Roth Ira

To convert or not convert…is that the question you are facing? Hopefully this article will help you make this, potentially, life-altering decision. Before we go into details about whether you should convert or not, let's discuss the main differences between a Traditional IRA and a Roth IRA.

The Traditional IRA is the ideal alternative to an employer sponsored 401k account. Like a 401k account, the Traditional IRA is only set up for retirement and can only be drawn upon when you reach the age of 59 and a half years. And like a 401k the money you deposit into a Traditional IRA is tax-deductible.

For example, if you make $50,000 a year and you put away (let's assume that you are being a good saver) $12,000, then your taxable income is only $38,000. You've effectively reduced your tax bracket and you'll pay less in income taxes! This type of taxation makes the Traditional IRA a tax-deferred account.

Now that we have discussed the benefits of saving in a Traditional IRA, let's talk about the down sides. First, like any other retirement account, an early withdrawal will cost you dearly. If you withdraw the money from your Traditional IRA account before the age of 59 and a half, you will pay a hefty penalty fee…typically 10 to 20 percent. Of course, there are exceptions, but most people will not qualify for those.

In addition to this down side, the Traditional IRA is, unfortunately, taxable, as income, when you withdraw. Yes, your money will be taxed on the back end as if it were income. This means that as you are getting your distributions from your account, the government will be taxing it as they would the money of anyone who is working.

The Roth IRA, on the other hand, IS taxed when you deposit the money into your retirement account. However, the money that is in the account is allowed to grow and grow and grow…ENTIRELY TAX FREE! That's right, once the money goes into the Roth IRA, it is done…the government will not be able to take any more of it (unless you withdraw it before age 59 and a half). And better yet, when the distributions begin, all the money is yours.

And that is the crux of the decision to convert a traditional IRA into a Roth IRA. The question is whether taxation today will be more than taxation tomorrow. But that is not the only question. You also have to consider whether you can cover the cost of the taxes associated with the Traditional IRA to Roth IRA conversion.

If you can take the risk of banking on taxes being less down the road and can truthfully answer the question as to whether you can pay the taxes associated with the Traditional IRA to Roth IRA conversion (meaning you don't have to borrow from your Traditional IRA to pay the tax costs) then you may want to seriously consider converting your Traditional IRA to a Roth IRA.