Roth IRA Conversion

In 1997, the Roth IRA was introduced. This new IRA allowed for contributions to be made on an after-tax basis and all gains (or growth) to be distributed completely tax-free. Since then, people with incomes under $100,000 have had the option to convert all or a portion of their existing Traditional IRAs to Roth IRAs. Beginning in 2008, participants with funds in eligible employer sponsored plans could also roll those funds directly over to a Roth IRA in a qualified rollover if their income did not exceed the $100,000 threshold. Starting in 2010, all IRA owners and participants in eligible employer sponsored plans, regardless of income level, are eligible to convert their Traditional IRA and pre-tax funds in an employer-sponsored plan [401(a)/(k), 403(b) and governmental 457(b)] to a Roth IRA. Is this a good option for you? A conversion has both advantages and disadvantages that should be carefully considered before you make a decision. This calculator compares two alternatives with equal out of pocket costs to estimate the change in total net-worth, at retirement, if you convert your Traditional IRA into a Roth IRA.

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Definitions

Please note the following important information regarding any Roth conversion
  • You must pay ordinary income tax on the amount converted (specifically, on pre-tax contributions and investment gains).
  • If you pay the taxes using money from the traditional IRA, you will lose the potential benefits of tax-free growth on that amount.
  • If you are under age 59˝, you may be subject to a 10% federal tax penalty if you withdraw money from your traditional IRA to pay the tax on the conversion. You may also have to pay state tax penalties.
  • If you convert in 2010, you will have the option to include the conversion amount as income in 2010 or you can elect to split the income on tax returns for 2011 and 2012. Consult with a qualified tax advisor before deciding whether to post pone payment of taxes.
  • For an investor in a lower tax bracket, traditional IRA contributions may be tax-deductable while Roth IRA contributions are not.

Amount to convert
Amount to convert from a Traditional IRA account to a Roth IRA. We assume that you are paying any taxes owed with funds that you have available outside of the account you are converting. If you are under 59-1/2, the IRS treats any money not directly rolled over to the Roth IRA as an early withdrawal - even if that money is used to pay the tax bill caused by the conversion and, except in the case of a rollover from a governmental 457(b) plan, the funds will be subject to a federal tax penalty unless an exception applies.

Non-deductible contributions
The amounts, if any, contributed to your traditional IRAs or employer sponsored accounts made with after-tax contributions. It is important to note that you may not "cherry pick" funds that are either after-tax or pre-tax to convert. If you are not converting all of your IRAs or the entire amount in your employer sponsored plan, you must convert a pro-rated amount of the pre-tax (deductible) and after-tax (nondeductible) balance. All of your IRAs are added together and treated as one for this purpose.

Current age
Current age. This age must be less than 70. Since this calculator does not take Required Minimum Distributions (RMD) into account, which begin at age 70 1/2, it is not designed for individuals that are currently required to begin making these distributions.

Age at retirement
Desired age at retirement.

Rate of return
The annual rate of return for your IRA. This calculator assumes that your return is compounded annually. The actual rate of return is largely dependent on the type of investments you select. The S&P 500 for the ten years ending on December 31st, 2011 had an annual compounded rate of return of 2.92%, including reinvestment of dividends. From January 1970 through the end of 2011, the average annual compounded rate of return for the S&P 500, including reinvestment of dividends, was approximately 10.01% (source: www.standardandpoors.com). Since 1970, the highest 12-month return was 61% (June 1982 through June 1983). The lowest 12-month return was -43% (March 2008 to March 2009). Savings accounts at a bank may pay as little as 0.25% or less but carry significantly lower risk of loss of principal balances.

It is important to remember that these scenarios are hypothetical and that future rates of return can't be predicted with certainty and that investments that pay higher rates of return are generally subject to higher risk and volatility. The actual rate of return on investments can vary widely over time, especially for long-term investments. This includes the potential loss of principal on your investment. It is not possible to invest directly in an index and the compounded rate of return noted above does not reflect sales charges and other fees that funds and/or investment companies may charge.

Current tax rate
Current marginal income tax rate that will apply to conversion amount. Please note that the marginal tax rate for your conversion may be higher than your current marginal tax rate if the conversion moves your AGI into a higher income tax bracket. It is also possible, especially on very large conversions, that part of your conversion be subject to more than one tax rate. Below are the resulting tax rates and income ranges for 2012:

Filing Status and Income Tax Rates 2012
Tax rateMarried filing jointly
or qualified widow(er)
SingleHead of householdMarried filing separately
10% $0 - 17,400 $0 - 8,700 $0 - $12,400 $0 - 8,700
15% $17,400 - 70,700 $8,700 - 35,350 $12,400 - 47,350 $8,700 - 35,350
25% $70,700 - 142,700 $35,350 - 85,650 $47,350 - 122,300 $35,350 - 71,350
28% $142,700 - 217,450 $85,650 - 178,650 $122,300 - 198,050 $71,350 - 108,725
33% $217,450 - 388,350 $178,650 - 388,350 $198,050 - 388,350 $108,725 - 194,175
35% over $388,350 over $388,350 over $388,350 over $194,175
Source: Revenue Procedure 2011-52 http://www.irs.gov
Tax rate at retirement
Expected marginal income tax rate at retirement.

Investment tax rate
Expected marginal tax rate (base this on expected capital gains rate) for investments. This calculator assumes that you invest the amount that you would have had to pay in taxes in a taxable investment account. The investment tax rate is used for calculating the annual return on these taxable investments. For many, this will be the same as their income tax rate. If you expect your non-IRA investments to be primarily from long-term capital gains or dividends.

Use 2010 option to delay tax payments
Check this box to use the 2010 option to delay your Roth Conversion tax payments to 2011 and 2012. This option is only available for conversions that take place in 2010. When this box is checked, no taxes are due for the conversion in 2010. In both 2011 and 2012, one half of your converted amount will be added to your income and subject to income tax.