No Benefit From a Roth IRA Conversion
A follow up to my previous article: Roth Conversion in 2010, Don’t Do It.
I see your still getting conflicting opinions about converting a traditional IRA to a Roth in 2010 when there are no IRS income restrictions. And, it is still not a good financial decision.
There is actually a very easy way to decide. Ask yourself this question “would I do it if I am 701/2 years old? You probably would not. If that is your answer, then why would you consider doing it at any other age?
A 701/2 year old has a traditional IRA worth $200,000 and is in the 28% tax bracket. This individual has a choice to make: pay the tax now on a conversion to a Roth or pay it over the next 50 years – which is how long you get to pay the deferred taxes on a traditional IRA.
By converting to a Roth IRA the individual would have to come up with $56,000 to pay the tax now. Instead, put this same $56,000 into its own traditional IRA as cash – earning nothing. The individual has to take required minimum distributions as prescribed by law. The first withdrawal is 3.77% of the account balance. Amortize the $56,000 balance according to the official RMD schedule and the account would be depleted at age 120. Think about how much this account would accumulate if you could earn a return higher than 3.77%.
Lets go younger. You are 30 years old with a $30,000 traditional IRA. The Roth conversion tax is $8,400 at the 28% tax rate. If that amount stayed invested in the IRA earning 7%, it would grow tax deferred to $126,000 at age 70 ½. Put that amount in its own IRA and amortize it just like in the example above.
It seems to me that if I owed someone money, like the Government for taxes way into the future and there are no financing charges, why would I pay it off all at once now? I know there are many other Ezine articles that advocate converting to a Roth due to the tax free appeal, but most do not address the time value of money of the lump sum payment versus installment payments.
source: ezinearticles.com
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