Risk-Sharing Implications for Roth IRA Conversions: Fact and Fiction

35 Pages Posted: 4 Feb 2013 Last revised: 13 Jul 2013

See all articles by Stephen Horan

Stephen Horan

CFP Board of Standards; University of North Carolina Wilmington

Ashraf Al Zaman

Sobey School of Business, St. Mary's University, Canada; Saint Mary's University

Date Written: September 1, 2012

Abstract

We investigate the risk-sharing implications of taxation associated with the option to convert a traditional IRA to Roth IRA. Although the conversion option may create value for savers by potentially reducing their tax burdens, the risk profile of their holdings may change. Delaying payment of the conversion tax creates a leveraged equity position for the taxpayer. We show that the conversion decision depends on the dynamics of the underlying asset, including volatility and its path through time. Moreover, how asset dynamics affect the ultimate payoff depends on the financing source for the conversion tax payment. These factors render some conventional wisdom around conversion unreliable.

Keywords: IRA, Roth IRA, IRA Conversion option, Recharacterization, Risk-return profile

JEL Classification: D91, G11, G2, G23

Suggested Citation

Horan, Stephen and Zaman, Ashraf Al and Zaman, Ashraf Al, Risk-Sharing Implications for Roth IRA Conversions: Fact and Fiction (September 1, 2012). Financial Services Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2210908 or http://dx.doi.org/10.2139/ssrn.2210908

Stephen Horan

CFP Board of Standards ( email )

1425 K Street NW #800
Washington, DC 20005
United States

University of North Carolina Wilmington ( email )

601 South College Road
Wilmington, NC 28403
United States
4342272281 (Phone)
28405 (Fax)

Ashraf Al Zaman (Contact Author)

Sobey School of Business, St. Mary's University, Canada ( email )

923 Robie Street
Halifax, Nova Scotia B3H 3C3
Canada
902-491-6272 (Phone)
902-496-8101 (Fax)

HOME PAGE: http://www.smu.ca/academic/sobey/biographies/faculty/ashraf-zaman.html

Saint Mary's University ( email )

Sobey Building 116
923 Robie Street
Halifax, Nova Scotia B3H 3C3
Canada
902-491-6272 (Phone)

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