Monday, November 3, 2008

Convert IRAs that have plummeted in value to Roth IRAs

A Traditional IRA whose value has fallen off of a cliff is a good candidates to convert to a Roth IRA. You'll have to pay taxes when you do the conversion, but they'll be less than when (if?) the value of the IRA.

When you convert traditional IRA assets to a Roth, you have to pay the income taxes upfront on the account's value -- and in some cases, those values may be next to nothing at the moment.

Kent Lawson, a 66-year-old AT&T retiree in Bloomington, Ind., signed the paperwork last month to convert a traditional IRA containing a $40,000 Lehman Brothers principal-protected note to a Roth. "It's gone to a zero price, so hopefully we can convert it at no value," says David Hays, his financial planner. "We expect it to be worth something eventually, and then he won't owe any taxes on it."

This smacks of market timing, but I think it's a good move. Making this move is a bet that asset values won't fall further, so it carries some risk, but the tax savings could make it a smart one, since there should be no further taxes on a Roth.

One big caveat is that your income must be $100,000 or less in the year of the conversion. This will change in 2010, assuming the tax laws don't change, when anyone, regardless of income, will be able to convert a traditional IRA to a Roth IRA.