The new year and new decade ushered in new regulations concerning taxes and retirement. One of the most discussed is the rule allowing higher-income individuals to convert their traditional IRAs to Roth IRAs. Until this year, anyone with a modified adjusted gross income of more than $100,000 was not allowed to make that conversion. But is this a good deal?
"It's a great deal, but for Uncle Sam, not for the individual," says Michael Kresh, president of M.D. Kresh Financial Services in Islandia.
Kresh has crunched the numbers and says conversion is not a good idea for most people. Those who convert a traditional IRA to a Roth must pay income taxes now on the amount converted, although the tax bill can be spread over the next two years. The amount left in the Roth will grow tax free and can be withdrawn without paying additional taxes.
"If you're paying the taxes for the conversion with your IRA money today, it's going to take 20 years to break even," Kresh says. Conversion makes no sense for those who are older than 55 and expect to tap their IRAs after they retire, he says. "It makes sense only for those who will never need the IRA money at all and plan on leaving it to the next generation."
In a traditional IRA, money withdrawn after age 591/2 is considered ordinary income, and you must pay the appropriate taxes. The attraction of a Roth IRA is that you don't pay taxes on any money withdrawn after age 591/2.
The main reason to convert and pay the taxes now is the fear that the enormous federal deficit will mean tax rates will soar during the decade. But Kresh says that even if tax rates rise, chances are most high earners converting today will still be in a lower bracket after they retire. He notes that the high earners who became eligible for conversion this year are currently in the highest tax bracket, so they will be paying top dollar in taxes to Uncle Sam if they convert.
"If they're living on Long Island, their marginal tax bracket is over 40 percent," Kresh says. "Why in the world would you write out a check for that 40 percent and forfeit all the earnings on that money for the rest of your life?"