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Should I Convert My Traditional IRA to a Roth IRA?

This calculator helps you evaluate whether your should convert your Traditional IRA to a Roth IRA.

In 2010, the IRS changed to rules regarding eligibility to convert savings in a Traditional IRA to a Roth IRA. Prior to that time, in order to convert from a Traditional IRA to a Roth IRA your annual income needed to be under $100,000. In 2010, the IRS eliminated this restriction. When this law was changed, a whole new segment of the population was faced with the decision: should I now convert to a Roth IRA?

Before answering this question, it’s important to understand the differences between a Traditional IRA and a Roth IRA. The advantage of a Traditional IRA is that it offers tax-deferred contributions. You are not taxed on your contributions to a Traditional IRA until they are withdrawn in retirement.

A Roth IRA, on the other hand, is treated exactly the opposite. You are taxed on your current contributions in exchange for tax-free withdrawals in retirement. The taxable amount that you convert (any contributions for which you took a deduction, as well as any accumulated earnings) is added to your taxable income, and this now becomes the basis for your income tax rate.

When deciding whether to make this conversion, there are many important considerations, including, but not limited to:

  1. Is there a possibility you will need to access these funds early? In order to be totally tax free, converted funds must stay in your Roth IRA for at least five years, and can not be withdrawn until you are 59.5 years old. Withdrawing funds prior to these conditions being met will result in a 10% penalty, in addition to them be subject to taxes.
  2. What impact will the conversion have on your tax rate? Converting funds to a Roth IRA may push you into a higher tax bracket.  You should calculate your projected post-conversion income, and see if this changes your tax rate. If it does, this may negate some of the benefits of conversion.
  3. Do you have a variable income stream? If so, you may want to target your conversion for a “low income” year in which you may benefit from a lower tax rate.
  4. Has the government announced any increases or decreases to the tax rates? If you will be impacted by future tax rate increases, you should convert in the current year. Likewise, if you will benefit from future tax rate cuts, you may want to defer your conversion until these come into effect.

In any case, there are significant financial implications to this decision. The IRA Conversion Calculator below will help you with your decision making process. While this will provide some general direction, it is always wise to seek advice from a professional financial advisor to make a final decision as to which is the best option for you.

 

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