Convert to a Roth IRA – Not on Your Life?
There were a ton of people who talked about the need to convert their traditional retirement accounts to a Roth IRA at the end of last year. This is because of the elimination of the income limit for those who made the change. The change was motivated by a simple difference. You have a tax free withdrawal with a Roth IRA and other IRA's have Taxable withdrawals, and that a very major difference.
Under a traditional IRA, when you hit 59 years years old, you must begin to withdrawal. Under the Roth plan, there are no government enforced withdrawal requirements. Still, it seems that most individuals will not benefit from the switch and here's why?
If you make the switch, there is an immediate tax hit. Any money you take out of a traditional IRA and put into a Roth Plan is taxable prior to the transfer. Only upon advice of your accountant can you determine if this makes sense for YOU. You could convert over a period of years, instead of doing it completely in any one year.
The next key point is how far you are from retirement. The key number seems to be 58 years or older. If you are older than 58, it simply does not make financial sense to switch. It could take something approaching 20 years to make up for the taxes that you pay upon conversion. If you start to withdraw any money from the account, it will take you even longer.
There's also a concentration issue that you have to deal with. A lot of people keep a disproportion share of their retirement assets in their Roth IRA. This means they have to withdraw money to live on from the Roth IRA as well. What does this mean? It means you have even less time to build up the assets once again, if you are withdrawing money from them. If there is a portion that you think you might not need for a very long time, you may only convert that portion into a Roth IRA.
Some people believe tax rates are headed higher down the road. They then think let me cash out of the normal IRA now, and pay the taxes at current rates. I will convert into a Roth IRA and years from now, when I need money, I will pay taxes upon withdrawal at the higher rate then in effect. It's good thinking. However, it is offset by the likelihood that in retirement, their income normally drops off, and therefore, they should be in a lower tax bracket anyway.
The final point is that the amount converted is a lump sum, and you could find yourself placed in a higher tax bracket and therefore the lump sum would be taxed at that bracket. This could wind up causing you to have your social security benefits taxed as well. If you are expecting financial aid from colleges for the kids, it's another issue as well. If a divorce is looming, that's an additional problem to consider. Sit down and talk with your accountant before doing anything.
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