Skip to main content

Barker Financial Management

Fee-Only Financial Planning and Investment Advisory Services

About Us
Contact Us
Site Map
Our Advantage
Complete Trust Solutions
Long Term Care Insurance
Request Financial Seminar
Roth IRA Conversions
Small Business Help
Company Officers
Should You Perform a Roth IRA Conversion?
If you are like many people, your retirement nest egg has been been growing tax deferred for years in a Traditional IRA, 401(k), 403(b), or 457(b) retirement plan. If you were an individual earning under $100,000 or a couple earning more than $150,000, however, you were prevented from also contributing to a Roth IRA.
Roth IRAs have many advantages over traditional IRAs. Your contributions to a Roth IRA grow tax free and there is no limit to how long you can contribute. There are also no Required Minimum Distributions (RMDs) so you can let your money grow tax free for as long as you want. Money in a Roth IRA can also be withdrawn for qualified education expenses without tax or penalty or you can let it grow for retirement or a legacy for your children. There is much to like about a Roth IRA, but there are a few caveats and, now that anyone can convert a Traditional IRA to a Roth IRA regardless of income, those caveats must be diligently considered before you take on a Roth IRA conversion from a Traditional IRA or are ready to transfer a retirement plan into a rollover IRA which can then be converted.
Caveat #1: Pay Now or Pay Later. Unlike a 401(k) transfer or IRA rollover, you must be ready and able to pay regular income taxes when you do a Roth IRA conversion. The only way this makes sense is if you are able to pay these taxes outside of the IRA. There are few circumstances that merit paying your conversion taxes out of your IRA or other tax deferred retirement account especially if you are under age 59 1/2 as you will pay a 10% penalty if you do so. If you can pay your taxes from a separate taxable account, Congress and the IRS allows you to spread the payment of those taxes over a 2 year period beginning with the 2010 tax year. Does this sound too good to be true? It is for many, but there are unique opportunities for some investors and people far from (time for tax free earnings to pay for the tax hit next year) or near retirement and expect to be in a lower tax bracket as they retire.
Caveat #2: Traditional IRA Aggregation Rule. If you made non-deductible contributions to a Traditonal IRA, you cannot select the portion of the Traditional IRA you want to convert. The amount converted will be prorated and you will pay tax on both the taxable and non-taxable money in your aggregate accounts. This is not a desirable way to perform a Roth IRA conversion.
Caveat #3: Multi-Year Tax Payment. Although you can spread out your tax payment over 2 years beginning in the 2010 tax year, taxes will surely be higher for those in the top tax brackets in years 2011 and 2012. If you wait to pay those taxes in those latter years, your tax burden will surely rise thereby diminishing your ability to earn enough tax free money in your Roth IRA over the years to offset the higher taxes you will pay in 2011 and 2012.
The Bottom Line
Every case is different, but if you are already in a high tax bracket and were unable to contribute to a Roth IRA, it is unlikely that you will benefit from doing a Roth IRA conversion today unless circumstances change, i.e. tax rates for high earners are lowered in future years, your retirement porfolio has a lower taxable base due to losses incurred during the recession giving you a significantly lower tax base to perform a conversion, or you are young and have a small traditional IRA that you would like to convert to a Roth IRA so that you can use it for retirement or qualified education expenses (money in Roth IRAs are not counted as an asset in FAFSA) and can pay the small amount of taxes due from a separate non-retirement account.
If you are being asked to do a Roth IRA conversion and are concerned about the merits of doing so, please contact us for a professional analysis. We are your advocate in the financial world and we provide completely objective financial and investment advice to ensure your financial, retirement, and investment success.