Roth IRA Conversions: The Deal of the Century?

by: Ira Stoll

Bloomberg News has an article on taxes that runs under the headline "Tax Passage Gives U.S. Wealthy Interest-Free Loans for Roth IRA Transfers." It begins:

The extension of current income-tax rates gives wealthy taxpayers the equivalent of an interest-free loan if they convert a regular Individual Retirement Account to a Roth by Dec. 31.

Investors in traditional IRAs pay taxes up front on conversions to Roth IRAs to get tax-free withdrawals later. Earners in the highest tax brackets who expected rates to rise next year were faced with reporting all the additional income from conversions on their 2010 returns. With the tax legislation, wealthy savers can now defer and use those tax dollars to earn something, according to Christine Fahlund, a senior financial planner at Baltimore-based T. Rowe Price Group Inc.

"It's the deal of the century," said Ed Slott, a certified public accountant in Rockville Centre, New York, and founder of website "It's like Congress is giving you an interest-free loan to build a tax-free savings account."

This year taxpayers can choose to report the taxable income from the conversion in 2010, or split it equally between 2011 and 2012.

This strikes me as a very strange way of looking at it. For one thing, the rules on Roth conversions apply equally to everyone. There's no income or asset test. So Bloomberg's harping on "wealthy taxpayers" and "wealthy savers" is just class-warfare hype. If a non-wealthy taxpayer wants to move the Roth conversion income into 2011 or 2012, he or she can do that, too.

For another thing, the idea that the government is "giving" someone an "interest free loan" by allowing the person to pay taxes on their own money in 2011 or 2012 rather than when they retire is just odd. Take a 40 year old who expects to retire at age 65 in 2035 and has $100,000 in a regular IRA. If the 40-year-old does the Roth conversion, he has to pay income tax on the $100,000 — which could be $35,000, plus state income taxes — in 2010, 2011, or 2012. If he chooses not to do a Roth conversion and decides instead to stick with the regular IRA, he doesn't have to pay any taxes on the $100,000 until 2035. Who is giving whom the "interest free loan?" Is it the government giving a loan, for allowing someone to defer until 2012 taxes that would have been owed in 2010? Or is it the taxpayer giving the government a loan by paying taxes in 2012 that otherwise wouldn't have been due until at least 2035?

As to whether it is "the deal of the century," that depends on what you think tax rates are going to be in 2035 (or whenever you retire), or, more particularly, what you think your own tax rate will be during retirement. Maybe by then America will have moved to a system under which consumption is taxed, rather than income, and the income tax rate will be zero. Maybe by then we will have moved to a Bowles-Simpson style tax reform under which the base is broadened and rates are lowered, and the top marginal tax rate will be 23%. Maybe by 2035 you'll have died, and your much younger second spouse, who you had named your IRA beneficiary, won't have to worry about paying taxes on what is now her IRA until she retires in 2055. Maybe by then tax rates will have increased, and the charitable deduction you can get by donating your IRA to charity will be worth more then than it is now.

Characterizing the tax policy as some kind of giveaway to the wealthy tells more about the mindset of the Bloomberg editor and reporter than about the underlying reality of the situation.

Disclosure: None