Converting From a Traditional IRA to a Roth: How Much?

I believe income taxes across the board will probably be higher by the time I retire. If I’m right (I hope I’m wrong!) Linda and I will be better off with more retirement assets in tax-free Roth IRA’s instead of in tax-deferred Traditional IRA’s.

Recently, I’ve read articles describing the new for 2010 rules on who can contribute to a Roth IRA and articles describing the special (2010 only) rules for converting a traditional IRA into a Roth. The new and special rules don’t apply to me – I don’t make that much money. Still, converting (moving) some assets from a traditional IRA to a Roth is something I do every year.

All new IRA contributions go into a Roth. However, I’ve changed jobs a few times in my life and each job change ended up increasing my Traditional IRA account balance when my 401k account with my former employer was rolled into my Traditional IRA.

Since allowable 401k contributions are significantly higher than IRA contributions the amounts rolled over into my Traditional IRA drove it higher than my Roth; Even though I contribute the maximum allowed to my Roth each year.

Because I believe my income taxes will be higher after I retire – an arguable belief I know – I want to move as much money as I can afford from the Traditional IRA to the Roth. Now then, how much can I afford?

The problem is the value of the assets moved becomes taxable income for the year in which the move occurs. If you move $1,000 to your Roth and your income tax rate is 25% then your income tax for the year increases by $250. This can be a very expensive proposition if you convert tens of thousands of dollars. It can also be very expensive if you have no money budgeted to pay taxes other than your withheld wages.

I fall into the second category. I don’t want to write a check on income tax day. On the other hand, I don’t mind reducing my refund from Uncle Sam in exchange for moving retirement money to my Roth. So, I estimate what my refund might be and then conservatively calculate the amount I might safely move to a Roth.

Then, I split the difference and move the same amount from Linda’s Traditional IRA to her Roth as I move between my own accounts.

Timing considerations and the actual mechanics of the conversion (move) will be the topics of future posts.

Link to Other topics in the Special Report: Converting to a Roth IRA