taxes

Take tax control of your IRA conversion

However, says Rucci, it's a different story for someone half that age. "If you're 30, it might make sense when you consider the growth you'll get with contributions in a Roth."

But each person's situation is different, and an older person might find conversion a valuable strategy.

Take, for example, a person with a large traditional IRA, who is approaching 70½, the age at which he has to begin taking required minimum distributions, or RMDs, from the account. Such mandatory withdrawals are not part of a Roth plan.

"For retirees in a distributions situation, it's a great way to lower your IRA a little bit so that you don't have to take large RMDs," says Bogue, who also writes a financial column for MaineToday.com.

The retiree will then get to leave money in the Roth longer, producing more earnings that will be tax-free when he ultimately does take them out on his timetable, not the IRS's required distribution schedule.

"There's nothing to prohibit you from converting when it fits your financial and tax situation," says Bogue. "Doing a partial conversion may let you take advantage of 401(k) Roth advantages, but it won't kill you on taxes."

Conversion window opens in 2010

If you're willing to wait a few years, you can get a little IRA conversion help from Uncle Sam.

The Tax Increase Prevention and Reconciliation Act, or TIPRA, that became law in May 2006 will allow all taxpayers, even those making more than $100,000, to convert their traditional IRAs to Roth accounts as long as they do so in 2010 or later.

As an added incentive, the law also offers you the chance to spread out any conversion taxes you owe over the next two years. So if you convert in 2010 and owe $50,000 in taxes for doing so, you can pay $25,000 when you file your return in 2011 and $25,000 with your 2012 filing.

The new rules only apply to conversions made in 2010. And the removal of the earnings limit is for conversions only. The existing income ceilings on opening or contributing to a Roth IRA remain.

While removal of the conversion earnings limit no doubt will please many making six-figure-plus incomes, the basic considerations remain: Will converting provide you with more, not just tax-free, money in retirement? And can you pay the taxes from another source so that you don't eat into your IRA savings to pay them?

Generally, converting to a Roth IRA makes sense when you expect your tax rate to stay the same or to go up in retirement. If you expect your tax rate to fall in retirement, then you need to run the numbers carefully to see if converting now makes tax and financial sense.

Predicting future taxes

Bogue is an ardent supporter of Roth accounts and conversion to them when appropriate.

"Generally, I'm a believer in at least considering conversion, not just blowing it off," says Bogue. "You're taking the tax man right out of the picture in the long run when you do this. Consider the 401(k) conversion taxes as an extra contribution to your retirement 401(k) savings and you don't have to worry about it again."

Feeling comfortable about a conversion, however, also depends on your confidence as a tax bracket prognosticator.

Do you think you'll be making less in retirement? If so, you might want to hold off on converting since, if your prediction comes true, your IRS bills on retirement distributions should be lower than what you now pay. Just make sure you're figuring in all potential retirement income.

"A lot of people who've been saving through a 401(k) are going to get taxed on it and (in retirement) they will be right where they were (as far as taxes) when they were working," says Bogue.

And what if lawmakers decide to start increasing tax rates?

Both Rucci and Bogue agree that, given the large federal deficit, don't expect current tax rates to remain this low indefinitely.

"A lot of people are saying they're going to make a Roth contribution since tax rates are very low now," says Rucci. If you agree with that premise, paying the tax today and getting the leverage of growing your money tax-free is an alluring thought.

"Chances are they're going to be raising taxes," says Rucci. "No one has a crystal ball, but it gives you some indication of what you should consider."

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