) -- If you have money in an Individual Retirement Account, or IRA Rollover account, you're about to be faced with a big financial decision. Should you convert your traditional IRA to a Roth IRA? But your answer will depend less on mathematical formulas than on your basic beliefs about the future.
Answer these two questions: Question #1: Do you think personal income tax rates will be higher or lower over the next 10 to 20 years? Question #2: Do you think the government will keep its promise to allow tax-free withdrawals from Roth IRAs over that same period?
To convert or not to convert:
The reason your answers are so important is that starting in 2010 anyone, not just those with incomes under $100,000 -- will be able to convert a traditional IRA to a Roth IRA. There's one catch: You have to pay income taxes on the amount you convert to the Roth.
Remember, your IRA or IRA Rollover is likely to be filled with contributions that were deducted from your income when you made them, as well as any remaining gains that grew tax-deferred over the years.
The attraction of a Roth IRA is that while you don't get a deduction for contributions, all of those future withdrawals are promised to be tax-fee. So you have to pay the taxes sometime, and when you do a conversion, the taxes are due now. Well, almost now. If you do the conversion from a traditional IRA to a Roth IRA in 2010, you have a choice of recognizing all that income in the same year (2010) or split equally between the next two tax years (2011 and 2012).
Either way, it's going to be a huge tax bite. And that brings me back to the two questions at the start of this column.
Taxes: now or later:
If you believe tax rates are headed up, it might be tempting to do the conversion next year, unless top personal tax rates are increased even before then. Remember, when Kennedy became president, the top personal tax rate was 91%!
But how will you feel about writing that huge check to the government next year? What better things might you have done with that money you're sending to the government to pay the conversion tax? (By the way, don't take the money out of your IRA to pay the tax bill -- or you'll lose the best part of that benefit -- future tax-deferred growth. And definitely don't do that if you're under age 59 1/2 or it will be treated as a penalty withdrawal.)
The one group that might benefit most from this conversion opportunity are younger savers. They'll have more time for the money to compound, and overcome the taxes paid now. Then all that money would come out tax-free at retirement.
And for those who have lots of money, there is an additional benefit to converting to a Roth. Not only are there no required minimum withdrawals from a Roth (at age 70 1/2), but if you don't spend the money in your lifetime, your heirs can allow it to continue to grow tax-free, or withdraw it tax free, unlike withdrawals by beneficiaries of a traditional IRA .
Plus, by paying taxes on the money now, at today's relatively low rates, you lower the amount of your estate. For details on the pros and cons of conversion, go
The real issue is not the current rules, but the
rules. What if the government reneges on its promise to make future Roth withdrawals tax-free?
That's not unprecedented. Ask seniors who counted on receiving tax-free income from municipal bonds how they feel about having that income added back to their "modified adjusted gross income" to determine how much of their Social Security check is subject to taxes. Or ask seniors with higher incomes how they feel about paying twice the Medicare premiums, even though high earners paid more in Medicare taxes over the years.
As you sit down to consider the numbers, these nagging worries may make you think twice about doing that Roth conversion. Future tax-free withdrawals (made at least five years after conversion) are tempting. But writing a huge check to the government next year might be even more painful than those long-term promised benefits.
Yes, this is a complicated decision. That's why it's important to discuss it with your tax adviser. And if you can't come down on one side or the other, you can always convert a portion of your IRA. That way you'll never have complete regrets about your decision. And that's the Savage Truth.
Terry Savage is an expert on personal finance and also appears as a commentator on national television on issues related to investing and the financial markets. Savage's personal finance column in the Chicago Sun-Times is nationally syndicated. She was the first woman trader on the Chicago Board Options Exchange and is a registered investment adviser for stocks and futures. Savage currently serves as a director of the Chicago Mercantile Exchange Corp.