How does a Roth IRA work

As we are in 2011, we face some of the toughest economic climates in memory. With the average age we are living to increasing and the price of living only increasing it really is the age of saving and preparation for when our retirement comes.

Luckily, there are now means available such as 401k and IRAs which allow us to ready ourselves a retirement pot on which to live off when it is time to stop working and live out our retirement. You should consider checking out how a Roth IRA works and how it could be better than a traditional IRA when weighing up the idea of making a Roth IRA conversion in 2011.

How does the Roth IRA Conversion 2011 compare?

In the year 2010, the income limit placed upon conversions to Roth IRA very publicly disappeared. A lot of people who had previously been made to stick with a traditional IRA because of their higher income were now able to instead convert their traditional IRA into a Roth IRA. Roth IRA Conversion 2011 is still possible meaning that you can gain all of the benefits of having your savings in a Roth IRA. Also there is the potential to rollover 401k to Roth IRA without the need to make the intervening step of converting into a traditional IRA and then into a Roth IRA.

There is however a key difference, you cannot spread out the payments related to tax associated with your conversion to Roth IRA. Prior to making the decision to convert to a Roth IRA you really have to think about the tax implications you will face and how much making the move could affect you.

Taxes you will face on your Roth IRA Conversion 2011

One of the initial things you will need to do before you start making the decision to go through with a conversion to a Roth IRA is be aware of the tax implications of your decisions. In a standard IRA any contributions that you make are usually made with pre-tax dollars; that means that a tax deduction is made immediately. On the other hand any Roth IRA contributions are made with dollars that have already been taxed. Any growth that is made, through investments such as interest or stocks, bonds and property are entirely tax free up to withdrawal. Obviously this means that any money that you wish to move across from a traditional IRA to a Roth IRA will be held accountable to taxes being applied before you move it across.

In 2010, along with the income limit being lifted on conversions to Roth IRAs, the option was available for you to spread any tax payments over two years to lighten the load and reducing the immediate effect that was felt in your pocket. However, in 2011 Roth IRA Conversion transactions are being hit hard with a onetime single payment of taxes which has to be paid upfront when the conversion is made; no allowing you to put it off and spread the effect.

This obviously will have a large impact on your immediate financial situation and is something you should look into before making the plunge. In certain cases it will undoubtedly make sense to move the funds across now at the benefit of more flexibility provided by the Roth IRA; however this should be balanced against the need to pay all of the taxes immediately. If you think that the taxes will be raised then it makes sense to move over now at a lower tax rate and avoid the higher tax rate on withdrawals from you traditional IRA when you are in your retirement. In some cases it simply makes financial sense to ignore any conversion to a Roth IRA and just to pay the taxes in smaller increments later on.

Can I reverse my decision to undergo Roth IRA Conversion 2011?

Initially there was a lot of hype surrounding the limits lifting on the income limits for conversions to Roth IRAs. This meant a lot of people immediately assumed it was the right decision for them, however due to either not properly considering or assuming that it would work out best and then it not working out as they expected some found that perhaps it was the wrong decision.

Luckily for them and for anyone else who makes the change in the future, there is an option available to change back to a traditional IRA – you can re-characterize your conversion. However there are limitations on when you can do this. You can only reverse the action and re-characterize if you do it by the date 15th October of the following year. So if you make the conversion to Roth IRA by the end of 2011 then you will have up to the 15th October 2012 to allow yourself to make the reversal.

You cannot however keep flipping your decision and if you do re-characterize and you then decide you wish to reconvert again to a Roth IRA then you will not be able to do it in the same tax year as your re-characterization and it also has to be at least 30 days before your switch back to the Roth.

Should I make the Roth IRA Conversion in 2011?

It really needs to be decided on a case to case basis; while there are obvious benefits to having your money stored in a Roth IRA as opposed to a traditional IRA you will do well to consider the immediate and long term impacts on your finances based on tax levels and your expected investment returns. The best advice would be to get in touch with a financial professional and consider your options.