Converting IRAs

With the depressed stock market dropping values of many IRA accounts, I have noticed several people tempted to want to convert them from traditional IRAs to the newer Roth IRAs. While in theory, this looks like a good move - pay tax on today's lower value, and receive much more years later fully tax free - I'm still not a big fan of this idea.

I understand the temptation to want to capitalize on the down stock market in terms of IRA accounts. However, my initial warnings about converting normal IRAs to Roths still apply today; so I can't say that is a good idea.

To convert an IRA, you have to actually roll the money or stock over from a traditional IRA account into a new Roth IRA account. The taxation will be in the year that the rollover actually happens.

In order to qualify for a conversion, your AGI (not including the IRA income) must be under $100,000. The IRA income will be taxed as ordinary income; but there will be no early withdrawal penalty, as there would be if you didn't roll the funds over. Depending on the size of the rollover, it could push you into a very high tax bracket. It would also increase the AGI figure that is used to limit other tax breaks, such as deductions and exemptions.

You may have heard of the four-year payment option. This was only available for people who converted their IRAs in 1998. They had the option of picking up one-quarter of the amount on their 1998, 1999, 2000 & 2001 1040s. Any conversion after 1998 has to include the full amount in income in the same year.

Now for my biggest concern, the promise of our rulers in DC to leave Roth IRAs as fully tax free if you leave the money in for at least five years and don't start withdrawing it until you are 59.5 years old. From the very beginning of Roth IRAs, I distrusted this promise. People doing conversions must pay real tax dollars out now in exchange for a promise of tax free status several years down the road.

My prediction then, and even more strongly now, is that the promise will be broken for those people who our rulers consider to be among the evil rich. Means Testing, which allows tax breaks only for lower income people, is still very popular and will continue to be the gauge used. Just in the past week, none other than Rush Limbaugh, a person I agree with on most issues, was advocating Means Testing to freeze "wealthier" people out of Medicare and Social Security benefits. When he is on that side of the argument, that leaves very few of us to handle the fight for fairness.

I'm not saying that you shouldn't put new money into Roths, and hope that it will be tax free. I am just very very nervous about having you pay several thousand dollars in taxes on a conversion and then having to pay tax again on the same money when you draw it out. It isn't in the least bit fair; but it is what I fear our rulers will be doing. I may be overly pessimistic and paranoid about this; but I think it is perfectly justified. Future tax breaks are routinely erased by our rulers in DC who have no qualms about breaking their promises.

On a more trivial note, I have heard some people claim that to say "IRA Account" is being redundant, in the same way as it is to say "PIN Number" or "ATM Machine." That is not true. IRA stands for Individual Retirement Arrangement.

KMK
- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 3/09/2002 04:46:00 PM Send this post: