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Thread: Should I convert my traditional IRA to Roth?

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    God/dess Emily's Avatar
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    Default Should I convert my traditional IRA to Roth?

    Back before dancing I had a job with a 401(k). When I left that job to dance full time, I rolled it into an IRA. I was kinda of clueless about it (still am, obviously), but one thing I knew was that converting to Roth meant I had to pay taxes on it, which I was uncertain about.

    Well, anyway, it was rolled into a traditional IRA. And that's what I still have today.

    I read about converting into Roth and it's a guessing game. Will I make more next year? Should I convert it then? What will my tax situation be like when I retire? So many questions that I can't possibly answer, so instead of doing something stupid, I'm doing nothing. But maybe doing nothing is what's stupid? If I do it this year, I'll be hit with a big tax bill, but maybe I should bite the bullet?

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    Banned Melonie's Avatar
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    Default Re: Should I convert my traditional IRA to Roth?

    indeed the questions do boil down to A. will next year's tax rates be higher than this year's tax rates re the conversion tax (penalty), and B. will the same tax rules, benefit eligibility rules, and income tax rates still apply when you turn 62 and start withdrawing money from your 401k or Conventional IRA.

    With the election results now in, it is speculated by many that income tax rates will soon be increased, thus if you are ever going to convert you may want to consider doing so in the 2006 tax year where the tax rates are more or less already cast in stone.

    As to tax law and benefit eligibility changes when you reach retirement age, the curse of 401k and Conventional IRA withdrawls after you retire is that they are considered to be taxable income at that time ... which Roth withdrawls are not ! There is also a considerable amount of speculation that, with the huge financial problems in the social security and medicare system plus the demographics of baby boomers retiring, that 'means testing' of social security and medicare benefits will soon be instituted ... which essentially amounts to every dollar that you have personally saved in a 401k or conventional IRA costing you X amount of cents in the form of reduced gov't benefit checks until all of your savings have been used up. Since Roth money is not considered to be taxable income at the time of withdrawl (it was taxed in the year the money was earned and contributed), the same speculation would indicate that less future benefit eligibility consequences would stem from a Roth IRA than from a 401k or Conventional IRA.

    Because of all of these future uncertainties, my personal opinion is that the only 'tax deferred' retirement fund situation where the benefits outweigh the future risks is an 'employer matched' 401k contribution setup ... which basically amounts to 'free money' from your employer. IMHO non-matched 401k's and Conventional IRA's expose the contributor to unknown future tax and benefit consequences ... with the baby boomer demographics and the US deficit thus need for more tax revenues being extremely well known indicators that those future tax and benefit consequences won't be pleasant. At least with the Roth, your 'income tax' obligations on the contributed money don't carry into the unknown future.

    It might also be worth considering to pay the penalties and simply dissolve your 401k altogether. In this way, you would be free to invest the money in any sort of investment you choose ... and you are also free to use losses on this invested money to offset gains in other investments. If the money is behind the 'wall' of a Roth IRA, losses can't be (freely) used to offset gains on other investments. Obviously this isn't an issue with a self-directed Roth IRA where you will hopefully be managing actively enough to avoid any losses in the first place. However, if you sign up for a 'canned' Roth IRA with a limited number of sector options, losses could be a very real consideration in the near future.
    ~
    Last edited by Melonie; 11-09-2006 at 04:49 PM.

  3. #3
    Sitri
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    Default Re: Should I convert my traditional IRA to Roth?

    Wouldn't dissolving it also subject it to a 10% penalty tax also?

    I don't know your whole financial situation, but given your age I would consider biting the bullet now and paying the taxes to convert it into a Roth IRA. The Roth IRA will accumulate Tax Free.

    It used to be you would have to convert the 401k to a traditional custodial IRA and THEN convert it to a Roth IRA. I believe now you can do it directly from 401K to a Roth. If you go to someone like Schwab they can handle it for you and you can invest it in anything you want to. I trade in my IRA accounts daily and they are linked to my trading accounts so I can see everything all of the time.

    Unfortunately for the amount of gains I have, it doesn't make sense for me to convert to a Roth. I guess I don't understand the "objective" of having losses or offseting them. I think Melonie is saying get into something where you are not limited to a specific family of mutual funds.

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    Banned Melonie's Avatar
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    Default Re: Should I convert my traditional IRA to Roth?

    Certainly incurring losses isn't the intended objective. But certainly there are times when 'shit happens'. When this occurs with a 'standard' investment, it's at least a partial compensation to be able to apply the losses from one investment to cancel out taxes due on gains from a different investment. With a tax-deferred retirement plan, any losses are 100% losses.

