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This is a guest post from Steve Juetten, a fee-only certified financial planner in Bellevue, Washington, and long-time Get Rich Slowly reader. He has written a book for consumers on the topic of 2010 Roth IRA conversions. You can find out more about Steve, the book, and his services at finpath.com.
Traditional and on-line media have been filled with 2010 Roth IRA conversion stories since the start of the new year, and if you’re wondering how this might help you and you’re confused, you’re not alone. It’s a complicated subject because to really know if a Roth IRA conversion is a good idea for you, you need to:
- Understand some confusing tax ideas, and
- Be able to foresee your future with a high degree of confidence.
It’s the second point — predicting your future — that makes knowing if a Roth IRA conversion is right for you so frustrating. Let me see if I can present the tax issues clearly so you can decide if you’re a good candidate for a conversion; we’ll leave the prediction section to the end.
Why bother?
On 01 January 2010, the law changed to allow anyone to convert their taxable IRA into a tax-free Roth IRA regardless of their income. Previously, if your joint income was more than $100,000, you couldn’t do a conversion. So why would someone want to convert a traditional IRA to a Roth IRA? There are four main reasons. If your situation fits into one of these, you’re a good candidate to consider a move like this.
- Economics: You want to pay taxes on the value of your IRA right now when it’s smaller than it will be in the future when you take it out.
- Thinking of your heirs: You may want to leave a tax-free asset to your heirs by paying the tax now.
- Retirement income control: Money in a Roth IRA does not have to be withdrawn during your lifetime to meet the IRS required minimum distribution (RMD) rules.
- Tax diversification: You might like the idea of having some of your assets in a tax-free account and some in taxable accounts because future tax policy is always un-certain. You like the idea of “hedging” your tax liability.
These are the four main reasons most people list as their motivation for considering a Roth IRA conversion. There are many other reasons you might want to convert to a tax-free Roth IRA this year, such as currently living in a state with low income tax rates, but planning to retire to a high income tax state (i.e. California); having hefty charitable contributions you’re carrying forward or want to take now; or some other unique tax situation. If you think you have a special tax situation that might be helped by a Roth IRA conversion this year, please see your tax advisor.
The tax game
The first thing to understand about a Roth IRA conversion is that you’ll owe taxes on any money you convert. These taxes should probably be paid using money from outside the IRA. Unless you’re older than age 59-1/2, any money withheld from your IRA account to pay taxes is considered an early withdrawal by the IRS and the dreaded 10% penalty applies. Same rule applies to holding the money in the Roth IRA account for at least five years. This means that not only will you have to pay income taxes on the amount you withdraw or use before five years, but you’ll have to pay a 10% penalty on that amount. Not a good idea.
If you add to your income as a result of a conversion, it may have serious side effects:
- First, the additional income may push you into a higher tax bracket.
- Second, the conversion may disqualify you from certain tax benefits, such as the child tax credit and the higher education tax credit.
To determine if you might be affected this way, add the value of your IRA (or a portion of it; you don’t have to convert it all) to your other income and see if it moves you to a higher tax bracket.
You can choose to delay paying the income tax due on a 2010 Roth IRA conversion and split the income into two years. You would pay the conversion tax when you file your 2011 and 2012 taxes. Keep in mind that tax rates are scheduled to increase for the 2011 tax year.
Finally, if your IRA was created with only tax-deductible contributions (for example, from a 401(k) rollover), the tax liability is straightforward. Any money you convert is taxable. But if your IRA has both taxable and non-taxable contributions, a portion of anything that is converted is taxable, and another portion is tax-free; however, you don’t get to choose which part to convert. The full value of all of your IRA accounts has to be counted for this purpose. This complexity is called the IRS pro rata rule, and you’ll need to talk to a good tax person to understand what it means to you.
Predicting the future
Now we get down to the really frustrating part of the Roth IRA conversion question: predicting your financial future. Here’s the bottom line from an economic standpoint:
A Roth IRA conversion only makes economic sense if you’re going to be in the same or a higher tax bracket when you take the money out of it.
You may be saying, “Wait a minute. When I retire, shouldn’t I be in a lower tax bracket? After all, I’m not planning on working so darn much, and instead, living off what I’ve set aside.”
And you may be right. If the tax structure stays the way it is now, you probably will be in a lower tax bracket when you retire. But that’s a big “if”, which is what makes many tax and financial planning professionals nervous. The U.S. tax system is always changing, so it’s hard to know what your tax bracket will be in 10, 20 or 30 years. Even if your tax bracket is the same now as it will be during your retirement, it’s a very close call to decide if it makes better sense to convert a taxable IRA to a tax-free Roth IRA in 2010.
Summary
You’ll need to look at your own situation to know whether it makes sense to convert. Think about the reasons you might want to convert to a Roth IRA. Consider the tax implications, and make a reasonable guess about your future tax rates. If you need help, consult with a qualified tax advisor.
If your research clearly shows converting to a Roth IRA is a good choice for you, go for it. The benefits may outweigh the risks.
This article is about Investing, News, Retirement, Taxes Tuesday, 30th March 2010 (by J.D. Roth)
The big if about taxes, I don’t see as being big. No politician wants raise the income taxes, it is too obvious. All the plans I see floating like the VAT would mean consumption will be taxed, so you pay income tax now and pay the VAT later. So tax avoidance, I think, is the lesser of the reasons to convert. Inheritance tax is another issue. But the government is spending way more than it takes in and will for the foreseeable future, any tax rules that are in place now, I think have a very good chance of changing (just like brackets). For all these reasons and more, I am leaning towards holding on to my money and seeing what happens.
Even if you retire in the same bracket, there is an argument for having both Roth and Traditional IRA assets, because the tax system is graduated. You can use traditional assets for the retirement income that is taxed at less than your marginal rate, and either traditional or Roth assets for the highest income.
