This is the second of a series of articles on Roth IRA Conversion calculators. The first one, on the T. Rowe Price IRA Calculator can be accessed at http://www.rothira.com/daryanani.htm. The Strong Funds calculator can be accessed at http://www.strongfunds.com/strong/Retirement98/ind/calc/calc.htm. Alternately you can get the same calculator in disk form by calling Strong Funds at 800-359-3379.
The first part of this article will describe the Strong Funds Roth IRA Calculator. The second part is a general discussion on other retirement scenarios and factors you may wish to consider related to a Roth Conversion.
The retirement scenario the Strong Funds Calculator addresses is as follows: An individual currently has $ X in an IRA account. He or she is considering a conversion of all of the dollars to a Roth IRA in 1998. Three situations are analyzed:
Do nothing: i.e. leave all funds in the Traditional IRA.
Convert (rollover) all the funds to the Roth IRA, with the additional taxes for the conversion paid from the IRA account.
Rollover all of the funds to the Roth IRA, with the additional taxes coming from an outside account. This outside account is assumed to have just enough money to pay the taxes.
The tax for the rollover is calculated by multiplying the rolled over amount by the tax rate you specify as your current tax rate. The starting balances in these three cases then grow at a rate of return that you specify. You also specify the number of years the account will continue to grow. At the end of this period, all the funds are withdrawn in one lump sum. For the Traditional IRA case the amount withdrawn is taxed at the retirement tax rate that you specify. The Roth IRA ending balances are not taxed.
Example: Shana has $100,000 in her Traditional IRA, which she would like to consider rolling over to the Roth IRA in 1998. Her current tax rate is 31%. She will withdraw all of her balance at retirement, 10 years from now. At this time her anticipated tax rate is 28%. These tax rates include Federal and State taxes. The ending balances that Shana will have in the three cases are:
Case |
Value today | After tax(AT) value at retirement | Adjustments |
AT value at retirement corrected for outside funds and 10% penalty | Advantage of Roth |
|
1 |
Traditional IRA | $100,000 |
$186,749 |
0 | $186,749 |
reference |
2 |
Roth (tax from IRA) | $69,000 |
$178,968 |
($8,040) | $170,928 |
-8% |
3 |
Roth (tax from outside fund) | $100,000 |
$259,374 |
($51,274) | $208,100 |
11% |
| Value of outside tax payment account | ($26,310) |
($51,274) |
||||
| 10% penalty case 2 | ($3,100) |
($8,040) |
||||
| Italicized sections calculated by the author |
Two enhancements to this analysis should be considered. The first is that the outside funds used to pay for the Roth Conversion tax in1998 should be subtracted from Case 3 to make a fair comparison with the others. This is often referred to as the opportunity lost (money you would have if you did not convert). This opportunity lost account will be assumed to grow at the 10% rate and the growth will be taxed annually at the 31% rate. The second enhancement would be to take into account the10% penalty for withdrawals within five years when you have taken advantage of the four year spreadout of taxable income that occurs with a 1998 conversion. Assuming that this penalty as noted in the Technical Corrections Bill passes as expected, we need to impose this penalty on case 2. It should also be noted that there could be a second 10% penalty on withdrawals from the IRA account, if Shana is under 59.5 years.
The remainder of this article discusses other retirement scenarios and factors that you may want to examine when considering a Roth IRA conversion. This will be used as a general checklist that will be referred to in future articles on Roth Conversion calculators:
Scenario 1: Lump Sum: You may want to withdraw money from the Traditional IRA or the Roth IRA accounts in one lump sum. The taxes for the Traditional IRA account then are paid in one big installment. There are no tax implications on the Roth withdrawal. This is relatively easy to calculate and most programs will cover this scenario. This is the scenario used in the Strong IRA Calculator.
Scenario 2: Minimum Withdrawals You may want to delay withdrawals from the accounts as long as possible. There is a mandatory withdrawal required by the IRS. This is called the minimum required distribution (MRD). There are a variety of algorithms that are prescribed by the IRS to determine the rate of the MRD. These algorithms get very complicated and only a few of the higher end programs address the variety of MRD algorithms dictated by the IRS.
Scenario 3 Fixed Annuity: You may want to withdraw a fixed dollar amount each year, in the withdrawal (or post-retirement) phase. Since you have specified the fixed $ withdrawal the year in which your account depletes (goes to $0) will vary.
Scenario 4. Inflation dependent Annuity: You may want the amount you withdraw to increase every year to keep up with inflation for instance. In this case you will be asked to enter an increase rate for the withdrawals. Here also the year in which the account depletes will vary.
Scenario 5. Fixed Term to Depletion: These programs require you to specify how long you want your account to last. They then compute the annual withdrawal available during the specified withdrawal period. The accounts deplete at the end of the period you specify.
Second Generation Issues: Only a very few high-end programs address inheritance, estate tax and the second-generation MRD issues associated with Roth IRA accounts.
Inflation: You may want to look at assets in today's dollars. Some programs do include an inflation rate to allow a translation of future dollars to 1988 dollars.
Tax Calculation: Only a select few programs will compute taxes. This is particularly necessary for the post retirement years when taxable income may fluctuate considerably, especially if you are constrained by the variable minimum required distributions. Most programs will ask you to guesstimate the marginal or effective tax rate for the pre-retirement years and for the post-retirement years. Some programs allow an annual indexing of the tax rates.
In summary, the Strong Fund Roth IRA Calculator is a good
start towards the consideration of a Roth Conversion. It is based on a conservative lump
sum scenario: conservative in the sense that other scenarios where one can afford to
stretch out the withdrawals show the Roth Conversion to be better than the lump sum
scenario. You may want to consider using higher end programs to evaluate a range of
scenarios that reflect your retirement plans.
If you have a Roth Conversion calculator that you would like to have evaluated please send the information on the calculator to the author at rothinfo@dqi-roth.com.
The author Dr. Gobind Daryanani is the founder of DQI Inc., a company providing Roth Conversion Consulting Services. The company offers a current "Market study report of available software packages for the Roth Conversion". DQI also offers a Roth Conversion Service, which uses the best available software programs to evaluate a wide range of scenarios for clients.