Converting to a Roth? Answer These 3 Questions First

hi I'm Christine Benz from morningstar.com many investors have traditional IRA assets that they'd like to convert to Roth joining me to share some tips on the IRA conversion decision is retirement expert and author ed slot and thank you so much for being here great to be here live in Chicago we really appreciate it it's great to have you here in the studio let's talk about IRA conversions there are a lot of moving parts here this is a very complicated decision that a lot of investors are confronted with whether to take those traditional IRAs it's then that they've been building up convert them to Roth and enjoy those tax-free withdrawals in retirement let's talk about for people who are trying to make a good decision here are there any resources that you would send people to or where should they go for advice should they should they naturally seek out a tax advisor for help on this you could seek out a tax advisor your own financial advisor but I would first ask yourself three questions okay when what and where we're talking about paying a tax for moving IRA money to a Roth IRA but the good part is it's at today's rates where China all-time low we haven't seen rates this low most of our X rates that don't pay on the conversion RPO okay so when the first question was when I asked people these three questions all the time when do you think you'll need the money if somebody tells me well I might need it in five years don't convert the benefit of paying a tax now is the long-term compounding tax free its longevity the longer you keep it in that tax-free account the more it will grow on eroded by taxes but it certainly doesn't pay for most people to pay a tax now just to take out the money in a few years so if people tell me well I might need it in a few years I would say you're probably better not converting and giving up all that money upfront but if they say I intend to keep it the rest of my life remember Roth IRAs have no required minimum distributions that can really snowball and carry over to beneficiaries tax-free so the longer you got you plan on going out or not touching it the more it pays to do a Roth conversion that's my first question they're a minimum amount of time that I'd want to have until I marry I I would you know people are saying I need it in five or even ten years I would say yeah it's too short okay you got to go longer because it didn't get time to snowball right you know and all of that growth is tax-free you'd hate to stunt it cut it off right after you do have finished paying the taxes it's not worth it okay look at your time horizon them yeah the next question is what what do you think your future tax bracket will be that's really the biggest question but the problem with that question is nobody knows absolutely yet a lot of people tell me and accountants you know other advise say oh I'm sure retired people all think they're gonna be in a lower bracket in retirement but if taxes go up the lower bracket could be tomorrow's low bracket could be today's high bracket so you don't really know Plus at some point if you don't convert you are forced to take that IRA money out anyway at seventy and a half at the prevailing rate if future rates go up to forty or fifty percent that may be a hot that would be a higher rate but it's a double hit because if your IRA has done well it's a higher rate on a higher balance so it might pay to bite the bullet now if you think you'll be in a higher bracket later it might pay to do it would pay to do it now it means you have to part with some money there's an opportunity cost but look at the long term big picture it's all building tax-free and you won't have to worry about the uncertainty of what future higher taxes could do to your retirement savings just when you need the money most in retirement that's not the time you want to wonder how much is this going to cost me now and you're like I said if you don't convert you're forced to take it out at 70 and a half so that's what what do you think your future tax bracket will be okay and the final question where yeah where are you gonna get the money from to pay the tax if you don't have the money to pay the tax you shouldn't be converting you you don't want to go broke converting you know it's not for everybody but if you have money sitting in taxable investments that are just going to be exposed to current and future higher tax on your investment gains that's the money to use also you don't want to use the IRA money itself that's what I was gonna ask cuz it's a diminishing return you're converting less also there's a trap if you use the IRA money to convert you're not converting everything and one of the big benefits of a Roth conversion is the ability to get a second chance to undo it it's called a Roth recharacterization once you convert let's say you convert in 2015 you have until October 15 2016 to unwind that to undo it for any reason at all but you can only undo or recharacterize the amounts that were converted so you lose the opportunity to recharacterize all of it if not all of it was converted so it's best not to use IRA money also it's best to use taxable money if you don't have the money where are you gonna get the money from then don't convert so don't read some other no 401k or IRA oh no okay if you don't have it don't do it or what some people I tell some people they said but I still like the idea of having something in a Roth to hedge my bets having that tax-free account do a little overtime the best strategy really I say I know it sounds outrageous to most accounts I tell people convert everything and they're shocked do I have five hundred thousand there I can't get a tax bill no I say convert everything then remember you have until October 15th or the next year to undo it all make the whole tax bill go away if you want but by that time you know exactly all the other items in your tax return so you can go back and unconverted characterized right back to the number you actually want to keep say filling up lower tax brackets and then make it exactly the number you want so you can go in from the back end I call it getting the bet on a horse after the race is over so as long as you mind those deadlines for realization it won't be flexible to you to undo them in other words the key is not how much you convert it's how much you recharacterize or in other words how much of the conversion you actually keep so are there any situations where you look at someone they're asking you about conversion and you say yes absolutely the situations where you say green light do this do this do this young people okay the greatest money-making asset any individual can possess it's time and young people have more of it than anyone else but they don't capitalize on it so of course young people starting a job should be contributing if they can to a Roth should be converting they probably don't have a big 401k so far they're in a low tax bracket this is the opportunity of a lifetime to start building tax-free I wish I had that opportunity I had to pay a fortune to convert back in 2010 when they opened the floodgates and they repealed the income limits but young people have have unbelievable opportunity now so if there's one absolute for a Roth conversion young people should all be converting and contributing to Roth IRAs and at work if they have the option should be contributing to Roth 401ks as opposed to 401ks so take advantage of that relatively low tax oh yeah plus the long time horizon how about the opposite we talked about how if your time horizon is too tensed the conversion may not add up are there any other situations sometimes I hear from people who say am I too old to convert well it depends what you're converting for I would say if you're 70 or over and you're converting for yourself to take out money during your lifetime it probably doesn't pay because the cost you pay upfront giving you a life expectancy is probably not worth it but for example my mother's in her 80s and she saw my show on public television she called up and said she's 88 Eddie should I do that cover I said mom what do you know it's not for you don't do it right right you know first of all she has other things she has income she doesn't need it it's not for everybody I just thought that was funny that she called up and said but if you are older and you're doing it for your beneficiaries you have to look at the time horizon if you're doing it for just your time horizon it probably doesn't pay but if you're doing it for your beneficiary's time her eyes and that could add another 50 60 70 years attack free growth after your death then it might pay okay how about pitfalls since you see related to conversions obviously keeping an eye on what the tax bill will be associated with this conversion minding time horizon minding whether you have external assets to use to pay the taxes are there any other big pitfalls that you see people fall into well one is when you convert obviously you opening a new account so you want to make sure you name your beneficiaries on this new Roth IRA a lot of people miss that also making sure you have your ducks lined up that you do have the money but even if you don't like I said convert everything you could always undo it later but you've got to keep track of that deadline that's a hard deadline that it's a long time so sometimes people forget right it's October 15th of the year after you convert so don't let that slip by because you could always undo it and then some of the mistakes people make they don't keep track of after-tax money that's in their IRA you should look at that you should be filing a form called an 80606 so let's say you have a hundred thousand and you want to convert it and ten thousand of it is after tax you should only be paying tax on ninety thousand if you're not keeping track of your f2 tax money in your IRA that came from non-deductible contributions or Rowling's from a plan of after-tax money then you're paying tax twice on the same money so you should be careful about that okay and super-complicated that make you make it seem very very clear we appreciate you being here thanks thanks for watching I'm Christine Benz for Morningstar calm

Channel: Morningstar, Inc.

Views: 194,761

Keywords: morningstar, investing, stocks, funds, etfs, mutual, market, roth ira

Id: VkbbE6SBdvU

Length: 10min 31sec (631 seconds)

Published: Thu Apr 09 2015