To Roth or Not to Roth

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					To Roth or Not to Roth?

Beginning in 2010, anyone who has a traditional IRA will be able to convert to a Roth
IRA. The old rules prohibiting people from converting to a Roth IRA if their AGIs are
over $100,000 or their filing status is married, filing separately will be lifted.

But just because a person CAN convert, does not necessarily mean that they SHOULD
convert. Determining whether or not to convert to a Roth IRA is more of an art than a
science, and requires a lot of speculation about the client’s (and their beneficiaries’)
future income, needs, tax rates and behavior. It’s hard to give a definitive answer of what
is the right way to go, but here are factors to weigh.

When a person converts a traditional IRA or qualified retirement plan to a Roth IRA, they
have to pay income tax on the value of the assets at the time of conversion. In return, all
gains after the conversion can be tax-free if taken in a qualified distribution (i.e., when
the Roth IRA has been open for five years and the client is either over 59 ½, deceased,
disabled or a first-time home buyer $10,000 lifetime limit). For traditional IRAs
converted to a Roth IRA in 2010, the taxes due as a result of the conversion may be paid
at the time of conversion, or spread out over two years after the conversion. It is
important to note that the taxes due will be based upon the tax rates in effect at the time
of payment, and tax rates may be higher or lower than those in effect at the time of the
conversion. Clients should consult with a qualified tax advisor before making any
decisions regarding their IRA and to discuss which payment option is appropriate for
their personal tax situation.

The first factor is most important: Do not convert traditional IRA money to a Roth IRA if
the client’s (or their beneficiaries’) tax rate will be lower when the funds are withdrawn.
It makes no sense to accelerate the tax AND pay at a higher rate.

Once your client concludes that the taxpayer’s tax rate will likely be higher at the time
the funds are withdrawn, then you want at look at other factors.

Does the client have funds outside of the Roth IRA to pay the tax on conversion?
Yes—Favors converting. No—favors not converting. Taking money from the Roth IRA
to pay the income taxes hurts the economics of the transaction—you accelerate the taxes
but are deferring less because you withdrew to pay tax. This is especially true if the
client is under 59 ½ and will not only have to pay tax, but also a 10% penalty for a
premature distribution.

Does the client need the funds for retirement? No—favors converting Yes—favors
not converting. A special feature of Roth IRAs is that there are no Required Minimum
Distributions during the owner’s lifetime. A Roth IRA allows you to defer distributions
for life, so you can (assuming the qualified distribution rules are satisfied) put the tax-free
growth engine to work longer. The client can leave it all as a tax-free gift to children or
potentially grandchildren, who may have the opportunity to stretch the payments. But if
the client does need the funds for retirement, why accelerate the tax by converting?
Is the client headed for an estate tax? Yes—favors converting. No—favors not
converting. Consider this for wealthy clients who are setting aside the Roth IRA for their
children or grandchildren. When the client pays the tax on the Roth conversion, it
benefits the children or grandchildren because they won’t have to pay tax on the
distributions. Yet paying this tax bill reduces the client’s estate and doesn’t count as a
gift against the client’s $3.5 million estate tax exclusion.

Are the values of the assets currently depressed? Yes—favors converting. No—
favors not converting. The client is taxed on the assets’ value on the day of conversion. If
the IRA being converted is an annuity the amount will be based on the Entire Interest
Value including any future living benefits. An actuary from the insurance company will
be able to provide this amount. If the values are depressed when the client converts, this
will result in a lower taxable event.

Is the client young? Yes—favors converting. No—favors not converting. Being young
means the client has a longer time frame to grow funds tax- free. Also, the client might
earn less and be in a lower bracket now than an older, more established client.

Will the client receive Social Security benefits in retirement? Yes—favors
converting. No—favors not converting. A Roth IRA does not require distributions during
life, and even if the client does take qualified distributions, they are not added to AGI.
This can keep AGI low, which can help reduce the tax on Social Security benefits.
Compare this to a traditional IRA, where the client must at least draw the RMD, and it
will be added to AGI. Please remember, converting your traditional IRA to a Roth IRA is
a taxable event and could result in additional impacts to your personal tax situation,
including the taxation of current social security benefit payments.

Does the client need forced savings? Yes—favors converting. No—favors not
converting. By converting you will be forced to pay the taxes now—and will reap the
benefits later. Of course if you don’t convert you can put the tax “savings” in a side fund
and let that grow until retirement—as many Roth calculators assume. But who really
does that? Money tends to slip though our fingers if we have it.

Are all the client’s financial assets in Roth IRAs? No—favors converting. Yes—
favors not converting. It’s good to have tax diversification—some funds which are
taxable (traditional IRAs) some that generate capital gains and some that are tax-free
(Roth IRA qualified distributions). Then you have the flexibility to optimize your taxable
income during retirement. For example, the client can take taxable income to get to the
top of the 15% income tax bracket, and tax-free income after that.

Does the client need creditor protection? Creditor protection laws differ by state, so it
is important to have a client discuss with their attorney which types of plans may provide
the best creditor protection for their individual needs.
There are many factors to weigh in whether to convert a traditional IRA to a Roth IRA.
For some clients, accelerating the income tax will be worthwhile in exchange for tax-free
distributions in the future.

Please remember that converting a traditional IRA to a Roth IRA is a taxable event and could result in
additional impacts to your clients personal tax situation, including the taxation of current social security
benefit payments. It is generally preferable that your clients have funds to pay the taxes due upon
conversion from funds outside of their IRA. Please encourage your clients to consult with their tax advisor
to discuss their personal tax situation.

This document is designed to provide general information on the subjects covered. Pursuant to IRS Circular
230, it is not, however, intended to provide specific legal or tax advice and cannot be used to avoid tax
penalties or to promote, market, or recommend any tax plan or arrangement. Please note that Allianz Life
Insurance Company of North America, its affiliated companies, and their representatives do not give legal
or tax advice. Encourage your clients to consult their tax advisor or attorney.

Not FDIC insured * May lose value * No bank or credit union guarantee * Not a deposit * Not insured by
any federal government agency or NCUA/NCUSIF

Allianz Life Insurance Company of North America, 5701 Golden Hills Drive, Minneapolis, MN 55416-

9808-09           For broker/dealer use only. Not for use with the public                  (01/2010)

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