Should You Convert to a Roth IRA?

Moving all or some of the assets in your Traditional IRA to a Roth IRA may provide you with greater financial flexibility.

Qualified withdrawals from a Roth IRA are tax-free—potentially a significant advantage in retirement, especially if you find yourself in a higher tax bracket. A number of factors may determine whether a conversion is appropriate for your particular circumstances—and whether the tax obligation you'll have as a result of the conversion makes sense.

Consider these factors when deciding whether to convert.

  • If you expect to be in a higher bracket in the future, the taxes you pay on the conversion now may be at a lower rate than you would pay later on Traditional IRA withdrawals.
  • The more time you have until retirement, the greater the opportunity you'll have for a Roth IRA's potential tax-free growth to compensate for the taxes you pay on the conversion.
  • If you don't need to withdraw all of the money from your Roth IRA in retirement, you can leave those assets—and any tax-free earnings they generate—to your heirs, which would allow for many additional years of potential tax-free growth.*

TAX strategies
Decide which of these three conversion approaches—or a combination of them—is best for your circumstances:

Stagger the conversion: If a Roth IRA conversion would push you into a higher federal tax bracket, consider making multiple partial conversions over a period of several years.

Pay conversion taxes with non-IRA assets. Withdrawing from a
Traditional IRA to pay taxes on a Roth IRA conversion would result in additional taxes. And if you're younger than age 59½, you could also be subject to a 10% early-withdrawal penalty. Instead, use assets you have in a taxable account, if you can.

Consider a tax-free withdrawal from a Roth IRA. If you don't have enough savings available in taxable or other retirement accounts to pay the taxes, consider taking a withdrawal from your new Roth IRA. Because the money would come from contributions already made, you generally won't owe taxes on the Roth IRA distribution.

Both Traditional IRAs and Roth IRAs offer tax advantages. But with a Traditional IRA, you must take required minimum distributions (RMDs) every year once you reach age 70½. Each withdrawal is subject to ordinary income taxes, so you may be obligated to pay taxes on distributions you don't need. A Roth IRA has no RMDs—and you can make qualified withdrawals without paying taxes.

Contribution Limits for 2012/2013: $5,000/$5,500
Investors Age 50 or Older: $6,000/$6,500
You have until tax day, April 15, 2013, to contribute for 2012.

  Traditional IRA Roth IRA
Taxes on withdrawals Withdrawals of pretax contributions and earnings are taxed as ordinary income Withdrawals of contributions are tax-free. Withdrawals of investment earnings are also income tax-free if:
  • you've held the account for at least five years and
  • you are age 59½ or older
Required minimum distributions (RMDs) Begin at age 70½ None
Early withdrawal penalties Withdrawals of contributions and earnings prior to age 59½ may be subject to tax and a 10% penalty (with some exceptions) Withdrawals of earnings prior to age 59½ may be subject to tax and a 10% penalty (with some exceptions)
  • Tax-deferred potential growth
  • Tax-deductible contributions (when applicable)
  • Tax-free potential growth
  • Tax-free qualified withdrawals
  • No RMDs
  • Heirs can take tax-free withdrawals from Inherited Roth IRAs, but they are subject to RMDs
Contribution amounts subject to phaseout based on IRA owner's earned income (for Roth IRA).

*Your heirs must take required minimum distributions (RMDs) from inherited Roth IRAs.

1 Moving all or some of the assets in your Traditional IRA to a Roth IRA may provide you with greater financial flexibility.
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