Now is a Great Time to Convert Your Traditional IRA to a Roth IRA
You keep reading about ways to make money or take advantage of our down market, usually the article is a hoax or entails a substantial amount of risk. I think we have discovered a great way to not only take advantage of the down market, but also use it for a tax benefit and to milk the most of your future earnings—let me explain.
If you currently have money in a traditional IRA (a tax sheltered account where your money is not taxed until you make withdrawals) you can convert the account to a Roth account at any time, however you must pay taxes on the entire amount of your traditional IRA at the time of conversion. This works towards your advantage in a market like the current. It’s probably safe to assume the average IRA—especially if it’s heavily invested in a major index—is down around 30 % this year. The loss is depressing, but switching your IRA to a Roth allows you avoid paying taxes on 30% of what your account was worth just months ago.
You are going to have to pay taxes on your IRA eventually anyways, so by switching to a Roth now, you are assuring a HUGE reduction in your taxes. Consider the following scenario: If you have $100,000 in a Traditional IRA account and you have lost 30% so far this year, then your account is now down to $70,000 or a loss of $30,000. If you convert this account to a Roth you would then only owe taxes on $70,000 and assuming your tax rate is 35% you would save $10,500 in taxes. If this doesn’t sound like much, remember that $10,500 invested for 20 years could earn you approximately $50,000.
The benefits don’t stop at just the tax advantage. When the market recovers, which it will (eventually), your earnings will now grow tax free because your account is now a Roth. Essentially, you double your savings by converting and paying taxes now when the account is suffering and bank all the future gains tax free.
This market truly represents a great opportunity to convert your IRA to a Roth for more reasons than one. There aren’t a lot of good things that come out of our credit crisis, but the few things that do, we should milk them for all they are worth. $
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