Roth IRA conversions may not be best for you

By Jeffrey Brooks, CPA, CFP, MBA for JBrooks Wealth Advisors, PC
Converting from “traditional” regular IRAs to Roth IRAs may be a very bad idea!
The reason many people want to convert taxable “traditional” IRAs to Roth IRAs is because they believe that tax rates will be increasing in future years.

None of us wants to be “stuck” or forced to take out large amounts of taxable IRAs and pay huge income taxes. The idea is that we get the “pain” over with by converting to a ROTH IRA in lower income tax rate years and before we get to age 70 1/2 when we have to start taking taxable IRAs out.
An additional “penalty” of 3.8% Medicare Tax on Unearned Income such as conversions from taxable IRAs to Roth IRAs will start in 2013. The good news in that you don’t get hit with this penalty unless your modified adjusted gross income is over $200K (if you are single) and $250K (if you are married).
Based on the current tax rates, I can only see two cases why someone 60 years old would want convert $80,000 and pay tax on this amount now instead of taking a “wait and see” approach.
Case 1: The taxpayer had huge ordinary losses from a bad business venture resulting in a negative income situation. In practice, when someone loses a huge amount of money, they do not have a large amount of excess liquid assets sitting around that can be used for spending. Instead they need to dig into the dollars in their IRAs to pay off bank loans and to take care of their living expenses.
Case 2: One out of a thousand taxpayers who will soon be age 70 ½ have a huge amount of dollars in taxable “traditional” IRAs and will have to start distributing their RMD=Required Minimum Distribution or pay a penalty of 50% of the amount they failed to distribute. As a side note, Shari and I believe that since we have been blessed that we believe in giving charity to the less fortunate. Under the current tax rules, once Shari and I reach 70 ½, we are now allowed to use part of our required distribution to give to charity!
Let us take a look at John’s situation. John just retired at 66 years of age and has $2 million in taxable “traditional” IRAs including the IRA rollover from his former employer, $1 million in a variable annuity and $2 million in taxable mutual fund investments. John cost basis in the taxable mutual fund investments is $1.8 million so he only has $200,000 of appreciation on the taxable mutual fund investments.
John is getting $18,000 per year in Social Security and $40,000 in Interest and Dividends.
Let us assume that when John turns 70 ½ that his IRA account has stayed at $2 million because John has been taking taxable distributions each year up to the top of the 15% federal tax bracket to help pay for a portion of his living expenses. He has sold investment in his taxable mutual funds resulting in very little taxable income to pay for the balance of his living expenses.
Based on the IRS Uniform Lifetime Table (Table III of the Appendix C in IRS Pub. 590), John would have to distribute about $73,000 in the first required year.
By not converting a large amount of funds from his taxable “traditional IRA” to a Roth IRA, John will probably be taxed at a lower tax bracket than if he had transferred large amounts of dollars from the taxable “traditional” IRAs to the Roth IRAs.
Now there is even a better reason to NOT convert from taxable “traditional” IRA to a Roth IRA but to wait to see if tax rates go down!
Congress has begun looking at revamping the tax code. Tax reform will reduce income tax rates for individuals. The rate reductions are expected to be offset by cutbacks in credit and deductions, just I recall happening back in 1986 when the big Tax Reform Act was enacted.
Although many people believe that tax rates will have to increase to pay for the huge deficits, I think Congress and the President will be more concerned with a future recession. By having lower tax rates, people will spend more money that will create more jobs and tax revenues. Herbert Hoover tried to get a balanced budget and it made the economy worse.
The President and Congress will “kick the can” down the road for someone else to worry about the deficits.
The U.S. leaders know that those leaders in Europe who are focusing on increasing taxes and reducing spending are being voted out of office.
Or from an optimistic view point, maybe the Generation X group will have grown up now that they have experienced this horrific economic downturn and now realize that nothing replaces hard work..that a job is not easy to get and keep without hard work and sacrifice.
My projection is that the top tax rate in any final tax reform for most of us will be around 28%. The marginal bracket currently sits at 35% but can go as high as 39.6%.

I hope this article has been useful to you! You can email me at with any questions.

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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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Address: 4647 N 32nd Street, Suite B245
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Phone: 602-292-2009