RSY IV...Roth Conversions.

Very shortly we will be publishing our Rock Solid Yield portfolio here at The Sabrient Blog. But before that, I wanted to address an issue outside of the normal dividend yielding stocks issues but an issue that is still important when considering long term investments. In this post I want to cover some of the problems when converting a retirement account to a Roth IRA. The impetus for such an interest was a couple of recent articles that downplayed the benefits of a Roth conversion.

The first article is from Market Watch at Why You Shouldn't Convert to a Roth IRA. Annie Gasparro provides 5 important reasons why someone would not want to convert.

1. The tax bite is too big.
It more than likely is too big if there is not extra funds available to pay for the additional tax burdens. But considering that for 2010 tax year the burden can be divided up in 2011 and 2012 then it still might be worth considering how to pay the additional taxes. Another consideration is to think about the actual tax burden you face today versus an uncertain future. For example, the Making Work Pay Tax Credit helps reduce the tax burden for two years for middle to low income earners. There are a multitude of reasons that present income and thus marginal tax rates might be lower now and thus an important consideration when deciding the best financial moves now and in the future.

Along with taxes it is important to consider any effects it will have on benefits. Robert Powell provides some important considerations also at 12 traps to avoid when converting to a Roth. The two points that relate to the benefits side is first it might alter your Medicare costs and Social Security taxation rates and it may affect family eligibility for financial aid. Both have more to do with life cycle decisions and thus more to do with timing of conversions.

2. Retirement is too close.
The scenarios all point to very little to no benefit for near to retirement or retired individuals or couples. The one outside move is to do it for purely bequeaths motives to help benefactors in their tax issues. Fidelty also notes the importance of time to reap the full benefits of conversion as one of 3 considerations.

2. Time—The relative benefits of conversion will increase the longer your money remains in the Roth IRA. Generally, conversion may not make sense if your time horizon is less than five years as amounts withdrawn are subject to a 10% penalty. {Factors to weigh when considering a Roth IRA conversion}

3. The investor's savings are too concentrated.
This is another aspect of age. It is a lot easier for a young person to start planning for retirement and then adjust so that not all his/her eggs are in one basket. Gasparro does point out that partial conversions might be a good compromise but also there are other ways to reallocate assets and consider ways of diversifying income streams. For example many are considering partial retirement now as a result of the recent financial crisis. That is working part time that will pay for most bills along with SS checks and then that allows delaying the time to take out retirement funds. This would reduce the penalties for concentration indirectly.

4. Tax brackets often change in retirement.
True, it is expected that income tends to be lower in retirement age, but there is something to be said for the Federal debt is getting out of hand and that marginal tax rates are likely to "creep" higher and affect people in lower income brackets over time. This uncertainty each of us as individual investors must address. Although on the counter argument, there could be a shift from income tax burden on society to more of a consumption tax which would favor the traditional choice over time. But that scenario of a value added tax is hard for me to see it coming to full fruition.

5. The income can change your tax bracket now.
Again, if someone is close to or is of retirement age then a Roth conversion is not likely to make sense unless for bequeathment purposes to individuals. These issues are addressed in the second article to catch my attention from the Wall Street Journal titled Is a Roth IRA Safe From Taxes? Along with addressing the issues of estate planning, Laura Saunders also talks about tax burden changes and the VAT and the headline issue of whether social contracts are secure in the face of budget constraints. The last seems more like a headline searching for a controversy. Because ultimately Congress could in fact do anything if the Roth rules and regulations are for naught. In fact I can think of many ways they could in fact make any choice we make now merely random decisions. Take for example taxing Traditional IRAs at double the tax rates. Makes as much sense.

The Generalities Sound Great but What about My Situation?
There is no definitive answer for any individual as there are risks and uncertainties about the future but I did explore three web sites that provide a questionnaire and results that can help determine if the Roth conversion is right for you.
1. Fidelty-Convert to a Roth IRA Factors to weigh when considering a Roth IRA conversion

2. Roth IRA Conversion - T. Rowe Price

3. Should I Convert To A Roth IRA? - Financial Calculators from CalcXML

Ultimately, you may want to consult a tax specialist. Also a tax software package may provid valuable information even if you do not use them to file with. Last year before converting, I used a tax program and entered my estimated incomes without any deductions and got a rough estimate of the highest possible taxes and then experimented with different amounts of dollar amounts converted {partial conversion rates}. After being happy that I could afford the conversion, I went ahead and did a partial conversion.

