Convert to a Roth?

Mike in Minneapolis has $43,000 in a traditional IRA. He’s thinking about converting to a Roth IRA. He has another $10,000 in a Roth IRA and about $9,000 in his emergency fund. Should he convert it?

QUESTION: Mike in Minneapolis has $43,000 in a traditional IRA. He’s thinking about converting to a Roth IRA. He has another $10,000 in a Roth IRA and about $9,000 in his emergency fund. Should he convert it? Dave advises Mike that he’s going to have to pay taxes on it, and he’ll only come out ahead if he doesn’t pay taxes out of his IRA.

ANSWER: When you convert this, you’re going to create an $11,000 tax bill. If the only way you can pay it is to cash out enough to pay it, then you really won’t gain any ground. If you put $30,000 in a Roth IRA or $43,000 in a regular IRA, you’ll break even 25 years from now. One is taxable; one is not taxable. The only way the conversion from the traditional to the Roth makes mathematical sense is if you pay the tax bill on the outside, thereby putting $43,000 into your Roth. Now you’re going to come out ahead because it’s as if you have invested. You’re not quite in a position to do that. But you can do that next year. There’s nothing stopping you from doing that.

You need to claim more deductions. If you claim 0, you’re just creating a savings account with the IRS. You don’t want to do that at 0% interest. You want to take home a little more so that you don’t have a refund.

If you can cash-flow project and have the cash to pay for the taxes by the time they get here, I’m okay with the conversion. But don’t go creating debt with this, and don’t cash out the thing to do it. Cash flow it one way or another.