Quotes of the Day

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.

Many people saw their market accounts plunge as much as 60% in 2008, making them skittish about parting with their cash now. "It's the rare CPA that's actually telling people to do the conversion because they don't think their clients should pony up the money now either," says Losey.

However, Kilday says the market downturn could actually work in someone's favor, as the person would be paying less tax on a beaten-down portfolio of IRA assets than if the value of the IRA were larger.

The big surprise in all this, Kilday says, is the number of people who believe tax rates will be lower when they retire. "This is the third lowest set of tax brackets we've had since the advent of the income tax in 1913," he says. And with the deficit growing, "I don't think Congress will be able to justify lowering them anytime in the future." Income-tax rates on ordinary income are slated to rise in 2011 to pre-2001 levels of 15%, 28%, 31%, 36% and 39.6%. That's up from current rates of 10%, 15%, 25%, 28%, 33% and 35%.

Still, some cynical investors are worried that the cash-strapped government might change the rules down the line and pass legislation taxing Roth IRAs. After all, the federal government already showed it could renege on tax promises when it passed laws to start taxing Social Security benefits after promising it wouldn't.

"Nothing is written in stone, and certainly nothing is guaranteed anymore. I wouldn't put it past them that at some point they might want to change the rules around," says Losey. "There are so many unknowns and variables that people feel more content holding on to what they have now rather than gambling on what the government may or may not do down the road."

Leonard speculates there would be "total Armageddon" in the streets if the government suddenly reversed itself and started taxing Roth distributions. However, the government could potentially take less drastic steps to raise revenue, such as ending the tax-free growth of the Roth account investments, or counting Roth withdrawals as part of income in tabulations to establish who qualifies for certain social benefits. Or, the government could choose to phase out the ability of heirs to enjoy tax-free growth on the Roth account. "It's hard to say what they're going to do — it's really speculative," says Leonard.

The people jumping into the program now are primarily the wealthier segment of the population who have plenty of cash sitting on the sidelines to pay the tax and who want to use the Roth as an estate-planning tool, to pass the tax-free account to their heirs, advisers say.

It's most beneficial for people who have no intention of using their Roth IRA for income in retirement, says Kilday. "They're saving it for their heirs" so that money can be passed on tax-free, he says.

Leonard sees members of Congress among the program's biggest beneficiaries. "They're all in this income bracket [with adjusted gross income of more than $100,000], and most of them don't need that type of money for their retirement, so this really benefits them," he says.

• Janet Morrissey
• Convert your IRA to a tax-free Roth IRA, the financial advertising says. But so far, few retirement savers are taking the cue