Switching to Roth may ease conversion taxes

NEW YORK (11/19/08)--For some investors who've taken a beating in recent months, converting from a traditional Individual Retirement Account (IRA) to a Roth IRA may yield significant tax savings (The Wall Street Journal Nov. 2).

Why act now? When you convert, you pay the income taxes right away on your account's value. With some accounts looking thin, converting now instead of later would reduce the taxes you pay as your IRA balance increases when the economy turns around.

Understand the basic differences between a Roth IRA and a traditional IRA. Roth IRA contributions are not tax deductible, but there are generally no taxes on future earnings and withdrawals, as long as you've held the assets for five years. In contrast, traditional IRA contributions are tax deductible, but you pay taxes on withdrawals. Unlike the traditional IRA, which requires you to begin withdrawing money at age 70 ½, the Roth has no such age requirement for withdrawals--the earnings can keep growing tax-free for as long as you like.

For tax-year 2008, you can contribute up to $5,000 a year to a traditional or Roth IRA (combined) if you are younger than age 50, and $6,000 if you are 50 or older.

For additional information, visit irs.gov and search for Publication 590.

If you're thinking of converting from a traditional IRA to a Roth IRA, consider these guidelines:

Your income must be $100,000 or less--until 2010, when this income requirement goes away.

If you are age 70 ½ or older and wish to convert to a Roth IRA, you're still required to take this year's required distribution, although Congress soon may pass legislation suspending the required distribution rules for 2008 (USA Today Nov. 11). If the legislation passes, middle-income retirees who don't need the money now would be in a better position to make their savings last as long as possible.

To make penalty-free withdrawals from converted funds, you must wait five years or until age 59 ½, whichever comes first. However, any interest earned on those funds carries a five-year window before it can be taken out tax-free.

If you convert funds after age 59 ½, you can withdraw the actual assets you converted at any time, but again, you must abide by the five-year requirement on the earnings in those accounts.

It isn't necessary to separate converted funds from earnings--when you do withdraw from your account, money is drawn first from contributions, then from conversions, and last from earnings.

For more information, read "Avoid Conversion Confusion With Roth IRAs" in Home & Family Finance Resource Center.

courtesy of cuna.org