APRIL / MAY 2010 | H FINANCIAL MANAGEMENT ARTICLES | ORIGINAL CONTENT BY GARRETT S. HOGE
Liking or hating winter depends on your point of view. For example, if you love skiing, you’ll think this is the greatest winter ever! If you hate the cold, on the other hand, youmay be spending a great deal of time CaliforniaDreamin’.
Winter is a particularly challenging time of year for both accountants and their clients. For accountants, this is the time of year when they have to work longer and harder tomeet Federal and state tax filing deadlines (not toomany accountants are into snow sports). Sometime around February 1st, tax-payers’ thoughts too turn to filing deadlines.Many of these same individuals would dearly like to pay less in taxes over their lifetimes.
One potential tax-saving idea for 2010 is the Roth IRA conversion opportunity.While the Roth IRA conversion depends on personal circumstances and perceptions, the undeniable fact is that a Roth IRA grows tax-free and offers tax-free withdrawals in the future.
What’s changed is the adjusted gross income. Prior to this year, if your adjusted gross income (AIG) exceeded $100,000, you were not allowed to convert. This year, anyone can convert regardless of income. You’ll have to pay income tax currently on whatever amount you convert, of course, but you have the option of deferring the tax into 2011 and 2012. (Note however that if you think your taxesmay go up, youmay be better off paying the tax in 2010.)
There are several ways of looking at the Roth IRA conversion, and like one’s attitude towards winter, there is no right or wrong answer, only perception. Thus, there will bemany investors who will be averse to voluntarily paying the IRS now, when they can continue to defer the tax in their IRAs (paymore tax this year – are you crazy?!).Others will see it as an opportunity to possibly pay less tax over their lifetime. They may believe (as I do) that tax rates will go up in the future. For those with a long time horizon and other assets to draw fromfor a five-, 10-, or 15-year period, the Roth IRA conversionmaymake sense, since those dollars can be left to accumulate tax-free into the future. Another advantage to conversion is that Roth IRAs are not subject to the RequiredMinimumDistribution (RMD) at age 70½as are other IRA assets. Also, for those who think tax rates are going to go up in the future, the Roth IRAmay be advisable. Andmoreover, to obtainmaximumleverage the taxes should be paid fromother after-tax savings or investment sources, not fromthe IRA itself.
Of course, some will see this as a legacy planning tool. For example, for someone who thinks they will not have to draw fromtheir IRA, converting to a Roth IRA will benefit their heirs, who can then allow the Roth IRA to possibly grow tax-free formanymore years. The potential tax-free growth in the second generation can be extraordinary.
As you can see, there are several ways of looking at the conversion issue.One issue not often discussed is the opportunity cost of converting. Another is the consideration of how much to invest in a conversion.With the opportunity cost to converting, whatever you pay in tax ismoney that could have been invested at a certain rate over time. Therefore, you’ll want to determine a break-even point where you are actually ahead after paying the current tax. Thismay take 8–12 years ormore, depending on the previously discussed assumptions.
Also, there’s the issue of what exactly is an optimal amount to convert. Rarely do we think anyone should convert all of their existing IRAs into a Roth IRA.Determining the optimal amount depends entirely on each individual situation. To convert or not to convert, that is the question. I would encourage you to explore and consider the possibilities. Itmay not change your attitude towards winter days, but itmay help to stretch those dollars to support a CaliforniaDreamin’ lifestyle.
Garrett S. Hoge, RFC, CFP®, MS of H Financial Management, is a private wealth manager based in Southpointe serving the ever-changing financial needs of his clients.
Please contact Garrett at H Financial Management, 400 Southpointe Blvd., #420, Canonsburg, PA 15317, Phone: 724-745-9406, Email: garrett@hfinancial.net, or via the Web: www.hfinancialmanagement.com. Securities offered through Triad Advisors, Member FINRA/SIPC. Advisory Services offered through H Financial Management. H Financial Management is not affiliated with Triad Advisors. H Financial Management THURSDAY, JULY 22, 2010 OBSERVER-REPORTER | BUSINESS IN REVIEW