A Tax Bite to Convert to a Roth IRA?

My wife and I have always wanted to have a Roth IRA but were never eligible because of our income. As you know under the new law it is possible to convert our regular IRAs to the Roth’s. Most of our retirement assets are in 401-Ks and they cannot be touched. But we do have about $90,000 in regular IRAs.

This all sounds like a great idea but the taxes on the $90,000 would amount to nearly $30,000 and that doesn’t seem to make any sense to spend that money now just so the government will waste it on some stupid bail out or give away.

I’m 45 years old so I know that $90,000 could easily be over $300,000 when Kathy and I retire (figuring roughly 7%). But I can’t get around the $30,000 of taxes now.

What do you think?

Herb

Dear Herb,

Great question, and hopefully the following helps.

First of all as a financial planner I love to have different pot of money for my retirees. Any distributions from your traditional IRAs and 401-Ks will be taxable. Having a Roth IRA allows you to somewhat control your income and tax bite when you start taking money from those assets.

Also what if your needed a big sum of money, say $100,000 at retirement for either an emergency or an opportunity. You would need to take about $130,000 from a regular IRA to have $100,000 after tax.

Just like everyone else work for the other stuff you want, your parents did.

Therefore, if you decide to convert your regular IRAs you could take several years to do it so you can spread out the tax bite accordingly.

You could also mentally divide the IRA into three different types of assets, such as bonds, US stocks and emerging market stocks.

Follow this logic, if, for example, you converted $10,000 of your IRA to emerging markets stocks and they afterword fell in value, you would feel bad about paying $2500 of taxes on say $7500 of value (I just assumed a 25% market dip). The good news is that you have until Oct. 15th of the year of conversion to tell the government, King’s “X” I want a re-do (just like golf). You can then “re-categorize” the emerging markets Roth back to a traditional IRA and not owe the taxes on assets which have gone down.

You can latter transfer other moneys from your other IRAs to emerging markets and instead of owning taxes on $10,000 you’ll only owe tax on $7,500. You can do all of this without disturbing your other Roth’s. (Assuming they did not decline much in value).

The government gives you the opportunity to control your taxes to a degree. It may be a little complicated but saving tax dollars is a great investment.

By the way, Herb, great job at saving money.

Paul D. Reasoner CFP, CIMA

 

These are the opinions of Paul Reasoner and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice.

Compass Wealth Advisors, LLC is an advisor owned independent Registered Investment Advisory Firm. Registered Representative. Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, FINRA/SIPC. Cambridge and Compass Wealth Advisors, LLC are not affiliated.