Should You Convert to a Roth IRA? (Part 1)

Should You Convert to a Roth IRA? (Part 1)

You may have received materials about them in the mail, seen or heard about them in the mass media, or had your advisor contact you about them — the 2010 Roth Conversions that financial professionals are madly marketing as “America’s new tax break,” when, in fact, it really isn’t new at all.

For the next few posts, I intend to bring you certain facts that I believe you, as an investor, must know, understand, and definitely consider before taking the Roth leap, if you even find it necessary at all.

What Is a Roth Plan?

The general premise of Roth plans — as opposed to qualified plans — is that you contribute after-tax (nonqualified) dollars today and can access those funds later (including any gains) tax-free, provided you meet certain conditions which are laid out in the tax code.

All things being equal, given the fiscal climate of our nation and the bad tax planning advice most Americans receive when preparing for retirement, the Roth premise is better than traditional qualified plans for maximizing spendable income. I explain this in greater detail in two of my books, 5 Mistakes Your Financial Advisor Is Making, and Is Your 401K a Trap? If you haven’t already done so, please download your free copy!

Suddenly I’m realizing that pretty much out of nowhere, almost every financial advisor/expert now agrees with the common-sense concepts and strategies I have been promoting and implementing for my clients over the past decade or so. I wish they could have done so earlier, but it truly is better late than never.

So, What Is This “New” Stuff?

Congress passed a law called The Tax Increase Prevention and Reconciliation Act of 2005 which eliminates the $100,000 modified adjusted gross income (MAGI) limit on Roth IRA conversions in 2010 and beyond.

PLEASE NOTE — Until the passage of the new law, you were allowed to convert qualified funds only if your MAGI (before income from the conversion) was $100,000 or less, regardless of whether you were single or married.

MAGI is calculated by adding back certain items to your Adjusted Gross Income (AGI), which can be found on line 38 of your Form 1040; or line 22 of your Form1040A:

* Traditional IRA contribution deductions

* Student loan interest deductions

* Tuition and fees deductions

* Domestic production activities deductions

* Foreign income or housing costs excluded on Form 2555

* Foreign housing deductions taken on Form 2555

* Savings bond interest excluded on Form 8815

* Adoption benefits from an employer excluded on Form 8839

If Your MAGI Is $100,000 or Less

If your MAGI totals $100,000 or less, you have been able to convert your qualified dollars since the introduction of Roth IRAs in 1997. Meaning this new law changes nothing in your situation. Here’s the thing, though: most Americans’ MAGIs have always been and still continue to fall below $100,000.

Those With a MAGI of $100,000 or More

Now, if your MAGI is $100,000 or more, you also could have achieved the same general benefits of Roth IRAs by maximum-funding an investment grade life insurance contract within the confines of sections 7702 and 7702A of the Internal Revenue Code. You see, under those rules — regardless of your gross income, AGI, or MAGI — you many contribute any amount you want, and I mean ANY amount, and have access to those funds (including any gains), tax-free. Even better is that you do not have to wait 5 years and also be age 59½ in order to enjoy the tax-free access. Now that’s sweet — even better than a Roth, if you ask me.

So if your financial advisor really knows their industry, America’s “new” tax break is, in reality, nothing new.

Here Are the Real Questions

1. If the Roth principle is a preferable option for investors (including you) — my clients and I agree that this is true in most cases — why did your financial advisor delay making such a suggestion until now? This is 2010 — it’s been 13 years since Roths were introduced! One can logically suggest that certain so-called advisors don’t know what they don’t know, or they just don’t care. But since they are supposed to care, my only logical conclusion is that they’ve been living on Mars until now.

2. Can someone offer a sensible explanation as to why these same advisors are still encouraging younger investors to fund qualified 401(k)s, 403(b)s, 457s, and tax-sheltered annuities? Don’t they realize that they are literally building retirement-tax bombs, since these same so-called experts are, ironically, predicting an increase in future tax rates?

Look for Part 2 in next week’s post.
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