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Coverting to Roth IRA may add up for some

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06-11-2006

THE JOURNEY by Janet Stewart Kidd, Your Money, Chicago Tribune

Soon, all investors can sock away retirement money that will grow tax-free. But should they? 

Under recently signed tax legislation, affluent workers will be able to convert their traditional individual retirement accounts to Roth IRAs beginning in 2010. They can begin making maximum non-deductible contributions this year to traditional IRAs and convert in 2010.

Traditional IRAs give most savers an immediate tax deduction on their contributions, deferring the tax until they begin withdrawing the money in retirement. Those deductions phase out for higher-income workers. In Roth accounts, savers receive no deduction on contributions but the money grows and is withdrawn tax-free.

Currently, to be eligible to contribute to a Roth IRA, single filers have to have taxable income of $110,000 or less, while married couples have to make less than $160,000. Starting in 2010, anyone can convert any amount of traditional IRAs to Roths, regardless of income, by paying any owed taxes on the traditional IRA. And taxes on conversions made in that first year can be paid over 2011 and 2012.

On the plus side, Roth conversions could let savers get ordinary income taxes out of the way on their accounts while they are relatively small, leaving all the future gains untouched. Roth accounts are also more flexible on withdrawals, with no minimum required distributions starting at age 70 1/2.

"These [conversions] will help a lot of people, but you have to start early and plan for them," said Hugh Bromma, chief executive of The Entrust Group, an Oakland retirement plan administrator.

But haven't we been drilled on the miracles of compounded pretax growth in our workplace retirement savings plans and IRAs? Aren't high earners looking for any tax deferment they can muster?

"I think Roth conversion is a bad idea," said David Bizé, a financial planner in Oklahoma City. "Who in their right mind wants to pay income taxes in today's dollars ... not to mention that the money you didn't pay in income taxes this year compounds until you withdraw it."

When mutual fund firm T. Rowe Price performed a study on Roths versus traditional IRAs, researchers found virtually no difference in long-term account values if workers' tax brackets stayed the same in retirement.

If they converted from a traditional IRA to a Roth and paid the taxes out of other funds, or if they jumped to a higher bracket in retirement, the Roth outperformed. If they dipped to a lower bracket they were better off staying with the traditional IRA. The study did not consider the impact of inflation, however, a T. Rowe spokesman said.

Beyond your own bracket situation, think about where taxes in general are heading.

Citing rising deficits, Social Security liabilities and a maturing economy, some advisers are warning clients we may be at a low point in terms of the overall tax burden.

"If you think we're going back to a 39 percent top rate and higher capital gains rates, then there's an even more compelling case for a Roth," said Rande Spiegelman, financial planning vice president for the Schwab Center for Investment Research in San Francisco.

Aside from handicapping where tax rates are headed, workers need to make a few other assumptions.

Have an IRA you're reasonably sure you won't need? Making the conversion will relieve your beneficiaries of paying tax on their inheritance and taking required distributions.

Under 40? Retirement experts say the Roth is extremely attractive the younger you are. If you're at or near retirement, converting usually doesn't make sense because you are simply paying taxes to secure a few years of tax-free growth.

Will you have multiple income streams in retirement, say a pension, a 401(k) plan or two and a couple of IRAs? Then you might consider a blended tax strategy, converting only the IRAs to Roths to create a bucket of money that can be withdrawn tax-free to help keep withdrawals from pushing you into a higher bracket.

Don't count on cherry-picking among several IRAs to lower your conversion taxes, said Nick Kaster, senior pension analyst with CCH Inc., a Riverwoods, Ill., tax data publisher.

If you have an IRA rolled over from a previous employer and another IRA to which you've made non-deductible contributions, you can't just convert the non-deductible account, Kaster said. "You'll be taxed as if half came from one account and half from another," he said. But you don't have to convert the entire sum all at once, he said.

If you really love the idea of a Roth and want to maximize savings this way, you could convert your existing IRAs in 2010, then keep contributing the maximum each year to a traditional IRA and making the conversion immediately to a Roth, avoiding tax on the traditional account's earnings, Kaster said.

"The general rule is to never pay a tax today if you can put it off until tomorrow," Kaster said. "The Roth is potentially an exception."

E-mail Janet Kidd Stewart at yourmoney@tribune.com.

Have a retirement question? Write to yourmoney@tribune.com, or via mail at Your Money, Chicago Tribune, Room 400, 435 N. Michigan Ave., Chicago, IL 60611. If your letter is selected, we may include you and your question in a future column.