I allude to this here: http://allfinancialmatters.com/2008/02/26/roth-401k-vs-the-traditional-401k-one-readers-thoughts/
This argument could be valid even if you retire in a higher bracket. Only your highest income would clearly be better to be from Roth assets.
Personally my instinct is that most people would do well to have between 1/3 and 2/3 of their sheltered assets as Roth and the rest as traditional, but I haven’t done any numbers on that.
This decision is even more difficult when you’re in an income range that is subject to the Alternative Minimum Tax and have entered the region for the phaseout of itemized deductions. We’re blessed to have these problems, surely, but it makes the decision quite complex.
I would greatly appreciate any advice or futher resources to assist me with this decision.
I moved mine last month. It was painless. I’m not looking forward to paying taxes on the transfer, but at least I can spread it over two years.
“Economics: You want to pay taxes on the value of your IRA right now when it’s smaller than it will be in the future when you take it out.”
That’s not true if tax policy stays the same. If you put x dollars into your roth ira and pay taxes tc, the value of your roth ira after n years is something like x*(1+i)^n which is the same as an in deductable ira where the value after n years is (x+tc)*(1+i)^n*(1-tf). So the argument between traditional and roth is solely based on your expectation of your future tax rate (tf), relative to tc.
Good Summary. A lot of people are converting to a Roth without doing the math or seeing if it makes sense. It really comes down to analyzing the factors mentioned in the article and then determining if converting makes sense or not. For example, for someone who wants to pass on their estate, this could be a “no brainer” For others, it may not be an easy decision.
The question as to convert or not, is ultimately a personal decision that should only come afer considering all the facts.
Well laid out article.
Thanks for taking some of the mystery out of the Roth Conversion issue. I found the summary statement especially useful …
“A Roth IRA conversion only makes economic sense if you’re going to be in the same or a higher tax bracket when you take the money out of it.”
Although taxes will surely change in the future, I believe if I were going to retire today and begin pulling out IRA money, the following tax rates would be true for a couple filing a joint return (Standard Deduction = 11,400; Exemption = 3,650/person):
First $18700 — 0 Tax
Next $16750 ($35450 total) — $1675 Tax: effective rate = 4.7%
Next $51250 (86700 total) — $9362 Tax: effective rate = 10.8%
Only after this will I begin to pay a 25% marginal tax rate.
So I’ve never been able to justify paying 25% tax now for a Roth conversion when I’ll probably be able to live comfortably in retirement on $86700 with an effective tax rate of only 10.8%.
I am definitely going to have a higher income later. I have heard some rumors about creating a traditional IRA just for the purposes of rolling it over to a Roth, so that you could end up with more money in your Roth than the $5000 limit.
Is that true or am I just making that up?
And if it is true, I’d love to have a little more information on what situations that would be a useful move in (to me it seems like a good idea for anyone who will have a higher income at retirement, but perhaps I am oversimplifying?)
I don’t expect financial blogs or financial consultants to mention this, but this post assumes that the IRS and Federal government honor their Roth contract. As more and more people convert to Roths, the government will have less revenue in the future, yet look at the way it’s spending money now. To assume that they will honor this contract is hardly hedging for the future.
The government in the past has confiscated gold, and made tax payers bail out irresponsible institutions, all against the will of the people, so assuming that Roths will always be tax free is highly pernicious. The more people use Roths, the more risk they carry.
The government wants your money, and it will get it one way or another if citizens continue to allow the government to take without permission of the people.
@uncertain algorithm: I wouldn’t expect anyone giving out responsible financial advice to mention this crap either, because there really is no basis for what you are stating. Making the leap from pointing out the past bailouts to your ridiculous assumption that Roth IRAs will be taxed and the government will take all of your money is way off base and is a poor attempt at sensationalism. This website is about making responsible and informed financial decisions, and what you are saying runs completely counter to that goal. I’m trying not to call you names or pigeonhole you into any group of people, but it sounds like you really don’t belong on a site like this. If what you say here is really what you feel, then you believe the government is never to be trusted, and the social contracts between the government and its citizens should be treated as null and void. Instead of planning within the established system as the rest of us are trying to do, maybe you should be preparing for a future more like what certain hysterical right-wing talk show hosts warn us about. Take a hike and leave the rest of us sane people be, thanks.
Overall, this issue is one that requires a lot of self-reflection on the taxpayer’s part. Even in the most clearly beneficial cases I have seen, it still requires a bit of faith in uncertain future circumstances to make this conversion with any large sum of money. It really only applies in this narrow window of opportunity for people with relatively high income, and of a certain age that they have a sizable sum tucked away in a traditional or rollover IRA already. If you make less than $100k/yr, you always have had the ability to convert to a Roth IRA in years past.
Additionally, I have a hard time recommending a conversion to anyone who does not additional savings on the side from which to pay the tax bill out-of-pocket. If the conversion is a good idea, you should be financially secure enough to take the hit, and you wouldn’t want to reduce the size of the now tax-free investment account right up front, would you? If there is a possibility that you will use the money within five years (i.e. you plan on retiring soon), you should probably consider splitting your IRA and converting only a partial amount.
I have also heard some people get very excited about this possibility and will try to convert absolutely all of their retirement savings, but this may be counter-productive. Remember, these potential benefits will only work out in the long run IF predictions are correct (future taxes increasing in general, enough time for your accounts to grow significantly, etc). Tax diversity should be the goal here, so don’t go too crazy in any one direction. Having a good mix of taxable, tax-deferred, and tax-free investments is a very balanced way to plan for the uncertain future, so I recommend you use this opportunity to achieve tax balance instead of overloading in any one category.
