Q-and-A With Jonathan D. Pond: Roth IRAs

By: Jonathan D. Pond | Source: AARP.org | March 31, 2008

I've heard some talk about converting a conventional IRA over to a Roth IRA now, because the market is so depressed. What are the factors that I should consider if this is a reasonable option for me? –Michael, Michigan
 
What you've been hearing is correct. A Roth IRA conversion entails moving money from a traditional IRA into a Roth IRA. You have to pay income taxes on the amount that you convert, but that's why this could be a particularly good time to do so. Because the prices of mutual funds and stocks have been hit so badly, you can move money at a much lower tax cost than would have been possible when prices were so much higher. Then when prices rebound, you'll enjoy even more tax-free income when you begin making withdrawals in retirement, since most withdrawals from Roth IRAs are totally free of federal income taxes.
 
To be eligible for a Roth conversion, your adjusted gross income for 2009 must be no more than $100,000, regardless of whether you're single or married. You can do a Roth IRA conversion any time this year. If you should, but the prices of the investments you transferred continue to decline, you could "undo" the conversion to avoid paying income taxes on the higher balance when you made the conversion. The way to reverse the conversion is to ask the Roth IRA trustee to transfer the converted amount back to your traditional IRA. This is known as a "recharacterization," and, if the original conversion takes place in 2009, it can be done any time until you file your 2009 tax return (including any extensions through Oct. 15, 2010). 

My employer informed us that the company is temporarily suspending the company matching funds for our 401(k) plan. They said they will start it back up in the future, but probably not this year. Because they aren’t matching funds, is it better to stop contributing to the 401(k) and contribute to a Roth IRA instead? Or should I still contribute? -Michael, Ohio

This question leaves me conflicted. Contributing to a Roth IRA is more financially advantageous than contributing to an unmatched 401(k) plan. But the advantages come later on, when you can enjoy tax-free withdrawals from your Roth IRA account. You have to be prepared to give up the tax breaks of contributing to a 401(k) plan.

Simply put, if you contribute to a Roth IRA in lieu of a 401(k)—matched or unmatched—your taxes this year will be higher. But over the long run, even factoring in the higher current-year taxes, the Roth IRA beats an unmatched 401(k).

My concern is that opting for a Roth IRA may cause you to give up on your 401(k) plan, even after your employer restores the match. As the economy rebounds and you become more confident about your financial future, I hope that you can get into a position of funding both your plan at work and a Roth IRA.

The stock market crisis has caused retirement savers to lose site of the surest way to build up the resources you’ll need for a financially comfortable retirement: saving regularly and regularly increasing the amount you save, no matter how badly the investment markets are faring. Ideally, this would involve contributing to more than one plan.

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