    And yes this is particularly the case when you have signed up for a 'canned' IRA which offers a limited selection of various sector funds ... which are also typically weak on 'bearish' alternatives ... and which as mutual funds prevent you from 'bailing out' of or 'buying into' a surprise situation before the market closes for the day. I personally prefer to self-manage a Roth IRA, which allows me to bring into play a large number of ETF's and stocks that can be traded at any given moment during the day.

    You're also correct that dissolving a 401k or Conventional IRA will cost you a 10% penalty. However, when you get down to the nitty gritty, sacrificing 10% now in order to benefit 20% later still seems like a fairly sound approach under the proper circumstances. Many people have been 'sucked into' placing a large percentage of their assets into a non-matched 401k or Conventional IRA in the mistaken belief that the tax-deferred 'paper gains' they see will be theirs to keep when they retire, and as a result they are light on making 'normal' investments. My greatest fear is that the 10% penalty will serve as a bogus means of pursuading people to leave their assets in their 401k or Conventional IRA come 'hell or high water' in terms of market conditions ... only to be rudely surprised when they finally retire at age 62 or whatever and find that the 'income' generated by 401k or Conventional IRA withdrawls also disqualifies them from eligibility for SSI and other gov't assistance (that they have also paid into for 40 odd years).

    Of course, there is no way to know for certain what changes in the Social Security, Medicare, and other social programs will take place over the next 20-30-40 years, but the demographics and deficits clearly point to fiscal problems for these programs that will either require massive tax increases on younger workers, massive across the board benefit cuts toall retirees, or selective benefit cuts to retirees who have accumulated large retirement savings in order to distribute what money is available to others who are in 'greater need' - by allowing those retiree who HAVE saved money to pay their own bills until their own money is depleted, while the gov't cuts checks to those that haven't saved for their retirement. This is a variation of the 'tax the rich' principle, and would certainly have a lot of voter support from future young workers who don't want to see their SSI and medicare taxes raised sky high, as well as from future retirees who have not set aside a large amount of retirement savings themselves yet don't want to see their own Social Security checks cut by the same percentage as another retiree who has 1 million dollars in their 401k or IRA.
    Last edited by Melonie; 11-09-2006 at 08:15 PM.

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    Banned Katrine's Avatar
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    Default Re: Should I convert my traditional IRA to Roth?

    Convert it to a Roth. Taxes are predicted to go up. If you aren't pissing your pants worried that the world will end, and actually would like a comfortable retirement, don't liquidate it and incur the 10% penalty. If you don't need the money now, let it ride.

    Sitri why are you trading in your IRA's on a daily basis? Are you market timing?

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    God/dess Emily's Avatar
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    Default Re: Should I convert my traditional IRA to Roth?

    I don't plan on liquidating it. I am just so not into the idea of paying all that tax. But then, if I knew it was better in the long run, I'd do it.

    I guess that's the thing. Nobody knows what's going to happen to tax rates (and even then, I don't know which tax bracket I'll be in when I'm in my 60s.)

    I just thought of one more thing. Say I retire in a state with no income tax (definitely possible....I grew up in Nevada and could see myself going back, or even rot away in Florida.) I'm in a state that pays income tax now. That would affect things in a big way, correct?

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    Banned Melonie's Avatar
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    Default Re: Should I convert my traditional IRA to Roth?

    I don't plan on liquidating it. I am just so not into the idea of paying all that tax
    well, essentially, you'll wind up paying the penalty regardless of whether you're converting 401k money to 'after tax money' for the purpose of converting to a Roth or for the purpose of investing the proceeds in non-retirement oriented investments.

    And yes, as long as tax rules don't change over the next 20-30-40 years, and if the state you are residing in when you retire hasn't enacted a state income tax you won't have to pay any state income tax when 401k or Conventional IRA money is withdrawn. Of course, when you're talking that type of time frame, there is all sorts of conjecture re what future tax structures might be like, such as a 'flat tax' on income regardless of the amount of income earned (figures like 17% federal flat tax have been bandied about - see ). If this were to happen, people with fat 401k and Conventional IRA balances could wind up paying a higher tax rate when they retire and withdraw their money than they would have paid today.

    Of course there is also conjecture about dropping the income tax altogether in favor of a Value Added Tax (national sales tax) as a means of making US products more competitive versus foreign imports, or reducing income tax rates in conjunction with a VAT but not abandoning income tax altogether. The potential 'negative' consequences of a VAT are discussed at ... however it probably is the only way for the US gov't to significantly increase future tax revenues in the future to cover liabilities to Social Security and Medicare without causing a revolt among younger workers over massive increases in other taxes (and is also essentially the only tax that generates revenue based on the value of offshore manufacturing activities !). But if income taxes were reduced or abandoned altogether in favor of say a 20% VAT or national sales tax, then Roth money would be taxed at exactly the same rate as 401k and Conventional IRA money when it was withdrawn and spent after retirement.

