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Deciding on a traditional versus Roth IRA calls into consideration several factors, including tax rates.
Now, two rule changes will make it easier to convert traditional IRA assets into Roth IRA assets. First, beginning in 2010, the opportunity will no longer be limited to people with $100,000 or less in income. Second, for 2010 only, you will be able to defer taxes and pay them in equal installments in 2011 and 2012.
Unfortunately, the choice of whether to convert to a Roth IRA or, more broadly, whether to select a regular or Roth IRA or 401(k) in the first place, is not always clear. It depends on several factors. Key factor No. 1 is your tax rate in retirement compared with the rate today. Generally, if your tax rate is expected to be significantly lower in retirement than it is today, stay with a traditional IRA. If the rate will be higher, select a Roth.
From another standpoint, you will generally do significantly better with a Roth conversion if you deposit the entire sum allowed in the Roth, 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, you will do better paying 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 a situation where your tax rate in retirement turns out to be the same as now, if you pay the conversion taxes out of the IRA, converting will leave you in the same position, neither better nor worse off. If you pay the taxes out of a personal account, you'll be better off with the Roth.
On balance, the Roth conversion may be best for high net-worth people who have little need for retirement withdrawals and a strong desire to leave money for the next generation. That's because distributions are not required during your lifetime and your heirs can stretch the tax-free distributions over their lives.
On the other hand, if your assets are, and will continue to be, more modest, if you don't have the resources available in taxable accounts to pay the conversion tax, and your tax rate will decline significantly in retirement even if overall rates rise, you may want to stay with a traditional IRA.
NEWS & UPDATES
While most financial planners don’t recommend borrowing from an IRA, it is an option. Find out how at http://memag.com/IRAborrow
The author, a fee-only financial planner, is president of L.J. Altfest & Co., 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