30-something contemplating Roth Conversion Option in 2010

[do9403]

Hello,
I've been reading this board on and off over the last couple of years and enjoy everyone's opinions and insights on different topics...I thought it was about time I chimed in with my own question for the board.


About Me:
I'm 35 years old, married with two preschool-aged kids and live in the Midwest of the USA. I work a steady salaried job that provides health insurance for the family and DW (also 35) works as an independent contractor and receives a relatively lucrative hourly wage as long as she is able to find work - something she has been able to do for nearly 2 years now. Her contracts typically are for 6-8 month engagements. Her current contract is through July/Sept of this year and nothing concrete is setup beyond that (although she does have some leads). No debt other than 150K left on mortgage. No pensions.


At this stage of our lives, DW and I are definitely in wealth accumulation mode but would like to move to lower paying, (potentially part-time) more "fulfilling" jobs in our mid-to-late 40's.


Biggest 2010 Financial Decision (to be made):
Our MAGIs the last few years have not allowed us to convert or contribute to Roth IRA's and we are wondering if we should take advantage of this year's Roth Conversion Option. I realize this has been a popular discussion point throughout these forums lately but thought I'd throw out my numbers and see if I can get some input/insights/things to think about from you all.


My Retirement Accounts (eligible for Roth Conversion):
IRA (deductible) - $65K
IRA (~$10K non-deductible) - $20K
NOTE: $50K already exists in a Roth IRA for me


DW Retirement Accounts (eligible for Roth Conversion):
IRA (deductible) - $104K
SEP IRA (~$4.5K non-deductible) - $72K
NOTE: $11K already exists in a Roth IRA for DW


Available Liquid Assets (primarily cash) - $55K


My Assumptions:
- If we were to convert all eligible retirement accounts to Roth IRAs, I realize our tax bill could be more than the cash we have on hand, but I know we'd be able to save the appropriate amount by the time the bill is due. In other words, we have (or will have) enough cash to pay for any taxes owed on a Roth Conversion.


- While we are in one of the higher tax brackets, it is my belief that tax rates will inevitably be higher in the future so I am not overly opposed to paying the taxes on this money now. It’s hard to predict in which bracket we’ll be in come retirement, but my opinion/view is even if we are in a lower bracket, it may not equate to a lower marginal tax rate.


- I've heard the argument against converting with the premise that in the future, the government could change the rule of Roth IRA’s tax free status and will figure out a way to ding the earnings upon withdrawal. I think this is unlikely and suspect the government will sooner do away with Roths all together (but 'grandfathering' in those that are already in place). I hate to speculate about the future, but would rather not base this decision on this scenario playing out.


My Questions:
We have an upcoming planning session with our CPA to talk about some of these things, but I thought I'd throw this out to see if you could provide any insight into what additional things we should be taking into consideration while trying to determine which, if any, of our eligible retirement accounts to convert to a Roth in 2010.


Due to the pro-rata rule which basically says Roth conversion income is equal to the value of the traditional IRA funds on the day you convert, minus any cost basis you have in nondeductible IRAs, we feel that our options are:
A - Do nothing
B - Convert only my retirement accounts
C - Convert only DW retirement accounts
D - Covert all eligible accounts

Thanks, in advance, for your responses.

 

[do9403]

Does anyone have any additional things for me to think about while I consider a Roth Conversion this year? In hindsight, maybe I should have posted this on one of the other forums...

 

[RunningBum]

At 48, I'm going to wait until I've ER'ed (hopefully this year or next) and convert part each year at the lower tax brackets. My guess is that taxes will go up, but not much if at all for the low earners. If you're looking to cut back in 10-15 years you might be able to convert then.

Certainly it's nice to pay a known tax rate now than risk a higher rate in the future. You didn't mention which tax bracket you'd be in if you converted this year.

One downside is that it sounds like you might eat up your emergency fund with the taxes, but maybe you have other semi-liquid funds available. If you're depending upon your wife getting new work at some point, that might be important if she just can't get a new contract. I probably wouldn't do a full conversion if this was the case.

Welcome to the forum. Bottom line to me is that there isn't a clear cut right or wrong, and it sounds like you've thought this through pretty well.

 

[Sesq]

I converted $80K, w/6K of basis and paid a 31% effective tax rate. Conversions aren't taxable in PA, and I don't expect to be here in retirement, so I was able to use the no state tax as a hedge against me being in a lower fed bracket when I retire. I am adjusted my withholding to pay the taxes, its taken a toll, for sure.

I am not planning on downsizing my career until the end, so I like the certainty of the conversion. Since you have to allocat the basis amongst your traditional IRA's, but not your 401(k)s when you do a conversion, your wife may consider opening a solo 401(k) (she can since self employed), moving some money excluding the basis there, and then converting just the basis. I can't remember the rules for allocating between spouses, so I am not positive how that would work, I think you allocate to your own conversion since the basis is not fungible between the two owners in the joint filing. There is a big thread at Fatwallet.com in their finance section. They have a poster, LH2004 or something who is very informed.

 

[Nords]

Does anyone have any additional things for me to think about while I consider a Roth Conversion this year? In hindsight, maybe I should have posted this on one of the other forums...

I think that the vast majority of the board's posters feel this is a perpetual topic which has been done to death.

This thread hasn't been updated in 18 months but it's still pertinent:
http://www.early-retirement.org/for...vert-my-ira-401-k-to-a-roth-or-not-30664.html

Fairmark.com is also on top of the 2010 Roth conversion issues.

 

[do9403]

One downside is that it sounds like you might eat up your emergency fund with the taxes, but maybe you have other semi-liquid funds available. If you're depending upon your wife getting new work at some point, that might be important if she just can't get a new contract. I probably wouldn't do a full conversion if this was the case.

You are right - our emergency fund will definitely take a big hit with a conversion this year. We'll probably postpone our final decision until we feel comfortable that my wife will be able to find continued work into later this year.

I am not planning on downsizing my career until the end, so I like the certainty of the conversion. Since you have to allocat the basis amongst your traditional IRA's, but not your 401(k)s when you do a conversion, your wife may consider opening a solo 401(k) (she can since self employed), moving some money excluding the basis there, and then converting just the basis. I can't remember the rules for allocating between spouses, so I am not positive how that would work, I think you allocate to your own conversion since the basis is not fungible between the two owners in the joint filing. There is a big thread at Fatwallet.com in their finance section. They have a poster, LH2004 or something who is very informed.

I know my wife was considering opening a solo 401K here soon - I hadn't fully understood the benefits in doing this but you pose an interesting idea of moving some money there thereby reducing the basis across the other IRAs. I'll have to look further into this.

Thanks for your feedback.