Strategic ownership increases IRA value

Question: I have an IRA composed entirely of different stocks and I am over 59 ½ years old. What is the best way to convert to a Roth IRA account? I wish to pay income tax from the existing account. Does the entire portfolio have to be sold or just a portion to cover the taxes because I wish to remain in the stocks?

Answer: They say in California you can never be too rich or too young.

But that's not what they tell us in Washington, D.C - at least not in the halls of Congress, where the rules for Roth IRAs were drafted.

Roth IRAs are such a nifty idea that Congress decided that you actually could be too young and/or too rich to enjoy their benefits. But as long as you are over 59 ½ and make less than $100,000 to $150,000, you qualify.

Roth IRAs are tax-deferred accounts in which a taxpayer may contribute (in 2005) up to $4,000 per person. If you leave the money in the Roth IRA until you reach age 59 ½ (not too young, remember), you can take out all the money plus its earnings (no matter how much) - tax-free.

In a traditional IRA, you get a tax-deduction up front for your contribution, but you pay ordinary income taxes on the money when you take it out, - no matter how high or low taxes are at that time.

Because traditional IRAs have been around for a few decades, rules were drafted that would allow some individuals to "convert" their traditional IRAs to Roth IRAs.

This is the part where Congress doesn't want you to be too young or too rich. You can convert at any age, but your income must be less than $100,000 in the year you convert. And while conversion from a traditional IRA to a Roth IRA does not cause a 10% penalty for those under 59 ½, you still can't touch the money until that magical age.

This next part is a biggie: when you convert from a traditional IRA to a Roth IRA, you must pay taxes on the whole IRA. For example, if you have $100,000 in a traditional IRA and you are in a 20% tax bracket, you will owe $20,000 in taxes for the privilege of conversion.

If you are planning to withdraw funds from your traditional IRA to pay the taxes that will be due, please carefully revisit your calculations. Many times the high tax bill makes conversion too expensive. Better to pay that tax bill with funds outside the existing traditional IRA.

You mentioned that you have a portfolio of stocks in your IRA. You certainly do not need to liquidate the whole portfolio just to take a portion out.

However, if you plan on holding those stocks for a long time, have you considered owning those same stocks outside of your IRA? If you have other assets that could be owned in your Roth IRA (such as presently taxable mutual funds), you might consider holding your more tax advantaged assets (such as stocks) outside the IRA.

Suppose Joe has $100,000 worth of Exxon in his IRA. He also has $100,000 worth of a high turnover mutual fund in a regular taxable account. Joe ought to swap where he keeps those assets by having his IRA (or Roth IRA) buy the high turnover mutual funds, and buy Exxon in his taxable account.

The rules are complex. So along with that bit about never being too rich or too young, you'd better add one: You can never be too careful.