Converting to a Roth IRA: The upside of a down market
The Vanguard Group

The last days of summer, when the major stock indexes are languishing near five-year lows, may seem like an unusual time to consider making your retirement portfolio more tax-efficient. But moves you make now could pay off come next April 15—and for years after that.

Specifically, anyone with a traditional IRA may want to consider whether converting all or part of it to a Roth IRA is worthwhile.

Traditional IRAs provide tax-deferred growth, but owners have to pay federal income tax on deductible contributions and any earnings when they make withdrawals. They're also generally subject to required minimum distributions after the owner reaches age 70–1/2. Roth IRAs don't accept deductible contributions, but in return investors who qualify can withdraw earnings completely free from federal income tax during retirement. Also, required minimum distributions don't apply to Roth IRAs during an IRA owner's lifetime.

Why now might be a good time to convert
When you convert a traditional IRA to a Roth IRA, you have to pay income tax on all the assets you convert (except for any nondeductible contributions you may have made to the traditional IRA).

During the 1990s, when the account contained huge gains from the bull market, that could have produced a big tax bill. Now both valuations and income tax rates have declined. The result: Many folks might find that they won't face as large a tax bill, depending on what's happened with their account.

Here's an example: Suppose a 45-year-old had $50,000 in a traditional IRA in 1999, but now the account's value is $35,000. By converting while stock prices are depressed, rather than waiting until the market recovers, the IRA owner could save $4,550 in federal income tax.


*This example assumes that tax is due on the full amount of the conversion. The tax rate was 28% in 1999 and is 27% in 2002. Because state tax laws vary, the example does not account for state taxes.


And by paying taxes now, the IRA owner won't have to pay taxes on any future appreciation when he or she withdraws assets—a potential savings that is far greater than the taxes due now.

Of course, you should consider your overall financial situation before converting to a Roth IRA. For example, converting may not be the best bet for you if any of the following apply:

• You will have to dip into your retirement assets to pay the tax bill for the conversion.
• The amount of the conversion will push you into a higher tax bracket.
• You will need to take withdrawals from the IRA within five years of converting.

Also, to be eligible, your modified adjusted gross income must be $100,000 or less in the year of conversion and your tax filing status must be single, married filing jointly, or head of household. The same income limit applies to both joint and single filers. The dollar amount of the conversion is not considered part of modified adjusted gross income for purposes of determining eligibility.

Where to learn more
For more information, read Quick Facts About Roth IRA Conversions, or try our online calculator to see how you could fare by converting to a Roth IRA. And before you take any action, consult a financial adviser or tax specialist for a more comprehensive appraisal of your particular situation.