The Lowdown on Roth IRA Conversions

Beverly, I have a question I plan to talk to a tax planner about -- but after reading your article, if you feel you could help steer me...

I work for a city utilities company. We changed to a state retirement plan, which leaves me with $35,000 that I rolled over to a traditional IRA. Would I be better off to roll over to a Roth IRA?

With a Roth IRA can you withdraw for higher education expenses of your children?

Thanks in advance.

Cindy Dillard

You're right to speak to a tax planner, since only someone with full knowledge of your financial situation can determine whether you're better off in a Roth or traditional IRA, but I can give you a few rules of thumb.

The money you contribute to a traditional IRA is contributed before taxes have been assessed. That $35,000 you contributed to your employer's plan was likely deducted from your salary before taxes had been taken out. And when you rolled it into an IRA, you did so tax-free. When you withdraw that money in retirement, you'll owe ordinary income tax on each amount you withdraw.

Roth IRAs, though, don't offer any upfront tax benefit. Rather, the contributions are made with after-tax money, and the money that's withdrawn in retirement is taken out completely free of taxes.

Roth IRAs are typically better for people who expect to be in a higher tax bracket when they retire. Think about it: If you're in the 27% bracket now (which goes from $46,701 to $112,850 for married couples; $23,351 to $56,425 for singles) but expect to be in the 30% bracket in retirement, it's better to pay the 27% tax now and withdraw the money tax-free when you're in the higher bracket.

Conversely, if you expect to be in a lower bracket in retirement, you're better off getting the deduction now while you're paying more in taxes, and paying tax on the withdrawal at your lower rate in retirement. If your bracket doesn't change, it's pretty much a wash.

Also, Roths can be great estate-planning tools. So if you don't expect to need to use the money in your IRA (say, if you have enough in your outside, taxable accounts to fund your retirement) and don't want to be forced to withdraw money at age 70 1/2 (as you would in a traditional IRA), you can maximize the IRA's growth and options for your beneficiaries by converting.