Here today, gone next month

October caused huge shift in retirement outlook

Jane Anderson, a retired database manager, had a Money Makeover in September, but by the end of October, the results had drastically changed. (Mark Wilson/Globe Staff)

Want to know what the recent turmoil in the markets can do to your financial planning?

Consider the case of Jane Anderson, a 73-year-old retired database manager. In September, the Hopkinton resident sat down with fee-only planners at Waltham-based Pillar Financial Advisors for a Boston Globe Money Makeover. Back then, the numbers indicated that by converting her traditional individual retirement accounts to a Roth IRA, Anderson could likely live to be 100 without ever running out of money.

Today, she's only got about a 50 percent chance of hitting her centennial with money in the bank. What happened? Tumbling financial markets wiped out roughly $250,000 of her investment assets. Last week, financial planners Beth Gamel and Kathleen Kenealy redid Anderson's numbers to reflect that new reality. They found that the Roth conversion wasn't quite the "slam dunk" it appeared to be in the first analysis.

Anderson initially applied for a make over to figure out if she should take advantage of coming tax law changes to convert her traditional IRAs to a Roth. Starting in 2010, Uncle Sam will do away with the annual income limits that currently prevent anyone with more than $100,000 of modified adjusted gross income from converting to a Roth. Additionally, people who convert in 2010 will have the option of spreading federal income taxes triggered by the conversion over the next two years. That's like getting a big one-year interest-free loan for half the tax bill.

To see what would happen to Anderson's assets over her lifetime - which thanks to family longevity could easily reach 100, she said - the Pillar planners did a series of projections. Initially those calculations showed that if Anderson took no action, she had a 22 percent chance of outliving her money. But by converting all her IRA money to a Roth, the likelihood of running out of money dropped to zero.

"We were shocked," Gamel said at the time. "We did not expect that over time this would be such an attractive option."

When the Pillar planners reran the numbers, they found that the percentages had changed, but the advantages of converting had not. Since she was starting with 25 percent less money, Anderson's likelihood of outliving her money after a Roth conversion rose to 49 percent, but if she stays the course with her current IRAs she'd face a much scarier 61 percent chance of running short.

Here's why. Both types of retirement accounts allow money to grow tax-free. Withdrawals from traditional IRAs, which are generally funded with pretax dollars, are taxed as regular income. After decades of tax-free growth, withdrawals from traditional IRAs can produce some significant tax bills. But withdrawals from Roths, which are funded with after-tax dollars, are free of both income tax and minimum distribution requirements. In order to convert, however, you need to pay income taxes on every dollar moved from a traditional IRA to a Roth. That can mean a very big tax bill.

In Anderson's case, the federal and state tax bill for converting all of her IRA assets - which now total about $322,000 - to a Roth is estimated to be a whopping $129,000. But that number doesn't look so daunting when compared with what she would otherwise pay in taxes during her lifetime. Under the scenario where Anderson sticks with her existing retirement accounts, IRA distributions alone would generate income tax bills totaling about a $429,000.

But the potential tax savings is even greater. In most cases, anyone older than 70½, must take annual required minimum distributions from their traditional IRAs based on IRS tables. If Anderson holds onto her current IRAs, required distributions would thus reduce her tax-deferred retirement accounts and extend the life of her taxable accounts. The result would be a bigger tax bill. Under a Roth, however, there are no required minimum distributions, so Anderson could spend down all her taxable assets before ever tapping the Roth. Indeed, the Pillar projections show that by 2017 Anderson would virtually stop paying income tax, since her only remaining assets would be in her Roth.

Add it all up and the scenarios show Anderson paying $582,000 in income taxes if she chooses not to convert, compared with just $197,500 if she goes ahead with the conversion. That's a savings of about $384,500 over her projected lifetime. And if the stock market recovers and the value of her portfolio increases, the savings will be even greater.

"Not having to pay taxes really does make a big difference," said Kenealy.

The big gamble, of course, is Anderson's longevity. Family genetics may be on her side, but the numbers don't look as good if she falls short of her mark. The most recent projections show that the Roth doesn't actually start to be a better deal until Anderson turns 95, two years longer than the original analysis, which put the break-even mark at 93 years.

Having looked at both sets of numbers, Anderson still likes the idea of converting in 2010.

"Both the best case and the worst scenarios still show that I should do it," she said. The big question now, she said, will be whether she will be able to come up with the money to pay the taxes if the stock market doesn't recover.

Jane Anderson
Goal: Adapting her financial planning to a volatile market.

Planning issues:
Money makeover calculations done in September showed that converting traditional IRAs into a Roth IRA in 2010 would provide significant advantages.

Recent market volatility, however, wiped out 25 percent of Anderson's holdings.

Revised calculations now project Anderson having $2 million less at the age of 99 than the initial analysis.

Recommendations from fee-only financial planners Beth Gamel and Kathleen Kenealy: Consider both sets of calculations before converting since conditions will likely change by the targeted 2010 conversion date.

Understand that recent market losses may require belt-tightening, particularly in the early years, if Anderson is to avoid running out of money.

Remember that it will take roughly 22 years to hit the break-even point, so explore how a Roth would fit into any estate planning.