Retirement Savings: Pay Lower Taxes Now

Now, imagine you are retired 20 years from now. How much further will your nest egg go if no taxes are owed? Quite a bit, particularly if, as I expect, income tax rates are higher than they are now.

Another Roth advantage is that there is no requirement for mandatory distributions after reaching age 70 ½ as there is with traditional IRAs and other retirement plans.

You can reap the advantages of a Roth IRA by setting up one through a mutual fund family or other investment firm and contributing on an annual basis, provided you meet the income requirements.

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But you can also reap the advantages by converting what is now a traditional IRA or other retirement savings plan into a Roth.

The big downside of a conversion is that you pay taxes on whatever amount you convert in any given year. For instance, imagine you had a $10,000 traditional IRA at the start of this year and converted it to a Roth IRA at that time. When you file your 2008 tax return next spring, you would owe income taxes on that $10,000 conversion amount. For someone in the 15 percent tax bracket, the federal income tax on the conversion amount would be $1,500 -- a major hurdle for many middle income taxpayers.

But if you waited and the same IRA account stood at $6,000 after a 40 percent fall, the taxes on the lower Roth conversion amount would be $900 for someone in the 15 percent bracket. If you're in an even higher tax bracket, the savings are even greater.

That $600 savings won't entirely offset the market decline this year, but if stock prices recover before you retire, you will come out ahead.

Converting to a Roth IRA requires careful planning to ensure compliance with IRS regulations. Your best bet is to consult with a tax advisor or study IRS Publication 590 on Individual Retirement Arrangements.

Here are some key points to keep in mind:

To qualify for a Roth conversion, your income as a single or married filer must not exceed $100,000 for 2008. (In 2010, this cap will be lifted for one year.)

You can convert all or just a portion of a given IRA.