Roth IRA Conversion

Is It Right For Me?

Who doesn't need a source of tax-free income in retirement? It makes sense to consider at least a partial conversion of 401(k) plan, traditional or roll-over IRA assets, and minimally to learn more.

Here are 5 reasons why:

• # 1 -- Tax Diversification. When you have a variety of accounts from which to draw retirement income (taxable, tax deferred and tax free), you have much more flexibility in arranging your taxable 1040 income. We can’t know for sure what tax rates will be in the future, but if they do go higher, a Roth conversion done now will hedge against that possibility. Similar to investment asset allocation and diversification, it’s smart to have tax diversification too.

• # 2 -- Lock-In Today's Tax Rate. Another way to look at it is that you're locking in a rate on the converted amount. It might be 28% or 35%, if you're in the top federal tax bracket. Once you lock in that tax rate on those assets you never need to worry about how much tax you'll pay again. It'll be zero.

• # 3 -- Tax Flexibility. Another reason Roth IRAs are universally appealing is that they provide tax flexibility throughout retirement. You can literally design your tax return. Rather than taking big required minimum distributions (RMDs) at the end of the year, you can work to keep income below the next bracket. Each year, depending on investment income or other income, you can draw from the appropriate account to make taxes come out the way you want.

• # 4 -- The Future of Tax Legislation. As the nation struggles with high deficits, watch for more tax surcharges to be imposed. We’ve recently seen the new health reform law add a 3.8% Medicare tax on unearned income starting in 2013 for high income households. To save on this and other potential tax hikes, it just makes sense to have a source of tax-free income alongside your taxable and tax-deferred accounts.

• # 5 -- Ideal for Estate Planning. When it comes to estate planning, the Roth can’t be beat. For one thing, the tax payment itself lowers the value of the estate and consequently reduces estate taxes. We have to assume that the estate tax will eventually be reinstated. But even if it isn’t, Roth assets left to heirs maximize the Roth benefits because of the longer period of tax-free compounding of post-Roth conversion assets. Heirs also get to enjoy the tax-free status of all Roth required minimum distributions (RMDs). There’s something very satisfying about leaving a legacy that is free of all encumbrances.

Of course, there are always exceptions:

• Income needs. If you need income from the IRA now or will soon, you probably shouldn’t convert. It takes time to recover from the conversion tax hit. The longer the assets can remain invested, the more advantageous the Roth will be. Also, if you are close to retirement and will definitely drop to a lower tax bracket you probably shouldn’t convert. But you might want to run the numbers anyway, especially if you plan to delay distributions.

• 10% Penalty. If you are under 59 ½ and don’t have outside funds to pay the conversion taxes, there will be a 10% penalty on any funds that are taken out of the traditional IRA and not put into the Roth. The conversion might still work, but you should take a long, hard look at it before being subjected to a 10% premature distribution penalty.

When it comes to getting ready for retirement, it’s a huge and complicated challenge. One of the chief overlooked aspects of the Roth conversion opportunity is looking at how to sequence your income distributions in retirement so that your total annual income in retirement is the most tax efficient.

Fortunately we can help you make sense of all this – Roth IRAs and retirement planning. In addition to a Roth conversion with distributions calculator, we have analytical tools to help you assess the wide range of potential conversion scenarios you may face to help confidently guide your decision making process.

As you can see the flexibility of the Roth conversion opportunity means there are numerous ways you can leverage your assets.

I urge you to take the Roth conversion opportunity under advisement as it is a key wealth management issue – one that encompasses investment, estate and tax planning. I am happy to strategically work with your estate attorney and CPA to assist you in making intelligent decisions.

Our main objective at Green Valley Wealth Advisors is to provide personal and innovative wealth solutions of which a Roth IRA conversion is one. Call me to discuss your situation, happy to help.

Sincerely,

Eric Linser, CFA

Chief Investment Officer

(Sept. 1, 2010)

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