It might be helpful to try the various tests above with different scenarios and see if one provides a tilting point to when a decision to convert transitions from positive to negative. Each of the questionnaires have a slightly different algorithm for analysis so looking at the questions and determining the underlying assumptions might be a way to see which scenarios would fit your expectations more closely. For myself, all the tests resulted in positive results from the conversion but varied to the amounts of benefits as expected with most providing clear signals to the upside benefits.

At 7 Things To Know About The 2010 Roth IRA Conversion Rules, Jeff Rose touches on issues related to cost basis. This is important to keep in mind even if your broker will provide this information as stocks can also be converted. For example a person could covert the stocks that have done poorly recently but are expected to do better in the future. Which might result in lower tax bills now and higher gains in the future. Just another opportunity to adjust portfolios.

I close with one more link that presents the story of a couple and their factors that helped them to decide to do a Roth conversion at Kiplinger titled Switching to a Roth Makes Sense Now
Pay Uncle Sam upfront and get tax-free income in retirement. I hope you find the story interesting and as germination of some ideas.







Misc. Links {RSY V}:
The Dividend Play for a Lifetime (BWLD, CMG, FTR, MCD, NLY, PG, YUM)

Dividends Are Back - Investing - Stocks - SmartMoney.com

Are You Missing Out on Dividends? (IBM, KMB, KO, PCG, PG, PSA, SBUX)

Going down with the ship Commentary: Investment business is losing a generation of investors

Is This Really the Best Dividend Stock?

Strategies - Head for the Hills? No Way, Says Jeremy J. Siegel - NYTimes.com

Dividend Report Card: Coca-Cola (KO)

Think Twice Before Diving for Dividends (WY)

Dividend Report Card: Microsoft

Roth Conversions:
Is a Roth IRA Safe From Taxes? - MarketWatch
Duplicate: Is a Roth IRA Safe From Taxes? - Personal Finance - Taxes - SmartMoney.com

Portfolio rebalancing: How to do it right New study finds that using a time and target strategy may work best

Fidelty-Convert to a Roth IRA Factors to weigh when considering a Roth IRA conversion

Roth IRA Conversion - T. Rowe Price

Should I Convert To A Roth IRA? - Financial Calculators from CalcXML

Switching to a Roth Makes Sense Now Pay Uncle Sam upfront and get tax-free income in retirement.

7 Things To Know About The 2010 Roth IRA Conversion Rules

Switching to a Roth Makes Sense Now Pay Uncle Sam upfront and get tax-free income in retirement.

ISM June...Depression III, Double Dip Recession, Cooling or Slowing Economy???

The Institute of Supply Management (ISM) has again graced us with another two reports on the Manufacturing and Non-Manufacturing ISM Report On Business®. In this and other posts on the ISM, we wish to delve deeper into the raw numbers and get a better degree of understanding of the underlying currents in the macro-economy. Along the way let us also look at other voices and opinions of the macro-view.

Headline Numbers of ISM Report On Business®.
The PMI index {manufacturing index} was reported as 56.2% and NMI (non-manufacturing index/composite index) was reported as 53.8%. Both numbers missed Market Watch's Economic Calendar consensus numbers with ISM Manufacturing consensus at 59% and Non-Manufacturing at 55.3%. Econoday reports ISM Mfg Index as 59 consensus and the range as 57.6 to 59.7 and ISM Non-Mfg Index as 55 consensus and the range as 53.5 to 56 which indicates that only non-manufacturing fell within the range of consensus.

Both reports are remarkably similar in that the composite chart is marked most prominently in "Slower" under the rate of change. The indexes and indicators are mostly growing but are growing at a slower pace. Considering the number of months of trending growth especially in the manufacturing report, this slowdown could just be head winds slowing progress or just a small hill that will easily reverse and accelerate the growth in future months. I am just not certain that the slow-down is worth wringing hands over, but could easily frighten the equity markets as they appear to have done recently. Econoday notes the possible reaction from markets.

Today's report is not good news for the stock market which may continue to discount economic slowing for the months ahead. Today's report will also increase talk that new rounds of government stimulus may be in order.

Not sure another stimulus is a prudent move at least at this time. I also want to quote from both reports on the recent cooling episode.

