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Converting to Roth

Does it make sense for you to convert your traditional IRA to a Roth IRA?

A Roth conversion is essentially moving funds from a Traditional IRA into a Roth IRA. The conversion amount —less non-deductible contributions— is subject to federal income tax (and state tax where applicable) for the year in which the conversion is made.

Which IRA is better?

This depends primarily on your financial goals and on your current and future tax rates. Age, retirement income needs and legacy planning also come into play. Choose traditional if you can deduct the contribution and if your tax bracket will be lower in retirement than it is now. Roth IRA may be the better choice if you have multiple financial goals, your tax bracket is the same or lower now than it will be in retirement, you are concerned about having too much taxable income in retirement, OR you are not eligible to make a tax-deductible contribution to a traditional IRA.

Beginning in 2010, there is no longer an income limit for eligibility to convert a traditional to a Roth IRA. With that barrier removed, the primary consideration is paying any tax due on the conversion.

You should have funds available outside the IRA to pay any tax due on the conversion.

If you would like to contribute to a Roth IRA but are not eligible because of the income limits, the new rules allow you make a non-deductible contribution to a traditional IRA and convert to Roth on the spot. The only difficulty arises if you already have a traditional IRA with pre-tax contributions or earnings. The proportion of your aggregated IRA balance that is pre-tax will equal the proportion of your conversion that is taxable. If your entire IRA is pre-tax, consider moving it to your employer’s qualified plan, so that all future traditional IRA contributions will be after-tax, and all Roth conversions virtually tax-free.

Finally, conversions can be undone at tax time, if the IRA owner finds the decision is just too costly. This change from converted Roth back to a traditional IRA is called a recharacterization. A recharacterization eliminates the tax consequences of the conversion.

Be sure to consult your tax advisor for help with this decision.

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