Time may be right to convert to Roth IRA

Published 7:23 am Friday, March 13, 2009

Do you regularly contribute to a Traditional IRA?

If so, you’re taking an important step toward building financial resources for retirement. But it’s possible that you could take an even bigger step—by converting your IRA to a Roth IRA. And you may have two especially good opportunities to make this conversion in 2009 and 2010.

Before we examine why this may be so, let’s take a quick look at the differences between a traditional IRA and a Roth IRA.

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Depending on your income level, your contributions to a traditional IRA may be tax deductible; regardless of your income, your earnings grow tax deferred. With a Roth IRA, your contributions are never deductible, but your earnings grow tax free, provided you’ve had your account for at least five years and you don’t start taking withdrawals until you’re 59-1/2. However, if your modified adjusted gross income exceeds certain levels ($120,000 per year if you’re single and $176,000 per year if you’re married and filing a joint return), you can’t contribute to a Roth IRA.

Here’s another distinction between the two types of IRAs: With a traditional IRA, you must start taking required minimum distributions (RMDs) when you reach 70-1/2. But if you own a Roth IRA, you are never required to take distributions, so you can let your money grow as long as you can afford not to touch it.

Which IRA is “better”?

There’s no one right answer for everyone. Generally speaking, though, the combination of potential tax-free earnings and no RMDs might make the Roth IRA an attractive choice for most people.

Additionally you have access to the money you put into the Roth tax-free and penalty-free at any time, as long as you are not withdrawing earnings. So, if you have a Traditional IRA, you might wish to convert it to a Roth—if you can.

If your adjusted gross income is more than $100,000, you can’t make the conversion in 2009. Also, keep in mind that any conversion will require you to pay income taxes on your pre-tax contributions to your traditional IRA and any growth in your account’s value.

If you meet the income limits for a conversion in 2009, you might want to consider doing so, because your tax obligation for a Roth conversion might be lower in 2009 than it would have been in previous years.

Following last year’s steep market decline, the value of your IRA may be down significantly—and, generally speaking, the lower the value, the lower the tax bill upon conversion. Furthermore, if your income is somewhat dependent on the state of the economy, you could end up with lower earnings in 2009—another factor that could lessen the tax impact of a Roth IRA conversion.

Even if you don’t make the conversion in 2009, though, you may still want to consider this move next year. In 2010—and in 2010 only—you can convert your traditional IRA to a Roth IRA regardless of your income level.

Furthermore, the income taxes due on conversion can be spread over two years—2011 and 2012.

So contact your financial and tax advisers to determine if a Roth IRA conversion is appropriate for you. Over the next two years, you’ve got a good window of opportunity to make this move—so you’ll want to act before that window closes.