With all this talk about Roth IRA conversions available to everyone in 2010, I don't see the attraction. It seems so simple to me to understand that if I don't write a big check to pay the taxes a conversion requires, I will have a lot more money, along with compound earnings, to pay whatever taxes I might owe on future distributions.
Plus, I control all the money and I have hedged my bets against what might be changes in tax policy or another market crash over the next 40 years.
Yet, to hear everyone talk, one would think that the Roth was the best thing since sliced bread. From the Kiplinger newsletter to The New York Times, I have yet to see an article mention the long-term equivalent value of all that money people will otherwise have if they don't pay the cost of conversion.
Let's start with marginal tax brackets. Anyone in California today pays at least 33 percent in combined federal and state taxes on each dollar of income over $35,464 if single (and $70,921 if married.) The average tax percentage on total income might still be down in the 20 percent range, but only because we pay next to nothing on the first few dollars.
We should always be using tax rates paid on the highly-taxed additional dollars when making a financial decision that will increase income. The Roth conversion will effectively mean that additional dollars will be added to taxable income over and above what we already have rolling in. These highly-taxed additional dollars will mean that $100,000 of a Roth rollover will be taxed at 37.3 percent (the marginal tax rate for income falling above $78,851 for singles, $131,451 for couples). So, converting even a modest amount of an IRA to a Roth will trigger a tax cost for many equal to almost 40 percent of the converted amount.
So, what this means is that most people doing a $100,000 conversion will have to find $40,000 from somewhere else. If they take it out of the converted money, the net converted amount will only be $60,000. The $40,000 that could have been growing is gone forever.
Anyone approaching retirement should have as much money in these retirement accounts as possible. To support the continuation of a middle-class lifestyle, the dollar amount (including home equity) should be between $500,000 and $1 million. Anyone short of that should forget about converting. Anyone who wants to be assured of perpetuating an upper-middleclass lifestyle should have close to $2 million, or the equivalent in home equity and pension money. The fear that anyone might have to pay income taxes as they nibble away at retirement accounts should be the least of concerns.
The so-called value of tax-free Roth income is just goofy if it fails to include what could have been in the account, or in anyone's portfolio, if they had not had to pay the $40,000 and had allowed that money to grow.
That's the money that can be there to pay whatever taxes might be due. In the meantime, it will offer a nice cushion against the next market downdraft.
To accurately second-guess tax code into the future is futile. Controlling every dime in the meantime has both practical and psychological value.
As much as I love the government, I certainly trust my own money in the bank more than a promise that has to endure for as long as 40 years or more. I recall what we did to the Indians in the centuries before they could build casinos.