Retirement & Financial Planning Report

Starting in 2010, you can convert all or part of your traditional IRA to a Roth IRA, no matter how much income you have. Should you convert? Perhaps, but only if you have enough money to pay the income tax on the conversion from other funds. Consider two hypothetical taxpayers:

* Alice Benson has $100,000 in her traditional IRA, all money that has never been taxed. She is in a 28 percent tax bracket. If she converts the account to a Roth IRA, she will owe $28,000 in income tax.

Alice withdraws $28,000 from the IRA to pay the tax, plus $10,000 to cover the 10 percent penalty because she’s younger than 59 1/2. That leaves her with $62,000 in her account. If she earns 7 percent a year inside Roth IRA account, it will take Alice seven years just to get back to $100,000.

* Carol Davis also has $100,000 of pretax money in her traditional IRA. She also is in a 28 percent tax bracket, but Carol has $28,000 in other savings. If Carol converts and pays the tax from other money, she will have $100,000 in her Roth IRA.

Suppose Carol earns 7 percent a year. In seven years, that $100,000 will have grown to around $160,000. Roth IRA withdrawals are totally tax-free after five years and after age 59 1/2, so Carol can tap her account at will after she passes that age. Her $60,000 in growth will be tax-free.