The widely anticipated expansion of the Roth IRA conversion program steamrolled into 2010 in a blaze of hype and publicity, but a new report shows that consumer interest has been more of a whimper than a bang. The tax break offers basically one year in which anyone with an Individual Retirement Account (IRA) can shift the money into a Roth IRA and never again pay tax on it. Personal-finance magazines, newspapers, financial-news channels and a flood of financial ads have all excitedly announced this limited opportunity as the way to achieve a tax-free retirement.
The only ones not getting excited about this big opportunity, it seems, are individual savers — the very ones who were expected to convert.
A nationwide survey commissioned by financial-services firm USAA found that 72% of baby boomers polled indicated they had no plans to convert their traditional IRA into a Roth this year. Even those with adjusted gross incomes exceeding $100,000, who weren't permitted to convert until now, are snubbing the program, with 70% passing up the chance to convert this year, according to the survey, which polled 1,384 adults across the country between the ages of 45 and 64 in February. People have until the April 15, 2011, tax filing deadline to convert.
"We were surprised by how big a number didn't plan to convert," says Ken Kilday, a wealth manager at USAA. "I thought at least half of the people planned to convert at least a portion [of their IRA]."
The reasons for not converting: 44% are gambling that income-tax rates will be lower when they retire and therefore don't want to pay higher taxes to convert the funds now, and 27% said they didn't have the cash to pay the taxes now. Others said a tax adviser or financial planner had recommended that they not convert.
"It actually doesn't surprise me — it confirms what's been happening with my clients," says Bill Losey, a certified financial planner and author of Retire in a Weekend! The Baby Boomer's Guide to Making Work Optional. "If unemployment wasn't where it was and the economy was humming along and we didn't have this great recession a year and a half ago, more people might consider it."
If the economy were strong, "we'd see the opposite — where 70% would take advantage of it," concurs Joseph Leonard, a financial planner and author of The Retirement Vault.
Financial advisers and tax experts have been talking up the benefits of the program for more than a year, with many hailing the program's expansion as a once-in-a-lifetime opportunity for people with incomes exceeding $100,000. In the past, only Americans with adjusted gross income that didn't exceed $100,000 could convert an IRA into a Roth. This year, however, the legislative window opened to allow everyone, regardless of income level, to convert. Any untaxed money that is converted, of course, is taxed, but the new law allows people who convert this year to spread the tax payments out over 2011 and 2012.
The benefits of converting assets to a Roth IRA are several. First, the Roth's earnings will grow tax-free, and withdrawals are tax-free. Second, the account owners don't have to make mandatory withdrawals from the account when they reach 70½ years of age, as traditional IRAs require. Third, the account can be passed on to children and grandchildren, who can grow and withdraw assets tax-free. Fourth, cash can be withdrawn anytime after the age of 59½ without penalty following an initial five-year holding period. Fifth, up to $10,000 can be withdrawn in the first five years penalty-free to purchase a principal residence.
But financial advisers are cautioning investors not to convert if they don't have enough cash outside the IRA account to pay the tax. And in this environment, in which unemployment is high and the economic recovery uncertain, fewer people are willing to part with their extra cash to pay these taxes.
"Clients have told me they'd rather keep their cash close and not spend it on additional taxes," says Geoffrey VanderPal, a CFP at Skyline Capital Management in Austin, Texas. "There's a lot of moving parts to this — we don't know what future tax rates are going to be, what future tax-code changes will be and life expectancy." For those who do convert, VanderPal says they should be at least 14 years away from needing to withdraw cash from the IRA account to make the conversion financially worthwhile.