To the Editors:

“New Rules for Converting to a Roth IRA” [by William Reichenstein, Douglas Rothermich, and Alicia Waltenberger, January 2010 AAII Journal] was an excellent look at converting to a Roth, especially since it approached the subject from the perspective of using IRA funds to pay the taxes.

I am curious about two other things that might affect the case in which tax rates rise in retirement. First, we are not generally allowed to keep our IRA funds intact, but are required to make mandatory withdrawals every year. The amounts not taken for taxes may be invested and may partially offset taxes paid early (annually). Second, converting a part of an IRA to a Roth would lower the total amount left in the standard IRA, thus reducing the mandatory withdrawal and possibly providing an additional tax savings at the higher rates.

Barry McElmurry

Dr. Reichenstein Responds:

For a more detailed discussion of Roth conversions, including answers to your questions, please read our article in the TIAA-CREF Institute’s September 2009 Trends and Issues publication (www.tiaa-crefinstitute.org/pdf/research/trends_issues/ti_rothconversion0909a.pdf). For your first point, as shown in Figure 1 of this article, if the taxes are paid from the converted funds, the decision to convert is not a time value of money argument. It is purely a comparison of the marginal tax rate in the conversion year versus the marginal tax rate when the funds would otherwise be withdrawn in retirement.

For your second point, please read the “Convert to Top of Low Tax Bracket” section on page 8 of the TIAA-CREF article. The idea is to convert funds to the top of a “low” tax bracket for you. Depending upon your wealth, you might usually be in a 25% federal tax bracket in retirement. In this case, you should convert funds to the top of the 15% tax bracket. In your early retirement years when you may be withdrawing funds from taxable accounts, your taxable income may be unusually low; for example, if you withdraw $20,000 from a bank savings account, this provides $20,000 to live on but it is NOT taxable income. This would be a good time to convert sufficient funds to take you to the top of the 15% tax bracket. You are right that converting funds to a Roth before you begin Social Security and before required minimum distributions begin may lower your tax rate in retirement—especially since those required distributions might raise the taxable portion of your Social Security benefits and raise your Medicare Part B premiums.