Converting To a Roth IRA? 3 Questions to Ask Yourself First.

Written by , September 25, 2013

Converting To a Roth IRA 3 Questions to Ask Yourself FirstSaving money for retirement is one of the most important financial tasks you face during you life. However, there are a number of different options for retirement saving, and the method that’s best for you will likely depend on several factors.

One of the most popular types of retirement savings accounts is the Individual Retirement Account (or “IRA”). There are two different types of IRAs; the Traditional IRA and the Roth IRA, and in some circumstances converting from a Traditional IRA to a Roth account can provide you with significant long-term financial benefits.

Here is some retirement advice and three important questions you need to ask yourself first if you’re considering converting to a Roth IRA.

  • 1. What’s Your Expected Tax Bracket? Your tax bracket this year may be different from your tax bracket five, ten or twenty years from now. While you cannot predict your future, it’s important to look to the future and try to make some educated guesses. Along with your answer to question you’ll also need to estimate what you anticipate the future tax rates to be. Conventional thinking is that you’ll likely be in a lower bracket when you retire. If you’re in a significantly lower tax bracket during retirement then converting to a Roth IRA may not be the best idea, because you’ll have to pay taxes now (at your current higher rate) to avoid paying taxes later.
  • 2. When Are You Going to Retire? If you’re going to retire in five or ten years then it probably doesn’t make sense to convert to a Roth IRA because of the tax bill you’ll face during the year that you do the conversion. However, there are instances where converting to a Roth IRA is a good financial decision, even if you do plan to retire soon or have already retired. For example, an 80 year old person who doesn’t need the money in her IRA to pay for her own retirement expenses may want to leave as much money as possible to her children who are working in a higher tax bracket. In this type of situation, converting to a Roth IRA could make great financial sense because the Roth account would be preferential to her heirs.
  • 3. How Will You Pay the Taxes? If you convert to a Roth IRA now, how will you pay for the taxes? Will you have to borrow to pay for the current year tax hit? If so, would you have to borrow from your IRA? Neither of these situations is likely to make financial sense. In general you shouldn’t try to convert to a Roth IRA if you don’t have the money on hand to pay for the taxes that will be due. And definitely don’t use money in your IRA to pay those taxes.
  • Converting to a Roth IRA provides tremendous financial value for many who are saving for retirement. However, it’s not the right decision for everyone. Ask yourself the questions above and learn more about your options.

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