Peak growth may have already come and gone, a worry of the global markets and indicated by the ISM's June report on non-manufacturing.
...
The acceleration in manufacturing cooled but only slightly in June, according to the Institute For Supply Management's composite index which slowed to 56.2 from May's very strong 59.7.

Details, Details, Details.
The one number that was a relief that it was trending lower was prices, which was noted in both reports. Prices for both the manufacturing and services industries are still increasing but at a slower pace with the drop significant in both reports. Manufacturing had the biggest drop from May's 77.5 to June's 57 and non-manufacturing dropped 60.6 to 53.8 respectively and from April's high of 64.7. The manufacturing price index was a sudden drop off and was reported that it was mostly due to stable fuel and energy prices while non-manufacturing is seeing a more stable trend line over the past 3 months with more firms experiencing lower prices and lesser firms experiencing higher prices. At least in this indicator, a slowing of growth is a welcome sign especially considering the high index numbers the reports have shown this year.

Probably the one most disappointing number in both reports was the employment index for non-manufacturing that reversed trends for growth and began "contracting" to 49.7 from 50.4 with the index treading water right around the 50 mark for most of the year. But we also should note that the percentage of respondents with higher employment is greater than the respondents with lower employment and the report notes that 8 industries reported increased employment while 7 reported decreased employment.

Employment in manufacturing maintained its very positive index at 57.8 which was 2 percentage lower than what was reported for May. Mish's Global Economic Trend Analysis considers the reports pessimistic at best and that the non-manufacturing report is more important considering the economy is more concentrated in services sectors. But growth in employment does not necessarily have to come from the prominent sector. The US and most high income countries are in a post-industrial age so it is right we are not going back to the manufacturing society as our parents and grandparents experienced but manufacturing could lead the way to greater investments and thus economic growth.

The New York Times has a piece that could put a wrench in reducing unemployment in the manufacturing sector Factories Ready to Hire, but Skilled Workers Scarce. Even with so many manufacturing workers out of work there is still a "mismatch between the kind of skilled workers needed and the ranks of the unemployed." From other reports young people are also unwilling to make manufacturing their career choices and has left the US with an aging but skilled work force without much of a younger class of workers. I can understand their desire to avoid uncertain long term job prospects. Who would want to learn CNC machines if that is suddenly outsourced or becomes obsolete as these skills are not very transferable.

The difficult choices we have as a nation is how to transfer our skill sets and endowments to a future "undiscovered country". What actions now will result in an optimal solution for now and the millions of unemployed and the future workers? One way is to "prime the pump" with simple Keynesian stimulus and another is to look for structural rigidities in the economy that prevent transitions from one set of economic factors to another. One such tool for transition is immigration. I believe that the industrial revolution would have been more difficult in the US without immigrants. Immigration has also allowed our economy to structurally change through the decades and thus to greater economic growth.

With that in mind, it becomes obvious that plans such as those pointed out by the Wall Street Journal at Global Recession Led to Stricter Immigration Rules is not sound economic thought. Even if other countries decide that limiting freedom of labor to move around, does not indicate that we should follow the same path. Just as long term capital is more productive if allowed to find the most productive places, free flow of human capital will increase productivity. Just as the New York Times article talked about the mismatch, some of that skills and human capital could be imported. Reducing backlogs in employments in certain areas which will increase investment spending and thus create exogenous increases in absorption into the economy. The exact result that is desired from another stimulus package. The authors of the report from the Federal Reserve Bank of Dallas note this in the following statement.

“These could impede countries’ ability to recruit workers in sectors vital to their recovery and long-run economic growth,” the authors say.

What portents do the reports hold?
New orders for both manufacturing and non-manufacturing slowed but were both in growth territory at a strong 58.5 and 54.4 respectively. Manufacturing is just a reversal of the lofty last two months both at 65.7 but non-manufacturing is showing a slowing trend since March from a high of 62.3.

New export orders for the manufacturing sector remained strong at 56 even with a drop of 6 points from last month. Imports remained the same level at 56.5 for manufacturing while non-manufacturing imports dropped to 48. This contraction {under 50} in non-manufacturing imports has also shown up on the new export orders at the same 48. This is one area that manufacturing is more important than non-manufacturing as goods and commodities are still the biggest segment of international trade.