It may be beneficial to note that this is “reversible”, in that you can recharacterize the converted Roth back into a regular IRA before you end up paying the tax bill next year. Since this is already confusing as hell, here’s a case study to illustrate:
If you convert a $200,000 traditional IRA and pay the taxes out-of-pocket like I recommend, you now have a $200,000 tax-free account that you now owe a current (2010) tax bill of $56,000 for, assuming a 28% marginal tax rate. If the account performs poorly in the next 12 months and it’s worth $100,000 by April 2011 (or October if you file an extension), you will have “overpaid” in taxes for this diminished account and will be a sad, sad panda. To mitigate some of your buyer’s remorse, the IRS allows you to reverse your decision before you pay your taxes, making the account a regular IRA once again and removing your $56,000 tax liability for the conversion. Called a “recharacterization”, this is essentially a do-over. You get to keep your $56,000 and maybe some pride, but you still are stuck with an account that fell 50% in value.
Sorry for the long-winded comment, but you should definitely consider this a question that requires a lot of analysis and professional opinion. If you don’t have a financial planner to draw upon, this may be a great opportunity to shop around for one. Good luck!
Thanks for this.
When talking about “income in retirement” to make the tax bracket decision is that just working income or does that include dividends and capital gain income too?
Investment gains are only taxed a flat rate at this point, right? Does that figure into your tax bracket? If it doesn’t, could it 40 years from now with tax changes? I think I am very confused.
I did convert our Traditional IRAs to Roths (for the tax diversification)– some of those we were above the income limit for so we didn’t get any tax advantage on the money when we put it in, are the conversion fees the same?
I do believe the government will honor the Roth contract, but I also believe they will probably need to increase taxes some other way.
@Nicole: Long-term investment gains are indeed taxed at a flat rate, but only in a taxable non-qualified account. In a traditional or rollover IRA, gains are not recognized separately, only deferred income. In other words, you won’t realize any taxable income until you take money out of the accounts. Think of it as a way to generate a paycheck to yourself in the future. When you make a disbursement, it will be treated as current year income, and will be subject to income tax. Dividends and capital gains that accumulate in your IRAs get the same treatment; no tax until you take it out, and then it’s ordinary income.
To address your second question, it sounds like you made non-deductible IRA contributions in the past, meaning that you had already paid your income tax on the money when you added it to your IRAs. If this is the case, you should have been filing an IRS Form 8606 (http://www.irs.gov/pub/irs-pdf/f8606.pdf) every year that made such a contribution, and should therefore have a record of the overall basis in your accounts that has already been subjected to income tax. This only comes into play when money is distributed from the IRA, and Roth conversion counts as such an event. You will need to talk to your tax preparer to make sure this is taken into account, as it will definitely reduce the tax bill you pay in the year (2010) that you convert your IRAs. Cheers, and good luck!
I’m in my mid-twenties and I only have a Roth IRA. My logic is simply that I’d rather pay tax on my earnings now than when I’m retired. Right now I’m used to living frugally, have no dependents and have a strong support network of parents, grandparents, aunts and uncles to fall back on in the event of financial calamity. When I retire, I’ll probably have children and grandchildren to think of and perhaps even support in the event of financial calamity. So I pay the tax now to decrease the number of unknowns and sneaky little hidden costs that I’ll face in retirement.
@niner #10,
You’re being way too hard on uncertain algorithim. Sure, some of his or her terminology choices were a little extreme, but the basic idea that in 30 or 40 years the tax-free benefits of a Roth IRA will be preserved exactly as they are is not quite so clear-cut as you seem to think.
It’s not hard to imagine that, for example, maybe your Social Security benefits will be completely means-tested to a degree that the extra income you draw from your Roth IRA vs. what you would have gotten from your traditional is effectively zero because it only reduces your SS benefit. This type of thinking or planning or hedging for this sort of situation is certainly not the sole provence of right-wing paranoia.
It is actually not at all unlikely from a Congress that recently placed a “Medicare surtax” on capital gains income.
@Even harder: I realize that my tone was a little tough in that reply, and I realize that there is wiggle room for the non-taxable benefit of Roth IRAs to be reduced by the government certainly in the long-term. Likewise, I have serious doubts as to whether anyone under the age of 40 will ever see a dime from Social Security. I am turning 30 this year, and I have never imagined that I will personally ever see anything back from this admittedly failing institution without serious overhauling. What I do take argument against is uncertain algorithm’s tone, evident in this sentence: “The government wants your money, and it will get it one way or another if citizens continue to allow the government to take without permission of the people.” To me, this seemed entirely too antagonistic for anything but trolling, and I thought I would respond in-kind. I would be indeed very surprised and upset if the government explicitly exposed Roth IRA assets to double-taxation as his post suggests. Our lawmakers would probably avoid this situation directly, and would be more amenable to other forms of indirect revenue generation or expense reduction. Your suggestion that income from Roth IRAs may in the future be included in means-testing for other benefits strikes me as both feasible and rational, neither of which I gathered from uncertain algorithm’s comment. Indeed, if I just read his tone incorrectly, then I apologize for the trolling accusations. Thanks for keeping me honest! =)
Since we make less than $80,000 a year jointly and the standard deductions take us into the 15% tax bracket, so we love our Roth IRA. Even if taxes aren’t pushed higher by the deficit, I doubt we’ll be in a lower bracket anyway in 25 years.
For anyone trying to make up their minds, good luck. Financial decisions like this can be crazy…
@Niner
Concerning uncertain algorithm’s comments - I am surprised at your strong reaction. Particularly when you don’t bother to address and refute his comments. Instead, you engage in an emotion-laded attack on his person. This is demonstrative of someone who is unable to refute the argument, but is unwilling to honestly analyze the basis of their own belief system.
“There really is no basis for what you are stating.”
