Several factors will determine whether converting traditional IRA assets to Roth IRA assets is the right decision for you.
The Roth IRA works in the opposite way of a traditional IRA: instead of contributing before-tax dollars and paying taxes on the withdrawals, you contribute after-tax dollars and make tax-free withdrawals.
Two rules changes are making conversion easier. First, beginning this year, the opportunity no longer is limited to people with $100,000 or less in income. Second, for this year only, you can defer taxes and pay them in equal installments in 2011 and 2012.
If you decide to make the conversion to a Roth IRA, generally, you will do significantly better if you deposit the entire sum allowed in the Roth IRA, paying the taxes due out of a personal account, not an IRA.
For example, if you have $150,000 in a traditional IRA, wish to convert, and will owe 33 percent in income taxes, then you will do better if you pay the $50,000 with personal monies and place the full $150,000 in the Roth instead of using the pension money to pay the taxes and placing only the net sum of $100,000 in.
If your tax rate in retirement turns out to be the same as it is now, and if you pay the conversion taxes out of the IRA, then converting will leave you in the same position, neither better nor worse off. If you pay the taxes out of a personal account, then you'll be better off with the Roth IRA.
The benefit of paying the taxes out of a personal account assumes that your investments actually increase in value between the time of conversion and time of withdrawal. If they increase sufficiently, then the conversion can work out even if your tax rate is a bit lower in retirement.
The author, a fee-only financial planner, is president of Altfest Personal Wealth Management, a financial and investment advisory firm in New York City; an associate professor of finance at Pace University; and a Medical Economics consultant. The ideas expressed in this column are his alone and do not represent the views of Medical Economics. If you have a comment or a topic you'd like to see covered here, please e-mail firstname.lastname@example.org