    Like a 30 year mortgage, all tax favored retirement fund structures involve a person today making a long term financial commitment ... which looks good on paper IF assumptions about interest rates, tax deductibility, tax rates, property values rising with time etc. continue into the future along the same lines that they have in the recent past ... but with absolutely no guarantee that this will actually happen. What IS guaranteed is that the US gov't has promised trillions of dollars worth of Social Security and medicare benefits to future retirees, that the US population demographic dictates that the number of future 'younger workers' who will be paying income taxes will decline as well as that the number of SSI and medicare eligible (under today's rules anyhow) retirees will greatly increase, and that as a result the US gov't will need to increase tax revenues or reduce retirement benefit payments or both !
    Last edited by Melonie; 11-10-2006 at 03:46 AM.

  8. #8
    Sitri
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    Default Re: Should I convert my traditional IRA to Roth?

    Quote Originally Posted by Katrine
    Convert it to a Roth. Taxes are predicted to go up. If you aren't pissing your pants worried that the world will end, and actually would like a comfortable retirement, don't liquidate it and incur the 10% penalty. If you don't need the money now, let it ride.

    Sitri why are you trading in your IRA's on a daily basis? Are you market timing?
    Busted....

    but I like my NYX, and AINV. I'm just a naughty naughty dirty little trader.. and I need to be spanked...

    I have mostly long term but there are a few stocks I like to dominate.

  9. #9
    Sitri
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    Default Re: Should I convert my traditional IRA to Roth?

    Quote Originally Posted by Emily
    I don't plan on liquidating it. I am just so not into the idea of paying all that tax. But then, if I knew it was better in the long run, I'd do it.

    I guess that's the thing. Nobody knows what's going to happen to tax rates (and even then, I don't know which tax bracket I'll be in when I'm in my 60s.)

    I just thought of one more thing. Say I retire in a state with no income tax (definitely possible....I grew up in Nevada and could see myself going back, or even rot away in Florida.) I'm in a state that pays income tax now. That would affect things in a big way, correct?
    You get an A+.. You are correct.

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    God/dess doc-catfish's Avatar
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    Default Re: Should I convert my traditional IRA to Roth?

    Quote Originally Posted by Emily
    I guess that's the thing. Nobody knows what's going to happen to tax rates (and even then, I don't know which tax bracket I'll be in when I'm in my 60s.)

    I just thought of one more thing. Say I retire in a state with no income tax (definitely possible....I grew up in Nevada and could see myself going back, or even rot away in Florida.) I'm in a state that pays income tax now. That would affect things in a big way, correct?
    It would get you out of paying state income tax. Of course much like the Feds, states can and probably will change their tax laws in the future too.

    Perhaps the best thing to do is convert some of the money to a Roth, then once your financial picture looks a little bit clearer several years down the road, start steering future IRA contributions to whichever IRA is looking rosier.
    Former SCJ now in rehab.

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    God/dess Emily's Avatar
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    Default Re: Should I convert my traditional IRA to Roth?

    Along the lines of converting some....

    can I just stop putting money in my traditional IRA and open a Roth and make all future deposits in there?

  12. #12
    Sitri
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    Default Re: Should I convert my traditional IRA to Roth?

    Quote Originally Posted by Emily
    Along the lines of converting some....

    can I just stop putting money in my traditional IRA and open a Roth and make all future deposits in there?
    Check with your accountant. But as I recall, you can have mulltiple IRA's and types of IRA's. I have an old IRA and also a separate Custodial IRA which was a rollover from my 401k. You can even contribute over the legal limit to your current IRA but you would have to track the contributions separately.

    Going with a new Roth is a good idea. You can always roll the old one in later.

    The only advice that I would give is to open it up through a discount brokerage account with low fees. Then you can grow it and diversify it.

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    Banned Katrine's Avatar
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    Default Re: Should I convert my traditional IRA to Roth?

    Emily, you can put up to 4k total annually in EITHER your Roth or a Traditional IRA. You can mix it up, but it your 06 contribution cannot be more. Now, you can rollover that T-IRA to Roth (if your annual income is less than ~100k annually, although that might be for couples, check IRS.gov, I'm too lazy) and further contribute. If you want another option for a qualified plan, I'd look into a SEP for yourself possibly.

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    Banned Melonie's Avatar
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    Default Re: Should I convert my traditional IRA to Roth?

    ^^^ the contribution limit is $4000 per year (total spread between ALL types of IRA's) in 2006 and 2007, and will be $5000 per year in 2008 absent congress changing current IRA laws.

    'Rollovers or Conversions' are not bound by the annual contribution limit, but do have some limitations of their own

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