Did the US Government confiscate gold from private citizens in the past? Yes
Did the US Government bail out “too big too fail” financial firms at the cost of 100’s of billions of dollars despite vast public opposition? Yes
Did the US Government gather up Japanese-Americans and put them into prison camps during WW2? Yes
Did the US Government repeatedly break many of the treaties it made with Native Americans and kick them off their promised land? Yes
Did the US Government (Supreme Court) rule that it is legal for a government to confiscate land from private individuals and give it to developers? Yes
Did the US Government loan money to large banks for basically 0% interest and allow them to buy US T-Bills at 3%, in effect transfering money from the tax payer to the banks? Yes
The social contract between the US Government and Americans has been broken repeatedly in the past. The US Government does not always do what is best for the average American. Why do you think that 70% of Americans are angry at the Federal Government’s policies (Rasmussen)?
The US Government is not “evil” (as opposed to say, Microsoft…) However it is populated by lots of people who primary aim in life isn’t to promote the welfare of the general American, but to keep their job and hopefully move up the GS scale and/or move to a higher paying job in the private sector. Consequently, they will often make decisions based on that thought process and either ignore or justify 2nd or 3rd order consequences of those decisions.
Now you may believe that the US Government will never change the Roth tax rules, but that doesn’t mean it isn’t a reasonable question to bring up. Because you have no reasoning or facts to back up your assertion - it is a statement of faith. You are saying “I believe the US Government will not try to steal the money I put into a Roth IRA despite the fact that it is constantly trying to steal my money through taxes, fees, fines, etc.”
Just because you are paranoid doesn’t mean they aren’t out to get you.
Now you may be right, but to reject that possibility out of hand is as foolish as the people who rejected any idea that housing prices could ever drop or bennie babies/baseball cards/etc might someday be basically worthless.
The reason that our whole country’s financial system is in the dire straits is because far too few people questioned the comman wisdom of the day. They instead build an massive structure on a base that was fundementally unsound. And unfortunately, that trend continues today - instead of admitting that housing prices were vastly inflated by years of low interest rates, the Government is doing everything in its power to keep them elevated. And it is spending billions and billions of dollars to do this. And it is utterly doomed to failure - all they are doing is delaying the collapse while racking up huge debts for our children and grandchildren to deal with.
Personally, I use an Roth IRA - or at least I did until I exceeded the income cap. And when I drop back down below them, I’m sure I’ll be back to using it again. I’m not too concerned about IRAs being seized, like they were in Argentina a few years ago, but I am willing to admit that as foreign investors gradually stop buying US debt and Congress starts looking around for alternative sources of funding, the trillions invested in retirement accounts would start looking awefully appealing. But they would have to grab them in such a way that they aren’t immediately thrown out in the next election, which would be hard considering how consistantly most older individuals vote. Its far easier for them just to increase inflation and leach away the purchasing power of those dollars. And that is what probably will happen.
The pro rata part is highly annoying. I only want to convert an IRA I opened with non-deductible contributions and instead I’d have to pay taxes on the conversion. Thanks to Even Harder Than That #3 for pointing out the danger about AMT. I had never thought of that. I don’t understand how one becomes subject to AMT so I live in fear of it. I’m going to talk to an accountant about all of this.
One thing I don’t think the poster pointed out is that you can “recharacterize” back to a traditional IRA after converting to Roth if you want.
brooklyn money (#18)
take a look at the “Alternative Minimum Tax” article on Wikipedia. It actually gives a pretty good explanation of it, and the calculation about whether or not you’re subject to it is pretty simple. Actually, lots and lots of people are subject to it (those who make over something like $75,000 per year) but it just so happens that what they owe under the normal system is higher, hence the IRS has no reason for charging an “alternative” minimum. On the other hand, I think you can also make too much money to pay the AMT, because the AMT only has two brackets, I think, like 26% and 28%, so if, for example, 90% of your money is in the 35% bracket, then the IRS gets more from you under the regular system. It’s nuts.
But, yeah, trying to calculate this and guess the future is still maddening.
BTW, JD, an article on fully explaining the Alternative Minimum Tax might be a welcome addition to GRS.
@ Fredo, taxes, fees and fines are not theft. Do you want government services? Do you want a government?? If not, go away. If so, government must be paid for and the people who must pay for it - via taxes and fees - are the people who are governed.
Fines are not the government’s way of collecting unearned income from law-abiding citizens. People who break laws and in doing so damage public safety or infrastructure are fined to cover repair of the damage they’ve done, the cost of law enforcement, and/or to compensate the injured.
All you have to do is look at the countries without effective government to see what happens when a public financial structure doesn’t exist. No roads, no public safety, no sanitation, no power/water infrastructure … need I go on?
@brooklyn money
Depending on your circumstances, there is potentially a fix for the pro rata distribution rule. There was a law change in 2001 that allows IRA-to-qualified plan rollovers.
The fix involves rolling deductible IRA amounts into the qualified plan leaving only nondeductible amounts left in the IRA for the ROTH conversion.
Not all plans allow IRA rollovers, but if the fact pattern applies, you will be able to convert nondeductible IRA contributions to a ROTH tax free.
There has been a lot of confusion about this. Good article attempting to clear it up.
I really liked your website Steve. Looking around at other financial planners, they lack the simplicity your has.
Making the leap from pointing out the past bailouts to your ridiculous assumption that Roth IRAs will be taxed and the government will take all of your money is way off base and is a poor attempt at sensationalism.
I provided two examples where the government has not honored its contract due to financial problems, and if you think our society is done with those, you are quite the optimist (which is okay). I am historically warning people that the government has not honored its past contracts (please show me where the U.S. constitution states that the government can confiscate gold, or bail out feckless corporations).
