What to Consider When Converting a Traditional IRA to a Roth IRA

There are many types of IRAs. The two major types are traditional and Roth IRAs. A taxpayer can contribute up to $2000 to either a traditional or Roth IRA and there gains accumulate tax-free. With a traditional IRA, all or part of the contribution amount can be deducted from a person’s federal income tax, depending on his or her adjusted gross income. With a Roth IRA, contributions can never be deducted.

However, an advantage to using a Roth IRA is that distributions are also tax-free, whereas those taken from a traditional IRA are taxable as regular income. This is the reason that Roth IRA plans are becoming so popular. Accordingly, many people now desire to convert their traditional IRAs to Roth IRAs. Considering the tax savings, that would seem like a great idea. Anyone who has retirement savings in a traditional IRA might want to consider such a decision, especially in the current economy.

However, there are some things to take into consideration before doing this. One can only convert to a Roth IRA if his or her income is $181,000 or less and he or she is single, or married and filing jointly. There was a $100,000 income limit on Roth IRA conversions, however Congress eliminated it in 2010 and has been rising the limit since. This means that you can expect the limit to be set even higher in the years to come.

In most cases, when the question comes up whether or not a person should convert from a regular IRA to a Roth IRA, the answer is yes. However, one should consider whether or not he or she is able to pay the taxes that will be assessed at the time of conversion. Converting to a Roth IRA means that one will be paying tax on all the traditional IRA’s earnings and pretax contributions. These taxes could easily amount to more than a person could afford, or be willing to pay.

It may be better for people who are already in a high tax bracket and nearing retirement age to stay with a traditional IRA. That’s because they would likely move into a lower tax bracket when they retire and would not have enough working years remaining to make up for paying all of the extra money that it would take to convert.

Young investors could see the most benefit from withdrawing their money from a traditional IRA and putting it into a Roth IRA because there is plenty of time left for their funds to continue to grow and therefore offset the short-term tax liability.

The bottom line is that anyone who is deciding whether to convert to a traditional IRA should consider all factors and do the math. There are many benefits that come from that kind of conversion, such as large amounts of tax-free income during one’s retirement years. However, it’s not a wise move for everyone.