Sunday, May 17, 2009

Converting to a Roth IRA Right Now is a Very BAD Idea

Financial "experts" are bombarding the American public with advice about how to salvage their depreciating wealth - courtesy of the stock market's freefall. One very popular - but TOXIC - piece of advice is that now is a great time to convert qualified funds (pre-tax dollar accounts) to Roth IRAs.

Just so we are on the same page, this is NOT a discussion about Roth conversions, in general - we'll discuss that at a later date. Rather, I am challenging those financial "pundits" who are specifically advocating that converting to Roth IRA is smart and prudent after experiencing investment losses. Then again, maybe I'm a bit slow? Continue reading and then decide for yourself.
What They Are Claiming
Here is the whole rationale behind the current movement to convert to Roth IRAs: Since your IRAs/401(k)s have suffered significant losses, converting now will save you on taxes. A recent USA Today article claims, "An IRA conversion is a smart move in a bear market..."
But let's examine this thought process. For instance, assume you had $100,000 in a traditional IRA in January 2008. If you had converted it to a Roth at that time, your tax bill would have amounted to $25,000 (assuming a 25 percent marginal tax bracket). You would net $75,000 in this example. Then, going forward, you would be able to keep your money, income tax-free.
Common-Sense View
The investment choices that these same advisors are advocating withered up your savings, leaving you with around $70,000 (assuming a 30 percent drop in the value of your IRA/401(k), given the fact that the major markets tumbled more than 30 percent in 2008). If you were to convert now, based on their BAD advice, you would net only $52,500, after paying 25 percent ($17,500) in taxes.
Yes, the portion that goes to Uncle Sam is less ($17,500 instead of $25,000), but notice that YOUR portion is down from $70,000 to $52,500. Investing 101 and plain old common sense - a supply of which anyone needs a ton when it comes to financial planning - teaches that a larger seed is better than a smaller seed when starting your Roth IRA.
Financial professionals agree that Roth IRAs enable people to amass larger nest eggs, due to income tax-free withdrawals (provided you are past age 59-1/2 and have had the account for at least five years). And I am in total agreement with that assessment.
What I wonder about, though, is the fact that Roth IRAs have been around since 1997. Where have these so-called financial gurus been all that time? Why did they wait for their clients to experience significant losses - LOSSES! - before it became a good idea to convert to the Roth IRA? Now those clients are ending up with less money. Why are more than 95 percent of financial advisors STILL advocating qualified plans instead of income tax-free alternatives?
Income Tax-Free Withdrawal Is Always Better
I have always maintained that in almost every instance, income tax-free withdrawal is better. And we have always taught and helped our clients to "strategically roll out" their qualified funds at the most opportune time, tax-wise - NOT when they have incurred signifcant investment losses. Notice, there's a HUGE difference.
There's a $100,000 income limit, known as MAGI (your tax advisor is familiar with this term, and if he/she is not, find a new one), on the ability to convert to a Roth IRA. This limit is scheduled to end in 2010. But that should not, and has not, been a challenge for any of our clients. Why not? Because we DON'T use Roth IRAs.
No-Strings Roth
Why bother with a Roth that still has strings attached when the accumulation tool I refer to as "Roth on Steroids" is available? Now that I have your attention, GET THIS: There are cash accumulation vehicles under current law that, when structured and distributed properly, allow for income tax-free access without all of the strings attached to Roth IRAs.
Like, for instance, you can convert qualified dollars, regardless of your income. And my personal favorite: should you die too soon, the portion you paid in taxes due to the conversion is replenished (in most cases, several times over) to your beneficiary, income tax-free, giving your beneficiary way more than you paid in, all things being equal.
Of course, each individual's situation is different, which is why I recommend very careful analysis and consideration by competent tax and financial professionals, in all situations.
To find out more and determine what is best for your situation, request a free consultation with one of our strategists today.


  1. This is absolutely brilliant and simple. I must admit that I never looked at the whole converting to Roth issue from this angle. you make it very simple to understand.


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