Is a Roth Conversion Right for You?
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  1. Background – The Roth IRA
  2. Why Convert to a Roth IRA?
  3. When a Conversion May Make Sense
  4. When a Conversion May Not be Advisable
  5. Future Income Tax Rates May be the Key


Now that income tax season is behind us, many investors are doing tax planning for future years.  One of the best opportunities to come around this year is the ability for anyone to convert their traditional taxable IRA into a Roth IRA, regardless of earnings.  Prior to 2010, only those with incomes under $100,000 could take advantage of the conversion.

A lot has been written about this opportunity, but many investors don’t start their tax planning for future years until their current taxes are filed.  Therefore, I thought it would be timely to discuss the advantages and disadvantages of converting a Traditional IRA to a Roth IRA in 2010.

As you know, I also try to highlight political activities that may have an effect on your investments, and this conversion opportunity is no different.  After highlighting the pros and cons of a Roth conversion, I’ll also delve into some political factors that may affect your decision to convert to a Roth IRA.

Before I begin, please be aware that the following discussion will be based on our general understanding of the rules, but does not constitute tax advice.  Be sure to contact your tax professional before making a decision to participate in any tax-favored retirement plan.

The Roth IRA

I’m sure that most of you know what a Roth IRA is, but for those who may not be familiar with the term I’ll cover some background.  In a Traditional IRA, you usually get a tax deduction for contributions made and earnings grow tax-deferred until you actually take them out of the account.  Thus, taxes are deferred on both contributions and earnings until they are actually withdrawn from the Traditional IRA.

A Roth IRA works in a somewhat opposite fashion, in that Roth IRA contributions are not deductible, but if left in the account for five years or more, the earnings on these contributions are never taxable.  Thus, the main difference is whether you’d rather have a tax benefit now or later. 

For young people, the Roth IRA is almost a slam dunk because they have so many years for earnings to compound untaxed before retirement.  Tax deferral under a Traditional IRA is great, but you eventually have to pay the piper.  Under a Roth IRA, earnings are never taxed. 

For older investors, the wisdom of contributing to a Roth IRA usually depends upon the amount they can contribute and the amount of time to retirement, among other factors.  Fortunately, there are calculators on the Internet that can help you decide which type of IRA may be best for you (more about that later on).

Here’s an example of the tax-free earnings benefit for younger people.  Let’s say a 22-year-old college grad gets a good job and starts putting $5,000 per year in a Roth IRA.  Since there’s no tax deduction for the contribution, our youngster must actually earn more than $5,000 to make that contribution due to income and payroll taxes.

If this same person continues to put away $5,000 on January 1st of each year for 45 years until the current Social Security retirement age of 67, total contributions would be $225,000.  This isn’t a bad nest egg, but the real story is in the earnings.  If our saver could average an 8% return (used for illustration only and not guaranteed), those $5,000 yearly contributions would grow to $2,087,130.

Now, putting that accumulated value into the context of the Roth IRA, no withdrawals from the IRA during retirement would ever be taxed.  Thus, by paying taxes on the $225,000 of contributions, our consistent saver would have over $1.8 million in TAX-FREE earnings, assuming annual returns of 8%.  While equal contributions to a Traditional IRA would grow to the same value assuming equal returns, the entire amount would be taxable income when it is ultimately withdrawn.

Aside from tax-free withdrawals after five years (if you are over age 59½) , Roth IRAs offer a number of other advantages over Traditional IRAs, including:

  1. There is no requirement to begin minimum distributions at age 70½;
  2. Roth tax-free income is not currently included when calculating the amount of taxable Social Security benefits.  This can be a major advantage if you have substantial post-retirement income;
  3. Taxes on contributions are paid at current tax rates, which may be lower than future tax rates, especially with the US running trillion-dollar annual budget deficits;
  4. Contributions may be made to Roth IRAs after age 70½ as long as a taxpayer has earned income, while investors this age or older cannot make Traditional IRA contributions;
  5. Individuals participating in employer retirement plans such as a 401(k) can make Roth IRA contributions without restriction;
  6. In a Traditional IRA, you must withdraw more than what you need to live on in order to pay the necessary income taxes.  In a Roth IRA, you can withdraw less since there is no tax due, leaving more money invested in your IRA; and
  7. As a general rule, Roth IRA assets can be passed on to beneficiaries after death more easily than Traditional IRAs.

