Roth IRA- The Conversion Question

The Roth IRA provides an opportunity of investing after-tax money and allowing it to grow tax-free. Rules for taking money out of the plan are more liberal and there is no required minimum distribution at age 70 1/2. Taking advantage of tax-free money to some investors is like a free steak and lobster dinner. It is an event enjoyed only a few times a lifetime. And while I have no issue with an investor opening a Roth either individually or through a 401k plan I do have problems associated with converting a perfectly good tax-deferred IRA into a Roth IRA and paying taxes on the conversion.

This year wealthy investors were given the opportunity  of converting their IRAs into Roth accounts. This is a once in a lifetime occasion and has spilled over to the average investor who has given serious thought about converting their tax-deferred account into a tax-free IRA.

Investors who convert from regular IRAs to a Roth need to come up with a substantial amount of money to pay the normal income tax created by the conversion. The money to pay the tax usually comes from after tax savings and a $10,000 tax payment would cost an investor about $13,000 in earned money. In some cases the conversion also creates a higher personal income tax bracket altering the total amount of taxes on the year’s earned income. The argument is that today’s taxes may be cheaper than tomorrow’s income taxes. The fact is we don’t know that. In fact a few decades back investment wizards were all spouting that interest rates would be in the mid double digits by the turn of the century and look where we really are. Taxes may well be much lower or tax brackets changed to reflect the economy in the future. We don’t know and there is no reason to pay taxes now when we do not have to.

The other argument calls for paying the taxes from the tax-deferred account assets. The problem is that causes the portfolio to drop considerably and there is no guarantee that future investment growth will bring the new Roth account close to where it was when it was a regular IRA. Certainly it took years to grow assets in the tax-deferred IRA and there may be less years to do the same.

The rush to pay taxes when you do not have to is a phenomenon not understood by this writer and his tax professional friends.

The regular IRA tax deferred account has many benefits including spousal rollover and a beneficiary tax-deferred benefit that can preserve assets far down the road.

Advocates of a Roth conversion also fail to discuss the loss of purchasing power through inflation. Those investors who don’t convert but pay taxes on the required minimum distribution are doing it with cheaper tomorrow dollars because of inflation. A dollar a  few years  down the road, or even next year, is cheaper than today’s dollar.

Don’t rush into a Roth conversion just because you hear or read that the rich are doing it. The rich may be getting some darn poor financial advice.

Questions call Paul @ 877 783 7080 or write him at pstanley@westminsterfinancial.com. Share this blog with someone who cares about their money.