Q&A: Roth IRA Conversions and Taxes

Question:  I know you’re generally not in favor of converting IRAs to Roth IRAs, but why not — if it saves money in taxes? With the traditional IRA I am forced to take money out at age 70½ and pay taxes on it, but with the Roth I don’t have to withdraw money at that age. I can continue to let it ride, and when I do finally take money out, it’s tax-free.

Perhaps I could keep some money in both traditional and Roth IRAs and move cash from one column to another to help save on taxes. What’s the problem with that?

Ric: Unfortunately, it doesn’t work that way, and here’s why:

First ask yourself: What is the goal of investing? Why put money into IRAs in the first place? Obviously, the goal is to accumulate wealth — as much wealth as you can on an after-tax basis.

The question then becomes: Which type of IRA produces more wealth, the traditional or the Roth? The answer might surprise you.

If you run the numbers on a spreadsheet, which isn’t hard to do, you’ll quickly discover that the answer is neither. It’s a wash. There is no difference.

If you convert to the Roth, you trigger a tax immediately. But converting won’t increase your wealth, so why pay a tax right now that you don’t have to pay?

You also asserted that the Roth avoids the requirement that you take distributions starting at age 70½. Can you count on that forever? Be aware that President Obama inserted language into the 2015 budget that would require distributions from Roths at age 70½ just as with traditional IRAs.

That’s one of my fears about the Roth: The government could change the rules at any time — and do so retroactively. If you won’t reach age 70 for another 20 years, you’ll go through 10 Congresses and maybe five presidents. Are you sure they won’t ever change the rules? Consider that Roths will hold trillions of dollars by then — money that’s currently tax-free. That’s a pretty tempting target for a legislator trying to generate tax revenue.

That’s why we don’t endorse the Roth for most of our clients. Of course, there are exceptions. So please talk with us to see if the Roth is right for you before you choose it.

Originally published in Inside Personal Finance March 2015

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