What determines if converting your current IRA, SEP IRA, IRA Rollover into a ROTH IRA? Here are a checklist of things to consider in making a wise choice for you. What is your life expectancy and your current age? Why because the longer you can grow assets the better and if your seeking leave money to children and are not insurable then ROTH is the next best thing. Do you expect to see higher taxes for you and your family? Currently at the end of 2012 capital gain rates are scheduled to increase up to 20% and potentially higher from current 15%. Estate taxes are scheduled to increase dramatically at year end and potentially sooner as Congress looks for revenue now. Your Individual Retirement Arrangement or IRA has a problem when you die and leave to a non spouse. It’s called IRD or Income Respect to Decedent and tax term for well your heirs are going to pay ordinary income taxes on the proceeds (or choose to stretch it out) and estate must include the proceeds as taxable potential.
Why would someone be willing to pay taxes now on something tax deferred? Unknown tax liabilities in the future and the ability to create potentially wiser tax strategy. Mary has $300,000 in an IRA and mix of High Yielding Bonds, Real Estate Investment Trust Stocks and other higher dividend stocks and various bonds. Her cash flow is 5+% in 2012 and she is drawing out 5% of her IRA currently taxable 28% or net return after tax is 3.6% or $10,800 net. If she converts to ROTH IRA and pays the taxes upfront what would the effective net cash flow would essentially be the same net $10,800 or 5% on $216,000. However if she increases the risk of the bonds and holdings for greater dividends and cash flow to 7% the ROTH become more valuable as all proceeds are tax free earnings and cash flow in her pocket. Bottom line the more income that could be generated the more valuable the conversion to the ROTH IRA. I know of guy earning 12% on rental real estate inside his self directed IRA and he got excited to convert it to ROTH so he can now accumulate like before and when time to take cash he will be better off.
When would converting to ROTH IRA be considered a tactical tax move? Perhaps you have alternative minimum tax credits or unused charitable contribution carryovers? Maybe you have Net Operating Loss carryovers or current year ordinary losses that need to be offset? By convert to ROTH it may in fact allow you to use these loans to the U S Treasury and actual use them up. In fact it’s possible that you may not have to pay taxes if you have enough carryover.
One strategy is the opportunistic conversion. Let say you have three individual stocks and you believe there is strong chance 1 or 2 of the 3 positions could do extremely well in the next year. Trouble is you don’t know which one. Go and create three separate ROTH’s one for each asset. If one of the assets performs greatly realize that all the gains would be tax free. If let say two of the three do not perform or lose money then you simply re characterize the low or non performing and save on the tax costs. If there are private assets that could win big and provide a huge windfall then would you not want those inside of a ROTH IRA tax free forever? You could look up self directed IRA and there are a handful of custodians most you would never have heard of doing private stock and real estate and other assets inside of IRA and ROTH IRA’s. Some even do currency speculation and trading. Do not expect to see the big names in the financial world engaged in these transactions or at least not for their retail clients.
Bankrate site has a good basic calculator for ROTH IRA conversion.
Another question before doing a conversion to ROTH IRA is looking at your current cash flow needs and your future cash flow needs. Compare you current marginal tax rate to your projected marginal tax rate. As the government works hard to find additional revenues they know all those who saved hard for a long period of time have significant savings in IRA’s and other qualified money and it’s taxable and in fact the rules of RMD or Required Minimum Distribution makes sure you do not let your IRA continue to grow and it forces distributions at a greater percentage each year you get older and it starts when you turn 70 1/2 years of age. Did you know the penalty for not taking your RMD is 50% tax on the amount you should have taken? Guess what the ROTH IRA does not have RMD or it’s taxes or penalties. Tax stewardship is not discussed in the most media for main street investors, however it is discussed as wealthy individuals meet with their well informed advisers