As more companies eliminate or reduce their pension plans, people are taking closer and harder looks at their personal retirement saving options.
One possibility that appeals to owners of traditional IRAs is converting those savings to Roth retirement accounts. Right now, higher-income individuals can't take advantage of such a transfer, but that will change in a couple of years.
Be careful, though, whether you're considering a conversion now or down the road. While a Roth IRA has definite advantages for many people, it's not necessarily right for everyone.
And even if the move does make sense for you, you'll pay a price. There are ways, however, to manage the financial bite and ensure your IRA meets your retirement needs.
The price of change
If you started an IRA as soon as the option became available 33 years ago, for what we now call a traditional account, you'd likely have a nice nest egg. The one downside: When you start taking out money, much of it will be taxed. And it will be taxed at your ordinary income rate, which could be high as 35 percent, rather than the more favorable rates usually afforded investment income.
That's not the case with a Roth. Once you've held the account for five years, you won't owe the IRS anything when you withdraw the money at retirement.
Converting a traditional IRA to a Roth gives you that future tax-free benefit, but at an immediate tax cost. You'll have to pay taxes on contributions that you previously deducted, as well as on the account's earnings.
Conversion also could push you into a higher tax bracket, especially if you've accumulated sizable earnings over the years. True, only the portion of your income that falls into that new bracket will be taxed at the higher rate, but it's still an added bonus for the IRS at your expense.
Then you must consider exactly how to cover the conversion taxes. Some account holders end up using money from the traditional account to meet this obligation. Not a good idea, say experts, because that reduces, sometimes dramatically, your retirement holdings.
Plus, if you're younger than 59½, when you take out the cash to pay the IRS, you'll also face a 10 percent early distribution penalty.
Upon facing such tax considerations, some traditional IRA holders decide to forgo conversion. But that might not be the only, or best, option.
It is a fact that you can't escape the tax pain of transferring to a Roth account. You can, however, control it.
Simply move your traditional IRA money to a Roth gradually through partial conversions for several years.
"You can partially convert $100, $100,000 or whatever," says Jeff Bogue, Certified Financial Planner and principal of Bogue Asset Management LLC in Wells, Maine.
Even better, you don't have to transfer the money from one account to another on any specific timetable. That way, you have some control over your tax bill.
"You can stage the transfer over a period of time," says Bill Rucci, CPA and partner in the Boston-based accounting firm Rucci, Bardaro and Barrett. "That's where the graduated tax brackets come into play. If you do it all in one year, you might be pushed into a higher tax bracket and it wouldn't be worth it. Stage the rollovers in such a way that you don't face higher taxes."