3 Things to Consider Before Converting Your IRA to a Roth

If you haven’t already, you’ll probably soon see ads and articles urging you to convert your existing Individual Retirement Account, or IRA, to a tax-free Roth IRA. That’s because 2010 is the only year that special conversion rules apply. But should you do it?

What’s The Difference?

First, you need to know the difference between a regular and a Roth IRA… Quite simply, a regular IRA lets you write off money you put in, but you pay taxes on money you take out. A Roth IRA is the opposite, you don’t get to deduct the money you put in, but you don’t have to pay taxes on the money you take out at retirement.

What’s So Special About 2010?

In previous years you couldn’t convert your regular IRA to a Roth IRA if you had high income, and even if you were allowed, you had to pay a whole bunch of income tax and do it all in one year. However, 2010 is going to be different.

Eric Godes of E*TRADE explained it to us… “Previously if you earned a hundred thousand dollars or more, you couldn’t convert from a traditional to a roth. That goes away January 1st, 2010. The second fantastic bonus for all retirement investors is in 2010 you can spread the tax liabilty out over 2 years.”

Should You Convert?

So should you convert? Depends. First, you should know that the tax bill when moving from a regular IRA to a Roth IRA can be huge: up to $30,000 on a $100,000 account. Even spread of two years, that’s a lot of money.

And if the only money you have to pay that income tax is in your IRA, that’s a big mistake. Cashing out your IRA early just to take advantage of potential tax benefits is almost always a loosing scenario.

Also, age matters. The long you have to retirement, the better off you’ll be after making the switch. If you’re just about to retire, it’ll probably cost more to switch from your regular IRA to a Roth than you’d save.

If you think your tax bracket after retirement will be lower than your current one, it’s probably also not going to be worth it to switch.