2010: Year of the Roth IRA Conversion
If you’ve been obsessively reading personal finance news like I have, you know that the eligibility rules for Roth IRA conversions are changing in 2010 and that some people are getting quite excited about it. The current $100,000 income limit for conversion will be gone starting 2010. As an added bonus, converters in 2010 have the option of dividing their conversion income over two years (2011 and 2012, curiously skips 2010).
So, I’m not going to write a long post about all the factors that go into whether you should convert. You can read what Vanguard and Fidelity has to say about that. What I am going to do is discuss what is typically missed and share a simple calculator I plan on using next year to help me decide whether to convert.
The Roth 401k Decision
Contributing to a 401k account to save for retirement is an easy decision, especially when a company match is involved. However, how would you choose between contributing to a traditional 401k vs a Roth 401k? The obvious differences are:
- Traditional 401k: Income taxes are paid when the money is taken out during retirement. Contributions reduce current taxable income.
- Roth 401k: No income taxes are due when the money is taken out during retirement. Contributions have no effect on current taxable income.
Actually, there is one other major difference–the contribution limit. The 401k limit is the same dollar amount for both traditional and Roth versions, therefore the contribution limit for a Roth 401k is effectively higher since it is funded with after-tax money. One other benefit of the traditional 401k is that it can be converted into a Roth IRA later on, with some restrictions. The key benefit of both 401k’s over a regular taxable account is that they do not incur annual taxes on dividends and capital gains, allowing earnings to compound freely.
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