Ironically, Fredo has provided many more examples (some of which I wasn’t even aware of). I hope that you don’t think a Roth-IRA is a guaranteed tax-sheltered retirement account because in the future, they may need access to that.
Otherwise, I do actually hope that you are right. But I think that financial advisors and bloggers would be wise to call attention to this. By providing people some information on what’s happened in the past, it allows for more informed decisions, and less surprises down the road.
I’m trying not to call you names or pigeonhole you into any group of people, but it sounds like you really don’t belong on a site like this. If what you say here is really what you feel, then you believe the government is never to be trusted, and the social contracts between the government and its citizens should be treated as null and void. Instead of planning within the established system as the rest of us are trying to do, maybe you should be preparing for a future more like what certain hysterical right-wing talk show hosts warn us about. Take a hike and leave the rest of us sane people be, thanks.
You have the right to think that, and J.D. has the right to keep me from this site. However, pointing out that the government has not always honored its contract is not against the rules (that I know of), and letting people know that things could change is a wise idea. I’d rather be proactive than reactive, and letting people know some history prepares people. I tend to think that prepared people will do better in the long run than people who are unaware of major historical events.
I also hope that people who are managing their finances, like you and I, will learn to vote with our concern about where our society has been going over the past few decades (these problems are nothing new). If we stay out of debt and wisely manage our budget, shouldn’t we expect our country’s leaders to do the same? By the way, I am not defending nor supporting either party, as they’ve both contributed to the problem. But I do find it odd that people who are concerned about finance lack some concern about the way the government manages money. Poor federal management will hurt us all even if we do things right.
Otherwise, I agree with you that people should hope that our government will honor its contracts, but also recognize that it may not, and has not in the past.
Good post, by the way.
@Fredo: Goody, a challenge! In the name of honest and spirited debate, I accept and offer the following refutations, as requested. Here we go…
“Did the US Government confiscate gold from private citizens in the past? Yes”
Amazingly over-simplistic and damning in narrative, but you unfortunately made the mistake of leaving out a critical fact. Executive Order 6102 did not “confiscate” any gold, rather it compelled all citizens to exchange the majority of their gold (with certain exclusions) for a fixed exchange price. Although drastic and by some measures unprecedented, this was intended to fix a recurring problem in the early 1930s caused by dollar speculation and subsequent panics, all enabled by the Gold Standard. We ended up ditching said standard after all, and this was a huge catalyst in doing so. This is a great deal more complicated than I can give credit to, but I highly recommend a little self-education on this important subject.
“Did the US Government bail out “too big too fail” financial firms at the cost of 100’s of billions of dollars despite vast public opposition? Yes”
One can argue that the government has a well-established precedent and indeed a responsibility to act as lender of last resort to avoid catastrophic situations. Whether or not our country would have been worse off had companies like AIG, Citibank, Bank of America, GM, Chrysler, Goldman Sachs, JP Morgan, Wells Fargo, Morgan Stanley, etc. either failed or undergone significant and sudden downsize restructuring is up for debate, and we may never know what we avoided. What we DO know is that the majority of these bailout funds have been paid back (with interest), and the stock market has recovered back to non-panicked levels due to increased confidence in the US markets as the preferred method of capital investment ever known to humanity. In an ideal world, I too would like to see those responsible for this crisis to be appropriately punished, but to hope that millions more hardworking Americans lose their jobs just to satisfy a general desire for vague justice seems extreme to me. What happened is not ideal, but I think it is more preferred among the spectrum of possible outcomes.
“Did the US Government gather up Japanese-Americans and put them into prison camps during WW2? Yes”
As an American of Japanese descent, I agree that this happened. You neglected to mention that many of these US citizens and their families also had their assets and land seized and were never properly compensated. This is reprehensible, and should serve as a reminder of the heavy burden that our government has in exercising its considerable power. I have often wondered if there would have been more widespread popular violence or vigilantism expressed against Japanese Americans had the government not intervened, and I can’t quantify exactly what level would make it “right” for the government to isolate them so. Perhaps some things are not meant for us to pass hasty moral judgement on, but rather leave as open books for future generations to learn from.
“Did the US Government repeatedly break many of the treaties it made with Native Americans and kick them off their promised land? Yes”
Other than to point out your use of another generalized statement, I have no argument that this also happened. Please see above.
“Did the US Government (Supreme Court) rule that it is legal for a government to confiscate land from private individuals and give it to developers? Yes”
Ah, eminent domain, one of the favorite citings of big government opponents as well one of the most easily refuted. The fact that you mention the Supreme Court does half the work for me. You see, this necessarily admits that when this issue has presented in the past, it is exposed to our thorough constitutional system of checks and balances. I won’t do much here except to point out the relevant excerpt from the 5th Amendment to the Constitution of these United States, which states “…nor shall private property be taken for public use, without just compensation.” Just compensation is usually taken to mean a minimum of market value of the property in question. Again, a bit different than the big bad government stealing from its citizens with impunity.
“Did the US Government loan money to large banks for basically 0% interest and allow them to buy US T-Bills at 3%, in effect transfering money from the tax payer to the banks? Yes” (sic)
This ties into my above reponse regarding bailouts. Again, this is far from ideal, but our banking system at the time was under incredible strain and decisions were willingly made to err on the side of overcaution than possible collapse. One of many reasons I support financial reform which includes increased regulation of our banking system as well as guidelines to reduce the catastrophic impact that any one company can have on our economy as a whole when lead into failure. I believe that what we have lived through in 2008-09 was due to ineffective policing of our capital markets and banking system as well as a limited arsenal of tools available to our government to fix the problem once it started showing. What was done seems to me to be acceptable as a band-aid fix, but there is no doubt we need more in the way of prophylaxis moving forward.
