Just Because You Can, Doesn't Mean You Should
By Russell Dunkin, CFP®
2/12/2010
By now you've probably seen more than a handful of advertisements or solicitations encouraging you to convert your Traditional IRA into a Roth IRA. If you haven't, take a moment to Google Roth conversions and see how many ads and articles appear, extolling this opportunity.
Why all the hype?
2010 marks the first time anyone with more than $100,000 in modified adjusted gross income can convert Traditional IRA assets into a Roth IRA. Prior to 2010, only those with income below $100,000 were able to convert funds from their IRA's.
Why would someone want to convert in the first place?
The primary reason comes down to the tax benefits of each type of account. Traditional IRA's, and 401k's, offer tax deductions on your contributions, and grow tax-deferred, but are ultimately taxed at ordinary income rates when distributed.
The tax impact of Roth IRA's is essentially the reverse. Any money contributed goes into the account after your income is taxed, grows tax deferred, and is distributed in retirement on a tax free basis. By converting from Traditional to Roth, you pay current income taxes on the amount converted today, so future years the funds grow tax free.
The decision to convert comes down to a variety of factors. Unfortunately, the financial services industry has whipped up the Wall Street marketing machine to encourage anyone and everyone to "take advantage" of this opportunity.
How should you determine if it's right or not for you?
First, you need to think about your current tax situation, and where you think you'll be in retirement. There are really two considerations here. Do you think you'll earn more money in the future, and therefore pay taxes at a higher rate? If so, conversion could make sense. The second consideration is your prediction for future tax brackets themselves. If current, or future administrations, raise marginal tax brackets after you convert, it may be a smart move as well.
Other considerations include how long you plan on leaving the funds in the account. If you plan on spending the funds in the next 5 to 10 years, it probably doesn't make sense to convert. If you are nearing or in retirement, and are confident a portion of your retirement assets won't be spent in your lifetime, it could make sense to convert. In this example, your family may have many years for the assets to grow tax free.
Finally, if your situation is not clear cut, you may want to err on the side of caution, and not convert. Because many of these variables can not be known, conversion may not work out as planned. For example, what if you are confident that tax brackets will rise, but future administrations enact a national sales tax instead of raising income taxes? This would mean you were correct about higher taxes, but owning a Roth in that scenario wouldn't help.
Ultimately, the decision to convert to a Roth IRA can be advantageous for the right situation. By working with an unbiased advisor, focusing on your retirement plans, and ignoring the hype of Wall Street, you can make an informed decision that is right for your situation.
Russell Dunkin, CFP® is a wealth advisor with McKinley Carter Wealth Services (www.mc-ws.com), an SEC registered investment adviser with its principal place of business in the State of West Virginia. The information contained herein is general market information only and is not intended to be personalized investment or tax advice. Mr. Dunkin can be contacted at rdunkin@mc-ws.com, 304-230-2400 or 866-306-2400.