The $100,000 question: Convert an IRA to a Roth?

Written by Tom Henderson
Published by Crain's Detroit Business – February 22, 2010

A change in federal law allows those with incomes of more than $100,000 a year to convert their traditional IRAs to Roth IRAs this year. Depending on which financial advisers you talk to, opinions on the change range from "greatest thing since sliced bread" to "gamble of a lifetime."

Most take a more nuanced middle ground: There are investors for whom it makes no sense and others who should do it as soon as possible. Many others need to evaluate a complicated set of pros and cons.

One thing everyone agrees on? Boy, this sure has been hyped.

Anne McIntyre, president of Mt. Clemens-based Community Central Bank's financial services group, said a near-carnival atmosphere has developed in the investment community about the Roth conversions, with billboards and mass mailings touting them and fliers arriving in the mail inviting prospective customers to come to seminars, lunches and dinners to get conversion pitches.

"It's 'Step right up! Everyone has to do a Roth IRA conversion!'" said McIntyre. "I've seen marketing tools that horrify me. Financial advisory firms are prospecting for clients, and it's really getting overblown."

Mike Rubino, president of Troy-based Rubino Financial L.L.C., agrees that the topic may have been overhyped. But he disagrees with McIntyre that there are few who will benefit from a conversion. He thinks federal deficits sooner or later are going to result in higher federal tax rates, and that means paying taxes now, rather than later, makes good sense.

"When I talk to someone, I ask them, 'Do you think taxes are going up, down or staying the same?' And 100 percent say, 'Going up.' I'd bet the house (that) tax brackets are going to increase. They're going to increase for all individuals. And I think they're going to be significant. If that turns out to be true, then almost no one benefits from keeping their traditional IRAs and not doing a conversion.

"I don't know how you suggest it as a gamble. The gamble is waiting to pay taxes later," said Rubino, referring to an article in the Feb. 1 issue of Investment News, written by financial adviser Andrew Rice and titled "Roth Conversions: The Gamble of a Lifetime."

"I think the notion that tax brackets are not going drastically higher is absolutely ludicrous," said Rubino.

One thing that seems certain is the sunsetting of the Bush tax cuts. Unless Congress does otherwise, and not many expect it will, taxes in all brackets will rise 3 percent to 4.6 percent effective Jan. 1, 2011, with the highest tax rate going from 35 percent to its former level of 39.6 percent.

Bernie Kent, managing director of Southfield-based Telemus Wealth Advisors L.L.C., is far more cautious. His clients have high net worth, and he says the people he urges most strongly to consider a conversion are those who expect being in the highest tax bracket for the foreseeable future. Better to pay 35 percent now than 39.6 percent down the road.

"Overall, it's a relatively small number of people who are right for a Roth conversion," he said. He said there are so many variables and hard-to-predict tax consequences in the future that, "I only want to do it for someone I am reasonably sure will be in a high tax bracket and so will their heirs looking out many years."

One possible complication, he said, is what he calls "the double-cross issue." What's to prevent Congress, he said, in the face of future budget woes, from deciding that Roth profits are henceforth taxable?

"They can say, 'You've paid taxes on your conversion, but tough. We've got a big deficit and we're going to tax it again,'" he said.

Or, he said, the government could radically alter its tax policy, reducing income taxes and replacing them with value-added taxes or consumption taxes, in which case you'd wish you'd kept your traditional IRA.

"There are an incredible number of threats to a conversion," he said. "Which is why so many people are saying, 'Why bother paying taxes sooner rather than later?'"

Gary Gilgen, director of financial planning in the Troy office of Rehmann Financial, and Aaron Humphrey, a tax adviser in the office of a Rehmann Group affiliate, Rehmann Robson, echo the distrust of consistent federal tax policy.

"We did a study for our clients and found out that from 1913 to 2010 there have been 36 federal tax increases, from 7 percent to 94 percent," said Gilgen. "Could Congress change its mind and tax Roth IRAs? Yes. Will they? I don't know. What's to stop them if they want to raise taxes from taxing Roths? It is the gamble of a lifetime."

Jonathan Citrin, CEO of Southfield-based CitrinGroup L.L.C., a financial advisory firm, said the main beneficiary of Roth conversions is the federal government, which can collect potentially billions of dollars in taxes in 2011 instead of having to wait for years or decades for traditional IRAs to be cashed out.

"The government needs money now. It doesn't want to wait," he said. "A conversion isn't for everyone. It's very tempting, but you need to look very closely before you leap. There's going to be an immediate downside, so don't do it unless you're sure there's an upside."

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