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Roth vs. traditional IRA: Which is better?

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Which is better: A Roth or a traditional individual retirement account? In the words of William Shakespeare's Hamlet, "Nothing is neither good nor bad. Thinking it makes it so!"

In spite of everyone's opinion, all things being equal (tax rates, growth rates, etc.), they both work out exactly the same — the difference is when you (or your family, if it's after death) pay the tax on it.

But here's the thing: All things are never equal. Things are constantly changing and having a plan that works well in a variety of different situations gives you the most chance for success.

Converting a traditional IRA into a Roth means that you take that money as income today and have to pay the taxes this year on those funds as income; however, that money comes to you income-tax free in the future. Paying tax today on something that you don't have to pay until you pull the funds out in retirement generally is not a good idea for all, but for some, it can be the best financial move you ever made.

(Read more: Six tips for reducing taxes on investments)

I love the concept of tax-free money in retirement and the Roth is a tremendous planning tool; however, most people do not plan this out, which makes the conversion process wrong.

Here are six rules to use to determine if you should convert to a Roth IRA and make sure that you do it right — assuming that you have the cash available to pay the potential tax liability:

Rule No. 1: Convert to a Roth if you will be in a higher tax bracket later. (Maybe you will inherit money, have a Princeton MBA and expect your salary to increase, etc.) The only way that the Roth benefits you is if you convert from a lower tax bracket and pull out the funds in what would be a higher tax bracket.

(Read more: Move over, 401(k): Fees are what really hurt)

Rule No. 2: Convert to a Roth only within your current tax bracket. For example, at $120,000 per year in taxable income, and my projected taxable income in retirement is $100,000, this puts me right in the middle of the 25-percent tax bracket. The general rule is only convert into your current tax bracket (exceptions do apply). This 25-percent bracket goes up to $146,400, meaning that I can convert an additional $26,400 without bumping into the next tax bracket of 28 percent. (Click here to see a table of tax brackets.)

Rule No. 3: Convert to a Roth only in the state you know you will be for life. Why? Certain states have no state income. Converting in a state like NJ, NY, or CA that have high income-tax rates, then moving to FL, TX or the several other states that do not have taxes means that you paid these taxes for nothing!

Rule No. 4: The sooner in the year the better. There is a feature of a Roth conversion called a "re-characterization" that allows you to go back and make the Roth IRA back into a Traditional IRA, and not pay the taxes. This "do over" provision is one of the best features of the conversion and gives you until Oct. 15th of the following year to change your mind. Why would you want to do that? If the stock market drops, your potential tax liability may be larger than your acct value. You need to make sure that when you set this Roth up, you do not use an existing Roth or you lose the ability to re-characterize the acct.

Rule No. 5: Concentrate the stock positions in the Roth and the conservative positions in the traditional IRA. Let's assume someone has a $100,000 IRA and wants to convert $40,000 into a Roth and currently their allocation is 40 percent stock/ 60 percent bonds. I would make the traditional IRA 100 percent bonds, and the Roth 100 percent stock. I have not increased their risk or stock allocation (still 40 percent stock). If I am right, and the stock does well, I make it more conservative on Oct. 15th of the next year. If it doesn't, I re-characterize it back into the traditional IRA and I am no worse off for it … I really cannot lose.

(Read more: How to rescue your retirement at 55)

So, you check your projected tax brackets in retirement, and a Roth seems like a great option. You also converted in your tax bracket, you are sure you are retiring in the same state, did it early in the year to make sure you have plenty of time to see if you want to re-characterize the IRA, and concentrated your stock position in the Roth IRA. Is it perfect? Not yet. This is the most important tip:

Rule No. 6: Set up five different Roth IRA's at the same time! Let's assume that you are converting $50,000 from a traditional IRA into a Roth. I would put $10,000 in each Roth and would invest each one totally differently. One may be the S&P 500, another small company stocks, another international, another emerging markets, and maybe the last gold or some sector fund. Why would I do this? Simple: if you re-characterize a Roth, it has to be all or nothing. If I set up different Roth IRA accounts with different investment strategies, I can pick the individual Roth IRA that did not do well (for example gold was down around 50 percent last year) and only re-characterize that specific one Roth IRA, and leave the rest intact. This gives me the best opportunity for a successful conversion with the flexibility to go back and make changes if necessary.

The Roth IRA can be a tremendous powerful tool but it is not necessarily better than a traditional IRA. A Roth is not a "no brainer" and in the right situation, it can be a tremendous option. You just need to make sure that it makes sense for you.

(Read more: Bill Gross: Don't be a scrooge — pay more taxes!)

— By Jerry Lynch.

Jerry Lynch is a certified financial planner and president of JFL Total Wealth Management, a registered investment-advisory firm. Follow him on Twitter @JFLJerry.

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