Traditional to Roth

[Guest David Ardito]

In 1998, I met all the criteria to roll my traditional and Simple IRA's to a Roth. My Fiancial Planner received my signed paperwork and acknowledged receipt with their signature. In Feb. 99', I found that they never rolled the money. Amount to roll as of 12/31/99 was $118,000. How can I find out how much this mistake cost me?

[John G]

Your question is complex. You would need to provide more details before anyone could give you some perspective. For example, are you qualified to convert this year? What is the difference between the total assets when you made the request and now? What are the tax rates in prior yr, this year, the next three years, at retirement, and at a possible withdrawal date. What is you state income tax rate for those same periods. How old are you now, when do you expect to retire, what age do you expect to take out funds from the IRA.

If you still qualify to convert this year, your damages may be minimal. You have lost the opportunity to elect a four year averaging for taxes. That is a time value of money question since 75% of the taxes would be paid an average of 1.5 years later... maybe around 10% of your conversion tax obligation. On the other hand, if your assets shrunk in this recent stock sell off you could convert at a lower cost.

A bigger question is do you really want people managing your money who fail to do basic administrative acts? Time to find a new home for your money.

Next time you take an action, double check to make sure it was done. You bear some responsibility for not following up on your request. Your note suggests that you attempted to make this rollover in late December. Some custodians notified customers that their cutoff for conversion was mid-December. If you missed a well noticed deadline such as this your entire question might be moot.

[John G]

One extra point. You said "financial planner" in your question. If your financial planner is not the same as your IRA custodian, your problem becomes even more complex. The transfer is done by the IRA custodian.

[Guest David Ardito]

This issue is complex! No, I cannot qualify this year nor do I believe I will ever qualify for <$100,000 AGI. Difference in assests from them until now is $109,000 to $117,000. The simple was included and should not have been since it was only 1 year old at time of roll-over. Tax Rate in 1998 was 28%. It will go up to 31% 1999. Not sure about 2000 & 2001. I'm 37 now, 36 at time of roll-over and never planned to retire! This Roth was for my kids and maybe their kids.

As far as the Financial Planner, they are my IRA custodian. Poor choice of words. Since I have been negotiating with them since February, I felt it smart to leave my accounts as is. Once finished, adios to them!

I have a signed document dated by them as of 11/25/98 that the ROTH account was created. I probably should have asked them "what now?" but assumed they would move the money. That never happened! Shame on Me! They know they made a mistake and actually said I wasn't the only one but was one of the bigger mistakes! The ROTH as I wanted it will never happen!

[John G]

Don't give up on qualifying in the future. You have more options if you own your own business or have some influence over the timing of income such as bonuses. For example, you might be able to start up a business and end up qualifying due to first year expenses. You may be able to push some income into 2000. In addition, Congress may eventually change the qualification parameters.

Concerning your circumstances: your problem is indeed complex. I don't believe there is anything the custodian can legally do to "fix" the error. Under current qualification rules, your custodian's negligence has prevented you from taking advantage of the Roth conversion.

You definitely need to seek legal counsel on this issue, I would not negotiate without legal support. Creating a Roth is not the same as asking for a conversion. If you set up a conversion or standard Roth but never gave them instructions in writing to convert your existing IRA, you have a weak case. But if your instructions are clear, and they acknowledged in November that actions were being taken, then you have a very strong case.

Your damages can only be estimated by making some assumptions about tax rates, investment returns, time schedules, etc. I think you may want an accountant to run some scenarios on standard ROTH evaluation software. This would have more credability then your own spreadsheet. Your hard facts are the amount you asked to convert and 1998 taxes rates. Don't forget to add your state tax income tax rate to the bumped up Federal for the future. Your damages will be much larger if you can make a strong case for a higher annual investment return. While lots of folks plug in 10% automatically, I think you can make a good case for 12 to 14%. Some of the oldest mutual funds have 30+ year averages in this range. Your damages increase if you can make a strong arguement for a very long tax shelter period. I understand what you are saying about passing it to your heirs, but I doubt you will be able to prevail on anything beyond your lifetime.

Understand, that any sharp economist could punch holes in your scenarios. For example, at time of conversion you might live in a state with income taxes now but later on live in a state like Tx or Fl (no income taxes) when the funds come out. That example would reduce your damages.

