There's More Than One Way to Profit from an IRA Conversion

Growing investments. Heap of money with seedling.Some similar pictures from my portfolio:
Many Americans have traditional Individual Retirement Accounts, where your annual contributions are reduced from your taxable income, yielding a tax deduction now, but your withdrawals are taxed. And many also have Roth IRAs, where the money you invest is taxed normally in the year you deposit it, but the profits grow tax-deferred and can be withdrawn tax-free after you retire.

The two options raise the obvious question: Would you rather pay tax on the seed money now or the crop of money later? This point has been debated for years, but for this post we are going to assume you would rather pay the known tax now vs. an unknown tax later.

Many people with traditional IRAs also open and fund a Roth IRA. But, if you'd like, you can convert a traditional IRA into a Roth account. Taxes are due on any amount you convert. The benefits of conversion: As great at these benefits are, a conversion may not be for everyone. The longer you have until the money is needed, the better a move conversion can be. Get advice from a professional, input your data into one of the many software programs designed to calculate the costs and benefits, or email me for a free customized analysis.

Partial Conversions Can Be Powerful

Many people don't realize that they can convert just a portion of a traditional IRA. If you combine the partial conversion with certain financial products, your tax burden can be lessened dramatically.

Let's assume you have $400,000 in a traditional IRA and your effective tax rate is 20 percent.
You initiate a partial conversion of $130,841, which would mean you have to pay $26,168 in taxes. This gives you $104,673 for your Roth account and leaves you $269,157 in your traditional IRA.

You could elect to combine the conversion with a rollover into a solid fixed indexed annuity that offered a initial premium bonus. If you roll over your $269,159 traditional IRA into a product that gave you a 7 percent premium bonus and did the same thing with your new Roth account with a balance of $104,673 after taxes, then you would receive a $26,168 bonus that would put your starting balance of your combined IRA accounts back to the original $400,000 before the conversion.

The difference is that now $104,673 is now tax-free and not just tax-deferred. Assuming a modest 5 percent growth rate inside of both accounts, after just 10 years, you would be $43,785 ahead with this strategy than if you just let your traditional IRA stand. In 20 years, you will have over $83,000 more in your combined accounts (even after factoring in the taxes on your traditional IRA) than you would have had without the conversion.

John Jamieson is the best-selling author of "The Perpetual Wealth System." Follow him on Facebook and Twitter.

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The newest law as part of President Obama's 2015 Budget Proposal--still under review by Congress--states, in rough terms: Roth IRA's must now be drawn within 5 years of turning 70.5 years OR, if left to heirs upon becoming deceased, the entire Roth IRA must be drawn down in 5 years versus the "life-span of the beneficiary", as it had been (and currently still is today (9/23/2014). As I understand it, the Spouse-IRA may be excluded from these changes...and, as always, there are exceptions to every rule. (A recent article in the Wall Street Journal addressed these changes a little more clearly than I have above.) The bottomline: government makes the fules, government changes the rules.

September 23 2014 at 9:45 AM Report abuse rate up rate down Reply

What does the law that went into effect in July about retirement accounts have to do with this?
How do you get protected from it?

August 27 2014 at 1:15 PM Report abuse rate up rate down Reply
1 reply to PandEmiller31@ao's comment

What does the new law in July say? Can't find reference to it in article above.

August 27 2014 at 1:40 PM Report abuse rate up rate down Reply

Pay a large tax bill now.

August 27 2014 at 11:46 AM Report abuse rate up rate down Reply

It is a good strategy for those fifty nine-and-a-halfers who do have a great deal sewn up in their retirement 401K.

They should perform estimates (if possible) at least quarterly to update themselves on their AGI.

Then, if they want, they can estimate their taxes by 'adjusting' the AGI amount for deductions, exemptions, capital gains, qualified dividends, etc., which may be taxed at lower rates, and that should give them a truer view of their income tax liability (aka real tax bracket).

Lastly, they need to use the AMT Assistant on the IRS website to check and see if they are okay with the rate.

It probably sounds stupid, but who wants to end up in too high a tax bracket?

Pretty complicated process. ... may pull hair out doing it.

August 27 2014 at 10:14 AM Report abuse rate up rate down Reply

not many people have 400,000 in their retirement accounts early on-it takes awhile to accumulate that much and while you are doing that you are paying 20 percent tax or more. When you retire depending on how much you withdraw you might be paying 5 or 10 percent on what you take out.

August 27 2014 at 9:12 AM Report abuse +1 rate up rate down Reply
1 reply to cpruitt221's comment

Or more.

August 27 2014 at 11:47 AM Report abuse +2 rate up rate down Reply