When Not to Convert to a Roth IRA

Summary

WSJ Your Money Briefing – Detailed Summary

Episode Title: When Not to Convert to a Roth IRA
Date: August 20, 2018
Host: Charlie Turner
Guest: Laura Saunders, WSJ Special Writer
Duration: ~8 minutes (excluding ads/outros)

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Episode Overview

This episode of Your Money Briefing tackles a crucial personal finance decision: whether or not to convert a traditional IRA to a Roth IRA. Host Charlie Turner interviews Wall Street Journal tax expert Laura Saunders, breaking down not just the well-publicized benefits of Roth IRAs, but the situations in which making the switch might actually be a bad idea. The conversation focuses on tax dynamics, life circumstances, and key mistakes to avoid, arming listeners with practical criteria to make informed choices.

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Key Discussion Points and Insights

1. Introduction to Roth vs. Traditional IRA

Timestamp: 03:25

• Laura Saunders explains the fundamental appeal of Roth IRAs:
  • "A Roth IRA has wonderful advantages. If it’s not too expensive to get there. Roth IRAs, the money goes in after tax, it grows tax free, and then it comes out tax free. So if your hundred dollars grows to a million dollars, there's no tax on it."
    (Laura Saunders, 03:25)
• Key benefit: No required minimum distributions (RMDs) unlike traditional IRAs.
• The main caveat: The tax hit upon conversion—it's critical to know when not to do it.

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2. When NOT to Convert to a Roth IRA

a. If Your Future Tax Rate Will Be Lower

Timestamp: 04:28

• It generally doesn't make sense to convert if your future tax bracket will be lower, including if you plan to move to a lower-tax state.
• Quote:
  • "You want to do a Roth conversion... when your tax rate is the lowest..."
    (Laura Saunders, 04:41)
• Example situations:
  • Young workers taking time off for school (lower income years = better for conversion).
  • Recent retirees before Social Security or RMDs kick in.

b. If You Can't Pay Taxes from Outside Sources

Timestamp: 05:35

• You shouldn't convert if you must use funds from the IRA itself to pay the tax bill.
• Quote:
  • "You need to be able to write the check with outside money."
    (Laura Saunders, 05:44)

c. If Your IRA Assets Could Lose Value Soon After Conversion

Timestamp: 05:47

• If investments decline in value after conversion, you'll have paid tax on a higher amount.
• Quote:
  • "You paid taxes and you're out the money. You're not sharing those losses with Uncle Sam anymore."
    (Laura Saunders, 05:55)

d. Stealth Taxes Can Bite

Timestamp: 06:03

• Roth conversions increase your income for that year, possibly:
  • Raising your tax on net investment income.
  • Increasing Medicare premiums.
• Quote:
  • "It will spike your income for the year you make a conversion... it could raise your tax on net investment income. It could maybe raise your Medicare premiums for a year or two."
    (Laura Saunders, 06:08)

e. If You Need the Assets Soon

Timestamp: 06:37

• Only convert if you can let the Roth grow undisturbed.
• Quote:
  • "A Roth conversion works best if you can let the assets sit and grow for a long time."
    (Laura Saunders, 06:42)

f. Expecting High Medical Expenses

Timestamp: 06:52

• Medical expenses above a certain threshold are tax deductible only for traditional IRA withdrawals (which are taxable).
• If you convert everything to Roth, you lose access to these deductions.
• Quote:
  • "If you have a lot of expenses from home health care aides or you’re in a nursing home... if you’ve converted everything to a Roth IRA, then there’s no deduction available because you don’t have any income."
    (Laura Saunders, 06:59)

g. Fear That Congress Will Tax Roth IRAs

Timestamp: 07:36

• Some worry Congress might change the tax-exempt status of Roths, but experts are less concerned.
• Quote:
  • "Congress likes the upfront income from Roth IRAs... they will probably leave Roth IRAs alone."
    (Laura Saunders, 07:43)

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Notable Quotes & Memorable Moments

• On Timing a Conversion:

  • "Perhaps... you go back to school for another degree and your income takes a big dip. That would be a good year to convert your other earlier money to a Roth IRA."
    (Laura Saunders, 04:41)

• On State-Specific Rules:

  • "New York has a special exemption, about $20,000 per person of state taxes on this money."
    (Laura Saunders, 04:56)

• On Medical Expenses Deductibility:

