More people have access to the Roth individual retirement account (IRA) as a result of changing tax rules. The question, then, is: Could you benefit?
A Roth IRA differs from a Traditional IRA in regard to taxation. With a traditional IRA, contributions are tax deductible, but you pay taxes on withdrawals. With a Roth IRA, you don’t get a deduction when you contribute, but you won’t pay taxes on withdrawals, which include earnings that have accumulated over the years. That makes the Roth IRA attractive.
In the past, however, many investors couldn’t participate because their income was too high. But on Jan. 1, 2010, the rules for Roth IRAs changed. Now there is no income limit for individuals who want to convert traditional IRAs and employer-sponsored retirement plans to Roth IRAs. Although the converted amounts are subject to income tax, future withdrawals that meet certain holding requirements will be tax free.
So how do you determine if you should convert a traditional IRA to a Roth IRA? As a general guide, you may want to consider the past and anticipated future performance you expect from your investments. If you have an investment that you consider depressed in value, with appreciation potential, it may make sense to convert it to a Roth – because that way you won’t have to pay taxes on any potential increase in value.
On the other hand, you may not want to convert an investment you think is at or near an all-time high, such as a stock you bought for $25 per share that has climbed to $200 per share.