Convert to Roth or make use of tax funds needed elsewhere?
My age is 59. Calculators that I use show a slight advantage to convert IRA to Roth by age 66 (I know there are other Roth benefits, as well).
IRA balance is $45,000, taxes to convert estimated to be $15,000. Since the increased difference with Roth conversion is so slight, roughly $1500, assuming same tax rate, same inflation rate and same 6% annual growth rate and if retire at 66.
There is an opportunity cost of paying $15,000 in taxes. I am thinking of leaving the $45,000 as an IRA and taking the $15,000 to open a non-retirement, regular investment account. In effect, creating an alternative to Roth conversion.
Please give me your thoughts? Pros and Cons.
Thank You
Permalink Submitted by Alan Spross on Tue, 2012-08-14 23:58
Many calculators include a slight bias toward conversion. But a fully comprehensive calculator does not exist, so you should consider some of your own individual financial profile.
In your case, the estimated marginal tax rate in retirement is the key. It gets complex if you will in the AGI phase in for SS benefits. However, if you expect your federal rate in retirement to not fall below 25%, then 85% of your SS income will be included and it makes analysis easier.
What makes sense for many is to delay filing for SS benefits, and do some conversions after retiring and before filing for SS. You might be able to convert a worthwhile amount for 3-4 years at 15% fed, and that will make it worthwhile by greatly increasing the odds that your conversion cost will be less than your marginal rate in retirement. Meanwhile if your SS grows by 8% per year plus COLAs, you end up with a much higher lifetime annuity with a COLA and 15% of it is tax free. Another factor is your state income tax rate now vrs where you might move in retirement. I assume state rates are included in your 33% marginal rate now.
If it’s a push and you do not have ANY ROTH assets now, then conversion makes more sense since it will provide you with tax diversification. If you need funds in retirement, you can take the Roth money only when you want to, for example when you are already spilling into a higher bracket. This flexibility can save tax dollars.
The tax rate on the invested 15k if you don’t convert will be questionable, since the future rates for dividends and cap gains is very much up in the air. There might also be split rates for those over a certain AGI or taxable income and those below that threshold.
Another factor to consider is job security, health, or choice to retire earlier. If any of those situations exist, you will accumulate less and a Roth conversion while still working would be questionable. This might also cause you to convert less in retirement if your retirement income will be lower.