Should someone who is early in their career convert to a Roth IRA?

The YOUNG Roth Conversion: You are in your early earning years - should you convert to a Roth?

Use the calculator at Roth Conversion Calculator to help you with your conversion:
Roth IRA Conversion with Distributions

If you are in your twenties or thirties, converting a traditional IRA or other qualified plan to a Roth IRA can be a great idea. Even if your tax rate were to be higher in retirement, the extra time you have to compound your earnings can make up for this potential pitfall.

You simply can't under estimate the biggest thing you have going for you – lots of time before retirement. If you consider your lifespan, and then have the plan inherited by a spouse and then inherited by a child, you could stretch out the distributions for 80 years (or even a little more). More than likely the current balance isn't that large, but over this long time-span it can create a huge nest egg. If you are in this situation, you need to be asking:

1. What is your real marginal tax rate of the conversion? Fortunately this is pretty easy to answer. As long as your conversion doesn't bump you through different tax brackets, it is usually the same as your current tax bracket. You can use the calculator at: http://www.dinkytown.net/java/TaxMargin.html to see your current marginal tax rate for little guidance.

2. Do you have the money to pay the tax bill? Since you are under 59 ½, taking money out our your account to pay the tax bill will incur taxes and a 10% penalty. If you don't have the money to pay this from other savings or income, it may not be a great idea to convert. Run a scenario both ways with the calculator, to see how the distribution plus penalty pretty much kills any advantage.

3. What is my future tax rate? This is really a no-brainer because anyone with a brain knows that predicting future tax rates 30 or 40 or 50 years into the future is crazy! Try running scenarios with high, medium and low retirement tax rates to get a comfort level of what is possible. Fortunately, with 30 or 40 years to retirement you can overcome a higher tax rate in retirement and still have a positive result with the conversion.

Use the calculator at Roth Conversion Calculator:

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Even more Roth Conversion factors to consider:

Should I delay my tax bill to 2011 and 2012? Unless you are in the highest bracket (35%) this is probably a good option. Run your analysis both ways to make sure, but unless your tax rate goes up in 2011 and 2012, delaying works for you. The exception is if you know you will be in the top tax bracket for 2010, 2011 and 2012. Currently the top tax bracket is scheduled to rise to 39.6% in 2011. In this situation, paying your entire bill in 2010 might work to your advantage.

Should I convert only part? If it's a good idea to convert some, in this situation it's probably a good idea to convert all of it. But – make sure you can afford the tax payment. If you can't, or it's just too much of a stretch, maybe a partial conversion is a good option.

Try to run through multiple scenarios for the factors that affect your situation. Splitting your tax bill or not is pretty easy to test out. Predicting your future tax rate? This is much more difficult. Now try it all again with only half of your balances. One point of all of this I want to make clear: The harder something is to predict, the wider range of potential outcomes you need to plan for. So, mix it up! Run your scenarios and compare the results and decide for yourself: Should I Convert to Roth?

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