: : : : : Personal Finance : : : : :
all answer. Basically you’re determining if you should pay taxes on your nest
egg now or later. What’s best for you
depends on your own tax rate, not rates
in general. Your time frame matters,
too: a conversion makes sense only if
the Roth IRA can grow long enough to
make up for the income tax you must
pay to create it. That can easily take ten
years or more, depending on how your
investments fare. But conversion need
not be an all-or-nothing proposition.
In your 50s, for example, you might put
just a piece of your nest egg in a Roth
that you earmark for spending tax-free
in your 70s or 80s.
;; Do you have cash outside the
IRA to pay the taxes you’d owe?
You defeat your purpose if you steal
from your retirement savings to pay
the taxes. Let’s say you pay the tax
with $25,000 from a $100,000 IRA.
That leaves only $75,000 to earn tax-free income in the Roth.
;; Have you taken care of higher
financial priorities? Consider your
entire situation. If your spouse was
just laid off or you’re still paying tuition
bills, don’t spend your cash on a Roth
conversion. If you’re under 591/2, you’ll
pay a 10 percent penalty for withdrawing converted Roth funds within five
years of setting up the account.
;; Is your personal tax rate likely
to rise in retirement? For many
people the answer is no. If you’re in
your late 50s and earn a substantial
income, you’re in a high tax bracket
now, but your rate may decline after
you stop working. You don’t want to
pay hefty taxes now on money you can
withdraw less expensively later.
Crunching the Numbers
Many free online calculators aim to
help you gauge the wisdom of a conversion. (One of the easiest to understand
is at moneychimp.com; type “Roth conversion calculator” in the search box.)
But you really need a professional’s
help to make this decision. Online calculators give you at best a rough idea of
UNL KE TRADITIONAL IRAs…
; Roth IRAs allow tax-free withdrawals of
earnings after you’re 59½ and have owned
the account for five years (counting from
January 1 of the tax year your account was
; Roth IRAs let you withdraw direct
contributions at any age, without tax or
penalty. If you’re under 59½, however,
conve ted funds can only be withdrawn
penalty-free after five years.
; A Roth IRA doesn’t require minimum
withdrawals after you turn 70 ½. You can
pass the account to your heirs—and they
won’t owe a penny of tax on it, either. —L B.
whether you would come out ahead. At
worst they can mislead you, because of
their built-in assumptions about essential variables—future rates of inflation,
taxation, investment return—and wild
cards such as whether you’d invest the
tax money you save by not converting,
whether you’ll make postconversion
contributions to the Roth IRA, and
whether you’ll withdraw your nest egg
in a lump sum or (much more likely) in
smaller pieces each year.
Yes, it can all be head-spinning, and
no online calculator can address individual costs and benefits. The extra
income you must declare when moving
funds from a traditional IRA to a Roth
could temporarily put you in a higher
tax bracket, or make you ineligible for
tax breaks that phase out as income
rises. If you’re a Medicare recipient,
it could temporarily increase your
Medicare Part B premium. Still, the
prospect of lowering your future tax
bill with a Roth can make these short-term costs worthwhile. And, notes
Barry C. Picker, a Brooklyn, New York,
tax accountant and leading IRA expert,
Roth IRA withdrawals aren’t included
in the income numbers the IRS uses to
determine whether your Social Security check is taxable.
The bottom line: If you’re seriously
considering a conversion, consult with
a certified financial planner or tax
accountant. Expect to pay $500 to
$2,000, depending on where you live
and the size of the firm you use. And
don’t be dazzled by the 2010 tax break.
Despite financial pros’ enthusiasm, this
isn’t your last chance for a Roth conversion. In fact, Picker predicts, many savers will find a gradual approach works
best. “For many middle-class people
in their 50s, I think it makes more
sense to do a series of small annual
conversions,” he says, to minimize the
immediate tax burden. “That’s a more
affordable way to achieve a meaningful
tax-free account in retirement.” ;
Contributing editor Lynn Brenner wrote
about getting the most from Social Security in the September–October issue.