What is the Status of Your Roth Conversion Decision?
March 4, 2010
We have previously communicated about the benefits of converting your eligible retirement plan balances. The reason we are reminding our clients about this opportunity is because, by converting to a Roth, you are taking assets taxed at normal rates and transferring them to non-taxable status. This differential may overwhelm the opportunity cost of paying the taxes today by creating a crossover point where the monies in the Roth IRA exceed the nominal value of monies in the Traditional IRA. This benefit is compounded by the fact that there are mandatory taxable distributions from unconverted retirement accounts. We are asking that all clients and/or their investment advisors update us as soon as possible regarding their decision to convert vs. not.
Eligible balances include both existing IRA accounts and the portion of your qualified 401(k) and other plan balances that may be eligible.
Generally, a Roth conversion may be worth the accelerated near-term tax cost even if you anticipate a moderate decline in aggregate tax rates by the time mandatory IRA distributions are required (i.e., if you move to a no or low tax state by the time mandatory IRA distributions would be required).
A Roth conversion, despite the associated up front tax cost, would likely yield greater sums for the following:
* Individuals building wealth that are relatively young (below age 50). Generally, the younger you are, the greater the advantage. Included in this category are those in the earlier stages of their careers who are faced with the same, or lower, tax rates today than will likely apply by the time they reach age 70.
* Those who will be subject to lower tax rates than usual in 2010 due to unique circumstances.
* Those younger than age 70 who expect to have enough wealth (inclusive of expected inheritance amounts) to enable them to forgo the required annual minimum distributions that would otherwise be required once they reach age 70 1/2.
* Those already over age 70 receiving mandatory distributions who have enough wealth to live the reminder of their lives without needing to further draw down their retirement balances as currently required. For these individuals, and those younger who anticipate being in this position, the results of continued tax-free growth for the remainder of the life of the second spouse to pass away, followed by stretched annual tax-free distributions over the life expectancies of young, named beneficiaries can be staggering as compared to what would be left under the same circumstances without a Roth conversion.
The tax consequences of a conversion can be reversed. Any portion of amounts converted in 2010 can be re-characterized by October 15, 2011 should circumstances cause you to change your mind or if values decline. Furthermore, you would have until such date to decide whether or not to elect out of the two year deferral to pay the taxes on a conversion that remains, should tax rates increase for 2011 and 2012.
While it is difficult to time the market, the earlier you convert in 2010, the more hindsight you will have to evaluate a re-characterization decision. If you do re-characterize, you would have to wait until the following year and at least 30 days from the date of a re-characterization to convert again.
Each case is different. We will be happy to assist you with specialized illustrations to help you determine the optimal 2010 amounts to convert and share these calculations with your financial advisors. Please contact your PerelsonWeiner partner.