IRA choices Which is right for you?

IRA choices Which is right for you?

BOSTON — Tax planning is rarely easy. But more individuals now have the option of taking the relatively simple step of converting a traditional individual retirement account to a Roth IRA.

In January, the government dropped restrictions that had prevented households with gross income of more than $100,000 from converting traditional IRAs into their Roth counterparts. The basic question to answer: Do you prefer to pay taxes on contributions to your account, or pay Uncle Sam when you make withdrawals years later?

Converting an account doesn't make sense in all instances. Online Roth conversion tools and financial planners can help sort through most of the common scenarios.

Money shifted into a Roth is taxable now — and treated like ordinary income — at your current tax rate. That's assuming you don't stash so much into a Roth that your increased taxable income temporarily bumps you into a higher bracket. The benefit? Withdrawals in retirement will be tax-free.

The savings can be big. If you climb to a higher tax bracket by the time you retire, you may end up wishing you had paid the taxes when you were at a lower rate. Or, if you don't move into a higher bracket in retirement, you could ultimately benefit from a Roth if Uncle Sam has raised rates across the board.

Indeed, you won't have to wait long. Income tax rates for high-income and middle-income taxpayers are expected to rise next year, in most instances by 3 percentage points — for example, 33 percent to 36 percent for the second-highest bracket.

One thing is clear four months after the $100,000-plus income group became eligible for Roths: Many who likely would benefit aren't converting, because of confusion, analysis paralysis, or just ignorance. That's according to surveys from financial services companies eager to win your Roth IRA business.

Another big factor is the human tendency to put off the uncomfortable.

"At the end of the day, you have to write a bigger check now to the IRS," says Chris McDermott, a Fidelity Investments vice president specializing in retirement planning. "That's not something people are going to take lightly — nor should they." With a traditional IRA, contributions are tax-deductible, and grow tax-deferred until the investor makes withdrawals, when it's time to pay Uncle Sam. With Roths, contributions aren't deductible, and taxes are paid up front, with no taxes on future withdrawals provided they meet certain qualifying rules. It can offer greater certainty about how much you'll have in savings entering retirement.

A survey conducted for Fidelity in March found just 35 percent of the upper-income group newly eligible for Roth conversions were aware of the change. And 55 percent of those with old 401(k)s from former employers were uncertain whether their assets could be rolled over directly into a Roth (They can).

Even so, the new rules are fueling a surge in Roth accounts. Conversions by Fidelity clients in the first quarter quadrupled from the same quarter a year ago.

Everyone's circumstances differ, so do your own homework. Here are tips if you're considering a Roth IRA conversion:

Who might benefit from converting:

— You're young and well-off. This is the group most likely to benefit long-term from paying taxes now. Consider the tax rate you'd pay now from shifting money into a Roth, versus the potentially higher rate you'll face if your income grows and you move into a higher bracket at retirement.

— You're in your 40s or 50s, and likely to move into a higher tax bracket at retirement. The considerations are similar here as with the younger crowd. You just won't have as many years to see your IRA grow tax-free.

— You're temporarily in a lower tax bracket. Many double-income families move to a lower bracket after they have children. That's because, in many cases, one parent may leave the work force to care for kids. Tax benefits from more personal exemptions, home ownership and investment losses also cab temporarily move someone into a lower bracket. Now could be a good time to take the tax hit from a Roth conversion at a lower rate than you'd face paying taxes on an IRA distribution entering retirement.

— You want to pass on money to heirs, or you're well-off late in your retirement. Traditional IRAs require withdrawals at age 701/2, regardless of whether you need the cash to get by. With a Roth, you can continue to let the account grow tax-free beyond that age. You can have more to keep for yourself if you live into your 80s or 90s, or more to pass on to children after you die.

Who might not benefit from converting:

— You're near the upper limits of your tax bracket. Putting money into a Roth increases your taxable income in the year the contribution is made. Gauge whether you're at risk of paying higher income taxes. If you are, spread out Roth contributions from year to year to limit instances when you might shift to a higher bracket.

— You can't afford a bigger tax burden now. Many individuals are stretched financially by the recession. If you don't have enough in cash or in a savings account to stash in a Roth, don't withdraw from a tax-protected account such as a 401(k) for a Roth contribution. You'd be incurring an early withdrawal penalty to fund a Roth, which doesn't make sense.

— You expect to drop to a lower bracket entering retirement. If so, you could end up paying a higher tax rate for a Roth contribution today than you'd pay by the time you withdraw when you're older.

— You're about to apply for college financial aid for an older child. Be aware that a Roth contribution will temporarily boost your income for that year. That increase could disqualify you for college aid.

On the Net:

Free online calculators for gauging IRA conversions: Internal Revenue Service information on IRA conversions:

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