I would not be surprised that you could develop scenarios that would show a future delta between IRA and Roth conversion of 100K to 700K. A good economist would then argue to reduce the damages to present day value (reduced for long term imbedded inflation). For example, at 4% inflation and 50 yrs hold this means that you would roughly divide any damages by 7.1 ! That would mean a settlement check 14K to 100K.

The more I think about this the more convoluted the calculation seems. This is not the best forum for providing you with a methodology, but your problem is a very good warning to others about custodian sloppiness. From that perspective, you are helping a lot of folks. Post another note when your problem is resolved. Good luck.

[Guest Oldtimer]

To: D. Ardito and John G. 10/11/99

Some personal opinions relative to your postings.

John G. commented ---"I think you may want an accountant to run some scenarios on standard ROTH evaluation software."--- I believe that using standard Roth evaluation software is a total waste of time. Standard Roth software used by most financial professionals isn't useful for many

individuals. These standard programs have serious weaknesses. For example, they 1) require users to guess at future tax rates, 2) only consider the IRA portion of ones retirement portfolio, and 3) while most software "invests" the lost opportunity money for taxes due on a Roth conversion, the don't invest these funds realistically.

1) Roth evaluations are critically sensitive to future and current tax rates. Standard software requires the users to guess future tax rates as well as other factors, and it is prudent to do several runs with rates both a little high and little low to see how sensitive the results are to the tax rate guesses. However, standard and professional programs don't accommodate a base point for today's tax rules applying in the future. Therefore, the user guesses may all be high or all low. Many retirees may move through 3 tax brackets during their retirement lifetime, so accurately guessing the correct future tax factor is difficult if not impossible. And many standard programs only allow Federal tax bracket inputs of 15, 28, 31, 39, etc. percent, when it is the

effective tax rate, not the tax bracket, that's the useful factor.

2) A realistic Roth evaluation must also consider an individual's total portfolio, not just the IRA type accounts. The standard software may correctly show the IRA account is better with a Roth startup or conversion by say $100,000. But it will not show the non-IRA portion of ones portfolio

is $200,000 worse by going with the Roth. An average individual would no doubt opt for the Roth based on the $100,000 advantage results of the standard software, but most wouldn't go for the Roth if they saw their whole financial picture and knew going for the Roth may actually cost them $100,000.

3) Most standard Roth software address the up front money paid in taxes for a Roth conversion, i.e. lost opportunity money. However, they assume these funds are invested in vehicle where the annual growth/gain is fully taxable, e.g. a CD or bond. Most people investing for retirement

principally buy stocks and funds where except for the usually small annual dividends, the gains are tax deferred until the equity is sold, and then the net gain is only taxed at the long term capital gains rate - a rate almost always less than their preference rate. This is yet another bias

toward the Roth.

Unfortunately for many individuals, the standard Roth software results are heavily biased in favor of the Roth. But this situation is pleasing to most mutual fund institutions and brokerages who benefit from people starting and converting to Roths. (Perhaps this is one reason that there is

such a plethora of standard Roth evaluation software and calculators available at their web sites.)

Mr. D. Ardito's postings seemed to imply he may have some recourse because he believed he was damaged by his IRA custodian not moving his traditional IRA to a Roth. In my opinion it is quite possible his heirs may be far better off because the Roth conversion was not implemented. That isn't to say he may not prevail if he takes legal action against the custodian (if he can find

an attorney who will take the case for a percent of the settlement). But he probably won't win because he was damaged. He could win because most fund institutions and brokerages may soon be fending off individual and class actions from the multitude who converted and/or started

Roths. That is, the many individuals who moved to a Roth based on the results of these institutions' flawed standard Roth software with inadequate warnings about the software's weaknesses, and who are now beginning to realize going to the Roth was a very costly move. (As of this posting, there are only 4 more days to recharacterize a Roth back to a traditional IRA.) So D. Ardito's custodian may prefer to pay a few "we should have converted them but didn't

claims", even if their error was advantageous to the individuals, rather than use the proper defense that their software was flawed and these few individuals are actually better off than if they had converted. The defense for a few claims totaling a few hundred thousand dollars would in effect be an admission of guilt to the claims, perhaps in the billions of dollars, of the many who were inappropriately influenced to convert, but shouldn't have converted.

