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Regular or Roth IRA?
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November 8, 2000: 6:00 a.m. ET
Consider your retirement income tax rate before converting a traditional IRA
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NEW YORK (CNNfn) - If you're already retired with a lot of money in a traditional IRA, you may not know whether to convert to a Roth IRA. You know the Roth has many advantages, but the transfer will also trigger a big tax bill.
Doug Flynn, a certified financial planner in New York, outlined the steps you should take before considering a conversion.
"There is a definite tax event triggered by the conversion," Flynn said. "And...the answer depends a great deal on your income tax rate during your retirement."
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 Douglas Flynn, a certified financial planner, answers questions on Your Money's viewer mail segment. |
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Flynn recently answered questions on CNNfn's Your Money and answered the following for CNNfn.com
Frank writes: Could you please tell me if it would be wise to convert my traditional IRAs into Roth IRAs? I'm retired with almost $200,000 invested in the accounts. Should I convert and pay the taxes or am I better off as I am?
The decision to convert a traditional IRA to a Roth IRA, or remain in your current investment, is a complex issue for two main reasons.
One, there is a definite tax event triggered by the conversion. And two, the answer depends a great deal on your income tax rate during your retirement years.
Unfortunately, people who are many years away from retiring may only be able to speculate on what income tax rates will be in the future.
The first thing you need to do is determine is if you have enough money in liquid cash to pay the tax bill generated by the conversion.
For instance, a $200,000 conversion can potentially cost you $72,000 in Federal income taxes (at the income tax rate of 36 percent). It could be even more if the income from conversion pushes you into the higher tax bracket of 39.6 percent. Then, you add in any state or local income taxes you may have as well.
Now you don't have to convert the whole traditional IRA in one year. You can convert any amount you wish in any year your income is below the eligible limit.
However, no matter how you convert, it generally does not make sense to pull the tax money from the IRA to pay the tax. This only adds to your tax bill, and lessens the value of the conversion since you won't have that money working for you any longer. You must have the money available elsewhere to pay the tax and to make it worthwhile.
Do you have a question about whether you can afford to stop working? E-mail our experts at retirement@cnnfn.com.
There are many benefits to the Roth IRA. For example: the tax-free growth; the ability to avoid Required Minimum Distributions at age 70 1/2; the ability to transfer the asset on your death; the access to principal after five years, etc.
However, my general experience has been that even thought these benefits are significant in the long run, the immediate tax hit that is created has forced most people to pass on converting.
There are many Web sites that have Roth conversion worksheets to help you in this decision. This can help you run several different scenarios which may help you in your ultimate decision. However, due to the complexity you should seek professional help before you ultimately decide to convert.
Essentially, it may come down to whether or not your primary goal is to pass down the largest amount of money to your heirs, and whether or not you are willing to part with the cash needed to pay the current income tax necessary to achieve this goal. But, there are many other factors that go into this decision as well.
Ralph writes: What are the pros and cons about fixed annuities? I'm 45 years old, have a good retirement plan, but I need some information about fixed annuities.
Annuities are tax-deferred investment vehicles offered by insurance companies.
You will not pay income tax on your earnings until you actually start withdrawing money from the annuity, and then, you will never pay income tax on your principal if you purchased the annuity outside of an IRA (or other tax-qualified plan).
Fixed annuities pay a fixed rate of return, and are "guaranteed" by the insurance company that issues the contract. However they offer no federal insurance protection against default. Most fixed annuities will pay a "guaranteed" rate for a set period of time, and then offer renewal rates at various intervals.
The place for an annuity today comes in after you have made the maximum contribution to your 401(k) or 403(b) plan at work, and after you have fully contributed to a Roth (or Traditional) IRA if you are eligible.
Then, if you have enough money on hand for emergencies and if you have a decent taxable (non-deferred) portfolio; and if planning for retirement is your number one priority, you should consider accumulating money in annuities.
In addition, please be aware of any annual fees and charges that the different annuity providers may assess. Most also have surrender charges if you do not hold the annuity for a set amount of years.
Essentially, annuities can serve a purpose in rounding out a retirement portfolio, but they should not be used as the "end all" investment. 
* Disclaimer
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