Should You Convert Your IRA to a RothIRA?

Good morning everyone, this is Brian Fricke and we are going to go ahead and get started with today’s Coffee Club call. Towards the end if we have time we’ll open the lines up for your questions, but first I want to just dive right in and get to today’s primary topic which is should you convert your IRA to a Roth IRA. The reason for this topic is because starting next year, regardless of what you make anyone is going to be eligible to covert an IRA to a Roth IRA. This year there is a $100K income limit, so if you make over $100K you are not eligible to covert an IRA to a Roth IRA. I suspect next year there will be a lot of media attention concerning whether you should convert to a Roth IRA.

So the simple answer to the question of course isn’t so simple. But in general terms should you convert an IRA to a Roth IRA, the answer is yes if the money is going to heirs, in other words the likelihood that you are going to use this money in your lifetime is slim and none. And, not only that, you can pay the increased income tax liability you are going to create for yourself with other non IRA money. And that puts you as a candidate but I’m going to tell why even then it might not make sense to do so.

The other rough analysis that we’ve done is if you convert an IRA to a Roth IRA, you’re going to increase your income tax liability voluntarily and it’s going to take about 10 years to recover the increased tax burden. That’s assuming of course tax rates stay the same. If we project or forecast a different tax rate or a higher tax rate, which I think everyone thinks will eventually happen, then the breakeven point gets even closer but doesn’t go away.
The other thing to bear in mind and this causes some confusion, if you go and set up a Roth IRA and fund it, make contributions, then you are able to take your contributions out of the Roth IRA at any time even during the first 5 years that the account has been open, without having to trigger your contributions as taxable income, in other words the IRS allows you to pull your contributions monies out first of course that money has already been taxed, and you leave the earnings in the account to be withdrawn last. So even if the account is less than 5 years old, you are able to withdraw contributions.

That is not the case if you convert an IRA to a Roth IRA. Converted Roth IRA monies have to stay in the account for 5 years. If you pull the money out in the first 5 years you’ve got the 10 percent penalty. So there is just a little nuance between a contributory Roth IRA and a converted Roth IRA.

Now, here’s our concern and here’s probably what you are probably going to come up across in the media. For most of our client’s, retired or nearing retirement, I think the media is going to suggest that it makes sense for you to convert maybe significant IRA balances to Roth IRA’s and the reason for that of course is the Roth IRA isn’t subjected to the requirement minimum distributions that you have with a traditional IRA. So anybody age 70.5 and older, if you’ve got an IRA account you have to withdraw a minimum amount of money from your IRA every year. Of course in 2009 Congress gave an exemption so no one has to take forced distributions in 2009. But in every other year, and unless things change, starting in 2010 everyone is back to taking forced distribution. So an appealing aspect of converting an IRA to a Roth IRA is you no longer have to live with the required distributions, but to get there you have to back tax on money that you otherwise would not have had to pay tax on. And I just want to warn you personally I am skeptical of the long term promises of the Roth IRA for a couple of reasons. First, think about this, if you convert to a Roth IRA, you increase your tax liability and the government benefits by

getting additional tax revenue, but it’s at the expense of future tax revenue. So 10,20,30 years from now can you envision a situation where the govt is going to be looking for additional revenue? And where might they look to for additional revenue. Maybe a sur tax on all those Roth IRA accounts growing tax deferred and not going to have to pay any taxes at all? I’m not suggesting anything but something to think about. Certainly I think there is a risk but not sure how big a risk of that occurring. Especially if you’ve got significant account balances in a Roth IRA, if not now then down the road and if not you, your children or grandchildren. So just think about that.

The other problem and I reference this in my book, Worry Free Retirement, a lot of the analysis is being done by the wrong type of analytical software and what do I mean by that. Most of the analytical software we have run across and some of it is free software and on websites, you plug in different assumptions and there is nothing wrong with that, but the problem we have with these assumptions is they are static. In other words you have to plug in an assumed tax bracket, you have to plug in an assumed rate of return and I think we all know that ain’t gonna happen! Your investment returns are going to change one year to the next, over the next 5, 10, 15 years we are going to have tax law changes, so none of these programs that use that static input are going to come up with the right real life solutions and what that may end up doing is cause us to make the wrong decision. Wrong decisions sacrifice enjoying life now and into the future. So the problem is that it doesn’t make sense to assume the same tax rate on all the different scenarios, taxes will change from one year to the next, investment returns are going to change one year to the next. This holds true especially if we are talking converting existing IRA’s especially the bigger the number the bigger the impact.

