Wednesday, December 30, 2009

Roth 2010: Should You Convert?

Last week I posted this entry discussing changes to IRA’s in 2010. A few days later an associate of mine sent me a link to this article on NCPA.org taking a more detailed look at who would benefit from a Roth IRA conversion. Like any major financial decision, converting your IRA is a big step and you should probably talk to a financial advisor before making the conversion.

Who Would Benefit from a Roth IRA Conversion?

Ostensibly, the benefit of conversion is that the taxes are paid today at a known rate, instead of in the future at an unknown and possibly higher rate. But deciding whether to convert a traditional IRA to a Roth IRA depends largely on the ability to pay the taxes that are due when the conversion takes place. For 2010 conversions, individuals have two years to pay the income tax due. A Roth IRA conversion is ideal for anyone who:

Can pay the taxes using money from nonretirement funds.

Expects that their federal income tax rate when they retire will be much higher than it is today - because their income will be higher and the burden of government will be higher.

Faces little to no federal income tax burden today - so that a conversion would cost very little to complete.

Taxes on a Roth Conversion.

Suppose you convert a traditional IRA to a Roth but take a distribution from the traditional IRA account in order to pay the taxes. Is it worth it? That depends on your current marginal tax rate, income level and how many years you are from retirement. Consider that a distribution from the IRA to pay taxes on the conversion is subject to a 10 percent penalty in addition to federal income taxes if you have not reached 59-and-one-half years.

With these considerations in mind, the table shows the cost of converting $25,000 from a traditional IRA to a Roth IRA and using money from the account to pay the taxes.