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Any downside to converting 100% of a $5,000,000 IRA to a Roth IRA on J


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Guest MTL-CPA

Does anyone see any downsides to converting 100% of a $5,000,000 IRA to a Roth IRA on January 1, 2000 and then recharaterizing 60% of it by April 15, 2001. My client only has enough non-IRA funds to pay the tax on $2,000,000 of the account. But would convert 100% in order to pick and choose the best performing stocks to leave in the Roth IRA. Any thoughts would be appreciated!

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I don't if your plan will work the way you want. If you convert $5mill and then want to recharacterize 60% of it, you will have to recharacterize 60% of the value at the time you recharacterize. So if the account grows to $6Mill, you will have to move $3.6mill of assets back to traditional IRA to cancel out $3mill of conversion income.

Barry Picker, CPA/PFS, CFP

New York, NY

www.BPickerCPA.com

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I am not sure your idea buys you much. You can't use the recharacterization to after the fact put the best performers in the Roth and send the rest back. You are moving value not shares.

I suspect this client is jumping through a lot of hoops to keep 2000 income under the threshold.... such as keeping the money to pay the taxes in munies for a year? You often end up paying a big price for distorting normal behavior.

Converting to a Roth may reduce this persons taxable estate (although the rules may be changing) and give the client more control over IRA withdrawals. I would argue for simplicity: convert the part with which you are comfortable. Put your energies into making investment/business decisions not trying to game the system.

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Guest Art E

John G. - you commented that "Converting to a Roth may reduce this persons taxable estate (although the rules may be changing)------.

I believe I understand how giving ones money away to the IRS for conversion taxes (or throwing it out a window) will usually reduce ones estate, taxable or otherwise. But your () implied the rules may be changing and I am curious what you meant by that comment. How may they be changing?

Thanks Art

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Guest MTL-CPA

Barry--Would my plan work better if I split the 10 stocks that make up the $5,000,000 into 10 Roth IRAs? I believe that allows me to pick and choose which Roth IRAs to keep and which to recharacterize back to the traditional IRA? Is this correct?

John G--I think the idea buys me the ability to move the greatest value at the lowest tax cost. The only thing my client is doing differently in 2000 is not taking an IRA distribution. This is permissable since he is only age 64. His non-IRA investments do not generate very much income, unless he sells stocks, which he rarely does due to his solid buy and hold strategy. We are not trying to "game the system," but are instead trying to benefit from as much as 15 months of hindsight, which based on my understanding, is permissable under the law.

I believe that if the plan works as intended that my energies will have been focused properly.

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[[barry--Would my plan work better if I split the 10 stocks that make up the $5,000,000 into 10 Roth IRAs? I believe that allows me to pick and choose which Roth IRAs to keep and which to recharacterize back to the traditional IRA? Is this correct?]]

According to the way the regs are written, your plan would work if you used 10 different IRAs. But keep in mind that if your behavior is so outragious, you run the risk of the IRS arguing substance over form.

It's your call, or you can go for a ruling.

Barry Picker, CPA/PFS, CFP

New York, NY

www.BPickerCPA.com

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Follow up on inheritance changes:

Over the past few years there have been multiple proposals to change inheritance taxes. Ones that come to mind include: (1) dropping all inheritance taxes, (2) jacking up the threshold to $5M , and (3) setting the threshold to $10M. Not saying any of these become law, but the momentum seems to relax the rules since more people are finding they trigger the taxes as retirement funds and housing assets climb in value. My view is that while a good part of this is election year trial balloons, eventually they will relax estate taxes which many families think are grossly unfair. Historically, not many voters were effected... that seems to be changing.

When you pay Roth taxes, you reduce your taxable estate.... for the moment.

[This message has been edited by John G (edited 12-08-1999).]

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Guest Art E

What excapes me is why convering $2M to a Roth is good for either the owner of the IRA or his/her heirs. The $2M conversion will make the taxes due at conversion the highest level. My progran shows convering $2M of a $5M IRA will cost the heirs from $1M to $2M after tax.