(8:24)We came across a paper, in our industry that suggests there is a 97% success rate or probability of success if you convert to a Roth IRA and we are talking a $1 million IRA account but when we run it through our system. Let me back up, the flaw in the analysis is that it assumes a constant rate of return on investments and a constant tax rate. We can all agree on those issues, that is not going to happen. When we take the information from this research paper and run it through our system which allows for multiple scenarios, clients that work with us know this as the wealthcare success rate(9:18). So we model not one but literally 1000 scenarios, changing investment returns from one year to the next. We can also model different tax situations and tax brackets if you will and when we do that approach to the analysis, the success rate for converting to a Roth is 60%. By just leaving the money in an IRA or deferred 401k type of account, the success rate is 82%. And just a reminder, we like everyone success rate to be in the comfort zone of 75%-90%. (10:14)

So the bottom line is, this research paper, done by well known research companies, they are going to negatively affect people, in a significant way, now they got a less than acceptabkle success rate, just by virtue of converting IRA money to a Roth IRA. So you need to think about that depending on your own individual situation. We think, the analysis we’ve done for clients so far, leads us to the same conclusion that for most folks, it probably is not gonna’ make sense to convert IRA money to a Roth IRA unless, as I said before, unless you’ve got a piece of money in an IRA that you’re reasonably comfortable your never gonna’ use, need want to spend in your lifetime. But then I would challenge you may need to rethink some of your own personal goals and milestones that you want to accomplish during your lifetime if not for yourself, for your family, for your favorite charities or something along those lines. So the bottom line is it takes a little bit more than a static online calculator to determine whether or not it makes sense to convert to a Roth IRA. If you’re working with us, we’re happy to do these calculations with you, for you. If you’re not working with us, I want to warn you, caution you to don’t use the standard online free tools that are out there simply because most of those tools, ah, the inputs are static. They’re going to force a constant rate of return. They’re going to force an assumption on taxes throughout the entire analysis and that’s going to lead to the wrong output, the wrong conclusions and probably lead you to the wrong decisions. A couple of other things I just want to touch on, we are coming up upon close to year end. So year end tax strategies. If you make charitable contributions, and they’re going to be, oh I’m gonna’ say over a thousand dollars, and you’ve yet to make those contributions, you want to first look at your investment account. If you have outside, non-IRA type of accounts – Do you have any investments that are still showing a profit, and if so, give the appreciated assets, like a stock, give that to the charity, they can immediately sell the stock. They are a tax exempt organization. They don’t have to pay tax on your paper profit. Neither do you and you get credit for the current market value of the investment or the stock that you transferred to the charity. That, of course is assuming that you’ve owned the assets for at least a year. If it’s less than a year, the only deduction you can claim is your cost basis, not current market value. And if you’re inclined to do something like that, you need to get the ball rolling now. We’re telling everybody to initiate these gifts no later than December 15. Yeah, in today’s electronic society, we’re gonna’ be able to take care of these things in a couple of days, but we want to allow ourselves time in case the brokerage firm makes a mistake or there is an electronic glitch. So December 15, use that as your cutoff time to make those transfers on or before December 15.

The other topic, if you know someone that’s a first time home buyer and has bought a home this year, they’re eligible for the first time buyer tax credit. They do not have to wait until filing their 2009 tax returns to claim that credit. They can go ahead and file an amended 2008 tax return to grab that credit right now. And that’s what we think they should be doing. A couple of other things just going around just swirling around in my head; we need to keep in mind, and probably more after the new year, we keep reminding folks to just remember the media, by and large, is not your friend. That doesn’t mean they are out to intentionally misinform and deceive anyone, but nonetheless they end up being, more often than not, not our friend. And the reason I say that is think about the typical journalist. Especially if it’s a print or even radio or TV. If you’re a journalist TV reporter in that industry, you’re in an industry that’s struggling probably. We keep reading more and more about newpapers going under, having a tougher time. Magazines, the same thing. There used to be 3-4 major TV networks now there’s like 300 or TV stations all competing for peoples attention. SO that makes the job of a typical journalist much much tougher than compared to 10 or 15 years ago. And if you know a journalist, odds that they are probably more negative than positive because of the industry they work in and live in. Well if your mindset is biased in a negative way to begin with then guess what? Your stories and commentary is probably gonna’ be biased in somewhat of a negative way as well. Just a week or two ago, I forget the name of the host, one of the hosts on CNBC was doom and gloom about the market. He’s lost all this money. You could just hear the negativity just coming out in his voice. Wel you know that’s gonna’ permeate in the stories he reports on, the questions he asks his guests, and its gonna slant or distort whats really happening in the market place today. Which leads me up to the reminder announcement we sent out last night. What can we learn from Tiger Woods and Florida Gator football? I had to touch on this a little bit, it’s on the news all over the place. Well the bottom line is as I think about both of these situations, the one thing they have in common. At least on the one thing that jumped into my mind is that over the years is a couple of things I’ve observed. Rarely are things as good as you think they are. And you know, I’m thinking that Tiger thought he was on top of the world. He’s got the world by the tail so to speak. Same thing for a lot of the Florida Gator fans. Most of the fans I’ve talked with sorta’ felt they’d be heading toward the BCS Championship game by now and look what’s going on now for Tiger and the Gators. So things are rarely as good as you think they are. But the flipside is you know what, things rarely are as bad as we think they are in the bad times.

