Roth Conversions

All of a sudden my mailbag is full of articles about Roth Conversions. While this may be a good idea, be careful, it certainly isn't for every client. Let me start with some background.

The benefit of Roth is you can withdraw earnings tax-free AND you do not have to take minimum withdrawals upon reaching 70 1/2. Traditional IRAs did not have this benefit, and to be frank, I have been assuming all along they were going to take this gift horse away.

Beginning next year higher-net-worth individuals who earn $100,000 or more in a year will be eligible to convert their traditional IRA to a Roth IRA. Previously, it was only those under this limit AND married couples filing jointly. No more in 2010.

Now, higher net earning individuals and business owners that do not want to withdraw the money and would like to be able to pass it along to their children or grandchildren income tax-free will get their wish. Everyone on board? Not so fast.

A Roth conversion is expensive. There's a big up-front cost. Converting $20,000 some taxpayers could owe $5,000 to $7,000 in taxes for the 2010 return, depending on their income tax bracket. You could convert all the money in your IRAs or part of it, depending on your tax situation.

A high net worth person who converts $100,000 from a regular IRA to a Roth IRA could owe $35,000 in taxes based on the highest tax bracket for 2010. Plus, if that person is younger than age 59 1/2 , they're likely looking at a 10% penalty of they take the money out of a regular IRA specifically to pay the tax. Next year, only, you can pay the tax over two years BUT based on your tax rates for each year. If Congress takes no action, current federal income tax rates could jump to 39.6%, up from 35% in 2011.

Therefore, to decide whether it is worth the conversation, you need someone that can run the numbers based upon your reasonable expectations. You are looking to see if it is cost efficient to pay the tax now to save on taxes later. If you may need the money within 15 years and you expect your income tax rate to be lower in retirement, conversion may not be such a great idea.

My best,

Jim