Should a Baby Boomer convert to a Roth IRA?

The MID-LIFE Roth Conversion: Baby boomers in their highest income 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

The Mid-Life Conversion is probably the most common situation. The baby boomers are not quite in retirement, but close enough that they have accumulated large retirement balances that they may be able to convert to a Roth IRA. These are people in there forties, fifties and sixties, not at retirement but getting close.

For younger people, the most important factor was time, for the MID-LIFE conversion the most important factor is the tax rate. If you are in this category, you need to be asking yourself the same questions as the younger investors, but with a more specific emphasis on your current and future income tax rates. Here is what you know about your situation before making a decision about converting to a Roth IRA:

1. What is your real marginal tax rate of the conversion? This gets a little trickier as your income increases and your balance to convert get larger. You can use the calculator at: Marginal Tax Rate Calculatorto see your current marginal tax rate for a little guidance. But, use the Roth Conversion calculator's automatic marginal tax calculation to see the actual average tax rate on your conversion. This will account for the conversion moving you through different tax brackets. This will calculate the tax liability of an additional lump sum added to your existing income.

2. Do you have the money to pay the tax bill? If 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. If you are 59 ½, you will avoid the penalty on the distribution, but not the taxes. Might work for you, but might not.

3. What do you think your future tax rate will really be? This is the trickiest question of the bunch. You may have a good guess as to the direction of your tax rate (going up, down or staying the same) but that might be all you have. If you are in your prime earning years, you probably are being taxed at a higher rate now than your retired counterparts. But, if you believe taxes have nowhere to go but up, that might not matter. You can use the calculator at http://www.dinkytown.net/java/TaxMargin.html for some current guidance. But when you actually run your Roth Conversion scenarios, make sure to include scenarios of low, middle and high future tax rates. By doing so you can find your “tax break point” of where the conversion makes sense.

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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