Of course, no retirement plan is an suitable for everyone.  Some potential disadvantages of Roth IRAs include:

  1. Since contributions to Roth IRAs are not tax-deductible, having to pay income taxes on the contribution may limit the amount an investor can contribute each year;
  2. The ability to contribute to Roth IRAs is subject to certain income restrictions, even if you are not currently covered by another retirement plan.  Specifically, some upper income taxpayers may find that they cannot take advantage of the Roth IRA; and
  3. Annual contribution limitations to a Roth IRA restrict the amount that can be put away each year, which could put older savers at a disadvantage. The current Roth IRA contribution limit is $5,000 for all taxpayers, plus an additional $1,000 “catch-up” contribution for taxpayers over age 50.  This is far less than the current 401(k) maximum contribution of $16,500 for all participants, and an extra $5,500 for those over age 50.  Plus, in the 401(k), you may also have an employer matching contribution.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

The Current Conversion Opportunity

While regular annual contributions to Roth IRAs can be an advantage, the current buzz about these savings vehicles is focused on the ability to convert from a Traditional, taxable IRA to a Roth where distributions will be tax-free.  As I noted above, there has always been a provision for those with Traditional IRAs to convert to a Roth IRA.  However, prior to 2010, there was an earnings limit so that anyone with an adjusted gross income of $100,000 or more could not take advantage of this tax planning opportunity.

Fortunately, in 2010 and thereafter, the door is open to anyone with a Traditional IRA to convert to a Roth IRA and take advantage of tax-free earnings withdrawals, regardless of their income.  While this tax benefit alone sounds like reason enough to convert to a Roth IRA, there is much more to the decision than that.

Recall that contributions to a Traditional IRA were deducted from taxable income and earnings on those contributions grew tax-deferred.  In order to convert from a Traditional to a Roth IRA, the IRS requires that income taxes must be paid on the entire amount converted.  There is a tax exemption for the conversion of certain after-tax IRA contributions but as a general rule, these amounts are usually very small if they exist at all.

Thus, if someone converts $100,000 from a Traditional IRA to a Roth, and they are in the 28% tax bracket, they will owe $28,000 to the IRS.  Plus, the additional income could throw you into a higher tax bracket, increasing the tax upon conversion.  This alone could be a huge deterrent to participating in a conversion. 

Fortunately, the rules allow for partial conversions so that investors with Traditional IRAs can convert over time or to coincide with years where they have lower earned income.  For 2010 conversions only, there’s also a provision that allows you to delay reporting the conversion for a year, and then spread the taxes over the 2011 and 2012 tax years.  So, if there’s ever a time for you to seriously consider a Roth conversion, this is the year.

In the remainder of this E-Letter, I’m going to discuss situations where it may be beneficial to convert from a Traditional IRA to a Roth IRA, as well as situations where such a conversion may not be best.  As always, consult with your CPA or other tax professional before making a decision to convert your IRA.

Is a Roth Conversion Right for You?

It’s always important to remember that the decision to convert from a Traditional IRA to a Roth IRA is to maximize your retirement assets.  You should not convert just because you attended a snazzy seminar or because anything tax-free sounds like a good idea.  When converting from a Traditional IRA, you will pay taxes on these assets one way or another.  It’s only the future growth that will be tax-free under the Roth IRA, so the key is to minimize taxes, not eliminate them.

When making a decision to convert from a Traditional IRA to a Roth IRA, one of the most important factors becomes where you will get the money to pay the tax.  Even though taxes upon conversion can be spread out over 2011 and 2012, you still have to come up with the money to pay income taxes on the amount converted.

As a general rule, if you can fund the tax payments from assets other than those in the Traditional IRA, then a Roth conversion may be beneficial for you.  However, you also have to look at the way these other assets are invested.  If you have investments that, if liquidated, would generate a large amount of capital gains taxes, then conversion may not be as attractive.

If your other investments are in stocks, bonds, mutual funds, etc, it may also be beneficial to estimate the compound return from these investments over time and compare that to the amount of tax you may be saving in the Roth IRA.  In other words, funds used to pay taxes cease making returns or being available for emergency expenses.  The time value of money concept applies here, so it’s important to balance the payment of taxes today versus paying them with “cheaper” dollars in the future.

Perhaps the perfect scenario for a conversion is having a large amount of non-IRA money in cash, which is currently paying near-zero returns.  The potential earnings on this money are small, so there’s little incentive to keep it invested rather than paying taxes due upon a Roth conversion.

A final word about the source of money to pay taxes is that it’s probably not a good idea to borrow the money to pay taxes, even if you can find a willing lender and an attractive interest rate.  Any cost of borrowing will negate a portion of the future income taxes to be paid.  Even so, borrowing may be a better option than withdrawing money from the Traditional IRA to pay taxes (more about that below).

