Roth Conversion, A Potentially Helpful Tactic

Many of my clients would rather have their IRA money in a Roth IRA, and anyone who can contribute directly to a Roth IRA probably should chose that over an IRA.  But how do you know if it makes sense to do a "Roth Conversion" of existing IRA money to get it into a Roth IRA?

First things first

Roth IRA withdrawals in retirement are tax-free while IRA withdrawals are taxable, and Roth IRA contributions are non-deductible while IRA contributions are deductible (except for folks earning too much money), and, therefore, you probably have to pay taxes on any money you move from an IRA to a Roth IRA.

Is it worth it to pay that tax?

• Many experts think giving up the tax-deduction now, or paying conversion/income tax now, is worthwhile in order to get the tax-free retirement withdrawals later.
• This is especially so for folks who are now younger than age-40 or anyone who might be in a higher tax bracket in retirement than they are now.

Here are some ways to look at Roth Conversion

No-tax Roth Conversion, the basics

1. $0 balance in any/all IRAs (total balance of all IRAs for each person must be counted in this case).
2. deposit contribution into IRA, take deduction
3. convert IRA balance to Roth IRA, give back deduction (because the tax amount is same amount as deduction amount)
4. zero-net-tax

Or

1. $0 balance in any/all IRAs, like above.
2. deposit non-deductible contribution
3. convert IRA balance to Roth IRA, no tax hit because conversion was of dollars already taxed
4. zero-net-tax

Taxable Roth Conversion, the basics

1. IRA has money in it
2. any deductible contributions, and any gains from the IRA investments, are taxable if converted to Roth IRA
3. any non-deductible contributions are not taxable
4. Roth Conversion amount is up to 100% taxed, with the ratio of taxable to non-taxable IRA dollars in the IRA determining % of conversion amount is subject to tax
• example:  if IRA has $100k and $20k was from non-deductible contributions, 80% of any Roth Conversion amount would be taxable

Examples of No-tax Roth Conversion

1. $0 IRA balance, $5500 IRA deductible contribution is moved right away to Roth IRA, entire balance of IRA was from untaxed dollars and thus is taxable when moved to Roth IRA.  If IRA owner is subject to, say, 30% tax, then $1650 is owed on the $5500 conversion but is offset by the $1650 tax deduction for the original contribution.
2. $0 IRA balance, $5500 IRA non-deductible contribution is moved right away to Roth IRA, entire balance of IRA was from already-taxed dollars and thus is not taxable when moved to Roth IRA.  So, $0 is owed on the conversion but $0 deduction was received also.

Example of Taxable Roth Conversion

• $100k in IRA, $20k of which was non-deductible contributions and $80k was deductible contributions of tax-deferred growth of investments.
• Move the whole $100k to Roth IRA and $80k is subject to tax.
• Let's say tax is $30%, so $24k is amount of tax owed.
• Roth IRA can get all $100k and the owner would have to pay $24k more in taxes for that year.
• OR, Roth IRA can get $76k after the custodian (Schwab, Fidelity, etc.) withholds for taxes at request of account owner, BUT that $24k withholding is considered an IRA distribution and is subject to a 10% penalty for anyone doing this prior to age 59.5 years-old.

NOTE:  Please consult with a tax expert.  I am happy to work with clients and their own tax expert on this Roth Conversion idea, but I am not qualified to give formal tax advice.

Portoflio Model Performance Through December 2017

2017 was positive year across stock and bond markets.  Most clients of Potomac Wealth Strategies experienced gains greater than their benchmarks--an up year that included value-adding outperformance even after paying advisory fees.

Below is some perspective and performance data.  It is not specific information about any individual client.  Please check your Client Web Portal for your Performance Summary, or contact me to schedule a conversation.

PERSPECTIVE

• Most of us are, and should be, invested in portfolios that are diversified, with exposure to various types of stocks and bonds, and even to some cash and alternative investments.
• But that means we are unlikely to do as well as the hottest market indexes in up years (or as badly as the worst-performing indexes in down years).
• Here is how each type of diversified investor "should" have performed* in 2017 (assuming invested suitably for their risk tolerance):

Aggressive  +14.3%
Moderately Aggressive  +12.1%
Moderate  +9.8%
Moderately Conservative +7.7%
Conservative +4.6%

*gains/losses of the benchmark for each risk profile, minus 1% to account approximately for advisory fees deducted from accounts' performance.

PERFORMANCE OF PORTFOLIO MODELS

• Here are the performance data for various portfolio models my firm created and run for clients, along with some of the popular competition.
• Most clients are using "Strategic III" models, with 95 being "aggressive", 40 being "moderately conservative", and so forth.

