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Author: Bob78164 Big red star, 1000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121189  
Subject: Re: Conversion Quandary Date: 2/21/2000 2:50 PM
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rjm111 writes:

IRA balance = $100K. After paying taxes, conversion Roth balance = $80K. Assuming my Foolish plans work out, I want to retire in 15 years at age 55. I am going to assume a 15% percent annual return (I know this is higher than average, but I belive it is most probable given the quality of my port). In 15 years w/o conversion my traditional IRA would be $813,706 and my Roth would be $650,965. Even if I assume that I will be paying 20% cap gains on my traditional IRA in 15 years, the value of these ports would be equal after taxes. The more likely situation is that I will be at 15% tax rate or lower, therefore my traditional IRA would be worth at least $691,000 after tax vs. the tax free $650,695 value of the Roth.

I reply:

There are at least two problems with your assumptions. First, the difference in value between your present IRA balance and the conversion Roth balance implies that you intend to use IRA funds to pay taxes on the conversion. If you are assuming that your tax liability would be 20%, that is almost certainly an underestimate. Your marginal federal rate will likely be at least 31%, and you will probably owe state taxes on the conversion as well. Worse, if you use IRA funds to pay the tax liability, the withdrawal will be deemed a premature distribution, subject to the additional 10% penalty at the federal level. If you can't pay the conversion tax from outside funds, conversion is almost certainly a bad idea.

Second, any withdrawal of earnings from a traditional IRA is taxed as ordinary income, not capital gains. Thus, assuming the current tax rates still apply in 15 years, you will never be eligible for 20% rates. Correcting this error will weigh in favor of conversion. --Bob
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