How To Make The Call On Converting IRAs

Let’s see if we can take some of the anxiety out of deciding whether it’s smart to convert your traditional IRA to Roth IRAs this year.

It’s a good move for younger savers who are a long way from retirement and can expect to be making more in retirement than they are in their late ’20s or early 30s.

It’s not a good move for savers in their 40s and 50s who are closer to retirement, have reached their peak earning years, and will almost certainly see their income drop after they retire.

There. Problem solved.

Follow those simple guidelines and you’ll stand a good chance of minimizing your tax bill and maximizing your balance for these retirement accounts.

The decision seems like a tough one because it requires you to make many assumptions about how much you’ll be making 20 or 30 years from now and what tax bracket you’ll be in.

Who can predict tax rates a few years from now, much less a few decades from now.

It is enough to drive you a little crazy and everyone’s fretting over this because the government has removed all income restrictions on these conversions this year, making them open to more prosperous taxpayers.

(Prior to 2010 you had to have a modified adjusted gross income of $100,000 or less.)

Washington is also offering taxpayers a one-time deal: You can pay all of the tax on your conversion in 2010 or in equal installments on your 2011 and 2012 tax returns.

All deductible contributions made to traditional IRAs, and all of the earnings from the investments in those accounts, will be considered taxable income if you convert to a Roth IRA.

Voluntarily paying the tax on that money now doesn’t make sense unless you think you’ll be earning more, and in a higher tax bracket, after you retire.

That certainly doesn’t describe many 40- or 50-year-olds I know. They’ve got to save like crazy to insure that their income doesn’t fall 20%, 30% or more after they stop working.

But if you’re young, with 30 or 40 years of better jobs and higher salaries ahead of you, then there’s a good chance your retirement income (and tax bracket) will be higher than your current income (and tax bracket).

Think about it.

How many people retiring today stand to earn more from pensions, Social Security and their savings than they did from their first or second jobs, 40 years ago?

A lot, right?

This Roth IRA conversion calculator reflects this reality, and can help you make a decision based on your specific age and tax bracket.