“The social contract between the US Government and Americans has been broken repeatedly in the past. The US Government does not always do what is best for the average American. Why do you think that 70% of Americans are angry at the Federal Government’s policies (Rasmussen)?”
If you ask me this question, I will argue that if you expose everyone to the same factual information, we would have much more enlightening and productive discourse. Instead, we as Americans have time and time again expressed our displeasure with the important task of self-information, and overwhelmingly demand an outsourced version of the “truth” which is willingly and happily supplied in pre-packaged, opinionated, and obfuscatory fashion by corporations driven by profit motive. Such news outlets have a great deal of influence on popular opinion, and therefore I don’t trust “70% of Americans” to know their asses from their faces these days, regardless of what a private and opinionated company says in their polls.
Whew, that was cathartic. I hope this falls more in line with you standard of “honestly analyzing the basis of my own belief system”, but in case you missed it earlier today, I did offer an apology for my tone in replying to uncertain algorithm before you posted in reply. I now offer you my own challenge: Before you try calling others out for not properly refuting arguments, you should try to avoid overgeneralizations in your own arguments. Regardless of what you believe, it can make one sounds just like the talking heads that lead our country down a path of illogical and self-defeating rhetoric. Better that you take the time to thoroughly bore everyone around you, I suppose. (I truly didn’t intend for this to be so involved, and it seems as though my late lunch break turned into something of a manifesto. Apologies all ’round!)
@uncertain algorithm: Indeed, I increasingly feel as though I misjudged your earlier tone, and quite hastily at that. My earlier apology stands, and I also appreciate your acceptance of my unbridled optimism. I’m still young, and sometimes optimism feels like the only thing I have that I can count on! I hope that I don’t give the impression that I will stand up for my government no matter the circumstance. I tend to believe that Americans will only get a government as effective as they deserve and desire. With increasing public access to technology and therefore information, we as citizens have an opportunity (and an obligation) to exercise more direct oversight of those we elect to govern. I can’t help but feel that we are somehow collectively letting this unprecedented ability remain not fully realized. On a grand scale, people are still allowing themselves to be spoon-fed sound bites and talking points because it’s easier than really understanding an issue in depth. It’s impossible to be an expert in all the varied nuances of government, but I think we’ll be better off if we at least tried a little now and then. After all, if our national dialogue gets constantly stuck behind rhetorical smokescreens, what provides the impetus for us to transform this nation into something that serves ALL of its citizens with more transparency and effectiveness? If the most visible expression of citizen oversight consists of toothless rednecks screaming racial slurs while waving misspelled posters on the Capitol steps during the 6 o’clock news, can you blame the vast majority of well-intentioned voters for their distaste for politics in general? Anyways, thanks for taking the time to listen. Cheers!
@Niner, you may be young but you are certainly eloquent.
Funny how a post on an inoffensive topic like IRAs became such a debate on government. And here’s to J.D. for not closing the comments! You are a tolerant man.
I think the key piece of the post is “predicting the future”.
Tough task.
I’d go with your gut and don’t agonize over your decision
@niner
You don’t believe the government will honor social security, but you believe they will honor tax policy?
Crazy.
Thanks to everyone who read the guest post that J.D. allowed me to offer to his readers. Here are a couple of my observations about some of the comments:
Comment #8 from Quinsy asks about a tactic that is called a “back-door” Roth IRA and it is available under current rules for someone who is not eligible to make a Roth contribution after converting an IRA or qualified plan rollover. Here’s how it works: you make a non-deductible IRA contribution, wait 30 days, and then convert the account to a Roth IRA. Do the same thing next year, and the next year and the next year. All the other rules apply — must have earned income, leave the money in the Roth until age 59 1/2 and five years, etc. Send me an email at steve@finpath.com if you have additional questions on this approach.
Comment #19 from Brooklyn Money is right that the IRS allows the account holder to recharacterize a Roth IRA back to a traditional IRA and avoid paying taxes on a Roth IRA that has lost value. Must be done before 12/31 of the year the conversion took place. An account holder may be able to do the same with a direct rollover from a qualified plan, but the plan record keeper may not allow it. I did not cover this aspect or some of the other intricacies of a Roth IRA conversion because J.D. suggested the title be “Roth IRA Conversions Made Easy” and at some point even my eyes roll back into my head with some of this.
I’m avoiding the political issues that are raised because my momma told me to avoid religion and politics whenever possible
Thanks.
Steve Juetten, CFP®
@Niner
“Amazingly over-simplistic and damning in narrative, but you unfortunately made the mistake of leaving out a critical fact. Executive Order 6102 did not “confiscate” any gold, rather it compelled all citizens to exchange the majority of their gold (with certain exclusions) for a fixed exchange price.”
Executive Order 6102 required U.S. citizens to deliver on or before May 1, 1933 all but a small amount gold coin, gold bullion, and gold certificates owned by them to the Federal Reserve, in exchange for $20.67 per troy ounce. Under the Trading With the Enemy Act of October 6, 1917, as amended on March 9, 1933, violation of the order was punishable by fine up to $10,000 ($166,640 if adjusted for inflation as of 2008) or up to ten years in prison, or both.
The price of gold from the treasury for international transactions was thereafter raised to $35 an ounce.
- Wikipedia.
So the government forces people to sell their gold, then immediately devalues the dollars it paid for that gold by 70%. And you consider that substantially different from confiscation? Interesting… I suppose then you would be fine if the government forced you to sell your house for $100,000, but then immediately sold it for $170,000 - particularly if it was to stop all of the real estate speculation that was ongoing.
“Although drastic and by some measures unprecedented, this was intended to fix a recurring problem in the early 1930s caused by dollar speculation and subsequent panics, all enabled by the Gold Standard.”
Please show how having a defined solid value for the dollar allows speculation.
