The Cons and Pros of Roth Conversions
Danny Allizadeh, ChFC?, CPFA
Unlock a Simple Path to Make Working Optional & Protect Wealth From Costly Risk Exposure Using Our Position Wealth? Outlook | Managing Partner | Ex-Merrill Lynch
We frequently get asked about Roth Conversions. 95% of the time it’s not the right strategy, because the reasons for wanting to do it are often based on unknown future events. We want to set the record straight with some points about what it is and who it might be suitable for.
A Roth Conversion involves transferring IRA money into a Roth IRA. You pay taxes on the conversion now. In exchange, you get tax free growth on the Roth IRA.
Why it might not work for you:
1.?Taxes: You must pay ordinary income tax today on the entire conversion amount. This is in addition to your employment income. I.e. For a $250,000 conversion, the additional tax burden could be at least 32%, or $80,000.
2.?Math: Your $250,000 conversion just got reduced by 32% to $170,000. Just to get the Roth back to the original $250,000, you’ll need an investment return of 47% (not 32%). BTW, a 47% investment return on your original $250,000 IRA would equal $367,500! Assuming the same investments, your IRA will greatly outperform your converted Roth over time due to compound interest on a higher starting number.
3.?Taxes (again): A popular opinion is that we’ll have higher tax rates in the future. While that may be true during your working years, this likely won’t be the case during your retirement. What that means is that your tax burden for taking IRA distributions (vs Roth) will be a) spread out over 20 to 30+ years when b) your tax rate will be lower.
Why it might work for you:
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1.?Income: You decide to take a sabbatical, start a business, or you’re unemployed this year. Your tax rate may be the lowest it’ll be for a while, so a conversion could be worth it.
2.?Beneficiaries: If you want to shoulder the tax burden for your beneficiaries, then a conversion might make sense.
3.?Relocating: If you live in a low tax state during your working years but plan on moving to a high tax state in retirement, then paying the taxes to convert now might also make sense.
If you’re unsure about whether a Roth Conversion makes sense for you, please contact us!
Please consult with your tax professional if you're considering a Roth Conversion
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