y multimillionaire client simple.
Bill called me the other
day. He wanted to talk But let me share some additional
about congress recently loosening information. Bill will retire in
the rules about who can convert about 25 years. He earns about 9%
regular IRA accounts to Roth-IRA a year on his $1,000,000 IRA. He
accounts. also pays the highest 35%
marginal income tax.
In the past, because of his
income, Bill hasn’t been able to If he converts, Bill will need to
use a Roth-IRA. Starting in 2010, pay income taxes on his
however, even high net worth, $1,000,000 conversion. Because
multi-millionaire taxpayers like Bill gets taxed as the highest,
Bill can use a Roth-IRA by 35% marginal rate, he’ll pay
converting existing traditional $350,000 today if he converts.
IRAs and IRA-Rollover accounts to But even so, he will end up with
Roth-IRAs. $5,605,002.43 in his Roth-IRA in
25 years. And the sweet thing is,
Bill understood he would pay of course, that money will have
income taxes on the conversion. already been taxed.
But wouldn’t it make sense, he
asked, to convert a $1,000,000 Bill thought that sounded great,
IRA account he’d been able to of course. And I had to agree.
accumulate to a Roth-IRA? More than $5,000,000 tax free.
Sweet.
A Simple Roth-IRA Conversion
Example What Happens with a Traditional
IRA and No Conversion
Unfortunately, I explained,
Roth-IRA conversions aren’t that I explained, however, that we
also needed to compare this I truly suggest clients like Bill
Roth-IRA future value amount to think of Roths and regular IRAs
what Bill would end up with after as "six of one, half a dozen of
tax if he just stuck with his the other" situations. That said,
regular IRA. where a person gets the money to
pay the taxes on the conversion
In that case, Bill ended up with makes a difference, too.
$8,623,080.66.
For example, if a client like
If he also paid a 35% tax on this Bill uses some of the IRA balance
money, after paying the income to pay the taxes (this is sort of
taxes, he would net what my example calculations
$5,605,002.43. Which is the exact assume), the taxpayer may have to
some number he ends up with if he pay an early withdrawal penalty.
converts to a Roth-IRA… That early withdrawal penalty
makes the Roth a worse deal.
Some sort of weird cosmic (Conclusion: Don't convert to a
coincidence? No. Here’s the dirty Roth unless you've got other,
little secret about Roth-IRAs: If non-Roth money to pay the taxes.)
the tax rates stay the same,
converting a traditional IRA to a And here's another example. If a
Roth-IRA doesn’t really make taxpayer uses other funds to pay
sense. the taxes, he or she gets a
slightly better outcome with the
But One Final Roth Wrinkle... Roth--even if tax rates are the
same now and in the future. This
Let me share a final wrinkle Roth-related boost comes from the
related to Roth-IRAs and Roth fact that with a Roth, a taxpayer
conversions. can save more money in a
tax-advantaged account.
retirement.
Getting Smart about Roth-IRA
Conversions Because most people's tax rates
fall in retirement, most people
The conclusion? Converting to a shouldn't use a Roth or convert
Roth-IRA probably makes sense existing an IRA to a Roth. Even
when you expect your tax rates to multimillionaires like Bill.
stay the same or to go up in
About the Author:
Seattle CPA Stephen L. Nelson wrote "Quicken for Dummies", the Do-It-Yourself Guide to California LLC Formations, and more than 150 other books as well. Reach him at http://www.llcsexplained.com/doityourself_California.htm.
Read more articles by:
Stephen Nelson
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