The Roth Conversion, Continued....

Last week, I left you with some important factors to consider when weighing this decision. Let’s take some time today to look a little deeper into one of those questions.

Future Tax Brackets

This is probably one of the most hotly contested areas of this debate. On one side of the coin, proponents for the Roth Conversion argue that rates have to go up, are scheduled to go up, and inevitably will go up. On the other side, economists and financial planners alike would argue that we just don’t know, so how can we base our decision on future tax rates if we can’t determine what they might be with any certainty? Now, obviously, the closer to retirement age you are, the more certainty you can have in predicting your tax rate base. So, where does that leave you and your decision making process?

There are a few certainties we can use as a leg to stand on when making this decision. First, the tax deferral rules that apply to contributing to a Traditional IRA work better for individuals that find themselves in a higher tax bracket today than at their retirement. Conversely, if you end up in a higher tax bracket at retirement, then you would benefit more from converting to a Roth IRA now and shielding your distribution at retirement from taxability. With these facts in hand, that leaves an important decision to be made by you and your trusted financial advisors. Will my tax bracket be higher or lower at retirement? We’ve determined that this is not the easy question to answer, but it is essential for you to answer when making this decision. Use the two “rules” above when thinking about your decision. For example, if you decide your tax bracket is going to be higher at retirement than it is currently, then that would lead you to strongly consider the path of Converting to a Roth.

One approach that might be worth considering is a hybrid method, or diversification of your taxability. Diversification is a term used commonly by investment professionals when discussing how to increase your return while minimizing your risk. The point of diversification is that we don’t know. We don’t know what asset class is going to earn us the most return or pose the most risk, so instead we diversify our funds across asset classes in order to hedge our bets. If this makes sense to you with your investment portfolio, it may be that it makes sense in your “taxability portfolio” as well. What do we mean by this? If you’re unsure what your tax rate base might be in the future or if you’re unsure whether you should lock in your taxes now by converting versus delaying taxation by not converting, then maybe a hybrid method is an option worth analyzing. If you’re contributing to a 401(K) or other tax deferred employer sponsored plan, then converting your Traditional IRA to a Roth might be a good fit. This would allow you to have the Roth IRA tax free growth and tax free distributions at retirement by paying taxes now on the Conversion amount, and, at the same time, will still provide you with a Tax-deferred piece of retirement funds with your 401(K) or similar investment vehicle.

This is by far the biggest area of debate with the Roth conversion and requires in depth analysis of your situation. Just because converting is the right answer for your neighbor does not necessarily mean that it is the right answer for you as well. We’ll be back next week to consider the remaining factors. Until then, email us with any questions you might have regarding this Conversion opportunity or any other tax matter that you would like.

To Convert or Not Convert?

For many months, the opportunity for any taxpayer to convert their IRA, SEP, SIMPLE IRA, and qualified plan amounts into a Roth IRA has been highly publicized and widely ballyhooed. So, I’m sure many of you find yourselves in the position of asking that very questions we pose above…To Convert or Not? Over the next few weeks, we are going to discuss a number of different angles surrounding this decision and try to provide you with as much information as possible to help you make that decision. However, this decision should not be made lightly and without careful consideration and planning. We highly recommend you consult your CPA, Financial Planner, and Investment Advisor before proceeding.

Before jumping into the details, I think it is important to highlight that many of the items that need to be weighed when making this decision are assumptions and/or questions that we don’t have the answers for: Will tax rates go up? What will market conditions be like? Will I be in a higher or lower tax bracket when I retire? Nobody knows the absolute answer to these questions; educated guesses can be made, but bear in mind that you are making a choice her on an educated opinion and that your final results may vary depending on what the future holds.

The Basics:

The reason this conversion opportunity has gained such wide spread publicity is that prior to 2010 the ability to convert was limited to individuals with Modified Adjusted Gross Income of under $100,000. That limitation has now been lifted, opening up the conversion opportunity up to any taxpayer (exceptions still may apply). Further, unless a taxpayer elects otherwise, then no gross income will be recognized from the conversion in 2010. Rather, it will be spread evenly across 2011 and 2012. This unique “tax liability spread” feature is only for 2010. After 2010, the taxes will all be in paid in full for the year the conversion is made.

Factors to Consider

The rules are pretty simple, but the decision is very complicated. The reason behind that are the various factors that come into play and the unknown aspect of those factors. Some important things to consider are as follows:


• Will I be in a higher or lower tax bracket when I retire?
• Where will I pay the taxes that result from my conversion?
• What are my goals with these funds? Will I need them for Retirement or do I want to leave the funds
to family?
• Will this affect my Social Security position at Retirement?
• What if I’m not sure? Where do I go for help?

These factors will each play an important role in your decision. Some may weigh certain factors higher than others, but it is certain that they should all be analyzed before moving forward with your decision to convert or not. Join us next as we will move into analyzing these factors and how they might work into your own situation. Until then, April 15th is approaching quickly, round up your tax materials and visit your local CPA.

info@mcarthurco.com
704.544.8429