So we are about halfway through 2010!  Hard to believe isn’t it?

Although some of the buzz has seemingly died down about the year of the Roth IRA Conversion, there is still some controversy regarding whether folks should convert their Traditional IRAs to a Roth.

For those of you wondering what exactly is a Roth IRA,  Well, here are the basics:

A Roth IRA is funded with after-tax contributions; the money grows tax-deferred; and withdrawals are TAX FREE!

In other words, you use money you’ve already paid taxes on to fund the Roth, and provided you meet certain qualifications you never have to pay taxes on that money again!

What is a Roth IRA Conversion?

A Roth IRA conversion then is withdrawing money from a Traditional IRA and putting it into a Roth IRA where it will grow tax free.

Sounds good right? 

Well, the problem is that whenever you do this you have to pay taxes on the amount you withdraw from your Traditional IRA. 

So, let’s say you are converting $5,000 from your Traditional IRA — you would have to tack on 5G’s to your income for the year and pay tax at whatever rate you are at.  It’s as if you earned an additional $5,000 of income for the year.

As many of you already know, one big change for 2010 is that anyone can convert to a Roth regardless of income level. Previously, if you made over $100,000 you could not convert to a Roth.

If you convert in 2010, you now have a choice to pay all of your taxes in 2010 or average the taxes owed on the conversion over two years (i.e. pay in 2011 and 2012).  Uncle Sam is giving you a choice on when you pay your taxes.

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Don’t forget though that 2010 is the last year for the current low income tax rates. The current law plans for higher tax rates in 2011 — so, if you chose to average your tax payments over the two year period in 2011 and 2012, you might get hit with higher tax rates.   That Uncle Sam – he’s always got an angle doesn’t he?

Should You Do a Roth IRA Conversion?

Back to the question at hand.  Should you perform a Roth IRA Conversion in 2010? 

Usually the answer to such questions is “it depends”.  This might be a great year to convert your money to a Roth and potentially pay lower taxes than you would normally if you are in a lower bracket due to retirement or a layoff and you’ve got some cash on hand to cover your taxes! 

This is important because if you are under 59 1/2 and use your IRA to pay the taxes on the conversion you’ll get whacked with a 10% penalty on top of the taxes!

Let’s take a look at some things to consider:

Factors to Consider for Your Roth IRA Conversion

• Do you have money to cover your tax liability?  Having cash on hand to cover your taxes will help soften the blow, and you certainly don’t want to pay taxes with the money you are converting.
• Will the money you convert push you into a higher tax bracket?  If so, you probably don’t want to do it.
• Do you have non-deductible contributions in your IRA?  No taxes are due on the non-deductible portion.  *There are some additional factors about non-deductible IRAs that I covered in a post at Bible Money Matters.
• Are you planning on applying for financial aid for yourself, your spouse or your child?  Better think twice about the conversion – conversion income counts on your application.

Ultimately, whether you convert your Traditional IRA to a Roth will not determine your retirement success, there certainly are other things to consider to help you make a great run at retirement. 

So which retirement account is right for you?  Consider the above  factors, your overall situation and the Roth IRA conversion rules to determine whether the Roth IRA conversion makes sense for you in 2010.

This was a post I originally wrote for ChristianPF.com and adapted here for my site.

Retirement is a fascinating topic don’t you think? 

Millions of people long for it, plan for it and obsess over it.

On a daily basis, people ask themselves questions like these:  when can I retire?; how much money do I need to retire?; and which retirement account should I be saving into as I get ready for that big day?.

The last question is what we want to tackle today – which retirement account is right for you?

We certainly won’t cover every single type of retirement account out there today, but I do want to tackle the big four – 401ks, Traditional IRAs, Non-Deductible IRAs & Roth IRAs to see which one(s) make sense for you.

Let’s take a look:

401k Retirement Account

401k legislation was written in 1978 and finally passed in 1980.  401k’s allow employees to choose to receive deferred compensation rather than direct compensation.  That compensation gets put into a 401k account that is invested.

401ks are tax-deferred retirement savings accounts.  Basically they allow you to reduce your taxable income, which gives you a tax-break now.

They also grow tax-deferred – meaning you are not taxed on the growth of the investments each year.

When you pull the money out in retirement, however, you must pay the Piper!  Uncle Sam will ask for all that deferral to be taxed.

Every dollar you pull out will be included in your taxable income for the year – it’s as if you earned that money. 

401ks – The Right Retirement Account for You?

401k retirement accounts are right for folks who like having an easy way to save for retirement (deductions are taken from your payroll), who want to reduce their taxes now and who are getting an employer match on their 401k contributions.

Traditional Individual Retirement Account (IRA)

A Traditional IRA works much the same way as a 401k except for the payroll deduction.  The limits are much lower in terms of what you can contribute as well.

If you are covered by a retirement plan at work and making between $56,000 and $66,000 for singles and $89,000 and $109,000 for joint-filers then the deductibility of your contributions are phased out.

That means you cannot deduct the entire amount of your contributions from your income. 