On a side note, I have maintained that construction is not likely to be the impetus to economic recovery {aside from possible Federal stimulus in roads, etc} and so this report on U.S. Office Vacancy Rate at 17 year high indicates that office construction is not likely to change in the near future. Industrial and retail spaces are also on the rise. HT to Paul Krugman at More On Low Business Investment for graph below.


Where is the 3rd depression as the title indicated?
Paul Krugman is actually predicting The Third Depression. As we see from the ISM reports nothing seems to indicate that going forward and we should continue modest growth for the foreseeable future. He is right that unemployment is at too high of levels and if that is the basis for describing the current situation as a depression then it might also be worth considering. He is also right that inflation is not something that should be overblown and that we still face possibilities of deflation as the Capital Spectator noted at DEFLATION RISK IS STILL RISING.

But unlikely that the austerity measures enacted will eliminate all deficits. The IMF and most austerity programs just try to lower the level of debt as a percentage of GDP over time. Thus, this still leaves room for fiscal stimulus, but not on such a grand scale. The question to consider is whether there is marginally reducing benefits from fiscal stimulus. The case example is Japan and not sure anyone can say that more stimulus would have achieved faster growth rates in the 90s and the 00s. Even Krugman at the time questioned Japan's fiscal policies and noted the following at TIME ON THE CROSS: CAN FISCAL STIMULUS SAVE JAPAN?

What continues to amaze me is this: Japan's current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do - even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe. Meanwhile further steps on monetary policy - the sort of thing you would advocate if you believed in a more conventional, boring model, one in which the problem is simply a question of the savings-investment balance - are rejected as dangerously radical and unbecoming of a dignified economy.

Many have stated that "deficits" do not matter and that is correct in a Keynesian world as the deficits are compensated by surpluses in expanding years. And as we know that is rarely invoked as the drive toward 0 unemployment is unabated in politics. At some time though debt overhang is a concern and needs to be addressed. Also with larger and larger resources in the hands of the Federal Government then it stands to reason that less is available for individuals and businesses to invest and grow the economy. Does too large of central government prevent transitions to the undiscovered country? And does this also create structural rigidity which prevents flexibility of an economy that allows this transition in time?

At the beginning of the year, I predicted unemployment would not go significantly below 9% and just recently the IMF seems to be saying a similar tune as noted at Market Watch, IMF says U.S. on mend but job rate to stay high.

The U.S. economic recovery is becoming increasingly well-established but the unemployment rate will stay above 9% through 2011, according to a report from the International Monetary Fund released Thursday. The U.S. economy and financial system have made great strides in recovering from the Great Recession, but more work needs to be done, the IMF said. "The outlook has improved in tandem with the recovery, but remaining household and financial balance sheet weaknesses --along with elevated unemployment -- are likely to continue to restrain private spending," the IMF said. Important parts of the banking system remain vulnerable to shocks, even though the financial reform legislation would make major steps to close gaps in the regulatory system, the agency said. The European debt crisis has tipped risks to the downside because of potential financial market disturbance, the IMF said.

That is one number I hope we are wrong about in the positive direction and that the unemployment rate will go down sooner. I close with one more link worth reading about what the IMF has recently said and suggested for the USA at U.S. economy recovering well but risks remain.


Calculated Risk: ISM Non-Manufacturing Index shows slower expansion in June
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Fiscal Stimulus: Too Little or Ineffective? What Next? | Building Capacity through Rethinking Development

I’m Gonna Haul Out The Next Guy Who Calls Me “Crude” And Punch Him In The Kisser - Paul Krugman Blog - NYTimes.com

June ISM services index declines to 53.8% - MarketWatch

Bleak Outlook for Long-Term Unemployed - Economix Blog - NYTimes.com

China manufacturing PMI shows growth cooling Economic Report - MarketWatch

Misc. Links:
Shovel-ready, revisited

Worse Than 1982? - Economix Blog - NYTimes.com

Manufacturing Rebound Slows Down - Economix Blog - NYTimes.com



Obama Talks Jobs and Stimulus Grants - Washington Wire - WSJ

EMPLOYMENT REPORT | Angry Bear

Macroeconomics Doubtbook, Installment 3, Arnold Kling | EconLog | Library of Economics and Liberty

Economist's View

Dean Baker Is Advice From the IMF Better Than Advice From a Drunk on the Street?