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Guest MTL-CPA

Art--I can't tell you why you do not come to the same conclusion we have, because I don't know if you have considered all the factors that we have. However, the big advantage we see in the Roth IRA is that there are no required distributions until both husband and wife die and then the distributions can be taken over the life of the oldest child or maybe even each child's life, depending on how you set it up. That allows the Roth IRA money to grow tax-free for a very long time. Also, any income taxes paid before death will reduce the taxable estate. I realize that you get an itemized deduction for the estate taxes paid on IRD, but I do not think it provides as high of a benefit.

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Art E: I don't know whether the problem is in the program or in the user, but the Roth conversion is generally very beneficial. I suggest you consult with competent tax/estates counsel.

Even if there were no estate tax, and everything else were equal, to the extent the IRA owner has outside money with which to pay the income tax on the conversion, he/she is effectively stuffing more money into the IRA by converting. (In your example, that only covers $2 million of the IRA.)

Other benefits of the conversion include (i) no required distributions at 70 1/2, (ii) a tax-paid IRA to fund a credit shelter or GST exempt disposition, (iii) avoiding the IRD problem.

For more on this, see my column in the May/June 1998 issue of the CCH Journal of Retirement Planning. For information on this publication, see www.cch.com.

------------------

Bruce Steiner, attorney

(212) 986-6000 (NY office)

(201) 862-1080 (NJ office)

also admitted in FL

Bruce Steiner, attorney

(212) 986-6000

also admitted in NJ and FL

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Guest Art E

Regarding the question about the wisdom of going with a 2M Roth conversion. Unless your client just wants a Roth like he'd want another house, another yacht or another toy regardless of the possible cost impacts, the conversion may or may not be advantageous to the heirs. For some situations it could be very good for heirs, but as discussed below, for others it can be a very costly error.

A retired couple just in their 60's have a portfolio of 7M with about 5M in their IRAs and 2M in taxable accounts - a situation similar to what you have described. They wanted to convert some to a Roth because they were told the Roth would be the best way to leave money to their daughter. A conversion of about 2M to a Roth looked about right as they had enough outside the IRA to pay the conversion tax and still have ample money left in the taxable account. However, the daughter knew there were some risks of future tax rulings having a negative effect on Roths and wanted to see some numbers to see if the potential rewards of a Roth were worth even its minimal risks.

The numbers showed the conversion would provide her with a Roth IRA valued at 3.2M after estate taxes if her parents died in their mid 80's while she'd net about 4.2M from the estate in equities (from the taxable account) if they stayed with the traditional IRA, or a 1M advantage for the regular IRA in FY dollars or about 500K in today's dollars. Over the next 40 years with equal post-tax withdrawals annually, the 4.2M of equities would provide her 7 - 8 million more in FY dollars over her lifetime than the 3.2M Roth, i.e. the Roth account was depleted at her age 70 while the equity account still had a post cap gains value of about 3M at that age. The 7 - 8 M in FY dollars is about 1M or so in today's dollars, so she told her parents to forget about the Roth conversion as she believed she would be much better of if they stayed with their traditional IRA.

The numbers must have been surprising to whomever suggested the Roth, but they never contested them - probably because they never run any numbers or realized that their analysis tools, like most, were flawed and the results were unreliable. The daughter said they didn't even apologize to her parents for their actions, only saying they believed diversification is a good thing (no matter how much it costs??). But the daughter wasn't buying that lame excuse because she could see how much it may cost her and didn't believe diversification was worth that price. Losing a client didn't seem to bother them either.

No doubt there are many situations where a 2M of 5M conversion or whatever to a Roth is best for the heirs, but for this case the Roth conversion would likely have been a costly tragedy. I hope your client's situation is one where the Roth is a good move or that they have had the opportunity to see some realistic numbers before making such a major decision.

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Various comments on the Art E "model" results:

The above scenario sounds like an "urban legend", a very vague scenario. What model was used? Where the folks crunching the numbers knowledgeable about Roths/tax laws, were they even trained to use the model? I have a hard time believing that the Roth conversion would be so horrible given that about half of the conversion taxes would be offset by estate tax savings.

I draw upon about 25 years of experience in evaluating other folks analysis, spreadsheets and models. More than half that I have examined have a significant error. And a surprising number of times there are multiple errors! Wrong units (like a certain $135MM Martian probe that crashed), inconsistent assumptions, poorly labeled output, sensitive imbedded assumptions.... there are lots of things that can go wrong. Errors are surprisingly common when the output extends beyond the common economic framework. The user often can't see that the result is wrong, and that very professional looking printout is soooo seductive. Too often the user views the model as a substitute for thinking, rather than a tool to help organize thinking.

