Reduce Taxes Now- Convert to Roth IRA Before Tax Rates Increase

We have talked before about the 2 ways a Roth account reduces taxes-- tax-free growth and tax free withdrawals that a Roth IRA offers you and your beneficiaries. Frequently, converting your current traditional SEP or Simple Individual retirement account to a Roth IRA may place you ahead in the long run regardless of having to pay ordinary income tax on what you convert.

The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) was brought into law in 2006. It eliminated income limits for making Roth conversions for 2010 and after. So now anybody can make the conversion to a Roth and reduce taxes and the window might be closing to do so most cost effectively. If the government raises tax rates, an essential certainty to stabilize the budget, any kind of IRA distribution or IRA withdrawal will be more expensive. Therefore, a Roth IRA conversion makes much more sense now than ever to reduce taxes. Waiting could be quite costly if the top income tax rate moves from say 35% to 45%.

In the meantime, you should invest whatever you can in your Individual retirement account to build it up for conversion later on. You can make contributions to a non-deductible Individual retirement account in case your income prevents deductible IRA contributions. You only pay on the tax-deferred development in your non-deductible IRA since your contributions to it has already been subject to taxes -and that goes for the conversion to Roth tax also. Consider this comparison of hypothetical circumstances in the table below.

The table provides you with a theoretical comparison of the after tax worth of your Roth Individual retirement account after conversion together with the after tax value of your traditional Individual retirement account if you didn't convert - for years 2012 to 2017. Growth rates are assumed to be a hypothetical 8% while tax rates are put at 28%, and your IRA fund value is $100,000 in 2012. The $28,000 tax for the 2012 Roth conversion is paid at tax time in 2013 out of the Roth IRA while it grows at 8%. Preferably, the best way to make the most of a Roth to reduce taxes would be to pay the tax owed with non-IRA cash.

You can see the conversion preserves your Roth Individual retirement account value comparable to your conventional IRA's after-tax value. But there is one very big distinction between these two results. What you have in the Roth IRA has no minimum required distribution as does the standard Individual retirement account. The traditional Individual retirement account will consume itself as you age while the Roth IRA can maintain is entire balance growing if you wish.

	Roth conversion in 2012 Investment grows at 8% / year			Traditional IRA Investment grows at 8% / year
Year	Before tax value	Tax due @28%	After tax value	Before tax value	Tax due @28%	After tax value
2012	$ 100,000		$ 100,000	$ 100,000		If all withdrawn
2013		$28,000	$ 80,000	$ 108,000	$ 30,240	$ 77,760
2014			$ 86,400	$ 116,640	$ 32,659	$ 83,981
2015			$ 93,312	$ 125,971	$ 35,272	$ 90,699
2016			$ 100,777	$ 136,049	$ 38,094	$ 97,955
2017			$ 108,839	$ 146,933	$ 41,141	$ 105,792