Just think about how were you thinking about your situation a year ago, this time? Most people, I think have a much better outlook, are happier or are positive compared to where they were a year ago. So when you’re in the middle of something and in the thick of things, just remember rarely, when things are going along great, just pinch yourself and remind yourself, “things probably aren’t as great as maybe they appear to be”. And the flip-side, when you are up to your neck in alligators, so to speak, rarely are thngs ever as bad as they appear to be in the moment. And with that, I want to tell you a quick story.

The friend of mine over at the beach. We were at the beach last week. We were talking about living and enjoying life. This fellow’s retired. He is leaving for a two-month trip predominantly to Vietnam and he’s going to join 3 or 4 other people. None of them he knows. They are gonna’ ride motorcycles all over Vietnam and the surrounding countries. SO I’ve asked him to send us pictures and send in a story. That’ll be the second half of 2010 by the time he gets back and gets all that done. But I just wanted to share that with you as a reminder that life is to be lived and enjoyed. We’re here to help you in any way possible. But let’s not lose focus of the more important things in life. Yeah the money helps, but the more important things in life are making sure that we’re surrounded with people that love us, we love them and doing things that brings satisfaction into our life.

BT, do you have any thoughts or comments?

No, just listening to you talk about all the different things. If I could weave one thing together I did see something interesting in the recent history. Everyone has been listening to the real estate market and how far down it’s come in the last couple of years. You know that bubble popped and I think there’s a statistic that 40% of the homebuyers or maybe closer to half of the homebuyers that made purchase between 2006 and 2009 are under water at this point unfortunately in what they financed their house for. And I found something that was kinda’ interesting. The Pontiac Silver Dome, which used to be the NFL Detroit Lions home until 2001. IT was built for $55 million in 1975. And the city, Pontiac Michigan, had been trying to sell the facility for a long long time. And finally, it’s been sold. A developer from Toronto bought the Silver Dome for a, just a couple of weeks ago, for $583,000.

Wow.

I think, I don’t know if I’ve already said, it was built for $55 million in 1975.

Wow.

SO just a, you know, there are deals out there now apparently.

No doubt about it. All right so that get’s me going. This is just the lunacy and by the way, there’s a great book out by our favorit economist Brian Westbury, I’m trying to get him to come and speak to us some time in 2010. I’ll give you an update on that when I hear back from his office. But the book is called ‘It’s Not as Bad as You Think’. And in the book, he’s one of the world’s top economist Ranked by different publications, USA Today, Wall Street Journal, Barron’s, Forbes, and so forth. The guy knows what he’s talking about. Anyway, his opionion, the panic of 2008, and he refers to it more as a panic, as opposed to a recession because people just lost faith, trust, confidence in the financial system at least for a while. 90 percent of the panic was caused by the government, their decisions, their actions. 10 percent can be laid on the financial community if you will, the banks, the brokerage firms and so forth. Here’s an example of that. WE know of a situation where somebody is in forclosure. They owe, I’m gonna’ say somewhere in the neighborhood of $230,000 on a house. They’ve sold it in a short sale for $115,000 – 50% off of what’s owed on the mortgage. So the bank is willing to accept 50 cents on the dollar on what they are owed. Now here’s where it gets interesting. The buyer is a friend of theirs. They are going to rent the home back the current owner and the current owner is going to re-purchase this home in 2 or 3 years when their credit allows them to get a loan again for about the same $115,000. You know, their frinds are just helping them out not looking to make much money if anything. So, you know, why doesn’t the government allow something like that? The banks going to lose 50 cents on the dollar. So why not let the bank just reduce the mortgage balance to the current owner? It reduce their payments and they are no longer under water and now we haven’t had to go through these gyrations of displacing people forcing them to have to move. This situation is unique. The current owner isn’t going to have to move but that’s a rarity. And the bottom line is these folks are going to have to move someplace else, in a couple of years sell. I think, end up purchasing, ah hey, buy the Silver Dome for half a million instead of $55 million. What a deal. So same think out there but you do have to be careful and again you want to review and you’ve got all the facts and figures before you jump into anything. BT why don’t you tell everybody how they can ask a question and the logistics of this week have changed a little bit and we’ll see if anybody has questions.

Sure, sure, and in fact I’ll unmute the line and if anybody has a question, just speak up. If it sounds like there’s a few people going, let’s just try and sort that out amongst ourselves here but I’ll go ahead and unmute the line now.

All right, it’s un-muted and anybody have a question right now?

Ok, so everybody listening you have are free to talk. Everyone’s going to hear you and anything in the background too so so far everybody’s been kinda’ being shy and bashful so we’re going to give you a couple of more seconds to jump in and ask your question and otherwise were going to let everybody get on with the rest of their day. So time for your questions. Free financial advice from us. Anybody have a question? Questions going once, going twice. OK, BT, I guess we got another bashful audience this week.

Alrighty.

Thanks, BT, for your help and input. Everyone, were going to see you again next week, Tuesday at 9:00 AM for another edition of Coffee Club. We’ll talk to you then. Have a great day.

Thank you.

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