When I started working after college, it was a bit of a stretch to contribute to both my 401(k), to get my employer match, fully fund my Roth IRA, and build up a small cash cushion (I would later learn these are called emergency funds). I pushed to do it because my parents drilled this lesson into my brain as a young adult – save money today because you never know what will happen tomorrow. (I thought I dodged a bullet by avoiding the dot com boom and bust but I was later rewarded for my diligence with the largest recession since the Great Depression!)

So… what do I do with the money in my Roth IRA or my 401(k)? You will never be able to predict the future with certainty so you will never know beforehand which investments will perform the best. You will, however, know the cost of owning those investments and the cost of taxes if you pick correctly. The best we can do is have a good plan, execute that plan, and pick investments that provide the most value for the price that you pay in fees and taxes.

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CNN Money reported last week that 43% of Americans have less than $10,000 in retirement savings, which is a statistic provided by the Employee Benefit Research Institute in their Retirement Confidence Survey (2010 results). If that figure isn’t scary enough, it appears that 27% of workers have less than $1,000. Both figures are increases from 2009, when 39% had less than $10,000 and 20% had less than $1,000 a year ago.

While the statistics are sobering, it does show how much the recession has hurt a lot of people. If you lose your job, the first thing to go after your emergency fund is probably going to be your retirement savings. Keeping a roof over your head and food in your stomach is going to take precedence over retirement tomorrow.

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I, like many other personal finance bloggers, am a huge fan of IRAs because they give you a tax-advantaged opportunity to save for your retirement. Both types, the Roth and the Traditional, offer tax benefits that are hard to find anywhere else. The Roth IRA offers you to reap the growth of your retirement assets tax free while the Traditional IRA gives you an immediate tax benefit for contributing to your own future.

There’s a reason why the IRS puts contribution limits on IRA accounts. As many of you know, you have until April 15th to make a contribution to your Traditional or Roth IRA for the 2009 tax year. What you may not know is how much you’re able to contribute.

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Now that the income limitations have been lifted and anyone can convert a tax-deferred Traditional or Rollover IRA into a tax free Roth IRA, a lot of blogs, gurus, and news sites have been celebrating the Roth IRA conversion. I have always held the Roth IRA in high regard because it’s a fantastic retirement investment vehicle that offers a little more predictability. I pay taxes on my contributions today and I get all the appreciation tax free, what’s not to love about it?

Unfortunately, whether or not you should convert a Traditional or Rollover IRA to a Roth IRA is not as clear cut. There are a lot of important factors many people are overlooking when it comes to Roth IRA conversions. While you may gain some tax benefits in your retirement assets, it does come at a cost to your overall financial picture. To ignore those could be extremely detrimental. Let’s take a look at the four major factors to consider before you convert to a Roth IRA.

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A year ago, when I met with my accountant, we spent some time talking about our retirement, our goals, and how we were going to reach them. In looking at our retirement accounts, I saw that the vast majority of our savings were in tax-deferred accounts like 401(k)s and Rollover IRAs. We only had a very small percentage in tax-free Roth IRA accounts, which I’ve always said was probably the best retirement account in existence. Where else can you invest in the stock market and have your gains be entirely tax free? Nowhere.

Right now, you can convert a traditional IRA to a Roth IRA as long as your adjusted gross income is under $100,000. The $100,000 limit applies whether you are single or married, tax filing classification wise, which makes it one of the few limits that is the same for both. So if your AGI is under $100,000, then you can convert today and you don’t have to wait for 2010.

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A couple weeks ago I received a letter from my former employer’s 401(k) benefits company notifying me that I had $0.83 in my 401(k) account. Despite my best efforts avoid dividends and distributions on funds, I must have missed one in the process. I was told that since my vested account balance was less than $1,000, I’d have to roll it over or take a distribution, which would be taxed and penalized.

I was in a quandary. At such a small dollar amount, it certainly wasn’t worth the time to roll it over. If it appreciated at an average rate of 7% a year for forty years, it’s would be worth a mere $12.43. That’ll be enough to buy me a pack of bubble gum after taxes in 2049.

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This Foundation post is dedicated to what I consider the best retirement weapon available – the Roth IRA account. The Roth IRA was championed by Senator William Roth of Delaware and created with the Taxpayer Relief Act of 1997, signed by President Clinton. The primary tax benefit of the Roth IRA, at least the one most lauded, is that your account’s appreciation and earnings are tax free. The tradeoff is in the contributions, which are not tax-deductible.

This is the biggest distinction between it and the Traditional IRA. On a traditional IRA, your contributions are tax-deductible but your earnings and appreciation are taxed as ordinary income when you start making regular disbursements in retirement.

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In general, cashing out an IRA is a bad idea. That being said, and I think I’m contractually obligated to mention that as a personal finance blogger, there are times when you simply have no choice. When faced with certain decisions, you might have to make a few that you know are bad for the long term but necessary for the short term. To cash out an IRA may be one of them.

So, if you are faced with such a decision, I think it’s important that we review how you can cash out an IRA and avoid the 10% penalty. It will not be possible for you to avoid paying taxes on the withdrawal, since you never paid taxes when you contributed, but we can at least try to avoid the ugliness of the 10% penalty.

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