US and Foreign Indexes		3 mo	1 yr	2 yr	3 yr	5 yr	10 yr	2008
Stock Markets (72-21-7)		5.7%	21.0%	13.8%	8.1%	10.8%	4.3%	-41.0%
S&P 500 PR		6.1%	19.4%	14.4%	9.1%	13.4%	6.2%	-38.5%
Dow Jones Industrial Avg PR		10.3%	25.1%	19.1%	11.5%	13.5%	6.4%	-33.8%
MSCI EAFE		3.9%	21.8%	9.3%	4.9%	5.0%	-0.9%	-45.1%
MSCI EM		7.1%	34.4%	20.8%	6.6%	1.9%	-0.7%	-54.5%
Barclays Agg Bond--US		0.4%	3.5%	3.1%	2.2%	2.1%	4.0%	5.2%
Citi WGBI nonUSD (foreign bonds)		1.6%	10.3%	6.0%	2.0%	-0.3%	2.4%	10.1%
Aggressive (90% stocks-10% bonds)		4.7%	15.3%	12.0%	6.5%	8.5%	4.2%	-36.0%
95 Strategic III		5.8%	17.9%	14.0%	8.6%	11.5%	8.6%	-30.9%
95 Schwab index 2017		4.7%	19.2%	14.4%	9.3%	12.1%	6.8%	-34.3%
95 Strategic USA II		5.9%	17.6%	15.0%	8.9%	13.8%	10.5%	-25.8%
Confluence Value Opportunities								-22.3%
Confluence Equity Income								-18.9%
WealthFront 9		5.6%	22.4%	15.8%	8.6%	9.2%	4.9%	-38.1%
American Funds Port Ser Growth		5.9%	24.5%	16.4%	11.3%	14.2%	7.4%	-39.5%
American Funds Port Ser Global Growth		5.2%	27.2%	15.7%	10.9%	12.4%	6.1%	-40.3%
Moderately Aggressive (75-25)		4.0%	13.1%	10.5%	5.8%	7.3%	4.2%	-31.0%
80 Flex IV		4.0%	14.7%	10.4%	5.2%	6.2%		-17.5%
80 Flex V		4.2%	15.4%	9.8%	5.1%	7.6%		-16.9%
80 Strategic II		3.8%	17.7%	13.9%	8.0%	10.1%	8.1%	-31.1%
80 Strategic III		5.1%	16.1%	12.7%	7.9%	10.4%	8.2%	-27.7%
80 USA tilt		3.8%	15.4%	12.9%	7.4%	10.1%	7.8%	-28.5%
80 Schwab index 2017		4.0%	16.3%	12.0%	7.9%	10.2%	6.1%	-29.3%
Money 75		4.3%	16.8%	13.8%	8.6%	10.2%	6.7%	-32.7%
American Funds Port Ser Gr+Inc		4.6%	18.8%	13.6%	8.8%	11.3%	6.2%	-32.7%
Moderate (60-40)		3.2%	10.8%	8.9%	5.0%	6.1%	4.1%	25.6%
60 Strategic III		4.1%	13.1%	10.7%	6.6%	8.5%	7.4%	-23.3%
60 Schwab index 2017		3.2%	13.1%	9.7%	6.4%	8.3%	5.4%	-23.8%
American Funds Port Ser Balanced		3.6%	16.2%	11.3%	7.3%	9.2%	5.8%	-28.5%
Moderately Conservative (40-60)		2.4%	8.7%	7.1%	4.1%	4.5%	3.7%	-17.4%
40 Strategic III		3.2%	10.3%	8.9%	5.4%	6.6%	6.6%	-16.8%
40 Schwab Index 2017		1.9%	9.2%	6.7%	4.5%	5.6%	4.4%	-16.2%
Hartford Balanced Income A		3.4%	11.5%	11.3%	7.3%	8.2%	7.4%	-18.5%
Conservative (20-80)		1.5%	5.6%	4.9%	2.8%	2.6%	3.2%	-8.4%
20 Strategic III		1.4%	5.6%	6.1%	3.7%	3.6%	4.4%	-9.3%
20 Schwab index 2017		1.3%	6.1%	4.1%	3.0%	3.7%	3.4%	-9.2%
NOTE 1:  Past performance is no guarantee of specific future results.  This data is presented by Potomac Wealth Strategies, LLC.  This data is from Morningstar and should be accurate, but it has not been independently verified.
NOTE 2:  "Flex", "Strategic", and "Index" models are crafted/run by Potomac Wealth Strategies.  They show history of better returns, lower volatility, or both--or, with the Index models, closer tracking--vs benchmarks and competitors.
NOTE 3:  "XX Schwab index" models are relatively low-cost and tax-efficient portfolios.  They are comprised mostly of index funds available free of transaction charges to my clients at Schwab.  This is what many might recommend due to low-costs and portfolio efficiency.
NOTE 4:  Nothing on this blog post is specific investment advice to any individual or organization.  If the information hereon is of interest to you, please send e-mail to Info@PotomacWealthStrategies.com for a consultation.