  • "Maybe... saving a few years of nursing home expenses in that IRA, in a traditional IRA, that might be a good idea."
    (Laura Saunders, 07:17)

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Timestamps for Key Segments

• 03:25 – What is a Roth IRA? Major benefits and the conversion tax hurdle.
• 04:28 – Why you shouldn’t convert if your tax rate will be lower later.
• 05:35 – Conversion isn’t wise if you must use IRA funds to pay taxes.
• 05:47 – Why asset declines post-conversion can make you lose out.
• 06:03 – How Roth conversions can trigger stealth taxes and impact Medicare.
• 06:37 – Not worth converting if you’ll need the funds soon.
• 06:52 – Medical expense deduction limits as a reason to avoid a full conversion.
• 07:36 – Fears about future taxation of Roth IRAs addressed.

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Tone and Style

The tone is practical, focused, and matter-of-fact—Laura Saunders employs examples and warnings, not hype, and Charlie Turner keeps the pace brisk while seeking clarity. The advice is realistic, not alarmist, with an eye toward tailoring decisions to individual circumstances.

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Summary Takeaways

• Don't convert out of habit—wait for years of lower income, major moves, or special circumstances.
• Never use IRA funds to pay the conversion tax.
• Beware of the hidden costs—stealth taxes, lost deductions, asset value swings.
• Medical expenses and possible future legislative changes deserve careful consideration.
• Personal situations and state laws matter—a one-size-fits-all approach doesn't work for Roth conversions.

This episode is an essential listen for anyone contemplating the Roth switch; it could save listeners from costly mistakes and help align their retirement planning with their true financial best interests.

Transcript

[Small Business Owner]

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[Charlie Turner]

With your Money briefing, I'm Charlie Turner in New York. Converting to a Roth IRA from a traditional IRA can mean tax advantages for you, but there are reasons that you should steer clear of converting to a Roth. We'll have details, but first, here are some money in market stories you need to know. Tesla investors take note in the wake of CEO Elon Musk's tweet about wanting to take the carmaker private. But the securities and Exchange Commission is investigating the company on multiple fronts, including issues related to disclosure about production of the Model 3 sedan. Wall Street Journal Heard on the street columnist Charlie Grant says any SEC fine that may result from possible violations would have minimal impact on Tesla's finances. Charlie writes that the most important impact is Tesla may struggle to raise cash it badly needs while the investigation is going on. Few investors will buy new shares in a company under investigation, those who likely demand tough terms, which would come at the expense of current investors. You may have heard that President Trump wants the SEC to study the possibility of requiring public companies to report earnings every six months instead of each quarter. Proponents say it would make companies less likely to focus on short term profits. Heard on the Street's Justin Lehart writes that executives might want to say as little as possible, but investors want to know as much as possible about the companies they own. Longer lag times between financial reports would make investors view stocks as riskier, since a lot more can happen in six months than in three months. Stocks would eventually reach the same place, it would just take longer and the short term moves would be bigger. This ought to lead all else equal to stock prices a little lower and companies cost of capital a little higher. Also, writes Justin, longer lag times could create a less level playing field among investors. US Consumer sentiment slid in August to its lowest level in nearly a year as consumers registered concern about rising prices. That's according to the University of Michigan's preliminary August index. The survey found that buying conditions for large household durable goods, vehicles and homes were all viewed less favorably this month. If you have a traditional individual retirement Account, you may have already converted it to a Roth ira, but those who are still contemplating the switch to a Roth should think about whether or not this is really a good strategy for them. In our studio now is Wall street journal special WR Laura Saunders, who writes the tax report. Laura, since 2010, Congress has allowed owners of traditional IRAs to make full or partial conversions to Roth IRAs. Quickly tell us basically what a Roth IRA is and what the advantages are to converting to one of them.

[Laura Saunders]

Well, a Roth IRA has wonderful advantages. If it's not too expensive to get there. Roth IRAs, the money goes in after tax, it grows tax free, and then it comes out tax free. So if your hundred dollars grows to a million dollars, there' tax on it. Also, there are no required payouts like there are with traditional IRAs. So it's a great thing to have. The only question is, is it appropriate to do the conversion? Because you have to pay full taxes on the conversion. People really flinch when they have to write that check. But sometimes it's a good idea not to write the check. So we dredged up some of those circumstances.

[Charlie Turner]

Okay. Conversion is not always a good idea, according to experts that you've talked to. Right. First of all, you pay tax on the transfer.

