Roccy's Roth IRA conversion numbers are wrongArticle added by Roccy DeFrancesco on November 19, 2009
Roccy Defrancesco

Roccy DeFrancesco


Joined: May 24, 2006

Two of my most well read articles this year have been the following:

Roth IRA : Do they make sense?
Even Ed Slott is wrong about Roth IRA conversions

Why are Roth IRA conversions such a big deal? As you know, in 2010 anyone and everyone will be able to convert a traditional IRA to a Roth IRA (no $100,000 income limit).

The marketing firms are out in force to give you reasons to work with them because they have software or white papers or whatever that will help you "sell" the concept of conversion to your clients. Why? So you can go gather money under management or pour money into FIAs. The goal is to show clients why they are a "can't lose," so they will work with you.

Once you understand the math, you, too, will wonder why everyone is telling you Roth IRA conversions are an investment nirvana. The fact of the matter is that Roth IRA conversion makes little or no sense for the vast majority of your clients.

It's vitally important that you have the ability to run accurate numbers for your clients so you can give them client-first advice.

What was wrong with my earlier articles?

It's not often that I admit I was wrong. In this case, it's not so much that I was wrong with my numbers and conclusion that Roth IRA conversions make little sense for most people, it's that I figured out how to be even more accurate.

I took into account in excess of 15 variables in order to create a real-world output. Even though that is better than any other calculator out there, I forgot two important variables.

IRA distributions can increase taxes on Social Security (SS) benefits

I completely forgot that when you take taxable distributions from IRAs in retirement, doing so may increase income taxes on SS benefits (ironically, many people don't even know what SS benefits can be income taxed when received). Therefore, I needed to include inputs for expected SS benefits and adjusted gross income (not including SS benefits). These variables will help to more accurately calculate the increased taxes due.

When you remove money from a Roth IRA in retirement, it does not affect the amount of taxes you pay on SS benefits.

Let's look at an example: Assume Mr. Smith is 60 years old with $100,000 in a traditional IRA. Assume he converts his traditional IRA to a Roth at age 60 and has cash outside of the IRA to pay the taxes on conversion. Assume that in retirement, he is going to be in the 10 percent income tax bracket. Assume he will let the money in the converted Roth IRA grow until age 70 and then take money out of the then Roth IRA over a 20-year period. Assume his SS benefits are $10,000 a year and that his other adjusted-grow income (AGI) equals $10,000 a year in retirement.

How much could Mr. Smith remove from his taxable IRA vs. the Roth IRA starting at age 70?

After tax from the traditional IRA = $16,420.52 (every year for 20 years)

Tax free from the Roth IRA = $14,247.17 (every year for 20 years)

How much extra income tax did he pay on his $10,000 SS income because of the taxable distributions from the traditional IRA? $337.92 (a year)

It's not a big deal and is not going to mean that a conversion suddenly makes sense, but I strive to have accurate numbers, and therefore, I had to add this variable to the conversion.

FYI, if Mr. Smith is in the 35 percent income tax bracket in retirement, the taxes on his SS will be a little higher. The taxes, because he took taxable distributions from his IRA, would increase to $559.41.


So, yes, my earlier article and numbers were not as accurate as they could have been. I should have dealt with the increase of income on a person's SS. Even though my initial calculation was the most accurate output in the industry, the new calculations help widen the gap between my "real-world" numbers and others available in the market.

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