Until 2010, income restrictions prevented many people from converting their traditional IRAs or old employer retirement accounts to Roths. This year, however, those restrictions are permanently eliminated!

What’s the Difference?

Roth IRAs are funded with after-tax dollars and grow tax-free. When you withdraw money from your Roth, you will not owe any taxes. However, the money you put into a traditional IRA is tax-deductible and your savings grow tax-deferred. When you retire, you must pay income tax on withdrawals from your traditional IRA.

A conversion makes sense only if you can pay the taxes out of pocket without tapping the IRA funds. Otherwise, the reduced investment cancels out your tax savings. Fortunately, in 2010, the IRS is helping by allowing you to pay taxes on your conversion over two years. So start setting money aside now to cover your tax bill by 2012.

How Much Can You Save?

Let’s assume you and your spouse have $30,000 in a traditional IRA. If you convert that into a Roth IRA and it earns 12% for 30 years, without adding any additional money, your Roth IRA will be worth $2.9 million over a 30-year retirement—$476,820 more than your traditional IRA! That’s like an extra vacation home!

Here’s something else to think about. If you expect to have a higher tax rate when you retire (and many people do) the value of a traditional IRA will drop even more. But, higher taxes do not affect a Roth!

On the other hand, if you expect to have a lower tax rate when you retire, it may make more sense to keep your traditional IRA than to pay taxes on a conversion at your current, higher rate.

Many More Benefits

There’s more to a Roth IRA than just the tax benefits:

• IRAs in general offer more flexibility in investment choices—great news if you’ve been restricted in an old 401(k) or employer retirement plan.
• You can fund a Roth IRA even if you have a retirement plan with your current employer.
• You are required to take government-calculated distributions from your traditional IRA at age 70 ½. But, you don’t ever have to withdraw funds from your Roth IRA. In fact, your heirs can take tax-free distributions from your Roth over their lifetimes.

Is a Conversion Right for You?

The federal government has a lot of rules surrounding Roth IRA conversions and contributions. Then there are the current and future tax considerations. It’s best to consult a professional who will take the time to understand your situation and help you determine if a conversion will benefit you. Let Dave’s team help you find a local investing professional today.