Greetings,

 

 

          For some people with Individual Retirement Accounts ("IRA"), now may be a good time to convert a traditional IRA to a Roth IRA.  A traditional IRA is funded with pre-tax dollars so contributions are deducted on your income tax return and you don't pay tax on them when you contribute.  However, the distributions you take from a traditional IRA in retirement will be taxed.  Conversely, a Roth IRA is funded with after tax dollars so your contributions cannot be deducted on your income tax return and you do pay tax on them when you contribute.  However, the distributions you take from a Roth IRA in retirement will not be taxed.

 

          There is also a substantial difference between the distribution requirements for a traditional IRA and a Roth IRA.  With a traditional IRA the owner must start taking distributions at age 70 ½ and the distribution amount is based on the owner's life expectancy.  Therefore it is likely that a traditional IRA owner will withdraw (and pay tax on) a large portion, if not all, of his IRA before death.  Conversely, a Roth IRA has no required minimum distribution.  For an owner who may not need the funds during retirement this feature will allow the money to continue to grow tax free and then be passed to the owner's heirs.

 

          Why would you want to convert your traditional IRA to a Roth IRA now?  The current top marginal income tax rate is 35%.  Given our current economic and political climate and soaring deficits it is possible that the income tax rates will increase as soon as 2010 and it is very likely that the rates will be higher when you retire.  If you plan to work into retirement or if you will have a substantial amount of taxable income in retirement, it may make sense to pay the tax now at the relatively lower rate rather than in the future when those rates are likely to be higher.  If tax rates increase by 10% there may be considerable savings if you convert now and you don't plan to retire for 10-20 years.  If tax rates stay the same or only increase by a small amount there may be little to no savings, especially if you are close to retirement now.

 

          Also, when you convert, you pay tax on the balance of the IRA on the date of conversion.  For many people, their IRA balance has dropped significantly over the past year so making the conversion now means you are paying taxes on a greatly decreased IRA account balance.  Furthermore, because of the state of the economy and the stock market many people have losses to report on this year's tax return.  If you have losses and if you are otherwise a good candidate for converting your traditional IRA to a Roth IRA, you may be able to offset some of the tax liability from the conversion against your losses and reduce or even eliminate the tax due on the conversion.