The Skinny on Roth IRA Conversions

I have been highlighting the opportunity that is coming up for CERTAIN investors to take advantage of new provisions allowing conversion of regular IRAs to Roth IRAs. It's not for everyone, but for those for whom it IS appropriate, I believe the savings will be substantial.

As a reminder, here are some Roth IRA basics:

* Contributions to a Roth still carry
income limits ($176,000 for married;
$120,000 if you’re single in 2009).
It’s just conversions that have no
income restrictions.
* Until the end of 2009, conversions
from an IRA to a Roth are limited to
anyone with income of less than
$100,000.
* Contributions to a Roth IRA are
made with after-tax money. In other
words, the contribution is not
deductible. That’s why investors
owe income tax when converting
deductible contributions made to a
traditional IRA to a Roth IRA.
* Contributions can be withdrawn any
time without tax or penalty – this
includes any amount converted.
* Once your money is in a Roth -
whether from annual contributions or
a larger converted amount - it grows
tax-free.
* All profits can be withdrawn tax-free
provided the account holder is at least
59 ½ and the account has been open
at least five years.

Fidelity Investments, as part of its improved "investor-friendly" interface, has a nice article complete with examples,entitled "Conversion Confusion" demonstrating the opportunity. You can find it here.

Pay now or pay later? That is the question if you're weighing the pros and cons of converting your traditional individual retirement accounts to a Roth. The benefit of a Roth is simple: Once you're in, you don't have to worry about paying taxes on that account, ever. Tax-free income down the road, though, comes with a price. And that price can be hefty: In the eyes of Uncle Sam, what you convert is taxed as ordinary income.


A bigger tax bill is probably the last thing you need right now. But ironically, this tough economic environment may make it an ideal time to convert to a Roth. Those smaller IRA balances means you’ll owe less tax. (Talk about a silver lining.) Think your income disqualifies you? As of 2010 the $100,000 adjusted-gross-income cap on Roth conversions will disappear. And, next year — and next year only — investors will have the option of spreading their tax liability over two years.

Despite all of the excitement surrounding the Roth, converting doesn't make sense for everyone. At a minimum, says Chris McDermott, a certified financial planner and senior vice president of investor education at Fidelity Investments, investors should be able to answer “yes” to three key questions: Do you expect to pay a higher tax rate when you retire? Do you plan to hold the account for at least 10 years? Can you pay the taxes owed without tapping a tax-sheltered account?

Even if you do answer yes to all three, there are other considerations, notes Barbara Steinmetz, a certified financial planner in San Mateo, Calif. Among them, how will the conversion affect your overall tax situation? “Just a small amount could make the difference to bump you from one bracket to another,” she says. “My advice is to always run the numbers.”

The Fidelity conversion analysis tool appears to be for subscriber-investors only. Here's one that Wells Fargo makes available to all. I haven't vetted it but these tools should only be used to initially evaluate whether conversion MAY make sense for you. Then, as always, you should discuss your options with your trusted financial advisor or tax professional.