Five Questions to Ask Before You Convert

There’s a good chance you’ve been given a pitch to convert. No, not to some off-the-wall religion or cult, but by your financial advisor, insurance agent or broker to move your traditional IRA to a Roth IRA. And this can be a good thing ... After all, once your money hits the Roth you and your heirs will never have to worry about paying income taxes on it again. Plus unlike a traditional IRA, you won’t have to hassle with required minimum distributions beginning at 70½. So what’s not to like! One obstacle is that you’ll have to pay income tax on the amount you convert. That means, for example, coming up with $25,000 on a $100,000 conversion assuming you’re in the 25% tax bracket. But if you think you’ll be in a higher bracket when you retire or rates will go up in the future, paying the tax now could be a good choice. Think about your kids, too. Will they be in a higher bracket years down the road? Also, where will you get the money to pay the tax if you do convert? Your IRA custodian will ask if you want tax withheld from the distribution. This is generally a bad idea because you’ll end up paying taxes on those dollars, too. Moreover, it reduces the amount available to grow tax-free inside your Roth. A much better idea is to use money from outside your traditional IRA, such as from a money market or savings account. The second obstacle is dealing with the unknown ... How much do you trust Congress? Do you think they’ll revoke the tax-free status of Roths after they pocket the tax dollars you’ll fork over when you convert? The $1.4 trillion deficit they’ve rung up for 2010, plus $109 trillion Washington has promised to pay in Social Security and Medicare benefits, should be a clear warning that higher taxes are ahead. Already, House Majority Leader Steny Hoyer (D-MD) told reporters that raising taxes on middle class families will be necessary to tackle the debt. So where does this leave you if you’re thinking about converting? Consider these five points … 1. Do you have non-IRA money available to pay the taxes for the conversion?

2. Will your tax bracket be higher when you retire?

3. Is your beneficiaries’ tax bracket higher than yours?

4. Do you think Congress will raise income taxes in the future? What about your state taxes?

5. Do you think Congress will double-cross voters and tax Roths? If you answer “yes” for the first four questions, you’re probably a good candidate for a Roth conversion. It could pay off big time for you and your love ones. And if you answer “yes” for #5, then a Roth and any other tax-favored investment might be off the table for you. Best wishes, George