To Roth or Not To Roth, that is the Question.

Roth IRAs, despite their attractive features, have yet to match the popularity of traditional individual retirement accounts.  One reason Roths constitute such a small percentage of total retirement assets (5%) is that many wealthier individuals -- who potentially stand to benefit the most from them -- have been 1.) ineligible to contribute to a Roth or 2.) convert their existing traditional IRA to a Roth.

As of January 2010, the IRS income ceiling for Roth conversions disappears, presenting investors of millions with an interesting quandary: if they convert they will accelerate taxable income into an earlier year, which flies in the face of the cardinal rule that you pay no tax before it is too.  On the other hand, a Roth, unlike a traditional IRA, would enable both tax-free withdrawals and the avoidance of required minimum distributions.  This allows more wealth to grow tax-free for a longer period of time and is not an easy decision.

Research suggests that the best conversion candidates are those who can afford to pay the cost of conversion from their taxable assets and fit any one of the following criteria:

-- They don't expect a significant decline in their of effective tax rate in retirement;

-- They are making the conversion at a younger age;

--  They don't expect to spend meaningfully (or at all) from their IRA or will begin drawing from it only much later in retirement; or

-- They intend to transfer their IRA at death to beneficiaries who will then "stretch" it.

The math for calculating the benefits are based on comparing the ultimate return received in the future for the Roth account balance versus the net present value of the withdrawals from a taxable IRA net of tax.

The cashflow streams would be:

Roth = Value of Account - (Tax Cost of Conversion) + Compound tax free earnings until future withdrawal

Traditional IRA: Value of Account + Compound Tax Free earnings until 70 1/2, withdraw approx. 5 - 7% per year - Taxes on Withdrawals

The basic math suggsts that the best candidates meet three criteria, 

1.  They can afford to pay the conversion tax out of non IRA assets

2.  They do not intend to use the money in the IRA for living expenses but only future reserve and capital appreciation.

3.  They are young enough to earn back the cost of the tax on the conversion.