If Mr. Ardito really wants to know if his goals are better met with a traditional or Roth IRA, he should get professional advice - from someone using non-standard software, i.e. the type of software knowledgeable professionals and the attorneys will use in evaluating Roth options.

Bill T.

[Bruce Steiner]

I'm a bit confused by Bill T.'s comment.

The Roth conversion is generally very advantageous to the IRA owner.

See my articles on this subject in the CCH Journal of Retirement Planning .

Also see the articles by Jim Dam in Lawyers Weekly and the article in the New York Times in which I am quoted, all of which are linked to .

Of course, many clients are not eligible to convert due to the $100,000 income cap.

However, at least in the short run, it is not advantageous to financial institutions, since the IRA owner has to withdraw other funds in order to pay the income tax on the conversion.

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Bruce Steiner, attorney

(212) 986-6000 (NY office)

(201) 862-1080 (NJ office)

also admitted in FL

[Bruce Steiner]

The links in my previous message didn't appear. I'll try them without the symbols. The website for CCH is cch.com. The website for Roth IRAs maintained by Brentmark Software (whose products we use) is rothira.com. In each case, add the http://www. at the beginning.

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Bruce Steiner, attorney

(212) 986-6000 (NY office)

(201) 862-1080 (NJ office)

also admitted in FL

[John G]

Responding to Oldtimer - David Ardito's problem was very specific, the failure of a custodian to complete a Roth conversion in 1998 and how to calculate his potential damages. My comments addressed this issue and raised some of the difficulties in defining a methodology.

You have missed the point of my phrase "standard ROTH evaluation software". His problem is going to be resolved by negotiation, arbitration or litigation. I recommended STANDARD evaluation software over his own spreadsheet for "credability" reasons. There are a number of choices in sophisticated Roth evaluation software packages available to accountants. It would be extremely naive to use a simplistic mutual fund worksheet to examine Arditos damages question. If Ardito created his own spreadsheet, the door would be wide open to arguing about the basic structure of his personal spreadsheet. So STANDARD in this context means a third party model or evaluation tool that would be accepted by both sides. The arguement would then focus on assumptions and not algorythm/structure.

Oldtimer, you seemed to go nuts over the idea of using computer models to evaluate the Roth conversion. Is there any alternative that can address Ardito's problem. Do we stop crunching numbers because we have to make some assumptions? You seem to presume that every Roth evaluation model would be inadequate.

You said that Roth models are sensitive to future and current tax rates. That is only true if you make radically different assumptions about tax rates now and later and if the time period is short. Most of the managers I know are unlikely to move 3 tax brackets in retirement, perhaps this is your view or bias? Ardito is in his 30s and has already accumulated a large IRA lump which could easily grow beyond $2M in his lifetime on growth of the current lump alone. Do you expect that he would be taxed at a LOWER rate in the future? For Roth conversion scenarios for people early in their career, the assumption about the duration of the shelter is often a more significant issue. And since Roths have no mandatory withdrawal, the Roth funds are likely to be sheltered a long time and be the last assets used.

Oldtimer, you never mention the name of any Roth evaluation software. Then you make charges about software "biased in favor of the Roth", "flawed standard Roth software", errors in opportunity cost methodologies, and models that do not evaluate total portfolio (why?). If you have a beef with a specific package perhaps you should start a new topic. Please don't shoot from the hip with generalizations. The rothira.com site has lots of material on roth evaluation models. Very specific analysis.

The custodian has offered a 30K settlement. Ardito's math may now look something like this. Assume that the settlement is taxable income and you might reduce it by 40% to 18K, then grow it at 10% to about a pretax $288K in his 70s. His unconverted IRA in the mean time has grown from 118K to about $2 million. Over that period of time, the conversion taxes he did not pay ($47K) might grow to a pretax 750k. I would guess that leaves him about 500K (aftertax of 288+750) to pay the taxes on the IRA $2 million or about a 25% coverage. My guess that falls short of making David Ardito whole.

