Ask Money

Convert an IRA?

Chris Farrell Jan 9, 2009

Question: I am considering converting a Traditional IRA to a Roth IRA. My reasoning for this is: 1.The markets are depressed right now. If I convert now, the tax hit on conversion will be smaller, since my IRA has lost 25% of it’s value. I have money outside the IRA which I will use to pay the taxes. Furthermore, I am expecting the market to rebound long term, and when it does, I will eventually get to withdraw the appreciation tax free.

  1. I am self-employed, and so my income varies. This year my income is low, so I am in a low tax bracket, so I feel it would be advantage to convert at this time.

Is there any reason to not do this? Any other information I should be aware of?

At one point, McCain was talking about allowing people to withdraw from Traditional IRA’s tax free. This would annul the main benefit of a Roth IRA. Do you think this could actually happen? Andy, San Francisco, CA

Answer: For many people, converting a traditional IRA into a Roth-IRA is a smart way to take advantage of the bear market. The gain is that the upfront tax hit on conversion is relatively small and should be dwarfed by the benefit of tax free withdrawals in retirement. Remember, a traditional IRA is funded with pre-tax dollars; you pay your federal income tax rate on withdrawals during retirement. The Roth is funded with after-tax dollars, but when you take the money out you don’t owe Uncle Sam anything.

I think you’ve thought this through well. You’re right, you will have to pay taxes on the conversion, but the tax hit will be minimal with the sharp drop in market values and your low income. The finances of a conversion get better if you have savings to tap outside the IRA money to pay the tax bill.

Your modified gross income has to be less than $100,000 to make the conversion, but that doesn’t seem a problem in your case. (That rule will be scrapped starting in the 2010 tax year.) And added benefit of the conversion is that unlike the traditional IRA there is no mandatory withdrawal schedule beginning at age 70 ½ with the Roth.

Speaking of withdrawals, the two main law changes that I am aware of involving IRAs is first, allowing retirees to skip their mandatory withdrawals in 2009 and, second, extending the rule allowing each spouse to make a charitable distribution from his or her IRA account of up to $100,000.

To be sure, there are many tax cut proposals floating around fiscal-stimulus Washington at the moment. But it seems unlikely that Congress would let people withdraw money from Ira’s tax free–at least not for any lengthy period of time.

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