Should I convert to a Roth?

[Guest ac_onion]

I’m single, 36 yrs. old, 25 years until retirement. I have $29,000 in a SEP-IRA. Should I convert to a Roth, since I’m eligible and I’ll be in a low, 15% tax bracket this year? In retirement I'll also be in a 15% tax bracket or maybe a little higher. For 2003, I will only have about $1000 in dividend earnings from other investments, no additional income from work. I did a little math and grew $29,000 over 25 years at a conservative 4%. In the SEP column, I subtracted the 15% or 20% in taxes I'd be paying out at retirement from the total amount. In the ROTH column, I subtracted the growth lost on the conversion tax from the total amount. The tax I have to pay outright from funds outside my SEP will not have the benefit of growth over the next 25 years or so. Will I be losing out on growth that’s potentially more money than the amount of money I’d have to pay in taxes if I didn’t convert? Also, do I then need to subtract the amount of taxes I’d pay on Roth contributions from the Roth column? The problem is, when I do this I get roughly a $12,500 loss on the Roth side. I must be doing the math wrong because I expected to see that it would be advantageous to convert. Please help...

[John G]

I think I can help you work through the math. But like Holmes, Kojak and Columbo, I have some questions for you first.

1. What is your approximate current income and your occupation? I ask because I am puzzled by your expectation of a 15% tax bracket in the future. Note, the tax bracket would likely change if you marry and have two incomes.

2. You have 29k in the SEP and expect to retire at age 61? Do you have other retirement resources you are planning upon? What percent of your current income do you expect to retire upon?

3. Tell me a little about your cash reserves. Do you have the non-SEP cash to pay the conversion taxes and still have a reasonable amount of cash reserves for any negative event like losing your job, an accident or replacing a car?

4. Are you currently contributing to any retirement account? What type? Do you contribute the annual maximum to a Roth.?

5. What percent of your annual income do you save or invest each year?

6. Tell me about your debt. Credit card, mortgage, or other loans. The balances and current percent rate.

7. What is your investment experience and knowledge?

Sorry for the multiple questions... but the answers will give me a good chance to respond to your question and put the conversion option in the context of other financial moves you might make.

I see a few "red flags" in what you have already stated. Long term retirement investing (especially given your time horizon), should be more actively placed where the annual return will be far above 4%. The $1000 in dividends and interest is pretty low which has me wondering about your cash reserves and savings habits. As your experience and assets grow, many people move into higher tax brackets and I wonder why you are not sure that will happen to you.

Generally, a Roth conversion looks more attractive when your current tax bracket is low or lower than your expected future tax bracket. The mathematics are a little involved because you are looking at changes in two catagories of assets: tax sheltered vs taxable. However, there are other reasons to argue for conversion such as an expectation that you will not be able to qualify in future years or you want to eliminate mandatory distributions associated with IRAs.

I think you got an odd conclusion because you did not set up the problem correctly. With equal tax rates now and in retirement, the convert or not convert should be close to a wash. But, lets see your answers to the above and perhaps your facts will tip towards converting either all or part of the SEP this year.

[Guest ac_onion]

Thanks so much John G. May I email you directly? I wouldn't feel comfortable posting this vital personal information that you're asking for. Please advise.

Kind regards,

ac_designer@ hotmail.com

[Bruce Steiner]

Assuming no change in the tax rates, John would be correct that it would come out a wash if you had to use the IRA money to pay the tax on the conversion. But that would not be the case if you had non-IRA funds with which to pay the tax on the conversion.

Example, assuming a constant 25% tax rate: you have $100 in your IRA and $25 of other money. You convert and use your $25 of other money to pay the tax. Over some period of time, your $100 Roth IRA grows to $200. If you didn't convert, then over the same period of time your $100 traditional IRA would grow to $200 before income tax, or $150 after income tax. If you were always in a zero bracket, your $25 of other money would grow to $50, so you would be just as well off. But if your tax rate on your investment income is greater than zero, your $25 of other money will grow to something less than $50.

[John G]

Email - sure.

You are pretty anonymous on this site, but feel free to email me using Blackstone.summit@att.net and reference "benefits link" in headline so I don't delete it without reading.

Keep your response fairly generic. I don't need the fine details just approximate age, approx retirement age, rough other resources, etc. Some of my questions such as debt concern related choices.

After I respond you may want to cut and paste or add info here if you are comfortable at that point.

Bruce Steiner's example is along the lines of what I talked about, but sometimes there are details that shade it one way or the other. When conversions were first proposed, lots of folks thought they were a slam dunk great idea for everyone. That is not true. We will see what I can say in your case.