My multimillionaire client Bill called me the other day. He wanted to talk about congress recently loosening the rules about who can convert regular IRA accounts to Roth-IRA accounts.

In the past, because of his income, Bill hasn’t been able to use a Roth-IRA. Starting in 2010, however, even high net worth, multi-millionaire taxpayers like Bill can use a Roth-IRA by converting existing traditional IRAs and IRA-Rollover accounts to Roth-IRAs.

Bill understood he would pay income taxes on the conversion. But wouldn’t it make sense, he asked, to convert a $1,000,000 IRA account he’d been able to accumulate to a Roth-IRA?

A Simple Roth-IRA Conversion Example

Unfortunately, I explained, Roth-IRA conversions aren’t that simple.

But let me share some additional information. Bill will retire in about 25 years. He earns about 9% a year on his $1,000,000 IRA. He also pays the highest 35% marginal income tax.

If he converts, Bill will need to pay income taxes on his $1,000,000 conversion. Because Bill gets taxed as the highest, 35% marginal rate, he’ll pay $350,000 today if he converts. But even so, he will end up with $5,605,002.43 in his Roth-IRA in 25 years. And the sweet thing is, of course, that money will have already been taxed.

Bill thought that sounded great, of course. And I had to agree. More than $5,000,000 tax free. Sweet.

What Happens with a Traditional IRA and No Conversion

I explained, however, that we also needed to compare this Roth-IRA future value amount to what Bill would end up with after tax if he just stuck with his regular IRA.

In that case, Bill ended up with $8,623,080.66.

If he also paid a 35% tax on this money, after paying the income taxes, he would net $5,605,002.43. Which is the exact some number he ends up with if he converts to a Roth-IRA…

Some sort of weird cosmic coincidence? No. Here’s the dirty little secret about Roth-IRAs: If the tax rates stay the same, converting a traditional IRA to a Roth-IRA doesn’t really make sense.

But One Final Roth Wrinkle...

Let me share a final wrinkle related to Roth-IRAs and Roth conversions.

I truly suggest clients like Bill think of Roths and regular IRAs as "six of one, half a dozen of the other" situations. That said, where a person gets the money to pay the taxes on the conversion makes a difference, too.

For example, if a client like Bill uses some of the IRA balance to pay the taxes (this is sort of what my example calculations assume), the taxpayer may have to pay an early withdrawal penalty. That early withdrawal penalty makes the Roth a worse deal. (Conclusion: Don't convert to a Roth unless you've got other, non-Roth money to pay the taxes.)

And here's another example. If a taxpayer uses other funds to pay the taxes, he or she gets a slightly better outcome with the Roth--even if tax rates are the same now and in the future. This Roth-related boost comes from the fact that with a Roth, a taxpayer can save more money in a tax-advantaged account.

Getting Smart about Roth-IRA Conversions

The conclusion? Converting to a Roth-IRA probably makes sense when you expect your tax rates to stay the same or to go up in retirement.

Because most people's tax rates fall in retirement, most people shouldn't use a Roth or convert existing an IRA to a Roth. Even multimillionaires like Bill.