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Before You “Convert” to a Roth IRA

Throughout 2010 you will be bombarded with solicitations to “Convert” your traditional IRA to a Roth IRA,  with the appeal of having Tax-Free retirement income. Now I like Tax-Free money just as much as the next Guy, but this “conversion” comes at a price; one that may or may not benefit you.

When you convert any portion or your IRA,457, or 403(b) plan, you in essence take a taxable withdrawal. The amount you “convert” is reported as taxable income, which is in addition to your other soucres of income: wages, interest income,pension, etc.  Bottom line – you will pat taxes on this money for the benefit of having it grow again, this time tax free.

What gives me pause here is the matter of time. Just how many years will it take for your new “Roth Conversion” account to grow beyond the taxes you’ve paid? For instance, if you converted $10,000 to a Roth IRA, and you are in the 25% Federal Income Tax bracket, essentially it would cost you $2,500 in taxes. How many years do you think it would take for your account to gain another $2,500? Conservatively speaking, I’ve estimated between 5-7 yrs depending on what type of investing vehicle you place your money in.

So what does all this mean? If you have many years before you plan to take this money out as retirement income, the Roth Conversion may be a benefit to you. However if you only have a handful of years prior to retirement, you may not have enough time to earn back the money you paid in taxes.

It’s important to note that with this Tax Relief Plan, the Feds are allowing you to spread out the paying of the taxes on your Roth Conversion over the tax years 2011 and 2012. As with any IRA or Roth IRA decision, it is recommended that you consult your tax professional prior to “converting” or contributing to an IRA or Roth IRA.

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