Making good sense of a Roth conversion

Q: To Roth or not to Roth - that is the question. I've read a lot about the big window of opportunity for those with adjusted gross incomes above $100,000 to convert their IRAs to Roth IRAs in 2010.

Fortunately or unfortunately my AGI has never stood in my way to convert to a Roth. One of your recent columns addressing the taxation of Social Security benefits made me wonder whether I should convert now to avoid future taxation of my benefits.

I am single, 65, and live on a modest monthly pension of $1,000 (which just began a few months ago) and my Social Security benefits. I have an IRA valued at about $200,000 and some investments in a taxable account totaling close to $80,000. I think tax rates are going to increase in the future, and I'm concerned that if I let my IRA grow until I'm subject to required minimum distributions, I will have placed myself unwittingly in a position where either 50 percent or 85percent of my Social Security benefits will be subject to income tax.

Who knows - they may raise the percentage to 100! I've asked my investment broker for her recommendation, but she doesn't seem to have a clue about these sorts of issues. I don't think there is a clear-cut answer because of so many uncertainties. One does not know how long one has on this earth, when and how tax rates will change, how much the IRA value will increase (if at all), etc.

My thoughts are to convert half of my IRA this year and the other half next year. I can crunch numbers with the best of them, but I need some direction as to all of the different circumstances and criteria I need to use when assessing the value of converting to a Roth. Any guidance would be appreciated.

A: I'm sure my editor was tempted to steal your first sentence and use it for the column headline - very cute. The following steps should help, but you may want to find an adviser to assist with your personal situation.

The first step is to figure out your AGI if you don't convert. This will let you know what additional taxable amount you can have without subjecting your Social Security benefits to tax. To do this, add your pension, 50 percent of your Social Security benefits, other taxable income (interest, capital gains, dividends) and any tax-exempt interest to find the "combined income" amount used to determine taxable Social Security benefits. Subtract $10,750 from this amount if you are claiming one personal exemption of $3,650, and the standard deduction of $7,100 when filing your tax return.

If this amount is less than $25,000, additional income up as much as $25,000 will not affect the taxation of your Social Security. If this amount is $25,000 to $34,000, 50 percent of your Social Security will be subject to tax. If this amount is $34,000 or more, 85 percent of your Social Security will be taxed.

Next, project the growth of your IRA using a modest rate of return (6 to 7 percent) from now until you are 701/2. The current factor to use for age 701/2 RMDs is 27.4. Divide the future value of your IRA by 27.4 to determine your projected required minimum distribution, and using step one above, see how this additional taxable amount may affect taxation of your Social Security benefits. The higher the value of the IRA, the greater the chance that the RMD will cause taxation of Social Security benefits. If the RMD will cause your Social Security benefits to be taxed, determine and make note of the amount of additional tax you will pay.

If the RMD will not cause your Social Security to be taxed, a conversion probably doesn't make sense, and you needn't go any further.

If you think a conversion may make sense, your next step is to compute the additional amount of tax you will pay on the converted amount. The converted amount will be included in the "combined income" calculation to determine taxable Social Security benefits, and it may cause your Medicare premiums to increase in future years.

In 2010, most Medicare beneficiaries will continue to pay $96.40 a month for Part B. For those just beginning Medicare, it will be $110.50. If your income is higher than $85,000 (single) or $170,000 (married, filing jointly), your premium might be higher. The IRS reports the income-related monthly adjustment amount to the Social Security Administration. Depending on the amount that theIRMAA exceeds the above income limits, your monthly Medicare Part B premium might be increased by $44.20 to as much as $243.10 a month. Social Security uses income reported two years prior to determine your premium. A conversion in 2009 may affect 2011 premiums. Large RMDs also will affect future Medicare premiums.

Once you know the projected costs if you don't convert, and the cost of the conversion, you must compare these costs. In the analysis, money used to pay the conversion cost must be assumed to have an after-tax earnings rate, and this money could be used to offset any increased taxes owed because of not converting.

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