Many taxpayers who elected to convert the funds in their traditional deductible IRAs to Roth IRAs in the summer of 1998 converted back to traditional IRAs in September 1998 after the stock market fell (the Dow Jones Industrial Average fell from approximately 9300 to 7500). Many of these taxpayers, after converting back to the traditional IRA, then converted over into the Roth IRA at the lower stock market levels. Treasury Regulations allow taxpayers to undo a conversion and to re-convert at a later date.
a. Explain the rationale for reversing the original conversion and then making the re conversion at the lower stock market level. In your explanation, assume that a taxpayer facing a marginal tax rate of 39.6% converted over $ 100,000 from a traditional IRA into a Roth IRA at the start of the summer of 1998. After the conversion, the stock market declined 20% (that is, the value of the assets in the pension account declined in value by 20% since the taxpayer had invested the plan assets in the stock market). Assume also that the taxpayer has a 20 year investment horizon and faces a tax rate of 39.6% currently and in retirement.
b. Does your answer to part (a) depend on the future performance of the stock market (that is, on R)?