Friday, Jan. 08, 2010

Traditional IRA vs. Roth IRA

In years past, the question of whether you should convert your traditional IRA to a Roth IRA didn't come up all that often. High-income earners who had been locked out of the Roth by law either still had too much income in retirement or found that the tax math didn't work with what time they had left before starting to make withdrawals. Things are different now.

For the first time, if your annual income exceeds $100,000, you can convert a traditional IRA (as well as a SEP IRA, Simple IRA or 401(k) or 403(b) plan held with a former employer) to a Roth IRA and take advantage of its many benefits. But make no mistake: a Roth conversion doesn't make sense for everyone; you'll have to ponder a few variables. In a recent survey, TD Ameritrade found that nearly half its clients who are newly eligible to convert remain undecided. The subject is that confusing.

With a traditional IRA, your contributions are tax-deductible and portfolio earnings grow tax-deferred for life. But when you begin making withdrawals, as you must by age 70.5, any money taken out gets taxed as ordinary income at that time. With a Roth, you get no tax deduction for your contributions. But earnings grow tax-free, and there is no tax upon withdrawal, so long as you've held the account for at least five years and are at least 59.5. Whether you should convert depends largely on which tax treatment you believe will leave you with more money in the long run.

For answers, it's a good idea to consult a tax adviser or have your financial adviser do so. But to get a quick idea if converting to a Roth makes sense, try fiddling with an online conversion calculator like the one at or The answer may become clear in an instant. Here are the key variables:

See if you should convert to a Roth IRA:
What Are Your Tax Assumptions?
When Will You Start Making IRA Withdrawals?
How Will You Pay The Roth Conversion Tax?
Will You Convert Your Entire IRA Or Just Part?