Is now the time to turn your IRA into a Roth?

It's the question du jour in financial planning: Should you take advantage of some special perks in 2010 and convert your traditional Individual Retirement Account to a Roth IRA?

The answer, as with nearly anything in personal finance: It depends.

Yes, it's an idea to consider. Moving money from a traditional IRA to a Roth opens up a lot of possibilities, not the least of which is tax-free growth and withdrawals in retirement. SEP-IRAs, SAR-SEP IRAs and SIMPLE IRAs can be converted as well, as can 401(k) balances from past employers. There are good estate-planning opportunities, too.

Congress removed the $100,000 income limit on conversions this year. It also gave us the option of paying taxes on the conversion in 2011 and 2012, easing some of the up-front cost.

Nice perks. But it's still not for everyone.

"To convert just to convert doesn't make sense to me," said Brad Fields, a certified financial planner at Delta Financial Group in Portland. "You have to look at the whole picture."

First of all, you must pay taxes on the amount converted now rather than later. That means a household earning $75,000 a year converting the median IRA of $60,000 would have to fork over an additional $15,000 on their 2010 federal tax bill.

That might not be the best way to use your extra savings. Especially if you carry a credit card balance, lack an emergency savings account or have a college tuition bill to boot.

And in very few cases should you use IRA assets to pay that tax bill. You'll pay a penalty and lose future earnings potential.

So, here's a guide as to when you might, and might not, want to convert.

You might want to
You're young.
If you've got 30 years of earnings ahead of you, you've got plenty of time to let a Roth grow. That means you'll get more out of the tax-free growth than someone with only 15 years left in his or her career.

Start with $5,000 in an IRA and add $1,000 each year. At the end of 30 years, and assuming 7 percent annual growth, you'll have slightly more ($139,100) than someone who started with $40,000 and saved $1,000 a year for 15 years ($137,250).

You're in a low tax bracket.
A married couple with adjusted gross income of $55,000 falls into the 15 percent marginal tax bracket. Converting $20,000 would add about $3,700 to their federal tax bill.

However, reporting all that income in one year actually bumps the couple into the 25 percent bracket. That means they'll pay 25 percent on anything they earn above $67,900.

If they spread that $20,000 conversion equally across their 2011 and 2012 tax returns, and their income remains about the same, they'll stay below that $68,000 threshhold both years. And their tax hit will be slightly lower -- about $3,000 over two years.

You have a small IRA balance. You'll pay less in taxes now than you would in retirement. Think about it. A $20,000 IRA growing 7 percent a year will be worth more than $77,000 in 20 years. Which would you rather be taxed on, $20,000 or $77,000? And remember, you can spread the conversion amount across your 2011 and 2012 income.

You think you'll be taxed at a higher rate in retirement. Many expect Congress to raise taxes to pay off the debt our government has taken on. Or, perhaps you just started your career as a doctor or teacher and expect to earn much more later in life, including in retirement.

Then, a conversion makes a lot of sense.

You want to leave an IRA as a gift.
One of the greatest things about a Roth is you don't have to ever draw from it. Traditional IRA rules force you to take distributions when you reach age 70 1/2. Roth IRA rules don't.

You can name a grandchild as a beneficiary and pass the entire balance on to them upon death. They will have to take distributions, but they can do so in relatively small amounts across their lifetime. And they won't have to pay taxes on what they take out.

"If you're not somebody who needs to rely on that money to live through retirement, you can totally make it into an estate planning vehicle," said Jonathan Mishkin, estate planning and tax attorney at Harrang Long Gary Rudnick in Portland. "It can be used almost as a defacto trust, where you can set aside money that can grow tax free to your children."

Maybe not
You can't afford it. There are plenty of other things to do these days with your extra savings.

"If you have credit card debt, forget it," says Fields, of Delta Financial. "Pay the credit card debt off first."

Remember, too, that if you need to tap funds in a Roth IRA within five years of opening it or before you turn 59 1/2, you risk a 10 percent penalty and getting taxed on any earnings you take out.

"If you need the money, you shouldn't go broke converting," says Ed Slott, publisher of a newsletter and books on IRAs and a big proponent of conversions.

You're in or near retirement. There may be some individual circumstances in which converting makes sense. But if you're in this camp and not doing it for your heirs, you need to think long and hard. Consult a CPA, or at least a financial adviser or planner first.

Converting puts you into a higher tax bracket.
The amount you convert is essentially counted as income. If you convert $100,000, and your adjusted gross income normally is $60,000, you could suddenly find yourself leaping from a 15 percent tax bracket to the 28 percent bracket for the year. Be sure to take this impact into account when you explore converting.

And keep in mind . . .

You can undo it
. If you convert this month and change your mind later, you technically have until Oct. 15, 2011, to undo what yo u did with no penalty. It's called a recharacterization. In fact, this could be your backstop if the market declines. Let's say you convert $100,000, then watch the market plunge in value. Suddenly your IRA is worth only $70,000, but you still have to pay taxes on the $100,000 amount.

If you recharacterize, you'll avoid paying taxes on that $30,000 loss. Check with a CPA or tax attorney to back out properly.

You can do partial conversions. Move $15,000 of that $70,000 traditional IRA into a Roth now if you can't afford to pay much in additional taxes. In fact, some brokerages allow you to designate a specific fund to convert, says Bruce Miller, a certified financial planner who teaches at the University of Portland. Fidelity and TDAmeritrade, for instance, allows partial distributions by security or fund and by dollar amount or number of shares. You often can also set up automatic, recurring distributions. And you can always merge separate Roth IRAs into one at a later date, Miller said.

This offers an interesting hedging strategy, Miller says. Move your bond fund and your aggressive growth fund into separate Roths. If the bonds fund fares well next year and the stock fund tanks, you can recharacterize the stock fund back into the traditional IRA.

Final words

Roths can be confusing. Entire books have been written about them. If you have questions at all, talk to a financial planner or CPA.

And if it doesn't fit, don't convert.

Brent Hunsberger does not give individual financial advice but welcomes questions and comments about his column or blog. Reach him at 503-221-8359. Read his blog at