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2010 Roth IRA Conversions

In January 2000, I resolved to start taking charge of my finances. After a couple years of working, I had a small 401k balance but financially, it was easy come easy go. I had no plan. I didn’t even have a savings account!

I sought out the advice of a financial “advisor”. And by “sought out”, I mean called an advisor based on a tip I got from my buddy at a bar. To make matters worse, the tip involved this cool “universal life insurance policy”. It sounded like a great deal at the time. I was sober. But not smart.

To the credit of the financial advisor, he did teach me a little about the difference between traditional and Roth IRAs. I had heard of a Roth, but did not understand why it was such a useful tool. The entire experience, and the losses I suffered as a result of our transactions, are what led me to the decade of financial education I’ve pursued since.

The biggest mistake I made that year was to convert my 401k to a Roth IRA. The rule of thumb I wish I knew then was this: if your tax rate is lower now that you expect it to be in the future, convert to a Roth. The year he converted my 401k, I was in the 35% tax bracket. For the last few years, I’ve been in the 15% bracket. This mistake made my small retirement egg even smaller. Thousands of dollars smaller.

A recent column by Robert Powell outlines a few pitfalls to avoid when converting to a Roth IRA. Among them are mistakes I made:

  • Failing to understand the tax consequences
  • Converting when your tax bracket is likely to fall
  • Forgetting to consider a recharacterization

The income limitations for conversions were lifted which makes 2010 a great year to convert. If you’re out of work or took a pay cut last year, it’s a good time to convert. If you accept the notion that you are paying lower taxes today than you ever will again, it’s a good time to convert. And if circumstances change, you can always recharacterize your conversion by April 15, 2011.

I’ve had good luck with my Roth IRAs at Vanguard and Wells Fargo. Vanguard is renown for their low costs and Wells Fargo offers 100 free brokerage trades in their IRA accounts if you have a PMA checking account.

Luckily, I made my mistakes early in life and I will have plenty of time to recover. But I’m still better off today than I’d be if I had done nothing at all. Take your first step today.

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