We've discussed most of the major topics related to Roth IRAs. Contributions. Conversions. Recharacterizations. Re-conversions. Regular distributions. Early distributions. Taxes. Penalties. Virtually everything about Roth IRAs you need to know to understand how they work, how they are taxed (and penalized), and how qualified distributions can be completely free from tax. So, after all that, the only question remaining is:

Should I Convert My Traditional IRA to a Roth IRA?

I bet you're saying something like: "Well...what should I do? You've given me everything except the answer to my question. You've told me all about the Roth IRA, how the conversions work, the taxes I would have to pay, and how I could get my money out...but you haven't told me if I should make the Roth IRA conversion."

You're right. We haven't. And we won't. It's not that we don't want to. It's just that the conversion issue is really a personal one. There are both tax and non-tax issues to consider. Only you, with the proper study and understanding, can really make that decision — maybe on your own, or you might require the assistance of a qualified tax pro and/or financial planning pro. Regardless, you have to be intimately involved. (Sorry, that's just the way it is.)

There are places you can do additional reading on the pros and cons of converting your traditional IRA to a Roth IRA. One of our very favorites would be Kaye Thomas's Fairmark Press site. You'll find a wonderful series of discussions there dealing with all sides of the issue — tax issues, non-tax issues, investment issues — the entire gamut. You also may want to check out the Roth IRA site, where similar discussions take place.

And, while this might be a lot of reading, there are some issues that virtually all financial professionals probably agree on regarding the Roth IRA conversion:

1) Paying the Tax: When you make a Roth IRA conversion, there will obviously be taxes due on those converted funds. Do you have other funds available with which to pay those conversion taxes? If not, it is likely that conversion is not for you. If you must remove funds from the IRA account to pay the conversion taxes and you are under age 59 1/2, you'll be subject to an additional 10% early distribution penalty on the funds withdrawn to pay the taxes. Certainly not a good thing. About the only time that paying the conversion taxes out of your IRA makes sense is when your traditional IRA is funded primarily by nondeductible contributions. While the 10% penalty will still apply, it will apply on a much smaller taxable distribution.

2) Pay Now...Save Later: When you make a Roth conversion, you'll be paying taxes now on that conversion. That simply rubs people the wrong way. Why pay taxes now when you can defer those taxes to some time in the future? Remember that, given the same principal amounts, a Roth IRA is much more beneficial than a traditional IRA. Why? Because, while the traditional IRA's earnings are tax-deferred, the Roth IRA's earnings are tax-free. Just think about it. Which would you rather have: a $20,000 traditional IRA or a $20,000 Roth IRA? Most people would take the Roth IRA in a heartbeat, because it will be growing tax-free. The traditional IRA will also grow, but at some time either the account holder or her beneficiaries will have to pay taxes on the distributions. No so with a Roth IRA. So, in many cases, paying the tax on the conversion now will save you lots of tax dollars in the long run.

3)What's My Rate? One of the potential disadvantages to conversion is that you're now probably in a much higher tax bracket than you will be in your retirement years. But this argument can be more fiction than fact. If this was a perfect world, and you could predict your future tax rate with absolutely certainty, and you determined that you would be in a much lower bracket in the future, then a current conversion might not be best for you. But there are two problems that normally crop up with this argument. First, take a look at some of your retired friends and family members. Have their tax rates dropped? After years of saving and investing Foolishly, many of your retired friends and neighbors probably have virtually the same tax rates they had when they were working. Next, think about our friends in Congress. How many tax rate changes have we had since 1986? Certainly a few. There's even current discussion to change some of the brackets again. Can you really believe that you can count on Congress to keep the general tax rate structure as it currently exists? Over the next 10, 20, 30, or even 40 years? Through no fault of your own, you may find your rates twisted on retirement. So don't let this argument scare you away from conversion if all of the other factors point in that direction.

4) State Issues: Two of the most valid reasons for not making the conversion have to do with the legal environment of your state of residence. Your traditional IRA may enjoy protection from creditors. That's certainly a nice thing to know if you run into a financial jam. But, in many states, the law is not clear regarding similar protection for a Roth IRA. So, if you think you'll need this creditor protection, give the conversion another thought. In addition, most states have conformed to the federal Roth IRA rules regarding not taxing future Roth IRA issues, but there may still be a few states that have not made the decision yet. So, you'll have to check out the tax laws of your particular state. If you find that they don't conform to the Federal IRA laws, you might want to carefully consider making a Roth conversion.

5) Minimum Distributions: One of the most powerful reasons to convert to a Roth IRA is that you won't be bothered with minimum distribution rules. As you know, in a traditional IRA, you're required to withdraw funds from the IRA once you turn age 70 1/2 -- and these funds are taxable to you at the time of the distributions. With a Roth IRA, there are no such minimum distribution rules. If you anticipate that you have sufficient other non-IRA assets to see you through your golden years, avoiding the required minimum distributions could allow you to leave substantially greater wealth to your children or other beneficiaries. If this is your situation, coughing up taxes now on a conversion may end up being a very small price to pay for passing substantial tax-free wealth to your children or grandchildren in the future.

6) Speaking of Beneficiaries: As you likely know, somebody will pay the taxes on a traditional IRA. Either you'll pay taxes on the distributions while you're alive, or your beneficiaries will pay taxes on your IRA distribution after you pass on (to the great tax-free zone in the sky). Either way, Uncle Sam will get his pound of tax flesh out of the traditional IRA. But that's not the case with a Roth IRA. You are able to take tax-free distributions in the future. And, even if you go to the great beyond prior to using up your entire Roth IRA, your beneficiaries will also be able to take those Roth IRA distributions tax-free after your death. So again, paying a conversion tax now may save many more tax dollars in the future.

As you can see, there are many issues surrounding the Roth IRA conversion question. What may be right for one person may not be right for another... which is why we can't give you an off-the-rack answer in a custom-fit world. We've tried to give you something to think about, and places to go to get additional information, though.

So...we've finally reached the end of the Roth IRA series. We certainly hope you now have a clearer understanding of the Roth IRA and how it works. It was a pleasure creating this series of articles. I hope it was as much of a pleasure for you to read them. Next week: On to new and exciting territory.

• Roth IRA Redux I
  
• Roth IRA Redux II
  
• Roth IRA Redux III
  
• Roth IRA Redux IV
  
• Roth IRA Redux V
  
• Roth IRA Redux VI - Conversion Issues

If you like the way Roy Lewis simplifies confusing tax issues, check out his just-published book, The Motley Fool's Investment Tax Guide 2000: Smart Tax Strategies for Investors. This handy 360+ page guide covers just about every tax aspect of a typical Fool's life: investing, marriage, children, education, homes, home offices, retirement accounts, medical expenses, and much more.)

February 25, 2000

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