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What’s Roth (Roethlisburger?) Have To Do With It?

OCTOBER / NOVEMBER | H FINANCIAL MANAGEMENT ARTICLES | ORIGINAL CONTENT BY GARRETT S. HOGE

Football season is here, and the Steelers are already 3-1! Who would have guessed that the Steelers could accomplish this feat with a 4th string quarterback? The Steelers are winning with Charlie Batch off the bench and their superstar quarterback absent from the stadium. This is a premier example of a team that has deftly utilized its available resources in the face of adversity to keep racking up the wins. I am rooting for Batch to stay at the helm all of the way to the Superbowl!

You might take a lesson from the Steelers when examining your retirement wealth accumulation strategy. The odds might be stacked against the taxpayer over the next few years because of rampant government spending and a financial bailout that somebody has to pay for. However, there are still some actions that you can take to accumulate wealth over your lifetime and to potentially reduce taxes in the future.

One possible asset protection strategy is to take advantage of new legislation that allows the conversion of IRA assets to a Roth IRA in 2010. Prior to this year, if your adjusted gross income (AIG) exceeded $100,000, you were not allowed to convert an IRA to a Roth. However, this year anyone can convert regardless of income. While the conversion is taxed at the time of conversion as earned income, the undeniable fact is that Roth IRA assets grow tax-free and offer tax-free withdrawals in the future under current tax law.

Two primary considerations to the conversion decision are opportunity cost and conversion amount. Opportunity cost is the calculation of what the conversion tax paid would return had it been invested. You can determine a breakeven point where you are actually ahead after paying the conversion tax (this may take >8 years). As for conversion amount, there is an optimal amount (0-100%) that can be calculated based on theoretical future returns on investments and individual factors. Rarely do we think anyone should convert all of their existing IRAs into a Roth IRA. Here are some tips that might help to minimize conversion taxes and maximize investment leverage:

• You have the option of deferring the conversion tax into the 2011 and 2012 tax years. This can help minimize the tax burden by spreading out the payment over two years.
• It might make sense to elect to pay conversion taxes in 2010 if you expect a drop in taxable income for the year. This will allow you to pay less conversion tax than you would pay in future higher earning years.
• To obtain maximum leverage, the conversion taxes should not be paid from the IRA itself. Rather, utilizing assets from after-tax savings or investment sources are better choices since more money will then exist in the Roth IRA for potential tax-free growth. There will be many investors who will be averse to paying the conversion taxes now when they can continue to defer the tax in their IRAs (pay more tax this year – are you crazy?!). Others will see it as an opportunity to possibly pay less tax over their lifetime since they believe (as do I!) that tax rates will go up in the future. After examining hundreds of cases with analytical software, however, our experience is that sometimes it is compelling to convert and sometimes it is not. It all depends on the individual situation of the investor.

We find that it often makes sense for the following investors to do the conversion:

• Investors in their 20’s and 30’s. It almost always makes sense for younger investors to do the conversion since so much time is available between paying the conversion taxes (a money-out event) and growth of the Roth IRA until retirement.
• Investors nearing retirement with significant after-tax savings. These investors can utilize their after-tax assets in retirement while the Roth IRA continues to grow tax-free. This allows longer tax-free growth of the Roth IRA until the distribution of funds is needed.
• Legacy-minded investors. The Roth IRA is a powerful tool for legacy-minded investors who wish to pass on tax-free assets to their heirs (beneficiaries receive tax-free distributions from inherited Roth IRAs). The potential tax-free growth for the 2nd generation can be extraordinary.

Performing an IRA to Roth IRA conversion and paying the conversion taxes is a difficult decision, but it is clear that monetary advantages can be realized in many situations. You should consult with your tax professional based on your particular circumstances. You and your professional should carefully weigh the options of this investment strategy. I would encourage you to explore and consider the possibilities and, like the Steelers, to use the resources that you have at your disposal to your advantage.

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.