I’m afraid that my recent posts (and tweets for that matter) have given the impression that I am, for whatever reason, anti-Roth. Nothing could be further than the truth. I seek to keep an open mind, understand the numbers, and help others to better use the right account at different stages of their lives. Tonight I worked on some year end planning for two people, and I’d like to share these as examples of when the use of a Roth conversion is ideal.
First, a woman now in her early 50′s. She is on disability, with non-taxed workers’ comp payments providing much of her income. When the Roth IRA was first available she had an IRA, all pretax, as well as enough post tax money to last her more than ten years. In 2009, her personal exemption is $3,650 and her standard deduction, $5,700. This totals $9,350 which she can have in income before any taxes become due. So a conversion of this amount from her Traditional IRA to the Roth is what I suggest. In fact, we’ve made an annual Roth conversion each year since the Roth started, and her Roth account is now worth over $75,000. Keep in mind, there are those who would have suggested she maintain a mix of accounts even while working, of course no one can foresee a disability for a woman in her 40′s. Fortunately for her, the Roth wasn’t available back then, but it is now and is an important tool in her long term planning.
Next, I counsel a woman in her 80′s. With pension income and RMD (required minimum distribution from her IRA), her taxable income calculates to be in the mid-$20Ks. This puts her in the 15% bracket. Keep in mind, RMDs continue to rise as a percent of your account balance, and in theory, the market rising should increase the value of your IRA year on year. As she gets older, there is a risk that the RMDs will force her into the 25% bracket. To help avoid this, I suggest that she convert just enough money from her traditional IRA to a Roth IRA to “top off” that 15% bracket. In other words, in 2009 we are aiming to end the year with a taxable income of exactly $33,950. Next year, the standard deduction and exemptions remain the same as in 2009, but the bracket shifts up $50 to $34,000 even. Over time, this strategy will help shift quite a bit of money into her Roth at 15%, and avoid the potential 25% bracket. It also helps her beneficiaries, as if they inherit the Roth account, no further taxes will be due. Withdrawals from the traditional IRA are taxed at the beneficiary’s margin rate.
I hope these two examples help provide a balance to my other posts. There are more examples I plan to offer for the best use of the Roth IRA account in future posts.