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Author: RDALEY Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75384  
Subject: Roth Conversion Date: 11/24/1998 10:43 PM
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Most of the recommendations I have seen regarding conversion from a standard IRA to a Roth discourage it for people in my age group (55). However I have been amazed at the performance of my Fool Portfolio in the last six months and consequently I want to re-examine this issue. Since this is apparently the only year we can spread the taxes out over four years, I feel that this is the best time to ask the following question:

Is there a threshold (expected) average annual rate of return for the next ten (or eleven?) years that would recommend switching from a standard IRA to a Roth IRA this year for a 55 year old?

My common sense tells me that it might be better to pay 28% of the present value of my portfolio now than 28% of its accumulated (but reduced by the tax) value ten years hence, especially if the annual rates of return implied in the Fool philosophy continue to hold.

I am assuming that my tax obligation will stay at 28% when I retire if I retain the standard IRA and that it will not exceed 28% during the next four years if I pay taxes on the conversion.

If it helps, assume the present standard IRA portfolio is at 50K, my present annual income is 60K, and retirement sources other than the IRA will provide 50K annually. I live in a state that does not tax retirement income. (Does the state tax the rollover from a standard to a Roth?)

HubCapBurger
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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: 6786 of 75384
Subject: Re: Roth Conversion Date: 11/26/1998 11:37 AM
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Greetings, HubCapBurger, and welcome. You asked:

<<Most of the recommendations I have seen regarding conversion from a standard IRA to a Roth discourage it for people in my age group (55). However I have been amazed at the performance of my Fool Portfolio in the last six months and consequently I want to re-examine this issue. Since this is apparently the only year we can spread the taxes out over four years, I feel that this is the best time to ask the following question:

Is there a threshold (expected) average annual rate of return for the next ten (or eleven?) years that would recommend switching from a standard IRA to a Roth IRA this year for a 55 year old?

My common sense tells me that it might be better to pay 28% of the present value of my portfolio now than 28% of its accumulated (but reduced by the tax) value ten years hence, especially if the annual rates of return implied in the Fool philosophy continue to hold.

I am assuming that my tax obligation will stay at 28% when I retire if I retain the standard IRA and that it will not exceed 28% during the next four years if I pay taxes on the conversion.

If it helps, assume the present standard IRA portfolio is at 50K, my present annual income is 60K, and retirement sources other than the IRA will provide 50K annually. I live in a state that does not tax retirement income. (Does the state tax the rollover from a standard to a Roth?)>>


There is no magic answer to your question. Conversions are tricky and depend on how you will pay the taxes due, what you think the tax rates for you will be in the future versus what they are now, how long the money can stay in the Roth IRA, your estate planning problems/desires, and a few other considerations. In general, if you pay the tax from money other resources (i.e., you don't keep some of the converted IRA for that purpose), if you stay in the same tax bracket in retirement, and you don't have to touch the funds for ten or more years, then conversion probably makes sense. See my analysis on this board at http://boards.fool.com/Registered/Message.asp?id=1040013000441002&sort=postdate for details. That missive will provide additional food for thought as you make this decision.

And yes, assuming you already pay state income taxes, then your state will want its cut of the income you must declare as a result of the conversion.

Regards….Pixy


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Author: RDALEY Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 6804 of 75384
Subject: Re: Roth Conversion Date: 11/26/1998 3:41 PM
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TMFPixy@aol.com wrote:

> Subject: Re: Roth Conversion

Greetings, HubCapBurger, and welcome. There is no magic answer to your question. Conversions are tricky and depend on how you will pay the taxes due, what you think the tax rates for you will be in the future versus what they are now, how long the money can stay in the Roth IRA, your estate planning problems/desires, and a few other considerations. In general, if you pay the tax from money other resources (i.e., you don't keep some of the converted IRA for that purpose), if you stay in the same tax bracket in retirement, and you don't have to touch the funds for ten or more years, then conversion probably makes sense. See my analysis on this board at HREF="http://boards.fool.com/Registered/Message.asp?id=1040013000441002&sort=postdate for details. That missive will provide additional food for thought as you make this decision.

And yes, assuming you already pay state income taxes, then your state will want its cut of the income you must declare as a result of the conversion.

Regards….Pixy


------------------------------------------------------

Thank you for your response. The reference was very helpful. I am still curious as to whether a higher rate of return than the 9% you use in your example would tend to make the Roth an even more advantageous decision. I don't have the formulas but my logic tells me that the greater the rate of return on investment, the larger the fund grows after conversion and before withdrawal and thus the greater the disparity between the front-loaded and the back-loaded net results. Is it possible to use what I assume to be spread sheet formulas in your Feb 98 example to run the comparisons at different rates of return than 9% - e.g. the apparent 11-12% the S&P has been returning or perhaps the more speculative but certainly well documented returns from the Fool Port.

The objective would be to be able to either make the comment "other things being equal, the higher the rate of return on investment, the more sense it makes to convert to a Roth IRA" or "other things being equal, the rate of return on investment doesn't make any difference between the Roth IRA and the Standard IRA."

P.S. Per your article and response, I will most certainly not use $ from the conversion to pay the taxes. It isn't logical to use this "special" money for taxes when it can be accumulating non-taxable interest. I MAY, however, reduce the amount I am putting into my 401K for four years to pay the taxes - or I will just take it out of hide. The best my 401K can do is the Contra fund - I would be interested in your views on this subject.

