While you don’t have to make a final decision until the end of the year, it is worth taking some time now to think about converting your traditional IRA or other tax qualified retirement plan to a Roth IRA. This decision process requires many assumptions. My preference is using facts to make financial decisions, but sometimes that option just isn’t available.
A quick summary on traditional qualified plans vs. Roth IRAs yields the following bottom line. Are you better off deferring taxes until you are age 70 ½ or should you get it over with now, and then get tax-free distributions from your retirement savings?
This brings us to 2010 -- a year that is notable because the income limitations on converting qualified retirement plans to a Roth have been removed. This means you can roll over money in other qualified pIans regardless of your income. In addition, moving the IRA into a Roth will not trigger tax penalty even if you haven’t reached the age where the IRA can be accessed. However, all taxes owed must be paid. If you make the decision to do this before the end of 2010, you can elect to pay the taxes over two years -- waiting to make the payments in 2011 and 2012.
Here’s where the assumptions stuff comes into play. Normally, using the time value of money approach to managing your finances, paying later is always better. However, if the Bush tax cuts expire in 2011, you could pay more in taxes that year than you would have if you took the hit in 2010. Another assumption to watch out for is the Medicare surtax on investment income. This tax is scheduled to start in 2013, and if you are in a higher income bracket you won’t pay it on your Roth distributions, but you will on your traditional IRA.
One offset to all the crystal ball gazing skills involved in the conversion decision is talking to a tax advisor. While it’s still an assumption, I’m convinced a thorough review of all your specific considerations this year is an especially good investment.