I have a friend who is a petroleum engineer and is about to retire. He called last week looking for some planning advice.
His request of me was “will you crunch the numbers to see if it makes sense for me to convert my traditional IRA to Roth?” Bear in mind this is an engineer, an analytic… A NUMBERS GUY. He just wants another specialist to validate right or wrong if biting the bullet, paying the tax and doing the conversion is in his best interest.
Like the engineer doesn’t everyone want to know if conversion is in their best interest? Under certain circumstances it could be one of the biggest financial decisions of a life time. But does it matter so much with this decision to “crunch the numbers”? That’s a reasonable question, isn’t it?
As a practicing financial planner going on forty years, I’ve “crunched” a lot of numbers – all kinds. College funding, life insurance and disability needs analysis, retirement income planning, estate tax forecasting and avoidance – the list goes on and on. And I will grant you there is a certain immediate warm and fuzzy feeling resulting from the exercise of crunching the numbers. It provides a certain sense of security about what may happen in the future at a given point in time and under a given scenario. The problem and it is a big one is that the suppositions, variables and scenarios you choose to use for data points in your planning likely will change in the future within days months or years of doing the math. And so, at best in “crunching the numbers” you end up with a ball park number and at worst something totally in left field and worthless because the variables you used in your projections simply changed. And they likely will because they’re based on unstable forces like the markets, the government, changing health, family dynamics, society or something right out of the blue like a black swan event. What to do about the dilemma to convert to Roth or not if crunching the numbers is in jeopardy as soon as we walk out of the financial planners’ office…. because the dynamics behind the plan change???
Rather than counting on crunching the numbers and being subject to the everchanging result, I favor a cover the bases process of elimination decision – making peace of mind approach. One that is based more on facts involving your unique financial identity and how you believe about what will likely transpire in your unique future in retirement.
Facts to examine and questions to ask yourself are:
- Where do I believe tax rates will be in the future in different points of need and utilization in my retirement? Will I be in a higher bracket than I am in now when I withdraw from the IRA?
- Will someone inherit my IRA or Roth and how will the status of it being a traditional IRA or Roth IRA impact their life tax wise?
- Am I charitably pre disposed and will I utilize “qualified charitable distributions “in donating to charity during retirement?
- Will I actively trade inside of the Roth and possibly benefit from no capital gains taxation on my trading?
- Am I ok with having the debt (taxes) owed to the government affiliated with owning the traditional IRA?
- Do I have the cash on hand outside of the traditional IRA to pay the taxes on the Roth conversion?
- Do I have confidence in the government’s ability to manage their affairs to avoid increases in my taxes in the future? Do I trust them?
- How do I feel about having the government as a partner sharing in my efforts and the expense of managing and growing my traditional IRA?
- Have I considered the benefits of tax diversification and the ability to draw on either taxable or tax- free assets to manage my tax bracket for income or to sustain a major expense?
- Will RMD’s (required minimum distributions) starting at age seventy – three and the additional income caused by them force unnecessary taxation on me because I have ample income and impose increased tax liability on me from ongoing increasing RMD’s? Can this situation push me into higher brackets over time?
- At the first death of myself or my spouse will the ever-increasing RMD’s and the loss of the marital deduction push the surviving spouse into a higher tax bracket?
- How dependent will I be for income from my traditional IRA to maintain my retirement lifestyle?
- Will RMD’s force me (and my spouse) into a higher Medicare premium tier called IRMMA (income related monthly adjusted amount) when we reach age seventy-three and we have RMD’s forced on us?
- Will the RMD’s at age seventy – three draw my Social Security benefits into my tax base?
- Do I believe that the government may change the law in the future that would prevent me from converting from traditional IRA to Roth?
It’s so important that we make financial decisions based our unique financial identity, plan for our future based on how we expect it likely to be and interpret facts as they appear to apply to us. In so doing we will be able to make a decision on Roth conversion not dependent on the guess work solely involved in crunching the numbers. And live confidently knowing we made a good decision at the time based on a lot more than more than just doing the math. I’ll venture to say a better use of math may be to tally the number of scenarios listed above that apply to your situation and use that as your guide.