“We ended up ditching said standard after all, and this was a huge catalyst in doing so.”
We ended up ditching the said standard because the US government was printing money and instead of accepting dollars, other countries were demanding redemption in gold. Thus the gold reserves were flowing overseas as a consequence of the deliberate devaluation of the dollar by the US Government and the Federal Reserve. The removal of the gold standard allows the Federal Reserve to print money without limit - as demonstrated by the doubling of the US monetary supply over the last few years.
“This is a great deal more complicated than I can give credit to, but I highly recommend a little self-education on this important subject.”
I have. Which is why I have come to the conclusion that the confiscation of the gold was to the determent of the average American and only for the benefit of the US Government.
@Niner
“One can argue that the government has a well-established precedent and indeed a responsibility to act as lender of last resort to avoid catastrophic situations.”
Certainly - so why are they only loaning on multi-billion dollar companies? What about the thousands of small businesses that are collapsing due to their inability to get loans? If the government will intervene to avoid catastrophic situations, why is it only doing so to save the rich?
“Whether or not our country would have been worse off had companies like AIG, Citibank, Bank of America, GM, Chrysler, Goldman Sachs, JP Morgan, Wells Fargo, Morgan Stanley, etc. either failed or undergone significant and sudden downsize restructuring is up for debate, and we may never know what we avoided.”
We also don’t know what we could have achieved if those failures had been allowed. Capitalism requires failure - it exposes inefficiency, stupidity, and greed. But the government stopped that - instead it propped up companies that were incredibly poorly managed and sucked away capital from businesses that could have allocated it more efficiently. It rewarded the stupidity of those who endangered the entire US economy and protected them. I could barely accept that if the leadership of all those financial firms had been prosecuted, but none of that has happened. Again - the US Government has placed the interests of a few about the interests of the general population.
“What we DO know is that the majority of these bailout funds have been paid back (with interest), and the stock market has recovered back to non-panicked levels due to increased confidence in the US markets as the preferred method of capital investment ever known to humanity.”
If you actually track capital inflows/outflows - most of the money that average Americans pulled out of the stock market is still out of it - thus the 100’s of billions of dollars that have flowed into bond funds. Personally, I have been transferring all of my investment out of US markets due to repeated demonstration how much they are manipulated by the likes of Goldman Sacks.
“In an ideal world, I too would like to see those responsible for this crisis to be appropriately punished, but to hope that millions more hardworking Americans lose their jobs just to satisfy a general desire for vague justice seems extreme to me. What happened is not ideal, but I think it is more preferred among the spectrum of possible outcomes.”
And so capitalism dies a slow death. Guess what - choices have consequences. The Big 3 automobile makers have been making stupid choices for years: they have a reputation for making poor quality products that are too expensive due to the demands of the UAW. And the market has responded by buying fewer from them and more from Toyota and Honda. Do you really think bailing them out is going to change the general culture that caused the problems in the first place? Especially when President Obama ignores the rights of bondholders and gives large undeserved share of the company to the UAW? Again - these interventions didn’t save anything - they just delayed the inevitable. And those 10s of billions that were used to prop up those companies could have instead been invested in small, vibrant, innovative car companies that would have lead the US into the next century.
And the same with the big financial firms - they made stupid gambles and they should have been allowed to collapse.
The GOP is constantly harping how Obama is trying to make the US more socialistic. While I tend to agree with their assertions, I also think we already have a socialistic economy - one where profits are privatized and loses are socialized - a socialism for the Rich.
I think the all of the interventions that have been made, both by Bush and Obama, have been to prop up their supports without regard to the consequences to the Americans who will have to bear the burden of those trillions of dollars of debt. And whatever short-term pain has been avoided is just building the long-term destruction of the US economy - because no one, Republican or Democrat, is willing to make the hard, painful decisions.
@Niner
“As an American of Japanese descent, I agree that this happened. You neglected to mention that many of these US citizens and their families also had their assets and land seized and were never properly compensated.”
You are right and again I plead brevity.
“This is reprehensible, and should serve as a reminder of the heavy burden that our government has in exercising its considerable power.”
It should, but does it? I’m afraid that far too many Americans still view it as an acceptable wartime behavior, as opposed to an appalling similarity to the racial cleansing of the Nazis. While we didn’t kill Japanese Americans, the fact that we distrusted and imprisoned a group of American citizens due to the racial heritage (while ignoring all of those German-Americans) is disgusting.
“I have often wondered if there would have been more widespread popular violence or vigilantism expressed against Japanese Americans had the government not intervened, and I can’t quantify exactly what level would make it “right” for the government to isolate them so.”
I don’t know. Its a hard question. How many backpack nukes set off in major cities by Al Qaeda would it take before the US government started rounding up all Muslims? Or even people who just look like Muslims? Fear is a powerful force.
“Perhaps some things are not meant for us to pass hasty moral judgement on, but rather leave as open books for future generations to learn from.”
Unfortunately, are future generations learning it, let alone learning from it. The Japanese-American experience, just like the Native American experience, is often glossed over or ignored by history textbooks. I love America, but we should not try to hide our failures, but admit them and deal publicly with the consequences of them. Like the housing bubble - how stupid were we to think that housing prices would always go up?
@Fredo #33: I appreciate the time you have taken to write your replies, and I hope to address them all in time. This is turning into quite an enjoyable exercise! I want to start with your most recent comment, since that is likely where we are most similar in understanding, if not necessarily in outlook.
In the weeks and months immediately following 9/11, I was afraid that innocent Muslims, both American citizens and foreigners alike, would be subjected to extreme measures of vigilantism within our borders. I was afraid not only for their own individual well-being, but also for the sake of our national identity and consequently our standing in the world’s eyes.