But that is the result of just one set of assumptions. Ardito needs professional help to define a range of results before he decides to accept, decline or counteroffer the settlement. David, the comparison is not just the 30K settlement vs the taxes you would pay to convert. Post again and let us know how this is resolved.

[This message has been edited by John G (edited 10-15-1999).]

[Guest Oldtimer]

Mr. Steiner - my responses are in the order of your comments.

You commented that "The Roth conversion is generally very advantageous to the IRA owner." I agree with qualifications that a Roth conversion is very advantageous to some IRA owners. And you may agree that a conversion is a mistake for others. My opinion is that many, certainly not all, who converted to a Roth based on the results of typical Roth software (yours included) made an expensive mistake. My earlier post summarized why I believe typical Roth software is heavily biased toward the Roth - and I haven't seen any rebuttal. When you run the numbers on a program that doesn't have these biases, the results are often much different, i.e. the Roth is far less attractive than the regular IRA. Individuals needing their IRAs for retirement income are

those most likely to have erred in going to the Roth. However, in some situations even those planning to pass the Roth to their heir(s) may have been better off staying with the regular IRA if they could spend down most of it during their lifetime. It depends on their overall portfolio characteristics, not just their IRA.

I searched for your articles on the Internet via the CCH Journal of Retirement Planning but couldn't turn up anything. I would appreciate any links to this publication you can offer.

The James Dam article was still referenced at Rothira.com, but the full article was only available for a fee. And as it was written in late 1997, I doubt that its conclusions would reflect the improvement in Roth software.

As for your reference to the New York Times, there were simply too many NYT articles (about 100) to read through.

I agree that in the short run, conversions may not be advantageous to most financial institutions, especially if the IRA owner must use funds from their IRA to pay taxes on the withdrawal. Although I've read that using one's IRA funds to pay the withdrawal taxes is considered disadvantageous to a conversion. So it's possible that some, perhaps many, who converted used funds outside of their IRA to pay the taxes and that these funds came from accounts not held by the IRA institutions. So for these individuals, the conversion didn't hurt the institution holding the IRA. Now on the plus side. If the institution has one's converted Roth, they are more likely to get the individual/spouse annual $2000/$4000 Roth IRA buys (assuming the owners who

couldn't buy a regular deductible annual IRA would now buy the annual Roth - as the annual Roth buy income limit is higher than the regular IRA limit). Only conjecture and assumptions of course.

[Guest David Ardito]

Whether the software today paints a good or bad picture has little relevance to me today. Unfortunately, I won't know, at least as it stands today! I did receive an sudo offer from Prudential though. They felt that since they did not roll the money to a ROTH, the money I saved by not paying tax on the roll, placed in a non-taxable investment???, I would need to place a $30,000.00 investment today in order to become whole????

My question to them was why convert? If I had to pay close to $47,000 in ROTH tax today in order to save $30,000 by the time I'm 70 1/2, sounds stupid. Maybe I'm missing something??? Remember, I'm a lay person at this unlike those who have responded to my original question. My accountant made some very good arguments which required more figuring on they're part. This happened two weeks ago and they said they needed a week. I've called but no return. Bruce, our meeting may be closer than you think!

[Guest Oldtimer]

Mr. Ardito

I wish I could be helpful in determining your damages because your IRA wasn't converted. I believe you actually saved a great deal of money because the conversion was not executed. From my pespective the $30000 looks like a gift. But they did make their first offer. If I were a gambler I'd be tempted to turn down their first offer and counter offer for a higher settlement.

The few numbers you quoted indicated the taxes on the withdrawal would be at a combined Fed and State rate of about 40%. This implies you are in relatively high tax brackets. I am very curious why you believe a Roth conversion would be advantageous to either you or your heirs. Did someone recommend that you should convert or was it simply a personal decison?

Bill T.

[Guest Oldtimer]

Mr. Ardito

I wish I could be helpful in determining your damages because your IRA wasn't converted. I believe you actually saved a great deal of money because the conversion was not executed. From my pespective the $30000 looks like a gift. But they did make their first offer. If I were a gambler I'd be tempted to turn down their first offer and counter offer for a higher settlement.

