Switching to a Roth IRA
A down market can be the best time to rearrange your money. Scott talks to Christine Fahlund about taking advantage of the moment to convert your Traditional IRA to a Roth.
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TEXT OF INTERVIEW
Scott Jagow: Yes, the economy's down. Yeah, the stock market's uneasy. But that doesn't mean you have to sit on your investments and wait things out. In fact, down time can be a good time to make some moves as Jeremy just pointed out in his story.
For example, shifting your money from a traditional IRA to a Roth IRA. Let's bring in Christine Fahlund. She's a certified financial planner for T. Rowe Price.
Christine, why is that a smart move?
Christine Fahlund: Well, right now the market is down, generally speaking, and you're probably looking at a Traditional IRA balance that's lower than when you saw, say, six months ago. So this could be a good time to consider converting some of your assets to a Roth IRA.
Jagow: What is the benefit of doing that?
Fahlund: When you convert from a Traditional IRA to a Roth IRA, you have to pay taxes on the money that you're converting. If you have less money to pay taxes on, you're going to pay less in taxes and that's going to be an opportunity for you that you won't have when the market goes back up.
Jagow: Of course that assumes that you have time for the market to go back up. I'm assuming this isn't for everybody?
Fahlund: Well, it is not necessarily for everybody, but there are a lot of pre-retirees, they say "Let me pay my taxes now. Once I'm retired, I'd like to avoid as many tax payments as I can, because that's not going to be much fun."
Jagow: So you're basically getting the taxes out of the way with the Roth IRA?
Fahlund: Exactly. Now, it's very important, Scott, that you pay the taxes from your taxable account, which might be invested in mutual funds, it might be in money market accounts. You don't want to dip into the IRA itself in order to come up with the tax money. If you do that, there won't be any advantage to you.
Jagow: Is everyone eligable to do this or are there restrictions on who can rollover from Traditional to Roth?
Fahlund: Well, today there are restrictions. In the year 2008 and 2009, there are restrictions that only people who have adjusted gross incomes of $100,000 or less are eligable to convert from a Traditional IRA or a rollover IRA to a Roth IRA.
Jagow: What's the argument for not doing this?
Fahlund: Well, the argument for not doing this is that a lot of people simply don't want to pay the government any taxes before they're due and for some folks, no matter how good the deal might be, they're simply not interested.
Jagow: Now is this conversion an all-or-nothing proposition or can you rollover a portion of your Traditional IRA into a Roth?
Fahlund: No Scott, you can convert as much or as little as you would like in any given year. As long as you're eligable, you certainly don't have to convert it all in one year.
Jagow: What other things do you advise people to do in a down market?
Fahlund: Well, you know you have to look at a down market as the silver lining and in a down market, everything's on sale if you think about it in those terms and we all like sales. What you're doing is you're able to purchase shares of investments at a lower price than you would be if the market were very high right now. So you need to take advantage of that if you are investing for the long term, it's counterintuitive. You say, "Oh, I think I'll wait until the market's back up again," but that's exactly what you don't want to do. You want to be buying now while the market is lower.
Jagow: Christine Fahlund, she's a certified financial planner for T. Rowe Price. Thanks for joining us.
Fahlund: Thank you.
Comments
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From Washington, 05/20/2008
Hi,
Christine Fahlund's advice on Roth IRA is incomplete, which makes it very dangerous. Marketplace must clarify that there are *many* cases where converting to Roth is a horrible idea, or otherwise many people may lose real money following the poor advice.
She said the argument for not doing this is "a lot of people simply don't want to pay the government any taxes before they're due and for some folks, no matter how good the deal might be, they're simply not interested".
This is dangerous. It's all about tax rates. If tax rates don't change in retirementing then converting to Roth now or sticking with traditional IRAs both yeild same result. If tax rates are lower in retirement then you'll lose money converting to Roth.
Following group of people should stick with traditional IRAs :-
* Already have both Roth and traditional IRAs as tax hedges?
* People like myself in combined 40% bracket. Converting to Roth now means paying 40% tax. Converting to Roth means paying 40% tax on the *entire sum*. Sticking with traditional means paying lower "average" taxes in retirement (since we have a progressive tax system). Heck I can withdraw more than six figures in today's money and still pay *far* less than 40% total tax every year.
* People in high-tax States who expect to move to lower tax States in retirement
* People who expect to have much lower income (therefore lower taxes) in retirement
And so on. Marketplace must clarify her response or else some people will make terrible mistakes.
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