Should you convert to a Roth IRA?

CarolinaFireJournal - CHARLES FLOWERS
04/26/2010 -

For many, the funding of a Roth IRA has not been an option for saving for retirement. However, since January 1, 2010, a new opportunity is available for those interested in a Roth IRA. New IRS rules are making it easier than ever to convert to a Roth IRA. All taxpayers are now eligible to convert a traditional IRA to a Roth IRA, regardless of income or filing status. In addition, individuals can convert some types of qualified retirement plans, including 401(k) plans, profit sharing plans, governmental 457(b) plans, and 403(b) plans. A Roth conversion allows individuals to convert future taxable income to future tax-free income.


 Why convert to a Roth? A Roth IRA allows for more flexibility than a traditional IRA. For example, contributions and earnings on the contributions to a Roth IRA are not taxed when withdrawn upon retirement, and the RMD law (Required Minimum Distribution at age 70.5) does not apply to funds in a Roth IRA. In exchange for the future tax breaks afforded by a Roth IRA, the amount converted into a Roth IRA is typically taxed as ordinary income in the year of conversion. A short-lived plus is conversion to a Roth in 2010 which allows for the tax to be spread over two tax years — 2011 and 2012. If conversion to a Roth takes place after 2010,  all taxes must be paid in the conversion year.

Keep in mind that a Roth conversion might not be right for everyone. Look at the pros and cons of a conversion based upon your unique situation. Several factors need to be considered. If any one of the following applies to you, you might want to consider a Roth conversion:


Consider whether or not your tax rate could be higher in retirement than it is today. We have no idea what future tax rates will be, but it is possible that tax rates across the board are currently low relative to where they might be in the future. If you don’t have enough money to pay the taxes on the conversion of all of your tax-deferred assets, or if doing so would push you into a higher tax bracket, you might want to consider converting a portion of your assets.


Consider how much time you have before you need to withdraw the money from your IRAs. Generally, the younger you are, the more beneficial a conversion will be because you will have more years to recover the tax bill. As mentioned earlier, Roth IRA savings are not subject to RMDs during your lifetime, giving you the opportunity to create a greater legacy for your loved ones.


Consider whether or not you can pay the taxes on the conversion from non-retirement assets. Using cash outside the IRA adds more leverage to the conversion, although you can still benefit from a Roth conversion by using IRA assets to pay the taxes.

The internet offers several Roth conversion calculators and other tools to assist investors in determining whether converting retirement assets to a Roth IRA makes sense. Be advised that these internet calculators may not be as accurate as those available to financial advisers. The calculators found in planning software developed specifically for financial advisers tend to be more sophisticated because they allow the adviser to make adjustments to individuals’ tax rates and withdrawal rates in addition to assumed inflation rates. The basic calculator generally does not allow for these adjustments and may provide a very different answer from a calculation prepared by a professional financial adviser.

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