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Author: TMFDj Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 120820  
Subject: Re: Roth Conversion Date: 9/17/2005 9:55 PM
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Am I wrong to convert it at all? I figure this is the last time we'll be in the 15% tax bracket, though I'm not sure this money's going to grow all that much. Would it be worth it in the long run? I'll have to pay $25 to do the conversion and then I'll have to pay a fee to invest the money somewhere other than the current sweep earnings.

I suggest that you very seriously consider getting some expert tax advice. You're personal, financial situation isn't particularly unique or difficult, but you're messing it up. A good expert can set you on the right track and answer your questions along the way.

I suggest you find a local CPA who specializes in personal finance, as opposed to corporate finance. CPAs calendars are filling now as the end of the tax year approaches. You should hustle.

For most investors, most of the time, the Roth IRA is preferable to the Traditional IRA. The younger you are, the better the Roth IRA.

If you have a Tradional IRA, the analysis to decide whether to convert to a Roth IRA is complicated. The math to do the analysis is easy, and it's easy to fool yourself into thinking that since you can do the math you can do the analysis, but if you don't understand the theory behind the math, you can hurt yourself badly.


There are many free conversion calculators available, and I think they have the same fault as doing the analysis yourself. If you don't understand the theory, you can hurt yourself badly.

The year that Roth IRAs came out, I paid a CPA about $100 to do the analysis for me alone, my wife alone, and the two of us together. I would imagine the price has gone up since then, but I still think the CPA is the right person to do the analysis.

As young as you are, and as small as your portfolio is, I would expect that you could blindly do the conversion. However, there will be taxes due for the conversion, and you MUST have the money in hand to pay the taxes, or the conversion doesn't make sense.

If you decide to do the conversion, then you do NOT want to elect the 10% withholding. You'll have to pay a premature withdrawal penalty on the 10% that is withheld, as well as federal and state income taxes. You want to convert the entire Tradtional IRA into a Roth IRA, and pay the taxes on the conversion.

In case you're wondering about those taxes on the conversion, with a Traditional IRA you don't pay taxes on the money you contribute, but you do pay taxes on the money you withdraw; and with a Roth IRA you pay taxes on the money you contribute, but you don't pay taxes on the money you withdraw. When you do the conversion from Traditional IRA to Roth IRA, you have to pay the taxes on the money that you didn't pay taxes on when you contributed them to the Traditional IRA. In the long term, you'll keep more money with a Roth IRA than you will with a Tradtional IRA.

You mentioned that you chose to keep your IRA with a stock brokerage. You're setting yourself up for failure. Given the size of your portfolio and your experience in stocks, you would be far better off investing in index mutual funds.

I advocate starting with a core portfolio consisting of ONE stock index fund tracking a broad stock market index like the S&P 500 or the Wilshire 5000. As you approach five to seven years from retirement age, you might want to consider adding to your core portfolio ONE bond index fund tracking a broad bond market index like the Lehman Brothers Composite Bond Index. After you have several years' gross income invested in your core portfolio, then you might want to consider expanding your total portfolio to include some sector index mutual funds, individual stocks and bonds, and perhaps some carefully selected managed mutual funds.

As you mentioned in your post, you need to get your withholding straightened out. You'd like to end up owing a couple to a few hundred dollars at the end of the year. If you're getting a refund, you're giving the Government an interest-free loan. If you owe more than a few hundred dollars, you're making yourself vulnerable to underwithholding penalties.

As I mentioned, a tax expert can get you straightened out reasonably quickly and painlessly. You probably could straighten yourself out, but doing this job yourself will take time and effort. Consider the CPA's fees as tuition, and make certain that you learn something from this class.

David Jacobs
TMFDj
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