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Should You Convert Your IRA? A tax law passed in 2006 included a nifty gift for those who save in an IRA. Since 2010, investors of all income levels have been able to convert their traditional IRA assets to Roth assets, though in doing so, they must pay ordinary income taxes on any deductible contributions and investment earnings. (Prior to 2010, your adjusted gross income had to be $100,000 or less for you to be able to convert, whether you filed your tax return as a single or you were part of a married couple filing jointly.) Note, however, that simply having some Roth IRA assets due to a conversion won't necessarily make you eligible to make future contributions to a Roth. As always, income limitations apply for Roth contributions; in 2013, individual tax filers making more than $127,000 and joint filers earning more than $188,000 cannot make Roth contributions. So making the conversion isn't, unfortunately, an automatic gateway into future contributions. Advantages to Conversion It may be hard to get excited about paying taxes now--as you would if you made the conversion--versus letting the assets sit in your traditional IRA and paying taxes later. Traditionally, the calculus about whether to convert from a traditional IRA to a Roth required you to project whether your income would be higher or lower in retirement than it is now, a question that's very difficult to answer if you have more than a few years until retirement. However, even though tax rates already went up for high-income earners in 2013, the odds are good that taxes across the board will be higher in the future as Congress works to address the country's fiscal issues--a process that will likely involve both spending cuts and tax hikes. If you share that view, you'll want to seriously consider any option to pay taxes now rather than waiting until later. The Roth IRA also gives you more flexibility than you'll have with a traditional IRA. Notably, you won't be required to take mandatory distributions from a Roth at age 70 1/2, as is the case with traditional IRA assets. That's a huge boon if you don't expect to need your IRA assets during retirement; you can allow those investments to grow and pass on a greater amount to your heirs. And while it's never ideal to tap your retirement savings prior to retiring, the Roth is a much better option than a traditional IRA should you need to do so. If you convert to a Roth and five years have elapsed since you made the conversion, you can withdraw the converted amount, plus any additional contributions, prior to age 59 1/2 and you won't have to pay taxes or penalties. Possible Candidates for Conversion In general, the younger you are, the more beneficial a conversion will be. That's because you'll have more years to recoup the tax hit. That's not to say a conversion should automatically be off the table if you're nearing or even in retirement, though. If it's fairly early in your retirement, longevity runs in your family, and you won't need to put your hands on your IRA assets for five years or even more, a conversion may well be worth it because you'll have a good shot at recouping the tax hit. Moreover, if you're already retired and taking Social Security, converting to a Roth could reduce the tax you pay on your Social Security income. Although the conversion could bump up the amount of Social Security benefits that are taxable in the year you do the conversion, the conversion could reduce your Social Security tax in subsequent years. That's because Roth distributions don't factor into the calculation that the IRS uses to determine which Social Security benefits are taxable. You're also a good candidate for a Roth conversion if you've primarily made nondeductible contributions in the past, because you won't owe taxes on those nondeductible contributions-only your investment earnings and deductible contributions will be taxed upon conversion. You should also look at an IRA conversion if you have amassed a large estate. There are a few reasons why. First, as noted earlier, the Roth doesn't require mandatory distributions, thereby allowing your assets to compound and increasing the amount you can pass to your spouse or heirs. The second key reason relates to estate tax. Because you've already paid tax on Roth assets, the overall nest egg that you pass to your heirs will be smaller under the estate tax system, and therefore could help to reduce your estate-tax liability. The traditional IRA assets, by contrast, will be included in your estate-tax liability, even though your heirs will have to pay taxes on those assets. Finally, if you're unemployed or your income is currently appreciably lower than it normally is, it can also be advantageous to convert. Provided you have the cash to pay the tax bill, your taxes related to the conversion will be lower than they would be if your income were higher. Who Should Think Twice Clearly, an IRA conversion can make sense for individuals in many different situations. However, there are other situations in which the conversion will be less beneficial. One of the key ones will be if you don't have the money in other assets to pay the tax associated with the conversion. If you're younger than 59 1/2 and your only option is to use part of the traditional IRA assets to pay the tax, you'll pay a 10% early-distribution penalty on any assets you don't roll directly into the Roth. Plus, you'll have less money at work for your retirement. In addition, those who know they'll be in a significantly lower tax bracket in retirement should think twice about converting. Also be careful if it looks like your conversion will push you into a higher tax bracket in the year in which you convert. The risk is that you could disqualify yourself for tax benefits, such as credits and deductions, that you would otherwise be eligible for. In all of the above situations, though, you should be aware that you needn't convert all of your IRA in one fell swoop. Partial conversions are also permissible. However, you can't pick and choose which IRA assets to convert--for example, you can't convert all of your nondeductible IRAs and leave your deductible IRAs intact, although that would be advantageous. Instead, each dollar you convert will receive exactly the same tax treatment based on your aggregate IRA's breakdown between deductible contributions/investment earnings and nondeductible contributions. For example, say you have $100,000 in an IRA that's composed of $30,000 in deductible contributions, $10,000 in investment earnings, and $60,000 in nondeductible contributions. In that case, 40% of every amount that you convert would be taxable upon conversion (that 40% encompasses deductible contributions and investment earnings), whereas you wouldn't owe taxes on 60% of your conversion (the percentage of your IRA portfolio represented by nondeductible contributions). Each subsequent conversion that you do would receive the same 40% taxable/60% nontaxable treatment. Logistics If you determine you want to move forward with a conversion, it pays to double-check with a financial advisor or tax specialist to make sure you're thinking through all of the variables. And when you do convert, make sure you mind your P's and Q's. IRS Publication 590 (Individual Retirement Arrangements) includes all of the nitty gritty details. Your investment provider should be able to walk you through the forms you need to fill out for the conversion; some investment providers now allow you to make the conversion using online tools. Also know that if you convert your IRA from a traditional to a Roth, you needn't change your investments--you're changing the tax treatment of those investments, not the investments themselves. Finally, be mindful of the deadlines related to conversions. Whereas you have until April 15 to make an IRA contribution, the conversion will need to be done by Dec. 31 to count for that tax year. You should consider the investment objectives, risks, and charges and expenses of the fund or ETF carefully before investing. This and other information may be found in the prospectus and/or, if available, the summary prospectus. To obtain one, please visit the fund company’s website or if you are a BancWest Investment Services client, log in to bankofthewest.com to access online. Always carefully read the prospectus and/or, if available, the summary prospectus carefully before you invest or send money. Money market funds are neither FDIC-insured nor guaranteed by the U.S. government or government agency and are not deposits or obligations of, or guaranteed by, any bank. Although money market funds attempt to maintain a constant net asset value of $1.00 per share, there can be no guarantee that they will be able to do so. It is possible to lose money by investing in money market funds. © 2014 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. Securities and variable annuities are offered through BancWest Investment Services, a registered broker/dealer, Member FINRA/SIPC. Bank of the West and its various affiliates and subsidiaries are not tax or legal advisors. BancWest Investment Services is a wholly owned subsidiary of Bank of the West and a part of the Wealth Management Group. BancWest Corporation is the holding company for Bank of the West. BancWest Corporation is a wholly owned subsidiary of BNP Paribas. Investment and Insurance Products: NOT FDIC INSURED NOT BANK GUARANTEED MAY LOSE VALUE NOT A DEPOSIT NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY