Starting
this year (2010), the income limitation on a Roth IRA has been lifted, allowing almost
anyone to convert to this tax-free growth retirement savings vehicle – making
the Roth a hot topic in 2010. Although a tempting option for many retirement
savers, if handled incorrectly, a Roth conversion can be costly. Consider the following four most common
problems before converting your retirement savings to ensure a Roth conversion
will make the most sense for you.
Problem #1: Converted even if it’s not right for your situation
– Roths aren’t right for everyone. For example, if someone approaching
retirement anticipates a lower tax bracket during retirement, they could easily
pay fewer taxes on their withdrawals from their existing account than they
would on a conversion today. Also,
if you can’t afford paying the taxes on the conversion without dipping into
your retirement account, don’t do it. You will face a 10 percent penalty tax
and income tax.
Problem #2: Converted the wrong way - Roth
conversions have penalty traps if conversion rules aren’t followed. For
instance, when pulling funds from an existing retirement account to convert to
a Roth, if the funds are issued in your name opposed to executing a direct
transfer, anticipate a 20 percent withholding tax. Also, if you rollover a Required Minimum Distribution from
your current retirement account you could also face a 6 percent excise tax if
you go over the amount you are allowed to contribute every year.
Problem #3: Converted ineligible funds - Not
all funds are eligible for conversion, including converted inherited IRAs or
dividends from employer stocks. Keeping these funds in a Roth will cost you a 6
percent excise tax for each year they remain in the account.
Problem #4: Converted without updating estate documents – Unfortunately
beneficiary forms don’t convert from one retirement account to another with
your funds. Therefore you need to get new conversion forms from your Roth custodian
and complete them to ensure your loved ones get their intended
inheritance.
Before making the
decision to convert to a Roth IRA, talk to a qualified financial professional
who can help you decide if it’s a right move for you and help you execute the
conversion properly.