Why Convert to a Roth IRA?

Key advantages make Roth IRAs an attractive investment option.

For many investors, converting a Traditional IRA to a Roth IRA makes sense because of the key advantages Roth IRAs offer. These include:

Tax-free withdrawals. Roth IRA owners can withdraw their contributions federal income tax and penalty tax free at any time. Withdrawals of Roth IRA earnings are completely federal income tax free for so-called "qualified distributions," through which the taxpayer takes the withdrawal at least five years after the IRA was established and meets one of the following requirements:
- reaches age 59½
- uses the funds for a qualified first-time home purchase (up to a $10,000 lifetime maximum)
- becomes disabled or dies

With a pretax Traditional IRA, income taxes are due on withdrawals made after age 59½. (Note that IRA withdrawals prior to age 59½ are generally subject to a 10% IRS early withdrawal penalty, plus ordinary income tax.)

No required minimum distributions. Unlike with Traditional IRAs, Roth IRA owners do not need to take required minimum distributions (RMDs) once they reach age 70½. In contrast, Traditional IRA owners must begin taking RMDs by April 1 following the year they turn age 70½. As a result, Roth IRA owners can leave their money in their IRAs much longer, potentially accumulating more tax-free income. This can be a boon to investors who live far beyond age 70½, giving them potentially more assets for their retirement income or for their heirs.

(Note that The Worker, Retiree and Employer Recovery Act of 2008 waived the RMD requirement for IRAs and employer-sponsored retirement plans for calendar year 2009. This legislation won't help people who were hoping to avoid taking a withdrawal in 2008, or have already done so. However, the U.S. Treasury Department is considering relief with respect to minimum distributions made during 2008. Talk to your tax advisor to learn more.)
The option to make contributions past age 70½. Taxpayers age 70½ or older who have earned income are eligible to open a Roth IRA. In contrast, contributions to Traditional IRAs are not allowed for anyone age 70½ or older.
Locked-in current federal income tax rates. If federal income tax rates rise in the future, Roth IRAs can provide an additional tax advantage over Traditional IRAs since qualified withdrawals from Roth IRAs can be withdrawn federal income tax free. In contrast, Traditional IRA owners will owe taxes based on whatever the future rates are.
Heirs generally do not pay income tax on IRA assets. Because people who inherited Roth IRAs get the same tax-favored treatment as do the original IRA owners, Roth conversions can be an effective estate planning tool. For example, while nonspouse beneficiaries are required to take distributions from an inherited Roth IRA over their life expectancies, if the withdrawals are "qualified distributions" and meet the requirements set above, they generally don't have to pay income tax on these withdrawals. So estate planning considerations can be a good reason for doing a conversion.

Also, note that in past years, if you had assets in tax-qualified plans, tax-sheltered annuities or 457(b) plans that you wanted to roll over to a Roth IRA, you first had to roll these assets over to a Traditional IRA. You would then convert the Traditional IRA into a Roth IRA. However, thanks to the Pension Protection Act of 2006, you can now convert tax-qualified plans, tax-sheltered annuities and 457(b) plans directly into a Roth IRA. Consult with your tax advisor about your particular situation prior to transitioning plan assets in this way.

Find out more about the potential advantages of Roth IRAs.

Tax considerations

If you are thinking about doing a Roth IRA conversion, keep in mind that the tax costs can be significant. You will pay taxes on the contributions you previously deducted, as well as on any accumulated earnings. A Roth IRA conversion can also push you into a higher tax bracket, especially if you are converting a large amount of money. Even though you can spread the taxes for a 2010 conversion over the next two years, think about the overall impact of the conversion's costs on your long-term investment strategy.

Note that there are income rules for contributing to a Roth IRA. For the 2009 tax year, individuals can make a full Roth IRA contribution if their year 2009 modified adjusted gross income (MAGI) is less than $105,000 (less than $166,000 for joint filers). Partial Roth IRA contributions are available to single filers with a MAGI between $105,000 and $120,000 ($166,000 and $176,000 for joint filers).

The tax information in this article is not intended to be used, and cannot be used, to avoid possible tax penalties. It was written to promote the products and services the article describes. Neither TIAA-CREF nor its affiliates offer tax advice. Taxpayers should consult an independent tax advisor for advice based on their own particular circumstances.

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