5 Reasons Why You Should Not Convert Your Traditional IRA to a Roth IRA

Your Individual Retirement Account (IRA) can be built up in one of two ways: as a traditional IRA, or as a Roth IRA. A traditional IRA collects money directly from your gross income without you being taxed on your earnings. This is advantageous because the untaxed income earns interest for you. Upon reaching retirement age, you are taxed on your IRA when you begin making withdrawals from your account.

The Roth IRA is taxed immediately upon deposit, resulting in only your net income being invested. This method is advantageous because all the interest and money in a Roth IRA is yours to keep; you do not pay taxes on your Roth IRA withdrawals during your retirement.

Many people choose to convert their traditional IRA to a Roth IRA because of several advantages that are inherent in the Roth IRA. For example, a Roth IRA does not limit a person to make withdrawals only upon reaching age 59½, which is one limitation with a traditional IRA. Also, some people may wish to know exactly how much money they have in their IRA, rather than take guesses at what amount of future taxes must be paid upon their retirement.

However, converting from a traditional to Roth IRA is not always advantageous. Here are 5 reasons why converting to a Roth IRA may not be in your best interest.

1. Excessive taxes. The problem with converting from a traditional to a Roth IRA is that taxes must be paid immediately. If sufficient money has not been set aside to pay for these taxes, then you may end up withdrawing it from your IRA. This can significantly reduce your retirement account. You may attempt to work around this issue by making periodic and smaller IRA conversions over time.

2. Upcoming retirement. It may take 15 to 20 years of tax-free growth to make up for the taxes that are paid during a conversion to a Roth IRA. This time can be even longer if you are simultaneously making withdrawals from your Roth. If your retirement is just on the horizon, it just doesn't make sense to convert your entire account to a Roth IRA.

3. Majority of savings in IRA. If the majority of your liquid assets are locked into an IRA, then this is from where you will be drawing the majority of your survival income during retirement. You will not have the option of dipping into your stock or money market portfolios, thus allowing your Roth IRA to grow for some time after taxes are removed.

4. Changing tax brackets. If you are not currently in the highest tax bracket, converting your IRA to a Roth could actually bump you into the next (higher) tax bracket. This is because any money you remove from your traditional IRA is treated as income. So, if you are already obtaining Social Security benefits, for example, you may end up paying taxes on those benefits. Alternately, you may affect your children's ability to obtain financial aid for their college education.

5. Retirement tax bracket. You may be tempted to convert your traditional IRA to a Roth IRA, figuring that any tax bite you take now will be more than made up by several years of tax-free growth on your account. However, keep in mind that your current tax bracket is probably higher than the tax bracket you enter upon retirement. This is because you are currently working. Once you enter retirement, your tax bracket will probably be lower due to your reduced earnings. This means that you will also be taxed less on the distributions you take during retirement.