Advice on whether to roll a large IRA to Roth?

L1: Advice on whether to roll a large IRA to Roth?Hi,
I have a Traditional IRA with a few hundred thousand dollars in it. I”m trying to decide whether to roll it to a Roth IRA, and would appreciate any advice.
It would seem that if I were to roll it, I would only want to roll part of it to keep myself from going into too high a tax bracket. I won”t have any significant income this year, so the amount of the rollover would pretty much dictate my bracket. I”m thinking I would probably want to only roll $120,000 or so to keep myself in the 28% bracket. Or, maybe I should roll $50,000 to keep myself in the 25% bracket (though I”d have to do this for a number of years in order to get a significant chunck of the IRA rolled, and I may get married and run up against the married filing jointly $100,000 restriction). In addition, I live in CA, so I”m stuck with 9.3% state taxes (I assume I have to pay state taxes on the rollover, but I”m not positive about that). I do have the cash on hand to pay the taxes in either scenario.
I found this on fairmark.com: “If your time frame is very long say, 10 years or more before you begin taking withdrawals tax rates are not much of a factor, partly because the long-term benefit of the Roth IRA will outweigh the added tax cost and partly because no one can predict what tax rates will be like that far in advance.”
I”m not sure I understand that advice. I”m 35 years old now, so the money will sit in the IRA for at least another 25 years. But, as I try running the numbers and using different potential future tax rates, it seems that the future tax rate does make a big difference, and that I might be better off leaving the money in the Traditional IRA. I”m very confused by the assertion that “If your time frame is very long … tax rates are not much of a factor”.
To roll $100,000 this year, I think I”ll have to pay about $36,000 in taxes. That $36,000 could grow quite a bit in 25 years, and even though I”ll have to pay taxes on it and the Traditional IRA in the future, it looks like I could still end up with more money if I”m in a low enough bracket in the future (relative to the 28% bracket I”d be putting myself in by doing the rollover).
Many thanks in advance for any help, advice, or thoughts.
Jeff2004-11-18 12:33, By: Jeff H, IP: [64.173.25.170]

L2: Advice on whether to roll a large IRA to Roth?Hello Jeff:
If you look at the math, and you are certain that your rollover & subsequent earnings will eventually become a qualified distributrion; e.g. after 5 years & attaining age 59 1/2; the Roth conversion is a dead bang winner.
You can potentially make it an even better winner by phasing your conversions in layers over multiple years so as to keep yourself consistently in in the 25% or 28% tax bracket.
TheBadger
wjstecker@wispertel.net
2004-11-18 13:57, By: TheBadger, IP: [66.250.23.22]

L2: Advice on whether to roll a large IRA to Roth?Hi, Badger. Thanks for the response. Here’s the math I’ve done.
I’m assuming the following values:
Current Principal in IRA = $100,000 Fed Tax Rate = 28% CA Tax Rate = 9% Interest Rate at which money will grow = 8% Years money will grow = 25 Fed Tax Rate at Retirement = 15% State Rax Rate at Retirement = 7%
So, if I convert the $100,000, then I pay $37,000 in tax, and the Principal grows to $684,848.
If I don’t convert, then at retirement I pay $150,000 in taxes on the $648,848, leaving me with $534,181. But, the $37,000 that I didn’t pay in taxes has grown to $253,394. I’ll pay $55,746 in taxes on it, leaving me with $197,647. Adding that to the $534,181 gives me $731,828, which is more than the $684,848 I’d get by converting.
This would seem to indicate that I shouldn’t convert. I’d appreciate any thoughts you have on what I might be not be doing correctly with my calculations and assumptions.
Jeff2004-11-18 14:19, By: Jeff H, IP: [64.173.25.170]

L2: Advice on whether to roll a large IRA to Roth?Check out our calculator in the left menu or click on http://72t.net/MN_RothConvert.aspx- if you tax bracket goes down following retirement, the Roth starts to lose some of it”s advantage.
A Roth seems to work best (in my opinion) when current tax bracket is low (less meaningful deduction) and when future income tax brackts will tend to increase. 2004-11-18 14:26, By: Gfw, IP: [172.16.1.71]

L2: Advice on whether to roll a large IRA to Roth?Hello Jeff:
I didn’t check every number in your reply; however if you assume the SAME tax rates going in as well as 25 years later; you should get equal terminal values after tax. So the real question is what is going to happen to tax rates in general and yours specifically.
1. In general, we are experiencing historically low income tax rates & my personal crystal ball says that rates must go up over time.
2. Never leave an unused lower tax bracket on the table; e.g. assume that for whatever reason one’s taxable income in a year will be close to zero when it is normally $50k to $150k. Automatically convert enough dollars to use up the lower brackets.
3. My experience with retirees is that they all expected their marginal tax bracket to be lower in retirement. Actual experience is the exact opposite. Over a sample of say 300; maybe 10 – 20 have experienced a lower bracket; 150 stayed the same & the last 120 actually wound up in higher brackets.
TheBadger
wjstecker@wispertel.net
2004-11-18 14:34, By: TheBadger, IP: [66.250.23.22]