Regards,

HubCapBurger




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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: 6813 of 75384
Subject: Re: Roth Conversion Date: 11/27/1998 12:24 PM
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HubCapBurger writes:

<<Thank you for your response. The reference was very helpful. I am still curious as to whether a higher rate of return than the 9% you use in your example would tend to make the Roth an even more advantageous decision. I don't have the formulas but my logic tells me that the greater the rate of return on investment, the larger the fund grows after conversion and before withdrawal and thus the greater the disparity between the front-loaded and the back-loaded net results. Is it possible to use what I assume to be spread sheet formulas in your Feb 98 example to run the comparisons at different rates of return than 9% - e.g. the apparent 11-12% the S&P has been returning or perhaps the more speculative but certainly well documented returns from the Fool Port.

The objective would be to be able to either make the comment "other things being equal, the higher the rate of return on investment, the more sense it makes to convert to a Roth IRA" or "other things being equal, the rate of return on investment doesn't make any difference between the Roth IRA and the Standard IRA.">>


You can change the rates of return, but the results will be the same in a relative sense. I ran the model for a conversion paying the taxes from other sources again. This time I used a 12% rate. The result showed if the tax rate in retirement fell to 15% it still would take 10 years for the Roth to better the deductible IRA. If the retirement tax rate stayed the same or rose, then the Roth would be better for all time periods. If the taxes were paid from the conversion IRA, then the deductible IRA would be better for all time periods. The easiest way to see this is to build your own spreadsheet model and run some varying rates of return.

<<P.S. Per your article and response, I will most certainly not use $ from the conversion to pay the taxes. It isn't logical to use this "special" money for taxes when it can be accumulating non-taxable interest. I MAY, however, reduce the amount I am putting into my 401K for four years to pay the taxes - or I will just take it out of hide. The best my 401K can do is the Contra fund - I would be interested in your views on this subject. >>

IMHO you should never scale back 401k contributions until you have reached the point at which you have received the maximum employer match to those contributions. After that, you should evaluate your options on a tax-equivalent basis. That assumes you invest the funds in the same disciplined fashion as you would in the 401k through an automatic deposit that increases as your pay does. See Step 4 of my 13 Steps to Foolish Retirement Planning at http://www.fool.com/Retirement/Retirement.htm for details. When it comes to paying the taxes due on the conversion, I personally would make every effort to find the funds to do so without curtailing my investments in a 401k or anywhere else.

Regards….Pixy


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Author: RJE1 Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 6912 of 75384
Subject: Re: Roth Conversion Date: 12/2/1998 12:04 AM
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I had outlined my financial situation on Your Finances / Tax Strategies, Subject: Roth Conversion - help Post # 6283. I was directed to your post on this board of 1567. It appears to me that my situation may be like the last example. Hopefully, with good investments I'll stay in the same tax bracket. However, since this is money invested in a treasury zero at 7.5% guaranteed until age 59 1/2, I wonder if there are things that I am not thinking about. When I run calculators I have a hard time figuring out what to put in some of the questions. Also, just running the tax and fees for conversion on the Motley Fool calculator, I came up with a total tax of $70,350 (ouch). I frankly wonder if I could afford to pay that at $1458.33 a month if I payed out of "cash". Comments or suggestions would be appreciated as I try to think through the issues.

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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: 6915 of 75384
Subject: Re: Roth Conversion Date: 12/2/1998 8:52 AM
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Greetings, RJE1, and welcome. You wrote:

<<I had outlined my financial situation on Your Finances / Tax Strategies, Subject: Roth Conversion - help Post # 6283. I was directed to your post on this board of 1567. It appears to me that my situation may be like the last example. Hopefully, with good investments I'll stay in the same tax bracket. However, since this is money invested in a treasury zero at 7.5% guaranteed until age 59 1/2, I wonder if there are things that I am not thinking about. When I run calculators I have a hard time figuring out what to put in some of the questions. Also, just running the tax and fees for conversion on the Motley Fool calculator, I came up with a total tax of $70,350 (ouch). I frankly wonder if I could afford to pay that at $1458.33 a month if I payed out of "cash". Comments or suggestions would be appreciated as I try to think through the issues.>>

I can't recommend what you should do, but I can tell you that your tax bill (assuming your calculations are correct) ain't gonna be "…1,458.33 a month…" for 1998, but could be for 1999, 2000, and 2001. Assuming you're in a 28% federal and 7% state tax bracket (combined 35%), you're thinking of converting about $200K. Do that before 12/31, and you can spread the income over four tax years, the first being 1998. So this year you would declare an extra $50K in income, for which the estimated withholding of income taxes must be paid by 1/15/99. Thus, you have but one month to pay your estimated taxes on that $50K ($17.5K due for withholding?). In the subsequent years you can probably get away with quarterly estimated withholding on the $50K of income reportable in those years.

You're talking about a healthy hunk of change here. We know nothing about you or your desires and have far too little information on which to comment authoritatively. I recommend you seek out - quickly - the services of a fee only Certified Financial Planner who can run some conversion scenarios for you to make the choice easier. Better hurry, too, 'cause you're running out of time.

Regards…..Pixy


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