As of January, anyone can now transfer funds from a Traditional IRA to a Roth IRA. By choosing to convert your IRA this year, you can benefit from the new change because it allows you to withdraw from your Traditional IRA, covert to a Roth IRA, and then elect to pay the withdrawal tax over the next two years. This is a one-time incentive for 2010, so you need to ask yourself if converting is the correct decision. To help you answer your original question, “Should I Convert My Traditional IRA?” consider these 3 tip to deciding:
Tip 1: Your Future Tax Rate. First, ask yourself; “When I retire, is my tax bracket likely to rise?” Most likely, if you are making good money now, then taking a withdrawal today may raise your tax bracket enough for you to pay more now than if done at a later date. In most cases, after people stop working, their tax bracket tends to go down. So take some time to consider what your financial situation will be like after retirement and make this part of your decision.
Tip 2: Can you pay the taxes? Now consider the following. If you do decide to convert your tradition IRA, do you have enough money outside your IRA to pay the taxes? If you are considering using some of the money in your IRA to pay taxes, then in the long run you’ll be decreasing the amount of tax free money available when you’re ready to begin withdrawals. Basically, if you use $20,000 from a $100,000 in your IRA to pay taxes, then you paid taxes on $100,000 but only have $80,000 of tax free money left in your account.
Tip 3: Spending the money elsewhere. Finally ask yourself; “Am I better off using this money elsewhere rather than using it to pay taxes during an IRA conversion?” If you currently hold debt and later find you are forced to withdraw from your Roth to survive, you may pay a 10% penalty if your Roth account has not been open for 5 years. So if you are up to you neck in credit card and loan debt, or simply unemployed and struggling to make ends meet, it might be wiser not to use on-hand money to convert an IRA.
Conversion is a tough decision and everyone’s circumstances are different. Research and learn what your future tax rate will be, decide where the money to pay the conversion taxes is coming from and make sure that you are not better off using it somewhere else. To read more about the new 2010 IRS rules visit: http://www.irs.gov/publications/p590/ch02.html#en_US_publink1000230961