L2: Advice on whether to roll a large IRA to Roth?Hi Jeff:
You didn’t tell us the total value, but if part is $120k and you’re 35, then it must be substantial. Congratulations!
My first suggestion is … assuming you have this option … to move away from California! Find a state with a lower or no state income tax. CA does have a nasty habit of trying to “follow the money” of successful people.
There is no problem making multiple conversions over several years. Just remember that you incurr a new 5-year period with each year of conversion.
The big thing you have on your side is time for growth and right now tax rates are low. Like I always say, do you want to pay taxes on a little pile of money or a big pile of money. The only danger I see is should your tax rate be substantially lower when you retire, and this is anybody’s guess.
Remember that you are limitedin making a conversion if your AGI is over $95k for a single and $150k for a married couple. Check out IRS Pub 590 for these details.
Finally, whether to convert or not is such an individual decision and not always based on age,income, tax rates of expected growth rates. Remember, it’s better to die with Roth IRA’s than Traditional IRA’s. I just met with a 72 year old client who’s in good health, has plenty of cash and LTC insurance in-place. We’re going to convert half of his $33k IRA in ’04 and the other half in ’05 after taking his RMD. The idea is to set upRoth IRA’s for his three children to use after they grow tax free for a few years … sounds like a good supplement for their Social Security benefits.
My point is you can calculate a gazillion scenarios for getting the most dollars, but you really have to consider the non-monitary options and benefits for using the Roth / Roth Conversion.
Good luck.
Jim2004-11-18 14:43, By: Jim, IP: [68.1.157.228]

L2: Advice on whether to roll a large IRA to Roth?And let’s throw one more item into the mix – also unknown – what type of tax system will there be in 25 years? Will it be a consumption tax, a sales tax, an income tax or a combination of all the above.
Best bet is to plan based on todays circumstances and watch the potential changes very carefully. 2004-11-18 14:44, By: Gfw, IP: [172.16.1.71]

L2: Advice on whether to roll a large IRA to Roth?Let me add to TheBadger’s last point with a 4th. My experience with retires is they have their financial house in order and the biggest gripe is they have to make RMD’s from their IRA’s when they don’t need or want the money. One more “non-monetary” reason to convert to Roth so you don’t have to make withdrawals.
Jim2004-11-18 14:47, By: Jim, IP: [68.1.157.228]

L2: Advice on whether to roll a large IRA to Roth?Jeff, Also check out our articles section or click on http://72t.net/MN_ArticlesShow.aspx?WA=25
I posted it originally a few years ago, but it is still valid today.
The link should work now.2004-11-18 15:03, By: Gfw, IP: [172.16.1.71]

L2: Advice on whether to roll a large IRA to Roth?Thanks for all the responses.
I like Badger”s point about never leaving an unused lower tax bracket on the table. At the very least, I suppose I should convert $29K or so at the 15% tax rate.
It does seem very difficult to know what taxes are going to be like 30 years from now. That makes me think that maybe I should convert some of the IRA, and leave some of it unconverted. The idea there would be to diversify across future tax rates. Regardless of what the tax situation is like in the future, it wouldn”t really affect me. Of course, I could do better by betting one way or the other by converting or not, but I”d have to be making the correct bet.
Not having to make required withdrawls is a good point to consider. I would hope I”m in a financial situation where I don”t have to make withdrawls :-)!
Moving away from California is a good suggestion, but not a practical one for me right now.
And thanks for the congratulations, Jim. I worked as a software engineer at a company for eight years and maxed out my 401K contributions. That helped, but what really did the trick was the company”s ESOP program where they put company stock in our retirement accounts every year. The company did well, and when I left I rolled the stock (and 401K account) to the IRA, sold the stock, and invested it in index funds.
Jeff2004-11-18 15:54, By: Jeff H, IP: [64.173.25.170]

L2: Advice on whether to roll a large IRA to Roth?Jeff:
Without a doubt you win the “Genius” award for the day because of your last sentence that your sold your company stock which had seen a good run-up. Too many people literally fall in love with their company stock and refuse to sell whether they still work there or left like you did. I feel that anything over a 10% concentration in company stock is too much. Just look back at the former employees of ENRON or WorldCom for confirmation.
From your first comments to your last I can tell that you have learned the complexities of your question. Just remember that regardless of your initial plan, be ready for changes as time progresses. Tax laws and personal situations are always a “work-in-progress” and we have to be ready to meet the changes.
Without a doubt the hardest thing to do in the investment world is to “pull the trigger” and sell something because “greed” sets in and the person thinks it will continue to go up forever. I think you have a pretty good handle on this one at this time … just remember the profit you did make and forget about any gains you missed when you sold.
Good luck for the future.
Jim2004-11-18 16:12, By: Jim, IP: [68.1.157.228]