Convert Traditional IRA to Roth IRA or no?

[Guest Kristin J]

When I resigned from my previous employer, I rolled my 401 K balance (about $70K) into a traditional IRA. I am 27. I have been doing a great deal of research on Roth IRAs and find that this a more attractive option. I realize the markets have not been performing well lately (my current balance has hit about $50K), but I should take a long term approach. I asked my CPA about recharacterizing. He suggested letting the traditional IRA in place, and simply opening up a separate Roth IRA. Is this a good idea, or should I convert portions of my Trad to a Roth each year in order to minimize tax penalties? Thanks! Kris J

[John G]

The math is complicated and based upon a large number of assumptions about your current tax rate, future tax rate, eligibility now and later, income qualifications now and later, future government tax policies and likely investment returns inside the shelter and out.

No one can tell you for sure what the correct answer is. Use your tax adviser to run some scenarios, maybe set up a simple spreadsheet for yourself.

Generally, conversion is a good idea if you are young (because you have a long compounding period), expect to have a higher effective tax rate later (because you are low now or because you expect future growth in assets will push you to higher brackets, and/or if you desire the no mandatory withdrawals or inheritance options (hard to see this as a big issue for you right now). Conversion at this time when the market is depressed could be attractive if you think the downside has run its course since you tax obligation would be smaller.

Conversion is a very bad idea if you plan to use some of the IRA assets to pay the taxes. If you are thinking this, DON'T CONVERT!

I like Roths, but you can often out smart yourself when rearranging your life to avoid taxes.