In 2010, income and filing status restrictions have lifted to allow anyone to convert a Traditional IRA into a Roth IRA. Converting from a Traditional IRA to a Roth IRA means that while you will pay taxes on your pre-tax contributions and any earnings from a traditional IRA now, withdraws made from your new Roth IRA in retirement will be tax free. Even better, Roth IRAs do not have mandated Required Minimum Distributions like Traditional IRAs have, making them a great tool for estate planning or as a long term tax deferred savings vehicle.
Remember that the tax liability for conversions done in 2010 can be spread out over years 2011 and 2012 as well. After 2010, taxes will be due in full the year the conversion is made.
So should you consider converting? Think about the following…
Market Value of Your IRA. If you have experienced significant losses in your retirement account, now might be a good time to consider converting your Traditional IRA to a Roth IRA. This is because you will be paying taxes on a smaller amount of money. As the market hopefully improves, you can enjoy your tax free ride inside the Roth.
Time Period. In general, the longer you plan to keep funds invested in your Roth, the more beneficial it becomes to convert. There are calculators online to illustrate “break even points” of a conversion, or ask your tax advisor or financial planner to assist you with this.
Tax Bracket. If you believe you are in a lower tax bracket now than you will be at retirement, it could make sense to pay taxes now rather than later. This is the same argument as to why young workers should invest in a Roth IRA before they invest in a 401-k retirement plan or Traditional IRA.
Diversification. It could be advantageous to hold various types of tax advantaged retirement plans such as both pre-tax and post-tax accounts for diversification purposes.
So, is converting your IRA right for you? You can try these online calculators to help you see various conversion options:
This is a weekly featured post on Own The Dollar from Sara Peak, a Certified Financial Planner and a veteran of the finance industry. In addition to her monthly “Money Matters” column in Kentucky Living magazine, she also writes about money and personal finance topics on her blog.
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