Let's be honest, most models and forecasts turn out to be wrong, even after just a few years. Besides mistakes.... we have unexpected events, changes in rules, etc.

A scenario involving two different tax payers, two decades of time and both inheritance and income taxes will generate many permutations. It just doesn't make sense to talk of a "result" as is it is a single number.

The above cautionary notes not withstanding, I am a great believer in models. I am just a lot more skeptical about the validity of "unussual" results.

[This message has been edited by John G (edited 12-13-1999).]

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[[The numbers showed the conversion would provide her with a Roth IRA valued at 3.2M after estate taxes if her parents died in their mid 80's while she'd net about 4.2M from the estate in equities (from the taxable account) if they stayed with the traditional IRA, or a 1M advantage for the regular IRA in FY dollars or about 500K in today's dollars. ]]

Talk about playing fast and loose!

You're comparing what she would get from THE ROTH ITSELF vs what she would get from the entire estate, if they didn't convert. From my reading, there is still about $3mill in a traditional IRA, plus about $1mill in the taxable account (assuming they lost 50% to income tax on the conversion) when the parents are in their 60's. WHAT HAPPENED TO THIS MONEY, BY THE TIME THEY WERE IN THEIR 80'S?????

As an additional aside, I've seen many of these analyses that use the same after tax rate of return for the IRAs and for the taxable account, which is a glaring error.

Go over your numbers again. There is $2mill in a taxable account if you don't convert. There is $2mill in a Roth IRA if you do convert. How can the $2mill in the taxable account be worth $1mill more net of estate taxes at death?

Can someone tell me what's wrong with this picture????

Barry Picker, CPA/PFS, CFP

New York, NY

www.BPickerCPA.com

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BPicker - thanks for jumping in on what appears to be very bad analysis. I agree with you. You can truely do this analysis on the back of an envelope with an HP12c and get a more reasonable result. The estate taxes will be around 50%, the income tax rate will be near that depending upon where the person lives.

If I was fooling around with 2M, 5M or 7M I would be running a blind parallel analysis with atleast two CPAs to run the numbers and ask them to explain any differences. Any lower level of effort would be foolish.

Adding to your aside: Lots of folks run models an plug different growth rates for taxable vs IRA, pre-retirement vs post which can produce weird results. And you get some folks getting confused over real vs nominal dollars and the various ways to represent inflation.

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Guest Art E

To: BPickerCPA and John G.

First - Realistic Roth evaluations are extremely complicated, far beyond the capabilities of almost any model with which I'm familiar. It is possible my conclusions are incorrect in that context. But the details of the analysis I saw appeared reasonable, so I assume the results are equally reasonable.

-Mr. Picker- You commented - Can someone tell me what's wrong with this (your picture? I'll try.

Regarding WHAT HAPPENED TO THIS MONEY---. For the Roth option the estate had a value of about 5M+ at the parents demise. From this the daughter netted 3M+ as a Roth IRA. The original 7M+ dwindled to 5M over 25 years due to the 1M taxes donated to Uncle on the conversion, annual (inflated spendable expenses of 200K, and annual Fed and State taxes. With this option their portfolio peaked in their late 60's at a bit over 6M. The regular IRA estate had a value of about 7.5M at the parents demise thanks mostly to the growth and availability of the "extra" 1M over 25 years that wasn't spent for Roth conversion taxes. F rom this 7.5M the estate taxes dropped her net to 4M+. That is the parents assets started at 7M+ at age 60, grew to about 8M+ until their late 70's and then declined to about 7.5M at their mid 80's due to the annual (inflated) spendable expenses of 200K and annual Fed and State taxes.

Perhaps it's important to note that for the regular IRA option there was nothing left in their IRAs at the parents demise. MRDs and living expenses depleted it earlier as they "wisely" chose to use the IRA exclusively as long as possible for all needed income and any extra income after taxes (because of MRDs) went to buy stock in their taxable accounts. So their estate consisted of only stocks in their taxable accounts. Which after selling some to pay the estate taxes, I assume the daughter received with no personal taxes due and a new cost basis, i.e. the 4M+. (Using their IRA first may not have been wise had they desired to spend all of their portfolio.)

