Most Popular ArticlesDecember 1, 2009
The way the paper approached income distribution was to simply take 1/20th of the Roth value the first year, 1/19th the next, and so on until it was depleted. Its authors then distributed the same dollar amounts from the IRA and taxed any remaining assets all at once at ordinary income rates at the end. Never mind that no one would do this and couldn’t really plan on a retirement lifestyle with this spending approach. But doing the analysis this way and using fixed-tax assumptions despite uncertain market returns lead to the erroneous conclusion there is a 97% chance we should rush to stroke a $450,000 check to the IRS. Hopefully, the public is smarter than this and most of them have an advisor that has the skill to appropriately model their unique situation. Exhibit 2 demonstrates that there is a cost to needlessly writing that check to the IRS.
Exhibit 2, confidence levels of supporting a $130,000 spending need for 20 Years by converting a $1 million IRA to a Roth, versus keeping IRA and $450,000 of taxable assets with $60,000 pension:
Do not take this analysis as an assumption that the Roth option is uniformly unattractive. There are a number of circumstances under which one would benefit from the Roth conversion. The key thing to remember is that paying taxes now with certainty has an uncertain future benefit or cost. The odds of a conversion being beneficial are reasonably high. But at comfortable confidence levels the certainty of giving up the assets, especially given the flexibility of choice that having those assets could otherwise have offered, can come at a price. Even if one is only making modest distributions and using the assets to grow an estate, at comfort-zone confidence levels it is often wise to avoid conversion. If markets perform better than these levels, there will be a price to not converting, but the Roth benefits are generally reserved for heirs and usually occur in markets that produce multiples of desired estate goals.
There is a clear benefit to the Roth conversion if an investor is highly confident that he will not need to use the IRA assets for any lifestyle goals at any time in the future and that he will remain in a high tax bracket throughout retirement. In such cases, conversion clearly makes sense. If one is so over-funded for his goals, however, this suggests a shortage of goals. In our process we would help the client identify what he wants to achieve with such excess wealth.
Don’t use conversion calculators that relinquish control of the analysis to an over-simplified user interface. If the inputs do not require careful thought and introspection, simplifying assumptions buried behind in the interface might lead to highly misleading and costly answers. Such systems give a false sense of security at the expense of our clients’ lifestyles. If you can’t figure out what is really going on under the hood or the tipping point of where the price and benefits cross in such decisions, contact us and we can lend our expertise to help you make an informed and objective decision.
A popular industry speaker and writer, DAVID B. LOEPER is the CEO and founder of Financeware, Inc. in Richmond, VA. He is author of the top-selling book Stop the 401(k) Rip-off!, three other books released in 2009 by John Wiley & Sons (Stop the Retirement Rip-off, Stop the Investing Rip-off and The Four Pillars of Retirement Plans) and numerous white papers. You may subscribe to our educational emails.
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