Of course, having the money readily available to pay taxes isn’t necessarily the only decision you need to make.  The following are some additional considerations for anyone trying to decide whether or not to convert from a Traditional IRA to a Roth IRA in 2010:

  1. Estate tax issues should also be considered.  Traditional IRAs are often deemed to be inefficient ways to pass wealth to heirs because they may incur both estate taxes and income taxes.  A Roth IRA conversion would allow someone with a large estate to pay the income taxes now, rather than upon transfer to heirs.  There are other estate tax benefits of converting to a Roth IRA that are too detailed to go into here.  Contact your estate tax professional to ask if a Roth IRA conversion may be beneficial in your situation;
  2. Traditional IRAs require that a Required Minimum Distribution (RMD) be paid beginning at age 70½.  Often, however, this income is not needed by the IRA account holder at that time.  For anyone whose retirement income is sufficient without drawing upon IRA assets, a Roth conversion may make sense because there are no minimum withdrawal requirements at any age;
  3. Conversion in 2010 allows an account holder to take advantage of current, known tax rates rather than waiting until later when tax rates may be higher.  The Bush tax cuts are still in effect for 2010, so tax rates are still historically low.  However, if you choose to spread the taxes over the 2011 and 2012 tax years, you will pay taxes based on rates applicable in those years;
  4. Conversion may also be beneficial if you believe you will be in the same or a higher tax bracket after you retire.  No one knows what the future holds for tax rates, so locking in the 2010 rates may be beneficial (I’ll discuss future tax rates in more detail later on);
  5. Since most amounts converted from a Traditional IRA will be deemed to be taxable income, it is usually best to time conversions for when your income from other sources will be lower.  Since partial conversions are allowed, you can also convert just a portion of your Traditional IRA account so you won’t be thrown into a higher tax bracket;
  6. Roth IRA conversions can also be reversed, or “recharacterized,” within limits, offering additional tax planning opportunities; and
  7. As I noted above, Roth IRA conversions are usually best for younger individuals.  What’s the age cutoff where it becomes questionable?  Unfortunately, there’s no single age for all individuals, since everyone’s situation is a little different.  I have read articles that suggest that age 45 is an appropriate cutoff, but my advice is that you should consult with a tax professional to see if a conversion is suitable for you, no matter what your age.

When a Conversion May Not Make Sense

I hope that, by now, I have effectively communicated that there are no investments, retirement plans, etc. that are good for everyone.  When I answer a question about any retirement-related matter, the answer is almost always, “it depends.”  The same goes for Roth IRA conversions, especially since entering into one of these transactions carries such a heavy income tax burden.

As a general rule, Roth IRA conversions don’t make sense for older individuals who have only a few years to retirement and will need to start drawing on their IRA funds for retirement income.  With just a few years to accumulate earnings, it’s not likely that the account will overcome the amount of taxes paid on the conversion.

However, there are always exceptions to the rule.  If an older individual has no need to draw upon IRA funds and wants to pass them to an heir, then a conversion may make sense because the time frame is based on the age of the heir, not that of the account holder.  Older individuals may also find it beneficial to convert if there are specific estate tax issues that favor tax-free income over taxable income when you take the money out.

Another generalization is that a Roth IRA conversion may not be the best decision if you have to withdraw money from the Traditional IRA to pay the taxes.  Withdrawing funds from the IRA reduces the amount of money growing tax-free in the converted Roth IRA, thus limiting the overall benefit of the conversion. 

Even worse is a situation where someone under age 59½ has to withdraw funds from the Traditional IRA to pay taxes upon conversion.  That’s because in addition to ordinary income tax, a 10% penalty tax will likely be due.  Someone in the 28% marginal tax bracket would find themselves paying almost 40% on the premature withdrawal.  It would be very hard for the Roth IRA to overcome this deficit, especially for an older individual.

A Roth IRA conversion may also not make sense for someone already retired and drawing Social Security, since the additional taxable income from the conversion may result in up to 85% of Social Security benefits being taxable in the tax year(s) that conversion takes place.  Unlike tax-free income from a Roth IRA, the taxable income generated by converting a Traditional IRA to a Roth IRA will count toward making Social Security benefits taxable.   

As I noted above, you should also think twice about converting your Traditional IRA to a Roth if the taxable income would push you into a much higher tax bracket.  Of course, you can minimize this possibility by spreading conversions over a number of years. 

Another possible negative that many people don’t realize is that the conversion could affect financial aid for college students.  Since awards of many forms of financial aid are based on the income of a student’s parents, increasing your income could decrease eligibility for financial aid.  Some schools are aware of this situation and are making adjustments accordingly, but it’s a good idea to talk to your child’s school before electing to convert to a Roth IRA to see if there will be any negative repercussions. 

