| No doubt soon you will be flooded with articles | | | | term of the IRA and the opportunity cost of the |
| and "advisor speak" in the media about the | | | | conversion tax can be disregarded only if the IRA |
| benefits of converting all or part of you traditional | | | | is spent down during your life time. If the IRA is |
| IRA to a Roth IRA in 2010 when the income | | | | ever inherited complete equalization or tax |
| restrictions are removed. My guess is most of | | | | neutralization if you prefer, is achieved only when |
| the opinions you hear will be in the favor of Roth. | | | | the account, whichever one you choose, is fully |
| Let me break it down to the key decision points: | | | | depleted. If it occurs during the beneficiary's lives, |
| Better dead than alive? | | | | they also must have the same exact combined |
| This is a multi-generational planning decision largely | | | | tax rate that was incurred at the time of the |
| due to the fact that the required minimum | | | | conversion and you still have to factor in the |
| distribution (RMD) factors for a traditional IRA | | | | opportunity cost of the conversion tax during |
| extend well past the age of 100. What does this | | | | your life. |
| mean? The traditional IRA cannot be spent down | | | | Permanent timing differences due to variable tax |
| during the owner's life time if all they do is adhere | | | | rates: |
| to the RMD rates. Even if the account does not | | | | If the conversion puts you at a marginal tax rate |
| earn a return after starting RMDs the account | | | | that is higher than normal for you, and your |
| value becomes zero at around age 120. This is | | | | taxable retirement income requirements based on |
| why I recommend that if you have a substantial | | | | today's tax rates reverts back to your normal |
| tax deferral balance built up in your traditional IRA | | | | rate, and your beneficiaries are projected to have |
| do not convert it to an immediate tax liability by | | | | an income tax rate that is equal to or less than |
| going Roth. As I stated in my previous article, | | | | your normal rate, then a conversion will result in a |
| "Roth IRA Conversion - Don't Do It", the | | | | permanent negative or unfavorable tax timing |
| opportunity cost, or the potential investment | | | | difference until the IRA is terminated. In other |
| returns foregone from paying the conversion tax, | | | | words, the timing difference will not reverse with |
| are not likely to be offset during the owner's life | | | | time and staying with the traditional IRA would be |
| time by the taxes avoided during the income | | | | preferred in this circumstance because the |
| phase of the IRA. They will be fully realized only | | | | opportunity cost resulting from the lump sum tax |
| when the IRA is terminated, usually well past the | | | | payment cannot be fully recovered during the |
| death of the original owner. Therefore, not only | | | | owner's life time without taking on considerable |
| do you need to project what your future income | | | | investment risk. |
| tax rates could be, but those for the beneficiaries | | | | If your future taxable retirement income is |
| as well to determine if the conversion is a good | | | | expected to be considerably more than the |
| financial decision. | | | | income you make today, based on today's |
| Speculation about future higher income tax rates: | | | | income tax rates you might be encouraged to |
| No one knows what income taxes will be beyond | | | | complete a full conversion in 2010. But, there is still |
| what they are today. A strong case can be made | | | | the opportunity cost of the conversion tax in |
| for assuming income tax rates for the highest | | | | your life time and the tax timing benefit may not |
| income tiers will rise, while not so for the middle | | | | be fully realized until it flows through to your |
| and lower income tiers. Then you have to | | | | beneficiary, and only if they are in the same or |
| consider how close you are to needing funds | | | | higher tax bracket. |
| from the IRA. You may be able to project you | | | | Let me repeat the point I made in the beginning |
| tax rate with a high degree of confidence for the | | | | of the article. The timing differences whether |
| very near term. But, the intermediate and long | | | | neutral or permanent are only realized at the end |
| term would be a wild guess. Those who are | | | | of the IRA, after it has been fully spent - either |
| nearing retirement and expect to stay in the | | | | by you or your beneficiaries. |
| highest income tax bracket may want to analyze | | | | Conclusion |
| if they will recover the conversion cost during | | | | As simple as the idea of "tax free" seems to |
| their life time before making this decision. | | | | you, it is extremely more complicated if you have |
| When it makes no difference: | | | | already accumulated deferred tax liabilities. If you |
| The decision point is will the account be depleted | | | | are contemplating the conversion, make sure you |
| during the owner's life or the lives of the | | | | consult with a qualified advisor who can thoroughly |
| beneficiaries? There is no permanent tax | | | | evaluate the financial and investment |
| difference when the combined income tax rates | | | | consequences during your life and the life of your |
| (federal, state and local) incurred at the time of | | | | beneficiaries. |
| conversion remains the same throughout the | | | | |