| My multimillionaire client Bill called me the other day. He | | | | If he also paid a 35% tax on this money, after paying |
| wanted to talk about congress recently loosening the | | | | the income taxes, he would net $5,605,002.43. Which is |
| rules about who can convert regular IRA accounts to | | | | the exact some number he ends up with if he |
| Roth-IRA accounts. | | | | converts to a Roth-IRA... |
| In the past, because of his income, Bill hasn't been able | | | | Some sort of weird cosmic coincidence? No. Here's |
| to use a Roth-IRA. Starting in 2010, however, even high | | | | the dirty little secret about Roth-IRAs: If the tax rates |
| net worth, multi-millionaire taxpayers like Bill can use a | | | | stay the same, converting a traditional IRA to a |
| Roth-IRA by converting existing traditional IRAs and | | | | Roth-IRA doesn't really make sense. |
| IRA-Rollover accounts to Roth-IRAs. | | | | But One Final Roth Wrinkle... |
| Bill understood he would pay income taxes on the | | | | Let me share a final wrinkle related to Roth-IRAs and |
| conversion. But wouldn't it make sense, he asked, to | | | | Roth conversions. |
| convert a $1,000,000 IRA account he'd been able to | | | | I truly suggest clients like Bill think of Roths and regular |
| accumulate to a Roth-IRA? | | | | IRAs as "six of one, half a dozen of the other" |
| A Simple Roth-IRA Conversion Example | | | | situations. That said, where a person gets the money |
| Unfortunately, I explained, Roth-IRA conversions aren't | | | | to pay the taxes on the conversion makes a |
| that simple. | | | | difference, too. |
| But let me share some additional information. Bill will | | | | For example, if a client like Bill uses some of the IRA |
| retire in about 25 years. He earns about 9% a year on | | | | balance to pay the taxes (this is sort of what my |
| his $1,000,000 IRA. He also pays the highest 35% | | | | example calculations assume), the taxpayer may have |
| marginal income tax. | | | | to pay an early withdrawal penalty. That early |
| If he converts, Bill will need to pay income taxes on his | | | | withdrawal penalty makes the Roth a worse deal. |
| $1,000,000 conversion. Because Bill gets taxed as the | | | | (Conclusion: Don't convert to a Roth unless you've got |
| highest, 35% marginal rate, he'll pay $350,000 today if | | | | other, non-Roth money to pay the taxes.) |
| he converts. But even so, he will end up with | | | | And here's another example. If a taxpayer uses other |
| $5,605,002.43 in his Roth-IRA in 25 years. And the | | | | funds to pay the taxes, he or she gets a slightly better |
| sweet thing is, of course, that money will have already | | | | outcome with the Roth--even if tax rates are the |
| been taxed. | | | | same now and in the future. This Roth-related boost |
| Bill thought that sounded great, of course. And I had to | | | | comes from the fact that with a Roth, a taxpayer can |
| agree. More than $5,000,000 tax free. Sweet. | | | | save more money in a tax-advantaged account. |
| What Happens with a Traditional IRA and No | | | | Getting Smart about Roth-IRA Conversions |
| Conversion | | | | The conclusion? Converting to a Roth-IRA probably |
| I explained, however, that we also needed to compare | | | | makes sense when you expect your tax rates to |
| this Roth-IRA future value amount to what Bill would | | | | stay the same or to go up in retirement. |
| end up with after tax if he just stuck with his regular | | | | Because most people's tax rates fall in retirement, |
| IRA. | | | | most people shouldn't use a Roth or convert existing |
| In that case, Bill ended up with $8,623,080.66. | | | | an IRA to a Roth. Even multimillionaires like Bill. |