For example: a local Tennessee TV news channel aired a sensationalistic report on a peaceful yet isolated Tennessee Muslim community dubbed “Islamville” earlier this year. Two days after this report aired, the Al-Farooq Islamic Center in Nashville was targeted by acts of vandalism. Following this shameful act, I was quite proud to see a rapid volunteer outreach by many others in the Nashville community in response.
While single incidents of violence or harassment occurred, I did not see a growing trend as I had dreaded. I hope this had at least some part to do with our shared memory of the fate of those Japanese Americans more than 50 years prior. I agree completely that we are collectively responsible for preserving our history in entirety for the sake of guiding our future actions.
Furthermore, I think we ARE managing to learn from our past. I do remember seeing open discussions about this particular chapter of US history on major media outlets following 9/11, which makes me believe that corporate news can be used for good after all…
To address your issue as to why German Americans were not rounded up, you should be able to concede two major points: German descendants are generally tougher to pick out of a crowd of 1940s Americans than Japanese descendants, and German Americans were both a much larger share of the overall national population, and more assimilated culturally as well. Not being alive at the time, I can only imagine how much easier it would have been to target and isolate the Japanese in comparison.
Ugh, after all that racial ugliness, it should a relative pleasure to discuss monetary policy, heh. I hope I can get to it today.
Thanks pro rata #22. That is news I (might) be able to use.
To the original poster: Even attempting to make this “easy” is an admirable feat!
@Even harder, regarding the ATM, Alternative Minimum Tax, since the Roth conversion is fully taxable income with no deductions, it will not have a negative effect on the ATM calculations.
More to consider:
1. If you are going to receive a pension outside of Social Security. If so, then your future tax rate will be even higher when you are drawing both SS and your pension. For example, my wife and I both draw a “retired” military pension which will be added to our SS pension later. So I’m taking no chances and converting what I can now.
2. When you convert, it will increase your AGI, which may make you ineligible to contribute directly to a Roth that year and you’ll have to do the two-step process that Steve Juetten mentioned in post #30. I had already made my Roth contributions and due to the nature of those contributions, it would be too complex to recharacterize them back to Traditional IRAs. So I’ll need to do a partial conversion this year and do the rest next year. Hopefully the 28% bracket won’t change next year.
3. I consider the possibility of the government taxing Roth withdrawals in the future slim. More likely would be that they might tax gains in the future. i.e. we might need to pay tax on the percentage of the withdrawal that was untaxed gains. Due to the complexity involved, I feel that even that possibility is fairly slim, but not impossible. You make your bets and take your chances.
4. Niner makes a good point in #16 with the means testing issue. But then you could say the same of all investment income. In the future, they could means test investment income in general the same way they test earned income now.
5. @Lucas, your mid-twenties is the perfect time to max out your Roth investments. All those many decades would grow tax-free!!!
6. An argument against conversion is that if you can afford to pay the tax on the conversion, then alternatively, you can invest that money in a taxable investment instead of paying the tax. So in the future, you *might* have higher taxes on the Roth withdrawal, but you *definitely* would have your “side” investment to consider as well.
I am finding it very difficult to decide if I want to convert my meager Traditional NON-deductible IRA into a Roth.
My wife and I have an AGI around $190,000/year and we both contribute 15% to company matched 401(k)’s. I also contribute 2% to a newly instituted Roth 401 (k) through my workplace and 3% to my company’s stock purchase plan . In addition, I contribute to a Traditional non-deductible IRA on my own. I will (hopefully) receive a defined benefit pension upon retirement.
The Traditional IRA is fairly small at the moment, approx. $6000, with very small gains up to this point. If I were to convert the tax burden would be very small.
There is one question I have which I have not found an answer, that is: Can I make contributions to the Roth IRA AFTER conversion from a traditional IRA? Or will the converted amount sit in the Roth and grow (or NOT grow) according to the performance of the funds I select?
I would characterize my thinking at the moment as using all the retirement vehicles at the same time and use the diversification to hedge my bets. That is fund my 401(k), my ROTH 401(k), my traditional non-deductible IRA, and convert what I have in the IRA now to a ROTH IRA.
Make any sense? It can twist one’s mind into a pretzel thinking about all this.
@IllinoisRugger, at an AGI of $190,000, you’re not permitted to directly contribute to any Roth IRA. So first pull back all the money that you’ve already paid into the 401k Roth or you may get hit up for some penalties.
There is a workaround. Contribute up to $5,000/year ($6,000 if 50 or older) to a non-deductible IRA and 30 days later convert it to a Roth. (Make sure you fill out your tax paperwork correctly.)
Once you’ve converted your traditional IRA to a Roth, then the next year you can do the same thing, adding more contributions (indirectly) to the Roth. Hopefully, they’ll remove this silly income limitation for direct contributions.
At your income level, provided you have no consumer debt of course, you should max out your 401k contributions and your Traditional IRA contributions. Once the traditional IRA is converted to a Roth, all growth from that point on is tax-free.
p.s. as soon as your company stock vests, sell it and buy a more diversified mutual fund like an index fund. Can you say “Worldcom” or “Enron”?
@Robert, so I will “contribute” to a Roth IRA by converting a traditional IRA every year. Sounds like a nice work around.
Regarding the Roth 401(k), it is a negotiated benefit within my union’s collective bargaining agreement. I’ve seen nothing in the benefits paperwork discussing income limits for contributing to the Roth 401(k). Where can I find more information regarding your statement?
Regarding my company stock, annually I transfer the qualifying stock to my brokerage account and sell some or all of the stock to invest in mutual funds. Of course, the decision of what stock to sell and when depends on purchase price and gain/loss from the sale. I use the ESPP for the 10% discount.
Whoops, you’re right IR. There is no income limit to a Roth 401k plan. Color me embarrassed!