Per Part 1 of this blog post last week, there are dozens of questions that need to be answered when deciding whether a Roth IRA conversion makes sense in your situation. Just looking at, let alone trying to answer, all of the questions is overwhelming and discourages many people from proceeding with one or more Roth IRA conversions.
This is without doubt an area that requires professional analysis and guidance. Even professional financial advisors, however, are often guilty of “analysis paralysis” when dealing with Roth IRA conversions. This term is defined by Wikipedia as:
“…over-analyzing (or over-thinking) a situation, so that a decision or action is never taken, in effect paralyzing the outcome. A decision can be treated as over-complicated, with too many detailed options, so that a choice is never made, rather than try something and change if a major problem arises. A person might be seeking the optimal or ‘perfect’ solution upfront, and fear making any decision which could lead to erroneous results, when on the way to a better solution.”
Roth IRA conversion analysis is a classic situation whereby one can spend an inordinate amount of time preparing dozens of multi-year “what if” projections, changing a single assumption in each scenario with each one being a potentially valid result. Is it necessary, forget about practical and cost-efficient, however, to go through such an arduous process in order to make a Roth IRA conversion recommendation and decision? I personally don’t think this is the best way to approach Roth IRA conversions.
While certain assumptions are important in Roth IRA conversion analysis, we need to recognize the fact that many of them are simply beyond our control. These include, but are not limited to, life expectancy, inflation rates, marginal income tax rates, and investment rates of return. While these assumptions need to be considered, they shouldn’t be over-analyzed since the possibilities are endless, inevitably resulting in analysis paralysis.
It’s also important to recognize that a Roth IRA conversion of any meaningful size is generally not a single event. It should instead be structured as a plan, or series of conversions, over several years in most situations. Besides reducing tax liability attributable to Roth IRA conversions, this approach also minimizes the possibility of unfavorable outcomes, in turn reducing the likelihood of analysis paralysis.
Perhaps the most important consideration in any Roth IRA conversion analysis is to not lose sight of the two main attractions of a Roth IRA that aren’t available to traditional IRA owners:
- Nontaxable distributions
- No required minimum distributions (“RMD’s”)
Analysis paralysis, combined with a natural and understandable reluctance to prepay income tax liability attributable to a Roth IRA conversion, can be a strong deterrent to implementing a prudent Roth IRA conversion plan, especially if one doesn’t understand, or loses sight of, the long-term potential benefits of the plan.