Roth IRA Conversion

In 1997, the Roth IRA was introduced. This new IRA allowed for contributions to be made on an after tax basis and all gains (or growth) to be distributed completely tax-free. Since then, people with incomes under $100,000 have had the option to convert all or a portion of their existing Traditional IRAs to Roth IRAs. Beginning in 2008, participants with funds in eligible employer sponsored plans could also roll those funds directly over to a Roth IRA in a qualified rollover if their income did not exceed the $100,000 threshold. Starting in 2010, all IRA owners and participants in eligible employer sponsored plans, regardless of income level, will be eligible to convert their Traditional IRA and pre-tax funds in an employer-sponsored plan (401(a)/(k), 403(b) and governmental 457(b)) to a Roth IRA. Is this a good option for you? A conversion has both advantages and disadvantages that should be carefully considered before you make a decision. This calculator compares two alternatives with equal out of pocket costs to estimate the change in total net-worth, at retirement, if you convert your Traditional IRA into a Roth IRA.

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Definitions

Please note the following important information regarding any Roth conversion
  • You must pay ordinary income tax on the amount converted (specifically, on pre-tax contributions and investment gains).
  • If you pay the taxes using money from the traditional IRA, you will lose the potential benefits of tax-free growth on that amount.
  • If you are under age 59½, you may be subject to a 10% federal tax penalty if you withdraw money from your traditional IRA to pay the tax on the conversion. You may also have to pay state tax penalties.
  • If you convert in 2010, the amount converted will be automatically split and reported equally as income on tax returns for 2011 and 2012, unless you elect to report the entire conversion amount on the 2010 tax return. As top income-tax brackets are set to rise in 2011, if you expect to be in a higher tax bracket in 2011 and 2012, it may be better to report the whole conversion amount on your 2010 tax return.
  • For an investor in a lower tax bracket, traditional IRA contributions may be tax-deductable while Roth IRA contributions are not.
Amount to convert

Amount to convert from a Traditional IRA account to a Roth IRA. We assume that you are paying any taxes owed with funds that you have available outside of the account you are converting. If you are under 59 1/2, the IRS treats any money not directly rolled over to the Roth IRA as an early withdrawal - even if that money is used to pay the tax bill caused by the conversion and, except in the case of a rollover from a governmental 457(b) plan, the funds will be subject to a federal tax penalty unless an exception applies.

Non-deductible contributions

The amounts, if any, contributed to your traditional IRAs or employer sponsored accounts made with after-tax contributions. It is important to note that you may not "cherry pick" funds that are either after-tax or pre-tax to convert. If you are not converting all of your IRAs or the entire amount in your employer sponsored plan, you must convert a pro-rated amount of the pre-tax (deductible) and after-tax (nondeductible) balance. All of your IRAs are added together and treated as one for this purpose.

Current age

Current age. This age must be less than 70. Since this calcualtor does not take Required Minimum Distributions (RMD) into account, which begin at age 70 1/2, it is not designed for individuals that are currently required to begin making these distributions.

Age at retirement

Desired age at retirement.

Rate of return

The annual rate of return for your IRA. This calculator assumes that your return is compounded annually. The actual rate of return is largely dependent on the type of investments you select. From January 1970 to December 2009, the average compounded rate of return for the S&P 500, including reinvestment of dividends, was approximately 10.1% per year. During this period, the highest 12-month return was 64%, and the lowest was -43% (Standard and Poor's, Dec. 2008). Savings accounts at a bank may pay as little as 1% or less (Federal Reserve Statistical Release, Dec. 2009). It is important to remember that future rates of return can't be predicted with certainty and that investments that pay higher rates of return are subject to higher risk and volatility. The actual rate of return on investments can vary widely over time, especially for long-term investments. This includes the potential loss of principal on your investment.

Current tax rate

Current marginal income tax rate that will apply to conversion amount. Please note that the marginal tax rate for your conversion may be higher than your current marginal tax rate if the conversion moves your AGI into a higher income tax bracket. It is also possible, especially on very large conversions, that part of your conversion be subject to more than one tax rate. Below are the resulting tax rates and income ranges for 2010:

Filing Status and Income Tax Rates 2010
Caution: Do not use these tax rate schedules to figure 2009 taxes. Use only to figure 2010 estimates.
Tax rate Married filing jointly or Qualified Widow(er) Single Head of household Married filing separately
10% $0 - 16,750 $0 - 8,375 $0 - $11,950 $0 - 8,375
15% $16,751 - 68,000 $8,376 - 34,000 $11,951 - 45,550 $8,376 - 34,000
25% $68,001 - 137,300 $34,001 - 82,400 $45,551 - 117,650 $34,001 - 68,650
28% $137,301- 209,250 $82,401- 171,850 $117,651- 190,550 $68,651- 104,625
33% $209,251- 373,650 $171,851- 373,650 $190,551- 373,650 $104,626- 186,825
35% over $373,650 over $373,650 over $373,650 over $186,825

Source: http://www.irs.gov/pub/irs-drop/rp-09-50.pdf

Tax rate at retirement

Expected marginal income tax rate at retirement.

Investment tax rate

Expected marginal tax rate (base this on expected capital gains rate) for investments. This calculator assumes that you invest the amount that you would have had to pay in taxes in a taxable investment account. The investment tax rate is used for calculating the annual return on these taxable investments. For many, this will be the same as their income tax rate. If you expect your non-IRA investments to be primarily from long-term capital gains or dividends.

Use 2010 Option to delay tax payments

Check this box to use the 2010 option to delay your Roth Conversion tax payments to 2011 and 2012. This option is only available for conversions that take place in 2010. When this box is checked, no taxes are due for the conversion in 2010. In both 2011 and 2012, one half of your converted amount will be added to your income and subject to income tax. Please note that under current law, existing tax rates are set to expire at the end of 2010 and, absent further congressional action, will revert back to the higher rates in place in 2001 beginning in 2011.