Should I Convert my Traditional Ira to a Roth IRA?

Converting a traditional IRA to a Roth IRA offers a number of potential tax advantages. However, before you decide to take this step, consider the tax implications of converting your traditional account. If you need an immediate tax break or your earnings were higher than average in a given tax year, conversion may not be the best option. Talk with your financial advisor or a tax professional about whether converting to a Roth IRA is the best decision for your current financial circumstances.

Tax Considerations

Both a traditional IRA and a Roth IRA offer specific tax advantages. The primary difference between these two accounts is that contributions to a traditional IRA come from pre tax income, while contributions from a Roth IRA come from post tax income. With a traditional IRA, you'll get a break on your taxes the same year you make your contributions, because contributions are tax deductible. If you are relying on that tax break to keep your income tax at a manageable level, converting to a Roth IRA may not be a wise decision.

With a Roth IRA, you get a tax break when you collect your distributions. Contributions to a Roth IRA are not tax deductible, so contributing to a Roth will not lower your taxable income. However, your assets can earn at a tax free rate for as long as you hold the account, giving you the potential to collect tax free distributions. In order to qualify for a tax free distribution, you must be at least 59 1/2 years old, and five years must have passed since your first contribution. After checking your Roth IRA balance, you may be eligible for an early withdrawal if you are buying your first home or you are disabled.

When you convert a traditional IRA to a Roth IRA, the funds you convert must be added to your taxable income for that year. In some cases, increasing your taxable income may not be an advantage. You will be required to pay income tax on the converted amount, because the money in your traditional IRA has not yet been taxed. Keep in mind that if you decide to convert to a Roth IRA and you receive the funds from your traditional IRA in the form of a distribution, you must make the conversion within 60 days, or the funds will no longer be eligible for conversion.

Advantages of Conversion

Converting a traditional IRA to a Roth may give you more flexibility with your nest egg after you reach retirement age. Because contributions to a Roth IRA come from aftertax income, there are fewer restrictions on how you use these assets. Unlike a traditional IRA, which has a mandatory distribution requirement, a Roth IRA has no mandatory distribution, so you may continue to use your Roth IRA as an investment fund for as long as you like. With a traditional IRA, you must begin to collect distributions by the age of 70 1/2.

A traditional IRA may also offer a tax break when you collect your distributions, but only if you're in a lower tax break after retirement. After you reach retirement age and you begin collecting funds from a traditional IRA, you'll be taxed at your current rate of income. If you happen to be in a higher tax bracket when you retire, you may end up paying more tax on the money you earned when you were working. Deciding whether to convert a traditional IRA to a Roth IRA can be challenging. Consider dividing your annual contribution between a Roth IRA and a traditional IRA to get the benefits of both accounts.

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