We have the opportunity to convert many of our tax-deferred accounts to a Roth type plan this year. But this may not be wise for the vast majority of us. For those of you who may not know what a Roth is, a 401(k) or an IRA designated as a Roth uses money that has been taxed. The idea is that you will not be taxed on the money you put into it again. The other attractive component is the ability to withdraw the money when you want and not on some mandatory time schedule. Yes, there are people out there who would like to use the money well after age 70 1/2, if ever.
Once tax-deferred investors, who are now able to convert to a Roth plan understand that taxes on the old plan must be paid, and often out of the current portfolio they own, the idea immediately becomes less attractive. Depending on your age – the closer you are to retirement the bigger the tax bite and the shorter the recovery time – the Roth conversion is probably not right for you. According to some analysts, the recovery time for the taxes in this sort of a conversion could take as long as two decades to even itself out.
Another huge concern is how much dependence you will have on this sort of plan, If your retirement income is highly dependent on your Roth, then the switch after age fifty might not allow you the time needed to recover the losses. Remember, paying taxes from those accounts essentially removes money that was put there to grow.
And then there is the taxes. If you think your tax bracket might be lower in retirement, the move will not benefit you. On the flip side, the conversion is taxed as income while you are working which may trigger a bigger than expected tax bill in the years you convert.
According to Annie Gasparro writing for the Dow Jones News Wire there are numerous other considerations. She writes:”If an investor is receiving Social Security benefits, the spike in income could force them to pay taxes on their Social Security money, he says. It also could interfere with efforts to receive financial aid for children’s college tuition. And, he adds, if an investor is going through a divorce, the additional income could affect the settlement.” Best advice is to get an advisor to help on this one and be sure she/he explains the pitfalls, which are many against the upsides, which are few.
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