Will a Roth IRA Conversion Boost Your Nest Egg?


Saving for retirement in a Roth IRA has plenty of benefits: Your contributions, which are made with after-tax dollars, grow tax-free forever, you're not required to take distributions in retirement if you don't need the money, and you can pass on that cash as an inheritance -- without a tax bill.

The downside is that not everyone can participate. To make the maximum annual contribution, which is set at $5,000 this year ($6,000 for those 50 and over), your modified adjusted gross income must be less than $176,000 if you're married filing jointly, or $120,000 if you're a single filer.

This year, however, anyone can convert a traditional IRA to a Roth. This involves paying taxes (at your current income tax rate) on the converted balance. From that point on, the money grows tax-free. As a bonus, the Internal Revenue Service is giving everyone an extra two years to pay the tax bill triggered by the conversion, so you can spread what you owe over your 2011 and 2011 returns.

The conversion may not be right for everyone, so here are some tips on making the decision:

Do you have to convert everything?
No. You can move your entire account balance, or just a small portion. My advice? Figure out how much you can afford to pay in taxes, and then decide how much to move. You don't want to tap your retirement savings to pay your taxes.

Should you close your other retirement account?
Absolutely not. The income-limit exclusion is for the conversion only -- if your income surpasses the ceiling for Roth IRAs, you still can't contribute to the account. If you've invested appropriately, the money in your Roth will continue to grow, but you should continue saving in your other retirement vehicles.

Who shouldn't convert?
Don't make the move if you can't afford to pay the taxes on the conversion, feel you'll be in a lower tax bracket in the future or you're at an age that doesn't make the conversion cost worth it.

"Older people -- in their 70s or older, I'd say -- if they're converting, they don't have the life expectancy to make the cost worth the benefit. So this isn't for them, unless they're doing it for estate-planning purposes, because then their kids or grandkids can have the money tax-free," explains Ed Slott, an IRA expert and founder of IRAhelp.com.

Can you change your mind?
Yes, if you do it before October 15, 2011. You can reverse the conversion in a move called a re-characterization of the account. Simply ask your bank or brokerage to directly transfer the money back into your traditional IRA.

Originally published