As for your concern about rate of returns, both options used essentially the same pre-tax ROR. The taxable account's pre-tax ROR w as actually a small fraction less than the IRAs due to some munis, US and corporate bonds. Of course the taxable account's effective (post-tax) ROR was reduced even more compared to the IRAs due to annual taxes on distributions, dividends and distributions.

I didn't understand your question about 2M in a taxable account and 2M in a Roth. If you would have asked about 7M+ without the Roth and 6M+ with the Roth, after paying the conversion taxes, it may have been something I could properly address. Maybe the 1M to Uncle is the answer.

I hope the above helps answer some of your question and I'll try to answer any other questions you may have or provide any added info desired.

Also, I'm sure that the range of results may differ significantly for different initial ages of the parents, different annual income needs, etc. etc. But this case illustrates that cavalier recommendations toward Roths based on common wisdom, hype and unsubstantiated opinions can be dangerous to clients, and perhaps eventually dangerous to the organizations making what may be seriously inappropriate recommendations. However, my opinions my be totally incorrect.

-Mr. John G. - I cannot overemphasize that I totally agree with your comments about model weaknesses and user apathy!! I would add that comments based on the unsubstantiated opinions of others, hype, etc. are at least of questionable validity.

Your statement about not being able to predict the future is also true. However, you have to make some basic and positive and negative assumptions about the future to make a decision today. The result isn't a single number, but a range of numbers which must be considered in making the decision. The example I gave was for the middle ground assumptions where the analysis spanned 6+ decades - 25 years to the parents death and 40 more for the daughter. I'm the first to admit the longer out you go the more unreliable the results become, but you have to start someplace.

But in my opinion there is no practical way you can analyze a Roth using an HP12c. You can't even do it using the available software I've tried, obviously with one exception. And as you noted, dealing with big dollars indicates at least a second opinion is mandatory - if you can find someone with both the right tools and the ability to recognize their weaknesses.

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Art,

I have neither the time nor the inclination to duplicate your financial analysis. It looks on the surface as something isn't right, but that isn't even the point.

The point you make is valid, in that there is no one right answer for every case.

But you're the one who basically made a broad statement in questioning why someone would make a $2mill Roth conversion. To quote you, "What excapes me is why convering $2M to a Roth is good for either the owner of the IRA or his/her heirs."

The RIGHT answer is that it may or may not be, depending on factors that we are not aware of, and will vary from taxpayer to taxpayer.

No one suggested that the roth conversion was ALWAYS good. You implied that the conversion was ALWAYS bad. You use one example, that even if we concede is correct, hardly qualifies to set a general rule.

The solution is that you need a case by case analysis, properly done using ALL relevant factors, to make a decision. Common sense doesn't hurt, either.

Barry Picker, CPA/PFS, CFP

New York, NY

www.BPickerCPA.com

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Guest Art E

Mr. Picker

I believe everyone who uses these boards enjoys and learns from your inputs because of your well deserved respect, unquestioned expertise and obvious interest in Roth IRAs. So I am more than surprised by your comment - "I have neither the time nor the inclination to duplicate your financial analysis. It looks on the surface as something isn't right, but that isn't even the point.". Because that (something isn't right) really is the point.

I simply questioned the wisdom of MTL-CPA's client converting to a Roth because my experience is most such large conversions are seriously disadvantageous to both parents and heirs. I was hoping his response would explain in what way his client was somewhat unique. The client just wanting a Roth regardless its 1M cost would have been one explanation.

I didn't mean to imply Roth conversions are always bad and always note that they are good for some situations. But I do have a concern. If my example is contrary to the general rule, then perhaps the general rule needs to be reevaluated.

In regards to your "The solution is that you need a case by case analysis, properly done using ALL relevant factors, to make a decision. Common sense doesn't hurt, either." Very true, and I would only change it to emphasize PROPERLY DONE because I obviously feel that's what the profession generally isn't doing.

Art

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[[i simply questioned the wisdom of MTL-CPA's client converting to a Roth because my experience is most such large conversions are seriously disadvantageous to both parents and heirs]]

In the majority of cases I've dealt with, the large conversion is advantageous. Now there are a few possible reasons for our differences. One is that we've seen different cases. Another is just there is a difference of opinion.