If you are making under that amount or you are not covered by an employer retirement plan at all, then you are able to fully deduct your IRA contributions.

Traditional IRAs – The Right Retirement Account for You?

A Traditional IRA is a great retirement account for those who may not have a 401k or other employer plan, or who perhaps do have one, but are making less than the phase-out limits and want to get tax advantages now.

Roth Individual Retirement Account (IRA)

Roth IRAs are Individual Retirement Accounts that do not give you a tax break up front.  Rather, they allow you to put in after-tax money, which then grows tax-deferred.

When you reach 59 1/2, you can take out your contributions and your earnings completely tax-free!

Like the Traditional IRA, the IRS has phase out rules for Roth IRAs.  For single filers, your Roth IRA contributions are phased out when your Modified Adjusted Gross Income (MAGI) is between $105,000 and $120,000.  Above $120,000 you are ineligible for a Roth IRA contribution.

For married filers, the phase-out limits are between $167,000 and $176,000 and above that you are ineligible for contributions.

Roth IRAs – The Right Retirement Account for You?

Who should open a Roth IRA?  Basically anyone who falls under the phase-out limits, wants to diversify themselves from a tax-standpoint and has ran the numbers and feels that income or tax rates will be higher in the future and their potential for tax savings is greater down the road than it is now.

Non-Deductible Individual Retirement Account (IRA)

A Non-Deductible IRA is simply an IRA that you contribute to when you are phased out of your deductiblility.  Remember how we said that if you are covered by an employer plan and make too much money you can’t deduct your contributions? 

A Non-Deductible IRA is the result.

Last year I would never have given the non-deductible IRA a second thought.  It made very little sense to contribute to them. 

This year, however, it may make a lot of sense for folks.  Here’s why:

The income limits for Roth IRA conversions have been lifted, meaning anyone can convert money to a Roth IRA!

I won’t get into the details of this strategy here, since I talked about covnerting non-deductible IRA contributions at length in this post - but quickly, here is the strategy:

Make Non-Deductible IRA contributions (no tax write off); convert those contributions to a Roth IRA (no taxes owed); let your money grow tax-free in the Roth IRA (no taxes owed) and then pull out the money in retirement (no taxes due!)

Non-Deductible IRAs – The Right Retirement Account for You?

This strategy is right for those who make too much money to simply contribute to Roth IRAs, but still want to take advantage of tax diversification by getting money into a Roth.

Which Retirement Account is Right For You?

Readers, let’s hear from you – which is your favorite retirement account and why?

According to Wikipedia, Baby Boomers are those who are born between 1946-1964 – meaning they range in age from 46-64 years of age.

Retirement is certainly on their minds and they are concerned about how much they need for retirement savings.

As baby boomers approach the magical age, there are some pretty important things to keep in mind about saving for retirement.

Let’s take a look at five things to keep in mind about retirement savings:

Retirement Savings Is Up to You!

Ok, so this is no breakthrough – I’m not pretending to discover a cure for cancer by any means, but this point needs to be stressed over and over again.

Years ago, you could work for an employer for 30 or 40 years, retire with a nice pension provided by the company and collect your social security and be pretty comfortable in retirement.

Not anymore!  Companies are dumping their pensions left and right, Social Security will need a massive overhaul to avoid going defunct – so what does that mean for you?

You are on your own for retirement savings – and that’s OK.

When Can You Access Your Retirement Savings?

This is something that all baby boomers should get really familiar with.  Accessing your retirement savings is generally what’s going to provide you an income in retirement, unless you have other business income etc.

Most people recognize 59 1/2 as the magical age to access your retirement savings, but get familiar with the rules surrounding your withdrawals.  Here’s a couple of them to remember:

• You can access your IRA at any time, but be aware of the penalties.
• You can withdraw from your 401k savings prior to 59 1/2 without penalty if you are at least age 55 when you retire.
• You can take out Roth IRA contributions at any point in time, but the earnings must left alone until age 59 1/2.

What is Your Retirement Savings Number?

A few years back, Lee Eisenberg wrote a book called The Number, where he talks about what you’ll need for the rest of your life and what it will cost.  It’s an entertaining and informative look at what the rest of your life will look like.

You should be asking questions like, “Is a million dollars the magical number?”  Many people think they need much, much more than that, but is that right?

In light of this, you’ll need a good retirement calculator and you’ll want to sit down with your loved one and figure out your income versus expenses and determine how much retirement savings you need?

How Will You Diversify Your Retirement Income?

This is one that boomers probably have in the back of their minds, but some careful consideration should be done.

Will you have a pension, social security, 401k savings, IRA money, or annuities to help supplement your retirement income?

What about starting a business or turning a hobby into an opportunity to make some side money?  Have you considered other ways to make money and diversify your income in retirement?  You probably should.

Once again, retirement savings is up to you, therefore you need to be prepared and should have multiple lines in the water so that you’re not relying on the fish always biting from one particular source.

How Will You Diversify Your Retirement Savings From a Tax Standpoint?

Tax diversification is extremely important and is something that everyone should get familiar with and take a look at for their own situation.

