Is conversion to a Roth IRA always a good idea? This is an excellent question – especially now. Roth IRA conversions are taking off in 2010.
But could the reason behind the jump be sinister? Could fund companies and advisers be pushing the move to boost their own profits rather than to help you?
Ya think? Vanguard Group Inc. converted almost 30,000 traditional IRAs into Roth IRAs in January alone. And Vanguard is only one example. The list goes on and on.
But I digress…
Upper-income investors (and that often means older investors) are taking advantage of new rules that took effect on January 1. As a result of those changes, you can convert to a Roth even if you earn more than $100,000. Also, you can spread the tax liability over 2011 and 2012. Is it a good tax strategy?
Considering the benefits of converting a traditional IRA to a Roth, you’d think it would be a no-brainer. After all, withdrawals of earnings and principal are tax-free.
But it’s really not a slam dunk.
First, it’s important to remember that the earnings can only be withdrawn tax-free after five years. Forget that rule and you’ll get dinged 10%. Ouch!
Also, the Roth IRA conversion can wreck your tax credit for homebuyers.
And of course there is the little problem of finding the cash to pay the tax on the converted assets. As you know, when you convert your traditional IRA to a Roth IRA, you have to pay tax on that money. If you use the IRA assets to pay the tax, the benefit of converting just about evaporates.
So, is conversion to a Roth IRA when you are over 60 smart?
The answer is simple – it depends.
And the real answer has nothing to do with your age. But it has everything to do with how long you want your money to survive. In other words, when it comes to this particular pot of money, which is more important, you or your IRA beneficiary?
This may be a new but critical concept for you.
I want you to start thinking about the longevity of your money just as much your own longevity.
And to be frank, from a financial planning standpoint, your money’s planned longevity is much more important than yours. This is especially true when it comes to the issue of traditional versus Roth, but it actually plays a vital role in any financial decision you make.
Let me explain by way of example.
You ask me if conversion to a Roth when you are over 60 is smart. I ask you how long you want the money to survive.
Assume you tell me you want that money to last for generations and you have money outside the IRA to pay the tax.
I say the conversion to the Roth is probably something to consider strongly. Why? Because you’ll have decades and decades of tax-free earnings to compound. That will probably more than compensate you for the tax you pay upfront. As a result, your beneficiaries will make out like bandits if you make the conversion.
But if you tell me that you are currently using the IRA distributions to complement your current income, it’s another story.
Following this example, if you tell me that you would use the IRA money to pay the tax and you will probably exhaust the money over the next 15 years, that throws up red flags.
Generally speaking, the less you need or want the IRA money, the more attractive the conversion is.
Bottom line time.
When the fund companies and sales slobs tell you to convert now, tell them to take a jump in the lake.
If you are considering a conversion to Roth IRA when you are 60 or over, think about how long you want that money to last before you make any move.
If you converted to a Roth, why? If not, why not?