Roth IRA Explained

Converting your Traditional IRA to a Roth IRA is a very complicated question and one that many people will start asking soon when the IRA conversion loophole opens up in 2010. Whether or not you should convert your IRA comes down to several questions and they will help you decide which one is the right course of action.

Paying For The Conversion

When you convert the Traditional IRA over to the Roth IRA, you will have to pay taxes on the amount that you convert. The tax you pay will be your marginal tax rate and you can pay with IRA funds or with outside funds. If you can’t afford to pay for the conversion outside of the IRA, it’s generally accepted that you shouldn’t do the conversion. It’s better to have the larger dollar amount sitting tax-deferred than a smaller dollar amount sitting tax-free. This is also true because your tax profile now, while you are employed, is likely going to put you at a higher bracket than in the future, when you’ll be retired. This assumes that the tax brackets will remain relatively stable, which is never a certainty.

Partial Conversion

If you can only pay for part of the conversion outside of the IRA, certainly consider it. Also be aware that while you could be in the 15% bracket, the conversion itself may have a portion pushed into the 25% bracket. You can use partial conversions to avoid this.

Traditional IRA Was Non-Deductible

If you contributed to a Traditional IRA and were not eligible to deduct the contributions because of a 401(k), your conversion of those dollars will be free (because you already paid the tax). It behooves you to take advantage of the conversion if you would otherwise be ineligible.