In essence, tax diversification takes a look at the tax status of investing into three different vehicles.  You have tax-deferred, taxed-as-you-go (or non-qualified) and tax-free.

No one investment vehicle is right in every circumstance, but I think it’s very important to spread savings out among these three types of accounts because the greater the flexibility you have for accessing retirement savings, the greater the options you have for lowering your tax burden in retirement.  Plus, after reading why tax-deferral may not be all that it’s cracked up to be you might agree with me.

If taxes are high in some years, you have other money to withdraw from besides your 401k.  If tax rates are low, then why not pull money out of your IRA and consider a Roth conversion etc.

How About You?

Readers, what are some other things to consider for retirement?

No doubt most people have heard of a Roth IRA, after all, they’ve been around since 1998.  Although they’ve been available for over 11 years, I’m constantly amazed by how many people are just simply unsure of exactly what they are or what they do. 

The Basics: What is an IRA?

An IRA is simply an Individual Retirement Account (IRA) that provides investors an opportunity to save for retirement in a tax-advantaged way.  Generally, you must wait until 59 1/2 to withdraw the money without IRS penalty. 

A Roth IRA is an Individual Retirement Account named after its legislative sponsor, late senator Bill Roth, that was established in 1998 to provide an alternative method of saving for retirement that offers different tax advantages than the Traditional IRA. 

Features

The main difference between the Traditional and the Roth IRA is how it is taxed.  With a Traditional  IRA, you typically contribute before-tax (with some exceptions) money to the account.  Depending on your eligibility, you can deduct your contributions from your income on your current year taxes.  You receive the tax break now.  The money grows tax-deferred so when you pull your savings out in retirement you have to pay taxes on every single dollar you withdraw at whatever your current tax rate is at the time.

The Roth IRA is just the opposite.  You contribute after-tax dollars to the account and the money still grows tax-deferred.  You cannot deduct your contributions; however, in retirement you can withdraw your money (provided you meet certain qualifications) completely tax free. Not only that, but as long as your Roth IRA has been in existence for five years, your beneficiaries on the account can pull out money income-tax free, so the Roth IRA becomes a nifty estate planning tool as well.

Advantages

1. Obviously the biggest advantage to the Roth IRA is the tax-free withdrawals in retirement.  This can be a huge potential tax savings for you especially if you think tax rates will be going up.

2. The Roth offers more flexibility on withdrawals prior to retirement.  You can withdraw your principal (your contributions)  tax and penalty free at any time during the life of the Roth IRA.  To an undisciplined person might have trouble with this, but someone who runs into a bind an is cash strapped can have a little comfort knowing they have some additional money available.  This is a huge plus compared to the Traditional IRA, where you would pay a 10% penalty on any pre-59 1/2 withdrawals as well as taxes.  

3. Another advantage is that you can contribute to the Roth even if you are covered by an employer-sponsored retirement plan (401k etc).  With the Traditional IRA you are subject to income testing to determine if you could contribute when covered already by a plan  at work. Even if you could contribute, you don’t get to take advantage of the deduction on your taxes.  So the Roth becomes the perfect additional savings plan when you already have a 401k or other employer plan.

 4. For older folks, the fact that you do not have to take withdrawals is a major advantage as well.  With a Traditional IRA, the government forces you to take money out at age 70 1/2 or face a 50% penalty for not withdrawing your savings.  The main reason is of course to generate tax revenue.  Since Roth IRA distributions are tax free, you don’t have to worry about this rule. 

Key Tradeoffs

1. Your contributions are limited.  Currently in 2009, you may only contribute $5,000 and if you are over 50 you can contribute an additional $1,000 for a “catch-up” provision.  Depending on your income, you might be phased out of your contributions.  For example, a couple making between $166,000 and $176,000 will have their contributions limited.  Income over $176,000 disqualifies you for Roth contributions altogether.  Try this online calculator to determine how much you can contribute to a Roth.

2. You still might have to pay taxes on non-qualified distributions.  In order to meet the specifications for a qualified distribution, you must have had the Roth opened for at least five years and meet one of the following:

• Reached age 59 1/2 by the time of the withdrawal
• Withdrawal is due to qualifying disability
• Withdrawal is made for first-time homebuyer expenses (up to $10,000) 

Again, you are still able to withdraw your contributions at any time without penalty or taxes.

3. Tax treatment differs depending on the state.  The tax laws mentioned above correspond to federal law.  Your state may have differing laws for Roth IRAs You should check with your tax advisor to ensure you won’t have to pay state taxes. 

How Do I Get One?

You can open a Roth IRA through any financial institution, bank, life insurance or mutual fund company or even right online through a brokerage website.  Where you establish one primarily depends on your own needs and preferences.  There are many investment options available as well, so consider the types of investments that will suit your needs (i.e. stocks, funds, CDs, ETFs etc).

Contributions must be made by the time you file your tax return. So in essence you have until April 15 of the following year to get your Roth contributions in for the previous tax year. 

The Roth IRA can be a great investment and retirement savings vehicle for many people.  Be sure to do your homework, develop a plan, assess your needs and be comfortable with your decision.