Q: I'm 41 years old and have about $90,000 in a traditional IRA, which I'm thinking of converting to a Roth IRA. Am I young enough that this still makes sense? I've lost quite a chunk of my retirement account over the past two years. How can I make sure I'm not paying extra taxes, if my IRA continues to decline between now and April 15?
A: With at least 25 working years ahead of you, time is definitely on your side, and this move absolutely makes sense—but it doesn't have to be an all-or-nothing decision right now. As you know, when you switch from a traditional IRA to a Roth IRA, you owe tax on the converted amount in that tax year. Once you settle that bill, though, you'll be able to withdraw all the money in your Roth IRA during retirement without owing any tax. In other words, a Roth conversion settles your tax bill today, while a traditional IRA delays that bill until retirement.
Generally, I think it's incredibly smart to move to a Roth IRA. Based on what's going on in our country, tax rates will likely rise, which makes paying at today's rates alluring. Still, with so many variables to consider, this is one area in which it's imperative you consult with a CPA or financial adviser.
Your trusted tax adviser can also show you the potential payoff of transitioning over a few years rather than doing it all at once. Remember, the amount of the conversion is counted as taxable income for that year, so the more you move, the greater the likelihood that you'll be pushed into a higher tax bracket. Smaller moves spread out over time can be a smart way to minimize tax-bracket creep.
One thing you don't need to be so worried about is the timing in terms of taxes. You're right that the tax bill is based on the value of the assets at the time you convert: If you move, say, $90,000, your tax bill is based on that $90,000 value, even if three months later the value has fallen to $70,000. But if that happens, the IRS will let you undo your conversion, meaning you won't face a tax bill at all. The technical name for this is a recharacterization. The deadline for recharacterizing a converted Roth IRA is mid-October in the year following the original conversion, provided you filed your taxes or an extension by April 15. So if you made the move in 2012, you'd be able to change your mind until mid-October 2013.
Suze Orman's new book is The Money Class: Learn to Create Your New American Dream (Spiegel & Grau). To ask Suze a question, go to oprah.com/omagazine_talk.
More Great Advice from Suze
From the February 2012 issue of O, The Oprah Magazine