To Roth or Not To Roth

Congress lifted the income ceiling in 2010 for conversion of a traditional IRA to a Roth IRA. So lots of people are wondering if a conversion is a good idea.  The answer is – as it so often the case – that it depends. 

What’s the difference between the two types of IRAs?  Contributions to a traditional IRA might be partially or fully tax deductable, so this type of retirement account has some or all of the balance subject to tax when the money is withdrawn.  Also, with a traditional IRA, you are required to withdraw a portion of the account every year beginning when you turn 70½ and those withdrawals are taxable.  Contributions to a Roth IRA are never tax deductible, but withdrawals aren’t subject to tax.  Also, you are never required to withdraw the money from a Roth.  Both types of IRAs have a 10% penalty if you take money out prior to your age 59½, with a few exceptions. 

Converting from traditional IRA to Roth means that the taxes need to be paid on the taxable portion of the traditional IRA, which sometimes means the entire amount.  During 2010, that converted amount can be taxed partially in 2010 and partially in 2011.  But unless you know you’re going to drop into a lower bracket in 2011 due to a life event – retirement, quitting a job to go to school full time, taking a big pay cut – spreading the tax over two years probably doesn’t make sense.  We know the tax brackets in effect for 2010 and it’s likely that they’ll be higher in 2011.

It’s important to remember that you don’t have to convert your entire IRA.  You could decide to convert just part of it.  So if the top IRS tax bracket you are subject to is 28%, you could convert enough of your IRA to a Roth that you wouldn’t have income pushed into the next tax bracket and leave the rest in your traditional IRA in place.  That Roth balance will now be available in your retirement years to be withdrawn only if you want to withdraw it and will be tax free if you do use it. 

So who is a Roth conversion most appealing to?  If you are in a lower tax bracket this year than normal, you might want to consider it.  Maybe you just retired or you’ve been laid off or had a pay cut in your household.  If you are ten or more years away from retirement and don’t expect your tax bracket to go down much when you leave the workforce, that’s another favorable thing.  So if you’ll have a pension that will pay you when you stop working or your IRA is really large, you might want to look at a conversion.  Ironically, the people who haven’t been eligible this year – high income earners – often have the hardest time justifying a conversion.  I recommend doing a Roth conversion prior to age 59½ only if you have enough cash outside the IRA to pay the tax.  So paying between 28% to 35% to the IRS (on top of any state income tax) to move into a tax free instrument is a difficult pill to swallow at just about any time.  But to do it during a recession when it’s especially important to keep lots of funds liquid in case of a loss of income or another financial emergency is too aggressive for some of these folks.  For people already in retirement, a low stock market can be a good time to do the conversion.  If you account values are down, moving some money to the Roth will allow that money to grow tax free.  Assuming growth on the account of 8%, it takes about three to five years to get back what was paid in taxes.  From then on, all the growth I  the Roth puts you ahead in the tax game on your retirement funds. 

Still undecided?  Make an appointment with a financial planner to see if your particular situation could make sense for a conversion.  Your situation is unique and one of the factors that can’t be quantified is whether or not you’re comfortable with the transaction.

Top Ten Reasons to Participate in Your Company Retirement Plan

Now that tax season is over, folks are taking a look at their bigger financial picture again.  With all deference to fabulous late night talk shows, here are ten reasons to consider putting some of your hard earned wages into an account with your employer’s retirement plan.

10. The company is required to provide a variety of investment choices and access to information about those investments.

9.  You’ll save taxes on the money you put in the plan now and you’ll probably be in a lower tax bracket when you take the money out after you retire.

8.  Forced savings – if you don’t get it in your pay check now, you don’t spend it now.

7.  It keeps you from trying to time the market.  The money gets invested every month. 

6.  The balances you have in retirement accounts don’t usually count against your kids’ ability to qualify for student financial aid.

5.  Many companies contribute some money to your account if you contribute.

4.  Lots of retirement plans allow you to borrow against your account if you need to. 

3.  If you want to “buy low” in the market, this certainly seems like the time to do it!

2.  You can brag to your friends at parties about your investment portfolio.

1.  You’re putting away money for retirement.  When you’re old and grey, you’re less likely to have to go to work and ask strangers, “Do you want fries with that?”

 

 

Employer Contributions

Everyone needs to save for the day they hope not to work any more to make ends meet.  If you are comfortable with your job security and have good savings you could get to in a pinch, investing through your company’s retirement plan is worth considering.  Staying on a consistent investment plan through a down stock market can pay off quite nicely when markets recover.  If your company offers to match part of what you contribute to the plan, that’s even better!

 

So check your employer benefits and see what’s available to you.  Some companies don’t allow employees to contribute to a retirement plan until they’ve been with the company a while.  Some allow you to contribute, but won’t match anything.  Or if they do contribute into your account, it’s based on what you invest and you have to be in the plan for awhile (sometimes up to five years) before you can have the company’s share if you leave the company. 

 

If your employer offers a plan, it’s a great benefit for you which is greatly enhanced if they offer a contribution to your account.  It’s certainly worth exploring if you can supercharging your retirement savings!

Funding Pensions

As you’re saving, you’ll also want to put money into retirement accounts.  Even if you don’t have all your liquid reserves filled up, it’s good to start socking money into retirement accounts as soon as you get your first “real” job.  The earlier you start saving for retirement, the more the money can grow over your lifetime. 

 

If your employer has a retirement plan, that’s a good place to start with your retirement savings.  Putting at least some of the money into a tax deferred plan is a great way to save on current income taxes as well as put money toward your future.  If your employer doesn’t have a retirement plan, you can put money into an individual retirement account, usually called an IRA.  Whether you put money into a Roth IRA or a Roth 401k is going to involve some more in depth analysis of your situation. 

 

No matter how long you plan on working, you should give serious thought to the advantages of putting money into retirement accounts.