Portfolio Model Performance through November 2017

US and Foreign Indexes		3 mo	1 yr	2 yr	3 yr	5 yr	10 yr	2008
Stock Markets (72-21-7)		6.3%	21.8%	12.1%	7.2%	10.9%	4.0%	-41.0%
S&P 500 PR		7.1%	20.4%	12.8%	8.6%	13.3%	6.0%	-38.5%
Dow Jones Industrial Avg PR		10.6%	26.9%	17.0%	10.8%	13.3%	6.1%	-33.8%
MSCI EAFE		4.6%	24.0%	7.7%	3.2%	5.4%	-1.3%	-45.1%
MSCI EM		3.0%	29.9%	17.3%	3.7%	2.2%	-1.0%	-54.5%
Barclays Agg Bond--US		-0.6%	3.2%	2.7%	2.1%	2.0%	4.0%	5.2%
Citi WGBI nonUSD (foreign bonds)		0.1%	9.2%	6.7%	1.6%	-0.5%	2.4%	10.1%
Aggressive (90% stocks-10% bonds)		6.0%	16.7%	10.3%	5.7%	8.6%	4.1%	-36.0%
95 Strategic III		6.0%	18.3%	12.3%	7.9%	11.6%	8.4%	-30.9%
95 Schwab index 2017		6.6%	20.6%	12.7%	8.8%	12.4%	6.6%	-34.3%
95 Strategic USA II		7.0%	18.4%	13.1%	8.7%	13.9%	10.5%	-25.8%
Confluence Value Opportunities								-22.3%
Confluence Equity Income								-18.9%
WealthFront 9		5.3%	22.0%	13.5%	7.1%	9.3%	4.6%	-38.1%
American Funds Port Ser Growth		7.1%	23.9%	14.5%	10.3%	14.3%	7.2%	-39.5%
American Funds Port Ser Global Growth		5.9%	26.9%	13.9%	9.8%	12.6%	6.0%	-40.3%
Moderately Aggressive (75-25)		4.9%	14.2%	9.0%	5.0%	7.4%	4.0%	-31.0%
80 Flex IV		3.3%	14.3%	8.9%	4.2%	6.3%		-17.5%
80 Flex V		4.5%	15.5%	8.7%	4.4%	7.8%		-16.9%
80 Strategic II		5.2%	18.4%	12.0%	7.3%	10.4%	7.9%	-31.1%
80 Strategic III		5.2%	16.4%	11.2%	7.3%	10.5%	8.0%	-27.7%
80 USA tilt		5.4%	16.2%	11.2%	6.9%	10.3%	7.6%	-28.5%
80 Schwab index 2017		5.4%	17.4%	10.6%	7.4%	10.4%	6.0%	-29.3%
Money 75		5.3%	17.0%	11.9%	7.9%	10.4%	6.5%	-32.7%
American Funds Port Ser Gr+Inc		5.2%	18.8%	11.9%	7.6%	11.3%	6.0%	-32.7%
Moderate (60-40)		3.8%	11.7%	7.7%	4.4%	6.1%	4.0%	25.6%
60 Strategic III		4.2%	13.4%	9.4%	6.1%	8.6%	7.3%	-23.3%
60 Schwab index 2017		4.2%	14.0%	8.6%	6.1%	8.4%	5.3%	-23.8%
American Funds Port Ser Balanced		3.9%	16.4%	10.0%	6.5%	9.2%	5.6%	-28.5%
Moderately Conservative (40-60)		2.6%	9.1%	6.1%	3.5%	4.5%	3.6%	-17.4%
40 Strategic III		2.9%	10.4%	7.7%	4.8%	6.5%	6.6%	-16.8%
40 Schwab Index 2017		2.7%	9.8%	5.9%	4.3%	5.7%	4.3%	-16.2%
Hartford Balanced Income A		3.8%	12.2%	9.9%	6.7%	8.1%	7.2%	-18.5%
Conservative (20-80)		1.1%	5.7%	4.2%	2.3%	2.5%	3.2%	-8.4%
20 Strategic III		1.2%	5.8%	5.4%	3.3%	3.5%	4.4%	-9.3%
20 Schwab index 2017		1.4%	6.3%	3.7%	2.8%	3.7%	3.3%	-9.2%
NOTE 1:  Past performance is no guarantee of specific future results.  This data is presented by Potomac Wealth Strategies, LLC.  This data is from Morningstar and should be accurate, but it has not been independently verified.
NOTE 2:  "Flex", "Strategic", and "Index" models are crafted/run by Potomac Wealth Strategies.  They show history of better returns, lower volatility, or both--or, with the Index models, closer tracking--vs benchmarks and competitors.
NOTE 3:  "XX Schwab index" models are relatively low-cost and tax-efficient portfolios.  They are comprised of index funds available free of transaction charges to my clients at Schwab.  This is what many might recommend due to low-costs and portfolio efficiency.
NOTE 4:  Nothing on this blog post is specific investment advice to any individual or organization.  If the information hereon is of interest to you, please send e-mail to Info@PotomacWealthStrategies.com for a consultation.