Traditional IRA or Roth IRA - Which One Is Best For You?

Here are a couple of advantages of having a Roth IRA instead of a traditional IRA:

You can withdraw money tax free.

You control when you withdraw your money. No such luck with a traditional IRA. The law says that you have to start withdrawing your money when you turn 70½.

Now, the actual conversion is a little tricky. You will be converting money that has not been taxed yet into tax-free money, so ordinarily you would have to pay taxes right away. Lucky for you, the rules have changed slightly. If you convert this year, you can spread out the taxes over two years (2011 and 2012).

Age may be another tricky factor. It is very important for you to look at your total financial picture to see if it makes sense to convert your traditional IRA into a Roth IRA. Here are a couple of things for you to think about:

How will you pay the taxes? Do you have money available outside of your traditional IRA to cover them?

The conversion will increase your income, which means you may pay higher taxes on your Social Security benefits. Are you ready for that?

Here is a lesser known fact: if your employer offers a Roth 401(k), you may be able to convert some or all of your 401(k) balance right into it. The recently passed Small Business Jobs and Credit Act of 2010, allows you to do it if you meet certain requirements.

Wait a minute! Can you mix those retirement plans up? The answer is yes, but let’s summarize before we get too confused:

401(k) – a chunk of your paycheck goes into this one BEFORE taxes. You pay taxes when you pull the money out at retirement.

Roth IRA – a chunk of money goes into this one AFTER taxes, so you don’t pay taxes on it when you take it out at retirement.

When you combine a Roth IRA and a 401(k) into a Roth 401(k), you can automatically defer a portion of your AFTER tax paycheck into your company’s Roth 401(k).

The rollover will be taxed, since you are transferring before-tax money into an after-tax account. Again, if you do it this year, you can spread out the tax payment over the next two years.

The bottom line: If you have a fairly small balance in your traditional IRA to keep the tax bite manageable, and you are not close to retirement, you are probably a good candidate to convert your traditional IRA into a Roth.

This type of conversion is the latest trend. But just like with everything else, don’t blindly follow the crowd. Check with your financial or tax advisor to see if it is the best choice for your circumstances.

Fads come and go. You want your investments to last at least a lifetime.

Denisa Tova MBA, CFP, CFDP(TM), ChFC, CLU provides divorce financial expertise to divorcing individuals. She is a Certified Financial Planner(TM) practitioner and Certified Divorce Financial Analyst. You can find more information about Denisa Tova at: http://www.denisatova.com
Reprinted with permission of The Colorado Springs Gazette