You've mentioned a specific case where you feel that the roth conversion is not appropriate. That's OK, except that you use that to question the wisdom of MTL-CPA's client converting to a Roth. Just as I don't the intimate details of your specific case, you can't know the intimate details of MTL-CPA's client's case. And that's true even if the majority of the cases are on your side. You still cannot generalize.

One very important consideration in a roth conversion analysis is the fact that roth IRAs don't have mandatory lifetime distributions. But the degree of importance depends upon the client's ability and desire to leave the account untouched. This one factor alone could tilt the analysis one way or another (I know because I've done plenty of them where it has), and this factor will vary from client to client.

The point is that you can't "simply question the wisdom of MTL-CPA's client converting to a Roth" because it simply isn't that simple!

Barry Picker, CPA/PFS, CFP

New York, NY

www.BPickerCPA.com

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Guest MikeE

My friends parents converted to a Roth IRA earlier this year because they were told it would be best for the two children. Their initial IRA wasn't quite $3,000,000 and I don't know how much they converted. Could they have done a bad thing to the children? Can they undo it if it was bad? How do you check these things out? I know it isn't free so how much would it cost Jerry for BPickerCPA or Art E do check it out for him?

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I am not convinced that Art E is an expert in Roth conversion issues or inheritance taxes. His role in the above scenario is obscure... was he just a third party "the details of the analysis I saw", or was he the financial planner, or the model builder? His credentials are not disclosed. Is he a mathematician, a tax accountant, lawyer or just some retired guy with a new hobby.

The scenario that he describes apparently involves other people. The facts are very loosely reported, I would call them vague. The "analysis" seems to be a classic mix of apples and oranges. Funds dispersed for living expenses, MRDs, post inheritance net assets, income vs inheritance taxes.... This scenario is so full of details and multiple objectives (or points of view) that it would take weeks to construct it correctly. It is not enough to be mathematically sound (which is by no means a given) but also be based upon logically consistent assumptions.

I don't buy the conclusion reported by Art E. The magnitude of the assets would indicate that max income and estate tax rates would be likely. The conversion taxes would be about 1/2 offset by the reduction in inheritance taxes. You can make the problem a lot more complicated but that relationship doesn't change.

Art E thinks you can't do analysis with a HP12C. Gee, someone should tell HP. The problem with overly complicated mathematical models is the are prone to have errors in their structure, assumptions or unit specifications. When the scenario gets so complicated, especially if you are compounding over multiple decades, the very small errors may grow in significance but remain hidden in the output. That is the beauty of very small (back of the envelope) models. My mom used to call that common sense. Art E doesn't get it. His complicated scenario just doesn't make sense.

I don't believe in hyping Roths as the answer to everyones problems. People can make up their own minds and assess how the future might play out. This site tries to provide expert insight into the rules and possible applications. Art E falls short of that objective.

In my previous comment I asked some questions about the model source and the knowledge/training of the users. No answers. You might add the the list, who vetted the model?

Why trust the poorly documented work from an unknown source that defies common sense?

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Mike: in a court the legal response to your question would be that you "have no standing", case dismissed. You are not apparently the heirs. You do not appear to be IRA owners. Therefore I wonder why you want to get involved. From my perspective, its none of the (presumed) heirs business either, the parents can choose any path they want. Its their money.

But to answer your question directly, the hourly range for expert assistance varies widely, perhaps $100 to $250/hr and up. You can get general opinions with no analysis by investing about two hours with a CPA/lawyer. Setting up a model with specific data and running some scenarios will take at the minimum 4 hours, it might take a lot more if the facts are complicated or you want to examine multiple cases.

You said "they were told it would be best"... sounds like they consulted with professionals. My guess is that they decided to shrink their taxable estate by doing the Roth conversion. This is a pretty well known estate tax management option. They may have also taken this route to avoid taking any distributions from the traditional IRA.

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I, too, find Art's results to be unconvincing. In the original scenario, it was stated that there would be "equal post-tax withdrawals annually". Later, it was explained that, in the Regular IRA scenario, there would be nothing left.

I would be interested to see the actual output of this analysis. The described results do not make sense. I'd be happy to look at the actual analysis and inputs, if Art would care to email same to me.

