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Roth Conversion Check List

Crossing the Social Security taxable income threshold and its effect on the economics of a Roth IRA conversion

In my previous articles on this site I rendered an opinion that it is not a good financial decision to convert a traditional IRA with a substantial deferred tax liability to a Roth IRA because of the conversion tax. For most, the opportunity cost of paying that tax in a lump sum upon conversion would probably not be recovered during the owner’s life time.

However, my previous articles did not address assumptions about the impact that the required minimum distribution could have on the taxable portion of Social Security benefits. My implied assumption was that at least half of the benefit would be taxable, as it is for most, and an issue only arises if the traditional IRA RMD results in the benefit becoming 85% taxable.

The issue of how much Social Security is taxable has a lot to do with all of the other sources of your retirement income. Generally, if Social Security is your only source of income in retirement, then it is most likely to be tax free. However, by having a taxable required minimum distribution from a traditional IRA, you could surpass the threshold for taxation of benefits, incurring a higher marginal tax as a result. This would degrade the benefits of staying with the traditional IRA instead of converting to a Roth. Most of you will have other sources of income in retirement resulting in taxation of part of you Social Security benefits anyway that makes this issue moot.

For married people filing jointly that threshold is $32,000. If one-half of you Social Security income plus all other income that includes the IRA RMD, plus adding in any tax free income, exceeds $32,000, then one-half of your Social Security benefits will be taxable. Should all of you other sources of taxable and tax free income – pensions, dividends, annuity payments, regular wages and interest on municipal bonds, push your income above $44,000 (married filing jointly) then it might make 85% of your Social Security income taxable. If your retirement income projects income from sources other than Social Security or IRA distributions, then the tax consequences on Social Security are not likely to changed by a Roth conversion. Stay with the traditional IRA instead.

However, the marginal or additional tax incurred when Social Security becomes taxable as a result of the RMD from a traditional IRA, if that is the only other source of taxable income, makes the Roth conversion a better decision. This means you have to accurately project all other sources of income in retirement to make this decision. Obviously, if Social Security and your IRA are the only sources of income, it will be advantageous to convert to a Roth and keep the Social Security completely tax free.

The Roth IRA conversion is more complicated then it seems because you have to thoroughly estimate the sources of all future income and determine whether or not these will have any substantial impact on your normal or historical tax rate in retirement.

Roth IRA Conversion Checklist

Now that 2010 has arrived, all of you with a Traditional IRA have an option to convert it to a Roth IRA and forever have a completely tax free retirement account.

I have written several articles, all available on this site, on whether or not the conversion is a good financial decision, particularly if the traditional IRA had built-up substantial deferred income taxes that won’t be paid back until after your death. I would like to summarize these articles in a check list format so that the decision factors can be presented to you in one source document.

You can only base your decision on tax rates as of today. No one can project what future tax rates will be. Here are the factors to evaluate.

If any of these apply or you are unsure about, then consultation with an expert should be considered.

Tax bracket in year of conversion (2010 tax rate structure):

A conversion bumps me up to a higher tax bracket in 2010?

I will be in that tax bracket when I retire?

I will be in a lower tax bracket than 2010 when I retire I will be I a higher tax bracket that 2010 when I retire I Have considered the impact on state and local income taxes

(For example, will you be moving to or from a state with no income taxes)

Payment of conversion tax:

I have determined the opportunity cost from paying the tax (default rate of 7%) (In other words, I would be better off keeping the money invested instead of paying the conversion tax)

I will recover this cost during my life time

I have determined the required rate of return to break-even and believe I can earn that rate on my investments every year in the future

Disposition of your IRA:

I expect to spend down my IRA during my life time

My spouse as beneficiary when required to take minimum distributions will be in a tax bracket that is: Higher than ours is in 2010

Lower than ours is in 2010

My non-spouse as beneficiary when required to take minimum distributions will be in a tax bracket that is:

Higher than mine is in 2010

Lower than mine is in 2010

Taxation of Social Security benefits (today’s rules):

Traditional IRA required minimum distribution result in my or my spouse’s social security benefits:

Will be taxed for the first time

Will raise taxation of our benefits from 50% to 85%

Factors having no consequences on conversion decision:

My age

I will spend my entire IRA during my life time

Conversion in 2010 will not change my 2010 tax rate

I plan on staying in the same state when I retire

RMD will have no impact on taxation of my or my spouse’s Social Security benefits

My tax bracket when taking required minimum distributions will be the same as in 2010

My beneficiaries – both spousal and non spousal – will be in my 2010 tax bracket when they take required minimum distributions in the future


I will never take any money out of my Roth IRA during my life time, then I should go for it!

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