You’ve probably noticed an avalanche of advertisements from mutual fund companies and brokerage firms about the opportunity to convert your Traditional IRA to a Roth IRA in 2010. This opportunity is nothing new, as investors have been converting traditional retirement accounts to Roth accounts for more than a decade. The difference this year is that investors can convert to Roth accounts without income limitations. There is no guarantee that the ability to convert to a Roth will continue past 2010, so it’s worth taking a look at.
Fidelity, a giant in the retirement account business, reported that there were four times as many Roth conversions in January of 2010 compared to 2009. The number of conversions was expected to increase this year but the rate of the increase has exceeded most expectations. Just because you can convert your Traditional IRA to a Roth this year doesn’t mean you should and there are three types of investors that should probably avoid a Roth Conversion altogether.
People Who Can’t Cover the Tax Liability: If you convert to a Roth IRA, you’re responsible to pay income taxes on the converted amount since the money was put into a qualified account on a pre-tax basis. You have two choices for paying the taxes if you convert this year. You can either pay the entire amount owed with your 2010 taxes or you can spread the amount owed over the 2011 and 2012 tax years, paying at the prevailing rates in those years. There’s a temptation with a Roth conversion to simply use money in the IRA account to cover the taxes. If you’re in the 35% tax bracket with an IRA worth $100,000 and you cover the tax liability from the IRA balance, your Roth IRA will be worth only $65,000 and it will take a lot of solid years in the stock market to make up for that deficit.
People Nearing Retirement Age: One of the things you want to have on your side if you’re considering a Roth Conversion is time. Tax Free Income is great but if you are within a few years of beginning to take income from your qualified account, you’ll probably come out ahead if you keep your traditional account intact instead of converting. There are plenty of tools available online to help you analyze whether or not a conversion is a wise financial decision.
People Leaving Their IRA Dollars to a Charity: A Roth IRA is great to inherit because beneficiaries can receive the money on a tax-free basis, so a Roth conversion makes a lot of sense if you don’t anticipate needing the money in your IRA during your lifetime. If your beneficiary is a charity though, tax-free income is meaningless since they are exempt from paying taxes on money that’s donated to them. If you’re not sure about who will receive any money left in your IRA when you die then a Roth conversion might make sense, but if you’re sure about your desire to leave money to a charity then your best bet is to stay away from a Roth conversion
