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For years, many investors have been locked out of one of the best opportunities to save for retirement. Come January, though, everyone will have access to this investment vehicle and the huge tax savings it has offered to some retirement savers for over a decade.

It's Roth time
This month's issue of the Fool's Rule Your Retirement newsletter comes out this afternoon at 4 p.m. ET, and in it, you'll find cause to celebrate. As Foolish expert Robert Brokamp explains to subscribers in the latest issue, a change in the tax law will allow everyone to gain access to one of the most powerful retirement planning tools available: the Roth IRA.

By way of back story, the Roth IRA has been around for over 10 years now. Billed as an alternative to traditional IRAs that were first rolled out back in the 1970s, the Roth gives you something that nearly no other investment vehicle offers: potentially unlimited tax-free growth.

The implications of tax-free treatment are enormous. Retirement accounts are often one of the largest assets you'll accumulate over your lifetime. And especially with stocks that appreciate steadily over decades, the amount of savings can be enormous. Just consider what you could have saved in taxes owning these stocks in a Roth IRA if one had been available back in 1979 versus a traditional IRA:

Stock

$2,000 Investment in 1979 Is Now Worth

Maximum Tax Savings at Current Tax Rates

ExxonMobil (NYSE: XOM  )

$162,989

$57,046

Procter & Gamble (NYSE: PG  )

$126,380

$44,233

IBM (NYSE: IBM  )

$33,171

$11,610

McDonald's (NYSE: MCD  )

$181,159

$63,406

Boeing (NYSE: BA  )

$48,233

$16,882

Caterpillar (NYSE: CAT  )

$33,112

$11,589

Hewlett-Packard (NYSE: HPQ  )

$92,415

$32,345

Source: Yahoo! Finance. Tax savings assumes withdrawing full amount from traditional IRA for taxpayer in the 35% income tax bracket.

The tax-free treatment of a Roth comes at a price, though: You won't get the immediate tax deduction that you're used to seeing when you make a traditional IRA contribution. Yet as you can tell from the table above, giving up a small tax break now can save you tens or even hundreds of thousands of dollars later on.

No holds barred
The problem is that many people haven't been able to get money into a Roth IRA. You can only make contributions to a Roth IRA if your income is below certain limits. An alternative to making direct contributions is to convert an existing traditional IRA into a Roth, but in the past, even stricter income limits have precluded many investors from taking advantage of Roth conversions.

But as you'll read in Rule Your Retirement, all that will change on Jan. 1, when the income restrictions on Roth conversions go away. Suddenly, anyone will be able to convert their traditional IRA to a Roth. And in fact, as you'll see in the article, there's a special tax incentive for those converting in 2010.

Is it worth it?
Whether converting makes sense depends on a number of factors, including the following:

  • Your tax rate now. If you're in a high tax bracket now, the tax cost of converting will be high. It might be smarter to stick with a traditional IRA and pay taxes during retirement, when your income may be lower.
  • What you expect your tax rate to be in the future. On the other hand, many expect tax rates to rise in the future. So even if you're paying a healthy amount of tax today, it still might be worth it to convert rather than risk paying even more during your retirement years.
  • How long you expect to keep money in the account. The longer you have before you retire, the longer you get to enjoy the tax-free treatment a Roth offers.
  • Whether you have money to pay your tax. Converting requires you to include the full converted amount in your taxable income, which can create a huge tax bill. Having extra money outside your IRA to pay the resulting taxes is essential to making the deal work.

Robert's article goes into many more details, including the mechanics of when and how you should go about converting your IRA, the tax implications of converting, and dealing with special issues like past post-tax contributions to your traditional IRA. Before you decide on a Roth conversion, a close look at the article will help you weigh all the pros and cons.

If you've spent years being locked out of Roths, you owe it to yourself to look into whether a Roth conversion makes sense for you. The right move could save you thousands in taxes for years to come.

To get full access to Robert's article and everything else Rule Your Retirement has to offer, sign up for a free 30-day trial right now. It's easy; just click here to get started.

Fool contributor Dan Caplinger was first in line for a Roth back in 1998 and has never looked back. He doesn't own shares of the companies mentioned in this article. The Fool owns shares of Procter & Gamble, which is a Motley Fool Income Investor selection. Try any of our Foolish newsletters today, free for 30 days. You never have to wait in line with the Fool's disclosure policy.


Read/Post Comments (4) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 03, 2009, at 5:57 PM, steinbrock wrote:

    In order to show how much you could have made on a stock, you show what $? invested in 1979 would be worth today. As an investor, any stock that appreciated more than, let's say, 20% would be sold for the profit. I don't know of any investors who would hold a stock from 1979 until today. Instead, why not show a 2 year increase or any other time limit, but how many people hold a stock 30 years?

  • Report this Comment On December 04, 2009, at 1:04 PM, mike9958 wrote:

    Not necessarily if steinbrock - particularly if you've got yourself in a company profit sharing plan where you have little choice for 25years...

  • Report this Comment On December 04, 2009, at 1:06 PM, mike9958 wrote:

    Not necessarily if steinbrock - particularly if you've got yourself in a company profit sharing plan where you have little choice for 25years...

  • Report this Comment On December 06, 2009, at 2:48 PM, Gorm wrote:

    1) Roth is a no brainer for annual contributions going forward. The issue is conversions. If this market corrects, as expected, and values are depressed, it might make great sense to take the tax hit on a reduced valuation, and then reinvest for the tax free gain on the upturn. (Assuming there is one!)

    2) Taxes on conversions MUST be paid out of non-IRA funds. Between past and upcoming corrections, there is NO way investments could make up the additional hit of a conversion tax.

    3) If conversions are popular this could be a terrific shot in the arm to the US Government, where revenues are down 16% this year. Somehow I don't see Congress allowing all that potential tax revenue to escape their spending needs.

    4) What if, the government, realizing its need for revenue and its huge revenue stream received from converted IRAs in 2010 decides to adopt a value added tax (VAT) in 2012?

    5) I am concerned, with a HUGE entitlement expense building attributable to boomers and inflation, the government will adopt incentives for SSA recipients with assets willing to decline SSA payments.

    Bottom line, at my near retirement age, I am sticking with my "income deferred" IRAs expecting I will take my RMDs while I optimize tax liability and pass whatever residual to my children at my death.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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