[Laura Saunders]

That's right. You have to write a check, and it can make your INC go up so that it could affect other benefits as well. You have an income spike. It could lower your child's financial aid for college or something like that. So there are all these circumstances that you want to think about, about when it's a good idea or a good time to make a Roth conversion.

[Charlie Turner]

Okay. Some other reasons, maybe this one's the most important one. You write that it doesn't make sense to convert to a Roth if your tax rate will be lower when you make the withdrawals. And this may include moving to a state with a lower tax rate.

[Laura Saunders]

Yeah, I think that's important to make that point again and again. Want to do a Roth conversion, pull money out, put it into a Roth IRA when your tax rate is the lowest. So perhaps somebody who, a young person, say, who's worked for a few years and has an IRA or a 401, so you go back to school for another degree and your income takes a big dip. That would be a good year to convert your other earlier money to a Roth IRA. Same thing if you've retired at, say, age 62 and you've got some lower income years before you have to start pulling money out of your traditional ira. Those can be good times to Convert as well. On the other hand, if you're about to move from a very high tax state to a low tax state, you should maybe wait until you move. However, look carefully at what your state does. New York has a special exemption, about $20,000 per person of state taxes on this money.

[Charlie Turner]

Also, you say don't convert to a Roth if you need to use the funds from the IRA itself to pay the tax bill. In other words, if you don't have an outside source.

[Laura Saunders]

Yeah, that's right. You need to be able to write the check with outside money.

[Charlie Turner]

Also, you're worried about, say, the assets lose value after a Roth conversion. You write the account owner will have paid higher taxes than necessary.

[Laura Saunders]

Yeah, you paid taxes and you're out the money. You're not sharing those losses with Uncle Sam anymore. And so it's real money that's gone.

[Charlie Turner]

What about the caveat that converting to a Roth IRA will raise stealth taxes? What stealth taxes are you talking about?

[Laura Saunders]

Well, that's an interesting interaction in the tax code. It will spike your income for the year you make a conversion and you can do partial conversions. So it might not spike at that, that much, but it could do something like it could raise your tax on net investment income. It could maybe raise your Medicare premiums for a year or two. So these are things to look at. You might not want to have a large capital gain and a Roth conversion in the same year.

[Charlie Turner]

You say there's really no sense in converting to a Roth if you need the assets now rather than later.

[Laura Saunders]

Yes, a Roth conversion works best if you can let the assets sit and grow for a long time. And so if you're going to need the money soon, you know, don't go through all this now. It's a lot of trouble.

[Charlie Turner]

And Laura, you want to bring up this point specifically. I know you shouldn't do it if you'll have high medical expenses.

[Laura Saunders]

Yes, this is something really to think about. It might be a good reason to do a partial conversion. You see, under the current tax code, medical expenses above a certain threshold are tax deductible. And that would apply, say, if you have a lot of expenses from home health care aides or you're in a nursing home or something. And so if you've converted everything to a Roth ira, then there's no deduction available because you don't have any income. And so maybe if you want to plan around, you know, think of saving a few years of nursing home expenses in that ira, in a traditional ira, that might be a good idea.

[Charlie Turner]

And finally, you say it's probably not a good idea to convert if you think Congress will tax Roth IRAs. Are there concerns about this?

[Laura Saunders]

I think that the general public is more concerned than the tax experts are. The tax experts point out that Congress likes the upfront income from Roth IRAs. You pay tax sort of going in, not coming out. And so therefore they think that Congress is so hungry for revenue that they will probably leave Roth IRAs alone.

[Charlie Turner]

Wall Street Journal special writer Laura Saunders. Thanks a lot, Laura.

[Laura Saunders]

Thank you.

[Charlie Turner]

And that's your money briefing. I'm Charlie Turner at the Wall Street Journal.

[Small Business Owner]

Access to affordable credit helps me pay my employees, but I don't really need it.

[Consumer Advocate]

Inflation is killing me, but who cares? Big retailers are making record profits. That's why we support the Durbin Marshall credit card bill.

[Small Business Owner]

See, banks and credit unions help small businesses make payroll. This bill would cut the vital resources

[Consumer Advocate]

they need while increasing megastore profits. They deserve it, don't they?

[Electronic Payments Coalition Representative]

Tell Congress, stop the Durbin Marshall money grab for corporate megastores paid for by the Electronic Payments Coalition.