The few numbers you quoted indicated the taxes on the withdrawal would be at a combined Fed and State rate of about 40%. This implies you are in relatively high tax brackets. I am very curious why you believe a Roth conversion would be advantageous to either you or your heirs. Did someone recommend that you should convert or was it simply a personal decison?

Bill T.

[Guest David Ardito]

Oldtimer,

My custodian made the recommendation. Unfortuately, he made the recommendation to my wife. She in turn convinced me to do it. She laid out very broad reasons why we should do it such as having the ability to leave it for my kids who are 9 and 7, non-taxable when they finally take it and of course the large amount Pru said would be there if and when they took it out. I sure wish I had those figures in writing now!

The offer of $30,000 is not in writing yet. Remember, I would need to invest $30,000 to become whole per Prudential. That amount does not include the income tax I would have to pay on it!

Thanks for all your imput guys! It is really appreciated. I will update you when and if this gets resolved!

[Guest Oldtimer]

Mr. D. Ardito

Thank you very much for responding to my questions.

If the conversion had been completed, you would wish even more that you had a record of Prudential's numbers that pointed you toward a conversion. If you had converted based on their recommendation and could demonstrate this, your damages would likely have been in the 6 - 7 seven figure range in future year dollars.

I believe if you get anything from them and the conversion wasn't executed, you come out ahead.

Good luck

Bill T.

[Bruce Steiner]

Let's not get hung up on the choice of software. One can run some numbers with Lotus, Excel, a calculator, pencil and paper or perhaps (if one knows how to use it, which I don't) an abacus.

Of course, the results will depend on the assumptions one makes.

I generally make the following assumptions, unless a client wants me to illustrate different assumptions:

1. He will live to his life expectancy

2. If he is married, he will remain married to his present wife, she will survive him and she will live to her life expectancy.

3. In the case of a traditional IRA, he will name his wife as beneficiary; during his lifetime he will take the minimum required distributions (for simplicity, I generally assume the term certain method, but you could run the numbers using recalculation or hybrid if you like); after his death his wife will roll the benefits over into her own IRA, name the children as beneficiaries, take the minimum required distributions (taking into account the MDIB rules); and after her death the children will take the minimum required distributions over the balance of the oldest child's life expectancy.

4. In the case of the Roth IRA, neither he nor his wife will take any distributions during their lifetimes.

5. In the case of the Roth IRA, for simplicity, I usually illustrate the wife leaving the benefits to the children, who take the benefits out over the life expectancy of the oldest child. But for people who don't otherwise use their GST exemption during lifetime (which is many if not most people), the Roth IRA is often a good place to allocate GST exemption. In that case, (i) his wife could leave $1.01 million of the Roth IRA in trust for the grandchildren and the balance to the children, (ii) his wife could leave the entire Roth IRA to or in trust for the grandchildren (and pay GST tax on the excess over $1.01 million), or (iii) he could leave $1.01 million of his Roth IRA in trust for the granchildren and the balance to his wife.

6. Since IRA assets are not subject to current income taxation, some reasonable pre-tax investment return on IRA assets.

7. The more difficult assumption to make is the after-tax return on personal (non-IRA) assets. This depends to a large degree on the client's preferences as to investments (e.g., tax-exempt bonds, equities with high or low turnover and high or low dividends).

8. Some reasonable income tax rates for (i) the income tax on the conversion, (ii) the income tax on future distributions from a traditional IRA and (iii) the income tax on personal (non-IRA) assets.

Even if he does not convert now, there is a reasonable chance that, under the current tax law, he or his wife will eventually be able to convert sometime before age 70 1/2. To do so, he would likely have to retire, and arrange his investment assets so as to keep his income under $100,000. Even if he can't easily do so, if he dies first, it may be easier for his wife to keep her income under $100,000 after his death, depending upon her own earnings and investment income. During the first couple of years after his death, the income from his investment assets can be kept in his estate (and there will likely be less capital gains due to the basis step-up); and after his estate is wound up, his wife need not be taxable on the income or capital gains from the credit shelter trust, and need only be taxable on the income (but not the capital gains) from the marital (QTIP) trust.

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Bruce Steiner, attorney

(212) 986-6000 (NY office)

(201) 862-1080 (NJ office)

also admitted in FL