For what it's worth, I'll chime in on the difficulty of comparing alternatives, where the scenarios involve numerous changed variables. I'm the the process of researching an article on this very topic - using Brentmark's "Pension and Roth IRA Analyzer", Impact's "Qualified Plan Distribution Analysis", Richard Franklin's "RPlanner", Ocaso's "Second 1/2", and Wealthtec's "Advanced Pro" Excel add-on.

Each of those programs offers a different set of strengths and weaknesses. Some analyses are cash flow based; others are NPV-based. Not all allow the same manipulations of variables (e.g.: tax rates in each year of the analysis; breakout of CG vs. OI components of the non-IRA accounts). I'm trying to establish baseline planning cases which are both germane to all the programs and (more importantly) reflective of Real World planning.

------------------

John L. Olsen, CLU, ChFC

Olsen Financial Group

St. Louis, MO

314-909-8818

John L. Olsen, CLU, ChFC

Olsen Financial Group

St. Louis, MO

314-909-8818

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Oops! I forgot to give my email address.

It's "olsenfin@ebal.com".

------------------

John L. Olsen, CLU, ChFC

Olsen Financial Group

St. Louis, MO

314-909-8818

John L. Olsen, CLU, ChFC

Olsen Financial Group

St. Louis, MO

314-909-8818

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Guest Art E

Mr. Picker

I can understand that we may have seen different cases, yet it's not clear how a difference of opinion can result in such seriously different conclusions.

But we agree that a Roth decision is more than critically dependant on the IRA owner's desire to either spend all (most) of the money or provide for heirs. However, it seems to be clear that the case in point is where the desire is to provide for heirs. MTL-CPA stated --- the big advantage of the Roth is no required distributions and then distributions can be taken over the life of the children.

I have tried to be specific and explain the bases for my comments; but perhaps unsuccessfully.

The comment "The point is that you can't "simply question the wisdom of MTL-CPA's client converting to a Roth" because it simply isn't that simple!" was a bit out of context. You omitted the rest of my comment, i.e. "I was hoping his response would explain in what way his client was somewhat unique. The client just wanting a Roth regardless its 1M cost would have been one explanation." (However, I should have said -- regardless of its POSSIBLE 1M cost --.)

That is, I understand the Roth's no required distributions and then distributions taken over the life of the children may be beneficial IF they provide the heirs more money. But since reasonable assumptions for a similar situation show they may cost the children lots of money, I am curious what circumstances would reverse this conclusion. So allow me to rephrase my comment about the wisdom of the conversion into a question.

I now ask MTL-CPA, in which areas do the circumstances differ such as to reverse the relative advantages/disadvantages of a Roth conversion for the following situation which seems similar to his client's.

-Married couple, he 60 the worker, her 59 never worked, retired in '97 after selling business, with no pensions, no other special incomes except max allowable SS beginning at ages 62, desiring annual spendable income of 200K that goes up with avg. 3.5% inflation, no mortgages on 200K home, both in reasonable health.

-One child age 38 who is beneficiary to IRA and all else, no annual gifting planned, goal is to maximize after-tax dollars to the child as they have more than enough to live on at desired income level.

-Non-home retirement assets totalling almost 6.6M of which 5M is a regular IRA with only 20K non-deductible, IRA growing at 6.7% and taxable (essentially no funds, only stock) growing at 6% plus 0.7% in annual dividends (i.e. IRA and taxable account have same pre-tax growth).

-No big expenditures or sales anticipated above the 200K annual, inflated spendable

-Other assumptions are, today's tax rules apply in the future, both make it to their 80's, and both die at 85 for nominal case, everything tied to inflation goes up at the 3.5% annual rate.

Perhaps there is something else needed to make a conversion recommendation that I've overlooked; hopefully not.

My numbers for the above show a 2M Roth conversion results in the child having about 600K, 1M, 1.1M LESS in-pocket (after estate and personal income taxes) if the parents die at his age 80, 85 or 90 respectively as compared to staying with the regular IRA. So for this case the Roth looks like it's the wrong way to go.

I'm naturally interested in knowing what set of circumstances would make MTL-CPA client's Roth conversion advantageous because it is so similar to my case which shows the conversion is a poor choice. I'm sure there are some circumstances where the Roth is best but wonder what they may be.

Thanks for any comments!

Art

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