Withdrawing Funds from IRAs

Q: What is a good rule of thumb for withdrawing funds when you have both regular IRAs and Roth IRA? Is it worth the expense to convert the regular IRAs into Roth IRAs before retirement?
- Joe, Aberdeen, MD

A: First, a quick review. A regular or Traditional IRA is typically funded with pre-tax dollars, meaning you get a tax deduction when you make the contribution. It grows tax-deferred, and is taxed as ordinary income when withdrawn during retirement. On the other hand, a Roth IRA provides no tax deduction when you contribute, grows tax-deferred, and can be withdrawn tax-free at retirement.

Every neighborhood has a big dog. In the world of IRAs, the Roth is it! The opportunity for a tax-free distribution makes the Roth IRA very attractive...especially if tax rates increase in the future. So, in retirement I would typically recommend withdrawing from the Traditional IRA first.

That said, should you convert all of your Traditional IRAs to the Roth? There are a number of online calculators that can help you with this decision considering current and future tax implications. There are several factors that would make a conversion more attractive. First, if you anticipate your marginal tax rate will be higher in the future (based on higher personal income or a view that the government is going to raise taxes), the conversion may make sense. Next, the longer the time horizon, the more sense a conversion makes. For example, it almost always makes sense for someone in their 20's or 30's to convert — they have decades for potential tax-free compounding. Finally, only convert if you intend to pay the taxes due upon conversion out-of-pocket (as opposed to reducing the value of the IRA).

Currently, you can only convert from a Traditional IRA to a Roth IRA if your Adjusted Gross Income (AGI) is less than $100,000. In 2010, there is a one year window in which the AGI ceiling is eliminated — I certainly anticipate a lot of conversions that year and Uncle Sam is expecting increased tax revenue, too!

A salaried financial planner would be able to assist you in developing a plan to meet your retirement goals in the most tax efficient way possible. Good luck!

The preceding discussion is not tax, legal or estate planning advice. Consult with your tax, legal or estate planning professional regarding your specific situation.