taxable income from the conversion over the next four 

 years. This is not as big a deal as some advertising 

 implies. You lose little by converting one fourth of the 

 planned amount in each of the next four years. Most of 

 the advertising by mutual funds or brokers is (or should 

 be) directed at employees. Self-employed individuals 

 have other possibilities (SEP-IRA and SIMPLE-IRA) 

 that remove much of the attraction of the Roth IRA. 



A contribution to a Roth IRA is income after taxes 

 have been paid while a contribution to a regular 

 (deductible) IRA is before tax income. Both types of 

 IRA accumulate earnings tax-free. Distributions from 

 a Roth IRA are tax-free, while those from a regular 

 IRA are taxable. The key issue appears to be whether 

 the tax rate on contributions will be higher, the same or 

 lower than the tax rate on distributions. If higher, the 

 Roth is an advantage. If lower, it is not. 



Worksheets that do not employ any "smoke-and- 

 mirrors" appear to show that conversion of a regular to 

 a Roth IRA is advantageous, even when the tax rate 

 during retirement is lower. That is, removing funds 

 from a regular IRA, paying the tax on these funds 

 (which are treated as ordinary income) and depositing 

 the funds in a Roth IRA gives greater retirement 

 income than not making the conversion. The money to 

 pay taxes must come from somewhere, but the result 



occurs even after factoring in the lost earnings on that 

 money. 



Why does the conversion "work" even if your tax 

 rates fall after you retire? Because it allows you to 

 shelter more interest and dividend income from taxes. 

 If it is your goal to put a lot of money away for 

 retirement, as an employee you are restricted to $2,000 

 of earned income each year (and usually less if you 

 participate in another retirement plan). A Roth IRA 

 conversion lets you increase this. Example: You 

 withdraw $10,000 from a regular IRA. If you have 

 sufficient other income to put you in the 28% tax 

 bracket, the tax on this distribution is $2,800. Without 

 any other source of money you only have $7,200 to put 

 into a Roth IRA. If in retirement you are subject to a 

 28% percent tax rate it turns out that your after-tax 

 retirement income is the same whether you converted 

 or not. (Worse, the $2,800 is treated as a premature 

 withdrawal and incurs a further 10% excise tax 

 penalty.) But if you have other money to pay the 

 $2,800 tax bill, you are effectively putting that same 

 amount into your IRA (in addition to the $2,000 that 

 you could put into a new Roth IRA). 



Footnotes: IRC. Internal Revenue Code; T.C., 

 Court; Treas. Reg., Treasury Regulations. 



Tax 



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12 



Fruit Notes, Volume 63 (Number 2), Spring, 1998 



