, it will grow to something less than $12,000, so your total will be less than $40,000.
If your IRA is $500,000, and you convert $20,000 a year, you’ll never complete the conversion.
You may wish to consider consulting with a different financial advisor, or (I think preferably) discussing this with the lawyer who handles your estate planning.
Bruce Steiner, attorney
NYC
also admitted in NJ and FL
Permalink Submitted by mk foss on Wed, 2009-01-07 00:52
I agree that you need to do a more thorough analysis. I think the answer will be, as you suspect, that this is a very good time to do a Roth conversion. That’s because some very good stocks and funds seem to be valued at artifical lows.
If you’re normally in a 28% bracket, you wouldn’t want to convert so much that you would reach a 35% bracket. But as Bruce indicates, $20,000 is a fairly low amount to convert. Alan points out that the Roth conversion doesn’t effect just your tax bracket but will affect the allowable itemized deductions, taxable portion of social security etc. You also need to be aware that increaed adjusted gross income for 2009 could increase your Medicare payments in 2011.
The other good thing about a Roth conversion is that you have time to rethink your decision. Any IRA converted to a Roth in 2009 can be recharacterized back to the IRA by October 15, 2010.
Permalink Submitted by Bruce Steiner on Wed, 2009-01-07 01:02
There are so many benefits to the conversion that it is often worth SOME increase in the tax bracket. If the increase is 7 points (28% to 35%), it may be worth some effort trying to run some numbers to see whether it makes sense. Other choices include (i) converting up to the top of the 28% bracket, or (ii) converting up to the top of the 33% bracket.