Future Income Tax Rates May be the Key

I promised in the Introduction that I would point out how politics may affect the decision to convert your Traditional IRA to a Roth IRA.  Unfortunately, Congress has a nasty habit of changing the rules along the way if too much tax revenue is lost.  A good example of this is the Traditional IRA.  A 1981 law made IRAs universally available without income limitation and even if you were covered by an employer’s retirement plan. 

However, IRA’s became so popular and so much tax revenue was lost that in 1986, the law was changed to restrict access to IRA deductions.  That change ushered in the limitations on deductions based on income and coverage by another retirement plan.  So, what Congress giveth, Congress can also taketh away.

The first political fallout may be the tax-free treatment of earnings in a Roth IRA.  Should Congress change its mind about this tax benefit in the future, the benefits of conversion could be nullified.  Before you say that Congress could never do anything like this, recall that Social Security benefits weren’t taxed at all until a 1983 law made them taxable, and then a 1993 modification increased the portion of Social Security payments subject to income tax.

Another political factor could be future tax rates.  Over the course of this article, I have noted that future income tax rates are a key factor when deciding to convert your IRA.  Conventional wisdom says that you will likely be in a lower tax bracket after you retire than during your working years.  Unfortunately, conventional wisdom has now encountered Obamanomics.

If we continue to see out-of-control government spending and spiraling deficits and national debt, it’s easy to believe that future tax rates may be higher than today’s rates.  In fact, if Congress doesn’t extend the Bush tax cuts, they will expire for all taxpayers at the end of this year, not just for those making over $200,000 per year.  The prospect of higher future tax rates could make conversion appear to be a better decision. 

You may also recall that candidate Obama promised to eliminate all income taxation for seniors making under $50,000 per year.  We haven’t heard much about that lately, have we?  However, a tax exemption for seniors may gain footing as a woefully unprepared Baby Boom generation enters retirement.  A future Congress will likely be torn between retirees who are outliving their savings and continued spending for pet projects. 

Do I envision a day when Roth IRA earnings are deemed to be taxable?  No, but Congress could revert to restrictions on Roth IRA conversions in effect before 2010, or even tighten these restrictions further.  All I can say is that Congress abhors a tax vacuum, and large amounts of non-taxable benefits are likely to draw its attention in the future.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Conclusions and a Conversion Calculator

The bottom line is that 2010 is probably going to be the best year for considering a Roth IRA conversion from the standpoint of favorable tax rates as well as access by high-income taxpayers.  However, as I have noted several times above, you should only enter into a transaction with the guidance of a tax professional familiar with the various rules associated with a conversion.

Before contacting a tax professional, however, you may want to do some research of your own to see if a conversion is a fit for your financial situation.  A good place to start might be on the Internet at the website.  This site offers a wealth of information on a variety of financial issues, and also provides calculators to help you convert the decision into dollars and cents.  Click on the link below to go to the Roth conversion calculator:

There are a variety of other calculators on the Internet, many of which are sponsored by investment product companies or brokerage firms.  I like the Bankrate.Com site because it provides an unbiased approach to answering your questions.  You can also access a number of Bankrate articles on Roth conversions by typing in “Roth conversions” in the search window.

The Roth IRA is a very enticing retirement planning tool in that it promises the ability to have future access to tax-free income.  In 2010, the rules allow virtually anyone to convert their Traditional IRA to a Roth IRA, pay the taxes, and look forward to tax-free income in the future if held for the required five years.  This year may also be the last time we see tax rates at their current level, so if you have any interest in converting your Traditional IRA to a Roth, now is the time to look into it.

If you have any questions or would like to talk to any of our Investment Consultants about the Roth IRA conversion, or if you have any questions about IRA rollovers and transfers in general, feel free to give us a call at 800-348-3601 or send us an e-mail at

Wishing you retirement savings success,

Gary D. Halbert


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"Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc. are not affiliated with nor do they endorse, sponsor or recommend any product or service advertised herein, unless otherwise specifically noted."

Forecasts & Trends is published by ProFutures, Inc., and Gary D. Halbert is the editor of this publication. Information contained herein is taken from sources believed to be reliable, but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgment of Gary D. Halbert and may change at any time without written notice, and ProFutures assumes no duty to update you regarding any changes. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Any references to products offered by Halbert Wealth Management are not a solicitation for any investment. Such offer or solicitation can only be made by way of Halbert Wealth Management’s Form ADV Part II, complete disclosures regarding the product and otherwise in accordance with applicable securities laws. Readers are urged to check with their investment counselors and review all disclosures before making a decision to invest. This electronic newsletter does not constitute an offer of sales of any securities. Gary D. Halbert, ProFutures, Inc. and all affiliated companies, InvestorsInsight, their officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Securities trading is speculative and involves the potential loss of investment. Past results are not necessarily indicative of future results.

Posted 04-27-2010 3:07 PM by Gary D. Halbert