Is Suze Orman the idiot or am I?

[maxtower]

Suze's column

She says that in 2010 you can convert your traditional IRA into a Roth and there is no income restriction. She says this is good because you're withdrawing tax free out of the Roth down the road. But she also says that you'll be taxed on the Traditional at the time of conversion. I don't understand the advantage here. Her article didn't offer enough detail in the explanation. I was hoping one of you finance gurus who keep up with this could let me know exactly how beneficial this is.

I believe if you pay the taxes now rather than later, you don't really gain anything, unless you know for certain when you'll have the higher tax rate. What am I missing about this supposed "big opportunity"?

If you pay the taxes now, you'll be compounding a smaller amount of money but with no taxes due at the end.

If your tax rate is the same later, you'll be paying a lot of taxes on a much bigger pile of cash because you compounded before taxes.

((0.66 x 1.08) x 1.08^29) = (1.08^30 x 0.66) where 1.08 is your average return and 0.66 is the money you keep after taxes.

Can someone please explain to me exactly how this rule will work, so that it is better to pay taxes now rather than later? Is some portion of the money tax free? If I roll my 401k into a Trad. IRA, and then in 2010 will I be able to roll it into a Roth tax free?

Obviously if you are going to pay a higher tax rate later, then this is a great deal.

Max

[David Steele]

I found an article that explains this fairly well:
This Article

It certainly doesn't seem like any bonanza for most.

D.

[Xcalibur]

Besides the reasons mentioned in that article David provided, another reason I can think of is if you have other sources of income when you starts withdrawing from your Traditional IRA it might put you in a higher tax bracket. So, if you only have Roth to withdraw from, it might keep you in a lower tax bracket.

In this article (link was provided by jively in another thread), the author advises against converting IRA into Roth. I am curious on what the reasons are. So if anyone had read the book or have any idea, please chime in.

[markum9]

I think that what you're missing is that the tax at conversion is only on your gains at the time of conversion, not on your deposits. So you're avoiding taxes on the amount you've contributed.

Mark

[Xcalibur]

I think I may have a clue in the author Ric Edelman's reasoning which I found in this Q and A.

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Buffalo, N.Y.: I did not understand Mr. Edelman's answer regarding 401s transferring over to Roths. If you are at a 25% bracket, and have a large 401 k, it is almost certain that you will be in higher tax bracket when you retire and start to withdraw 401 money (even if the rates stay where they are and they may rise). So, doesn't it make sense to pay less tax now rather than much more later?

Thanks for a further explanation.


Ric Edelman: It is almost certain? Really? Wow! I've never before met anyone who was able to predict what tax rates would be 20 years into the future!


20 years ago, the top tax rate was about 70%. Today, it's half that. What makes you so sure that future rates will be higher? What makes you so sure we'll even HAVE an income tax? There's lots of talk about flat taxes, value-added taxes, sales taxes and such - all of which would eliminate our income tax and thus render *all* IRA's - both traditional AND roth's tax-free.


So, sure, it makes sense to pay a lower tax today than a higher tax tomorrow...it's just that I have no confidence that tomorrow's tax will truly be higher! [img]/images/graemlins/smile.gif[/img]


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[broiler]

The income cap removal for Roth IRA conversion was a law that passed in the last year and it really has no impact on the majority of people. I have never seen a good calculation that shows how it benefits anyone that isn't really close to the current income limit for Roth IRAs.

I have also never seen a calculation that takes into account the current state tax impact. The thing that you have to remember is that the conversion amount is taxable to the state. If you plan on moving to a low/no income tax state when you retire, then the conversion is an even worse idea. Why pay 5-10% now on income that didn't need to be taxable?

The biggest problem is that the high income people that the new law targets are paying 33%+ in state and federal income taxes, without additional income from a Roth conversion. You don't have to take this money out until you are 70 and the required minimum distributions are very unlikely to be at a level that causes you to reach the same income tax rate, assuming that the tax brackets stay the same. A high income person is likely to have a higher taxable income today than they will in the future when they would draw from the IRA accounts. The big error in many calculations is that people don't remember to index the high end of each tax bracket for inflation. At 3% over 20 years, the 15% tax bracket for a married person would cover taxable income over $100k. I realize that some people might say that costs will also rise and negate this factor, but if you are in a high cost of living area today, will you move to a lower cost area for retirement?

The quick summary of this whole topic is that a Roth conversion is still a good idea for the same people today that it will be in 4 years.

Just noticed an area that needs to be addressed. The taxable amount of a Roth conversion is equal to the untaxed balance that is converted. In other words, if you are rolling a 401k or a fully deductible IRA, the entire balance of the conversion is taxable. Only a non-deductible IRA or certain other rollover will create a result that isn't a fully taxable conversion.

[Dazarath]

[ QUOTE ]
I found an article that explains this fairly well:
This Article

It certainly doesn't seem like any bonanza for most.

D.

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In that article, they make the following two assumptions:
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Jane cannot afford to pay the income taxes due on the conversion, so she will keep enough money from the rollover to pay all taxes due.

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She assumes her marginal income tax bracket will remain unchanged.

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For many people, that may not be true. If so, then wouldn't it be worthwhile to convert?

[maxtower]

Thanks for clearing this up guys. It sounds like Suze Orman is making this conversion sound like a much better thing than it is. I don't think that many people will gain from it, unless they know for certain that their tax rate will be higher in the future.