A Good Year to Convert to a Roth IRA?

You want to know what I think of the budget and the tax cut? I think they are terrible. It’s just nuts to give a huge tax cut to the top 1% or 2% when, under the current structure, they were already dramatically outpacing everyone else after-tax. Let’s use most of that money to pay down the debt. Yes, the surplus is ‘our money!’ but so is the $5 trillion National Debt ‘our debt’ – about $4 trillion of it racked up under Reagan/Bush, the last time we tried a huge tax cut for the rich. Why don’t we take the prudent course and first do the stuff we know needs doing, like paying down the debt and keeping cops on the street and providing a prescription drug benefit, and then, if we’re still rolling in it, turn our attention to cutting taxes for those in the top 2%? For shame!

Blood pressure falling . . . back . . . to normal.

OK.

Now:

With a Roth IRA, you get no tax-deduction for the money you contribute . . . but neither do you pay any tax on the money you withdraw. (There’s also less paperwork and more flexibility.) As a result, many people have toyed with the notion of converting their traditional IRAs to Roth IRAs. It often makes sense.

(The scenario in which it would not is if you are in a high tax bracket now, and expect to be in a very low one as you withdraw the money. I say: fat chance. But if you did expect to be in a very low tax bracket as you withdrew the money, the tax benefit of the Roth IRA would be correspondingly low, and would probably not justify giving up today’s tax deduction.)

You don’t have to convert by any special deadline. But if you were thinking of converting, this could well be a better time to do it than, say, this time last year. For two reasons:

• First, your IRA may have shrunk in value with the stock market. If so, there will be less money to convert and, thus, less tax to pay on the conversion. Later, when it bounces back, all that bounce-back will be free of tax.

• Second, it looks as if tax brackets themselves are likely to come down this year – so the tax you’ll owe may be lower still.

Of course, if the bear market has further to run, as it probably does, you might want to wait still longer to convert. And if some of the drop in tax brackets winds up being phased in over time, that, too, would be a reason to wait. But clearly, this year would be a better time for most to convert than last year – even if it proves not to be as good as, say, next year.

(You could always waffle, converting some now and – if the value of your traditional IRA falls further – the rest later.)

For Vanguard’s worksheet on Roth IRA eligibility and conversion, click here.

And don’t forget that the deadline for contributing this year to either kind of IRA (as opposed to converting, for which there is no deadline) is Monday. (Monday – oy! — is also the deadline for filing YOUR TAXES! Or at least your Form 4868.)