written by A.T. "Al" Benelli, CFP, FIC |  

So, I’m driving to the office listening to my favorite all-news radio station when along comes a commercial that says “Converting your traditional IRA to a Roth IRA without paying those nasty taxes is the smartest financial move you can make.”

And I’m saying to myself, “Did I just hear what I thought I heard?”

Not only is the ad misleading and somewhat (in my opinion) deceptive, but a move that could be the dumbest thing a person may ever do in his or her lifetime.

First of all, let me be about as clear as I can on this one. There is no legal way to convert a traditional IRA to a tax-free Roth IRA without paying the taxes on the converted money.

What the commercial may be alluding to is the fact that you may use some of the converted money to pay the taxes so there are no “out of pocket” expenses for the tax, but take my word, the taxes will be paid.

Now if you are going to use money from within the converted IRA to pay the income tax due, any monetary advantage to the conversion process has just been seriously diluted.

First of all, you will be paying income tax on money you will be using to pay income tax. Does that sound “smart” to you? Me neither.

Secondly, the advantage of a Roth comes from the ability for the after-tax monies to grow with no income tax liability on the growth.

If you convert a $100,000 traditional IRA and pay 25 percent in taxes you now have a $75,000 account growing tax free as opposed to a $100,000 account growing tax deferred.

Which one will be the better performer?

Answer: It will depend on the individual, his or her future tax rate, that person’s “window-to-liquidity” and the overall financial picture. To make a general statement that converting to a Roth is the best move you can make is simply downright irresponsible.

Now if you have money “outside” the IRA that you can use to pay the income tax, and if you are reasonably certain that your tax rate in retirement is going to be the same or higher as it is at present, you’ve just made the Roth conversion more financially attractive, but you haven’t made it a bona fide “good decision” just yet.

An analysis of the taxes paid to the U.S. Treasury versus a taxable side-fund used as an alternative to the conversion should be made.

Don’t know how to do that?

There are some available analysis programs out there, but I caution you not to use the ones that are provided by the companies attempting to sell you the Roth.

The conflict of interest should be immediately apparent. They might not outright lie, but they certainly could omit some key information.

Lastly, think of the incentives that exist at the government level.

Many Roth conversions mean much more new tax revenue sooner rather than later. Budget deficits will appear smaller. The current administration gets to take the credit. Later on, when the government “reaps” the harvest of no taxes on Roth withdrawals, will they tight...

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