This has been a hot topic since the Fall of 2009. When I first read the law I asked myself why my favorite Uncle Sam would want me to do this. Does he need the money? I’ve been in this business a long time, and the conventional wisdom has always been “defer income and accelerate deductions.” The Roth conversion goes totally against that conventional wisdom. There is roughly $7 trillion in IRAs and 401(k)s that have gone untaxed. With the current position in Washington, this is an untapped source of tax funds.
The only law that changed making the conversion possible for all people is the $100,000 limitation. Prior to the law change, only people with $100,000 or less in “modified adjusted gross income” could convert. Now anyone can convert. And if you think about it, the people who are more likely to convert are the ones that have more than $100,000 in income and have been able to save money in their IRAs or 401(k)s. The only additional benefit to converting in 2010 is the ability to pay the tax in 2011 and 2012. Otherwise, a conversion in any other year after 2010 means you have to pay the tax in total in the year of conversion. In the State of Ohio, one can reasonably expect to pay a maximum tax of 40 percent on the conversion amount. If you live in a state with no income tax, this rate will be lower.
So is the Roth Conversion a wise decision? For most individuals I would say NO!
The people a conversion makes the most sense for are those that :
- Do not need the money to live on in retirement
- Do not need the Required Minimum Distributions to support retirement income
- Have enough money outside the traditional IRA to pay the Conversion Tax-40 percent
- Have a long-time horizon (10-15 years) to let the funds accumulate
If you don’t meet all of the above conditions, in my opinion, a Roth Conversion is in most cases not advisable.
The only other individuals who should consider a Roth Conversion are those with tax attributes such as net operating loss carryovers or charitable deduction carryovers. These tax attributes help minimize the total tax paid on conversion and could have a direct impact on your decision.
Also remember in the year(s) of conversion because of the increase in income, the following may pertain:
- Medicare premiums may increase
- Social Security benefits may become taxable for years if conversion inclusion
- Medical expense deduction my be reduced or eliminated
- Dependency exemptions may be phased out
- May be subject to AMT
- Credits may be reduced (i.e. Lifetime Learning)
Starting in 2013 there is a 3.8 percent levy on investment income on singles with AGI over $200,000 and “married filing joint” with AGI over $250,000
You can find a number of conversion calculators on the web. This is a very individualized decision with many moving parts. It would be wise to seek professional help in making this decision.
One last thought: the main benefit of a Roth Conversion is being able to pay no tax in the future on any amount withdrawn. Remember: Social Security was never supposed to be taxable.
