Monday, September 7, 2009

Should I convert a regular IRA to a Roth?


On Mondays, we post a question from a reader and answer from Dan Danford in this space. We welcome your personal finance questions, too! Please post in the comments or e-mail to robynsekula@sbcglobal.net.

QUESTION: I’m looking at converting a regular IRA to a Roth. I’m 45, and the IRA has about $36,000 in it. How would I do that? Should I do that?

ANSWER: Roth IRAs will get a lot of attention in coming months because Congress changed the rules to make a conversion easier for some folks. Like I say, there will be a lot written as we go forward, and I'll let the experts add voluminous details to this discussion.

To convert a Roth requires that the taxes be paid now. So, with a $36,000 IRA, the conversion itself will create a $36,000 taxable event this year. You'll owe federal and state taxes on that amount. Depending on the rest of your family income, taxes could be computed at a fairly stiff rate. Most experts suggest that you pay the tax with other money (your savings account, maybe) so that you can roll the entire $36,000 into the new Roth. Forever after, that money will grow tax-free, and you'll not pay taxes on distributions in retirement, either. That part is pretty appealing, for sure.

I can't answer your question without further information. The theory is that taxes today may be lower than they will be in the future, so you'll pay at a lower rate. That may be true, but it's always dicey to predict the future. A lot could happen between now and your eventual retirement. And, if you make the conversion today, it will all happen at today's marginal tax rate. Without a conversion, you could stagger withdrawals to minimize taxes in any particular year. In other words, you might control the tax bite through a thoughtful withdrawal scheme. In fact, those distributions (and taxes) could be staggered over your beneficiary's life expectancy. That's even more to think about.

Look, this is not likely to be a life-changing issue with your $36,000 IRA. I'd not be in any hurry to convert until all the experts weigh in. Personally, I rarely rush to pay taxes anyway, so my inclination would be to leave things as they are. But that could change as we learn more in the future.

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