Amazing opportunities for investors don't come along very often. But before you jump on the bandwagon with any investment vehicle, you need to make sure that it really makes sense as part of your investing strategy. Often, you may find that what's right for most people turns out to be completely wrong for you.

Roths for everyone!
After over a decade of strict income requirements, anyone with a traditional IRA can now convert it to a Roth IRA. As we talked about earlier this month, doing a Roth conversion brings a number of benefits:

  • All future income and growth in your Roth IRA account is free of income tax. That stands in stark contrast to regular retirement accounts, where you have to pay income tax on the money you withdraw after you retire.
  • Unlike traditional IRAs, Roths don't force you to start making minimum withdrawals at age 70 1/2 if you don't need the money. That flexibility gives you the ability to maximize the amount of tax-free growth you earn on your investments.
  • Although you have to pay income tax on the amount you convert to a Roth, you are in complete control of the timing of your conversion. That means you can time conversions over the years to make maximum use of low tax brackets or other tax benefits.

But there are a number of situations in which it really doesn't make sense to convert to a Roth. I'm going to look at several this week, but the most common one is this: You expect your taxes to go down between now and when you withdraw money from your IRA.

Falling taxes
The key comparison in deciding to do a Roth conversion is this: Does it make more sense to pay taxes on your retirement money now or later? The question isn't as simple as it seems.

Clearly, if you invest successfully over time, then you'll likely pay a lower dollar amount in taxes by converting to a Roth now than if you wait until you retire. That's just common sense: As your retirement nest egg grows, you'll simply have more money that will get taxed at some point.

But the answer is more complicated than that. By paying taxes now, you don't just have to write a check to the IRS today; you also miss out on investing the money that went toward your tax bill. And depending on what you invest in, the lost opportunity from having that money taken away from you early could cost you a lot more than you'd think.

As an example, say you had converted an IRA invested in a seven-stock portfolio to a Roth 10 years ago. If you had $10,000 invested in each stock and paid tax at the then-highest rate of 39.6%, then you would have paid $3,960 per stock position, or nearly $28,000 in taxes in total, to convert at that time. And as you can see below, that would have cost you a lot more:


Total Return
Since 2000

Lost Gains From Paying Taxes
on Roth Conversion

Precision Castparts (NYSE:PCP)



Occidental Petroleum (NYSE:OXY)



Humana (NYSE:HUM)



AutoZone (NYSE:AZO)



Yum! Brands (NYSE:YUM)






Autodesk (NASDAQ:ADSK)



Source: Yahoo! Finance. As of Jan. 25.

Of course, if you hadn't converted and still had all that money in a traditional IRA, then those extra gains would still be subject to tax. But if your tax rate is lower than that 39.6% when you retire, then you could end up with more money after-tax than you would have if you'd converted.

And if you're in a high bracket right now, it's easy to come up with scenarios where you'll pay less in taxes in retirement. Anything from high deductions on things like medical expenses to simply having less income from investments than you have now from your work could push your taxes down -- even if higher overall tax rates are coming in the near future.

Think twice
Roth IRAs can be extremely useful for retirement savings. But converting to a Roth isn't the best solution for everyone, and unfortunately, you can't figure out the best answer for yourself by looking at just a single issue. That's why I'll be back tomorrow with another criterion that affects whether converting makes sense: how far you are from needing the money.

Tune in for the rest of this series on evaluating whether you're better off sticking with your current retirement plan rather than converting to a Roth.

Fool contributor Dan Caplinger knows that enjoying tax questions makes him an oddball, but he's cool with that. He doesn't own shares of the companies mentioned in this article. NVIDIA and Precision Castparts are Motley Fool Stock Advisor recommendations. The Fool owns shares of Autodesk. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy won't take you down the wrong path.