Three Reasons You May Not Want to Convert to a Roth IRA

There’s been a lot (I mean a LOT!) of press surrounding the coming “opening of the floodgates” for Roth IRA conversions. You only have to glance through the headlines lately to see wild cries about the coming tsunami of Roth conversions beginning with 2010.  Personally I think that, while there will likely be more conversions after the start of 2010, there are a lot of reasons why this might not be the best idea for a lot of folks.  Here are three really good reasons why you probably should reconsider…

Three Reasons You May Not Want to Convert to a Roth IRA

  1. “Same as it ever was…” Several factors must be considered when determining if a Roth conversion makes sense for you:
    1. the amount of the conversion
    2. your conversion tax rate
    3. your earnings on the converted account
    4. the amount that you withdraw from the Roth account
    5. the date that you begin withdrawing that amount from the Roth account

    If you would have begun taking the withdrawals on the same date (E) regardless of the account (traditional or Roth), in the same net (after tax) amount (D), at the same rate (B) – assuming your earnings would be the same either way – there is no advantage to the Roth conversion.

    In order for there to be a benefit to the conversion, one or more of the following must happen:

    • the date you begin taking distributions must be later;
    • the amount you would take as a distribution must be less; and/or
    • the tax you pay on the distribution would have been higher than the conversion rate.
  2. A downward spiral. If the value of the investments in the account actually reduce in value, or if the tax rates decline, you’ll be in a worse position if you convert to a Roth IRA.  For example, if your IRA was worth $100,000 when you converted it, if your tax rate was 25% the tax cost of the conversion is $25,000. If the value of the account subsequently fell to $50,000 (of course, some time after the time limit has expired for recharacterization) – now the overall rate that the conversion cost you has inflated to 33%.  By the same token, if (heaven forbid) the tax rates are lower in the future, it doesn’t make any sense for you to do a Roth conversion. The more likely event is that your personal tax rate might be a lot less – especially possible if in retirement you have a pretty low-cost lifestyle.
  3. The game changes. What happens to you if Congress decides that this Roth deal is just too good?  Maybe they’ll start requiring distributions of the original account owner – or restrict the amount of time that your heirs can stretch payments?It’s really impossible to guess what Congress might do – but given the potential cost of lost tax revenues from Roth accounts, it’s not hard to believe that the rules could be changed to have a negative impact on your converted account.

Of course, this is not an exhaustive list – just a few good reasons why you really need to think this over before you do a Roth conversion. Don’t let the hype over the coming tsunami let you get caught in a wave.

About the author

Jim Blankenship, CFP®, EA

Jim Blankenship is the founder and principal of Blankenship Financial Planning, Ltd., a financial planning firm providing hourly, as-needed financial planning and advice. A financial services professional for over 25 years, Jim is a CFP professional and has earned the Enrolled Agent designation, a designation that qualifies him as enrolled to practice before the IRS. Jim is also a NAPFA-registered financial advisor, which designates him as a Fee-Only Financial Advisor.

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