Q: Are there any tools or resources available to help me weigh the costs and benefits of rolling over my tax-deferred savings into a Roth IRA, where I can take full charge of investment decisions? As a new retiree, I now have the time to learn and actively participate in equity investing/trading, where my gains would be maximized by the Roth IRA advantage of being tax-free. I need to find a way to weigh the costs against the potential value of such a strategy.
A: You really have two issues. The first is the wisdom of converting your tax-deferred savings into a Roth IRA. The second is trading within the Roth.
Let’s deal with conversion question first. I think the single best retirement savings plan is the Roth IRA. The main reason: Since you’ve already paid tax on the money going in, you don’t have to pay taxes on accumulated gains when you withdraw the money during retirement. The Roth also adds to estate planning flexibility since, unlike the traditional IRA, there is no required minimum distribution starting at age 70 ½.
You first need to figure out whether it makes financial sense for you to convert and pay the accumulated tax bill now vs. later. I’m going to lay out some of the cautions and trade-offs to think through.
Here’s a reasonable rule of thumb: The conversion is worth considering if you have additional savings to tap for the tax bill. It doesn’t make sense if you use some of your tax-deferred savings to pay the tax levy.
I would recommend figuring out whether paying taxes upfront is the best use of your savings compared with, say, maintaining a flush emergency savings account, paying off debts, and so on.
Time is another consideration. The tax-free power embedded in Roth-sheltered accounts comes into play the longer the money is in it. But if you plan on tapping the money within five to seven years, it may not be worth paying the tax on conversion.
Other considerations? The odds that you’ll pay higher taxes in the future (which favors conversion now) vs. the likelihood your tax rate will go down (an argument for the status quo).
There are a number of conversion calculators that will help you think through the trade-offs. The program at Analyzenow.com allows for a detailed analysis. The comprehensive online financial planning site ESPlanner.com is good, too. I would also check out the writing of Ed Slott, the irrepressible expert on all things IRA, for additional insight at IRAhelp.com.
You might also want to consult with a fee-only certified financial planner for an analysis, since any decision about conversion should be within the context of overall household finances.
To your second point, I’m wary of actively trading in retirement accounts, traditional IRA or Roth IRA. Not everyone agrees with me, but I would trade in individual stocks and other securities in a taxable account. This way, if it turns out that you’re bet goes wrong, Uncle Sam will share your pain and reduce the financial blow.
With your retirement money I’d focus on creating a margin of financial safety for your retirement years.