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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76386  
Subject: Re: Rechar of Roth 'conversion' v. 'contribution Date: 10/13/1999 10:43 AM
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MKraft, slightly persistent <g>, comments anew:

TMFPixy at it again:

You're gonna pay taxes on that $2K at 28% whether you contribute to a Roth or not unless you put it in a fully deductible traditional IRA.


That was my whole point. You're normally a 15% taxpayer. In a particular year you have sufficient income to put you into the 28% bracket -- but you expect to return to 15%.

In that scenario, should you pay an extra 13% tax to contribute (non-deductibly) to a Roth or take a $2,000 deduction to contribute instead to a trad. IRA money you expect to later pay 15% on?

In my reading of your past posts on this topic, it always seemed to me you favored the trad. IRA. or at least questioned that the Roth would put one ahead.


My logic on the traditional versus the Roth is laid out in post 1567 at http://boards.fool.com/Message.asp?id=1040013000441002&sort=postdate. In that analysis, regarding Roth contributions I said:

QUOTE

In choosing between a tax deductible traditional IRA and a Roth IRA,
our marginal tax rate today versus that of tomorrow is important.
If the tax rate declines when the money is withdrawn, those who end
up in a 15% tax bracket will not benefit from Roth IRA contributions.
If the tax rate stays the same in retirement, neither choice has
an income tax advantage over the other during the owner's lifetime.
(Note: Because the Roth IRA passes tax free to heirs at death, it has the
advantage from that standpoint.) To beat the traditional deductible IRA,
an after-tax contribution to a Roth IRA must be exactly equal in dollars
to that made to the traditional IRA.

UNQUOTE

Regarding conversions to a Roth I said:

QUOTE

When funds are taken from the converted IRA to pay income tax due on the
conversion, the Roth IRA will be an inferior option to the traditional IRA.
This holds especially true if the withdrawal to pay those taxes also
results in an early withdrawal penalty. When taxes due on the conversion
are taken from other taxable assets, the Roth IRA is a more attractive
option. For those who remain in the same marginal tax rate at the time
of withdrawal, the Roth IRA is a clear winner. For those who drop to a
lower tax bracket at withdrawal, the Roth IRA must be held for more than
10 years to beat the traditional IRA.

UNQUOTE

My position hasn't changed in any of the posts I've made since then. Like Bob78164, I think when the contribution choice is between a nondeductible traditional or a Roth IRA, then the Roth IRA is a no-brainer. If the choice is to contribute to a deductible traditional IRA or a Roth, then the Roth gets my nod when one is sure the marginal tax rate will not fall in retirement. That's because heirs will get the proceeds completely tax-free, unlike the traditional IRA. When it comes to conversions, I believe those are advantageous only if the income taxes can be paid with assets other than the traditional IRA and when the Roth can be left untouched for longer than 10 years.

that $560 paid today in taxes is recovered in three years inside the Roth. After that, everything is tax-free gravy.

The same applies to conversions, doesn't it?

Are you in essence saying that recharacterization is worthwhile even for *conversions* only if the value of the account since conversion has decreased dramatically, and *not* because of any tax bracket considerations.

That is, are you opposed to recharacterizations of Roths just because they are being taxed at 28% in the case of someone who normally pays taxes at 15%?


I'm not opposed to recharacterizations of Roths at all. Definitely a recharacterization is in order for conversions in cases where the assets have declined in value since the conversion took place. Why pay income taxes on something that no longer exists? OTOH, if you converted when you were in a 28% tax bracket and expect to be in a 15% tax bracket in retirement, then you better be prepared to pay the tax bill with other assets and to hold the Roth for longer than 10 years. Otherwise, the conversion is (f)oolish. If you converted while temporarily in a 28% bracket and forevermore thereafter expect to remain in a 15% bracket, then (aside from questioning your motivation for doing so) I would say a recharacterization is in order so you could reconvert later when in a lower bracket. If you exceeded the $100K AGI limit for conversions, then a recharacterization is also in order. (But in that scenario you wouldn't be in a 15% bracket, either.) As to recharacterizations of contributions, I would again question the wisdom of using a Roth if you knew you were in a 28% tax bracket as an exception to the rule. If you expect to remain in a 15% tax bracket, then why would you have used a Roth in the first place? A fully deductible contribution to a traditional IRA that would be taxed at 15% versus a nondeductible contribution made to a Roth IRA when one is in a higher tax bracket is (as post 1567 points out) superior to the Roth. In that case, for pity's sake recharacterize the contribution and think twice before you use the Roth again. OTOH, if the choice is between a nondeductible traditional IRA and the Roth, use the Roth and forget about recharacterization of the contribution.

Post 1567 contains some pertinent information on the use of Roths. It was written prior to the implementation of recharacterization rules, but the logic therein can also be applied to those rules. If you haven't read it, you should.

Regards..Pixy
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