Time to Consider a Roth Conversion

Ever since the launch of the Roth IRA option in the late 1990s, many investors have had to decide what account to open and whether or not to consider a Roth conversion. It’s a tough decision to make since it has a significant impact on your retirement.

It has never been this easy to convert to a Roth IRA. There is no income limit set on IRA conversions, and more and more employers are allowing their employees to convert their retirement plan balances to Roth while still working there. This article looks at Roth conversion and whether it’s time to consider it.

What is a Roth Conversion?

It refers to the moving of your assets from a tax-deductible traditional IRA (individual retirement account) to a non-deductible Roth IRA. As a participant in a Roth IRA, you won’t pay income tax when withdrawing your funds in retirement since the money you deposited into your Roth account is from after-tax income.

A Roth conversion is advantageous if you have a large traditional IRA account, and you expect your future tax bills to either grow or remain at the same level at the time you plan to start withdrawing from your tax-advantaged account.

Situations When a Roth Conversion Makes Sense

1. Your Investments’ Value is Down

The opportune moment to pay taxes on your investments is when their value is temporarily low. With a long-term investment time horizon, they will grow tax-free.

2. You Suspect a Higher Tax Rate upon Withdrawal

A Roth conversion is a good idea if you have not worked for part of the year (either you were in school, caring for a child, or in between jobs), have another reason to fall into a lower tax bracket this year, or have larger than usual deductions.

You are better off paying your taxes presently if you expect a higher tax rate in the future. Perhaps you expect a large pension or have other income sources that will push you up a few tax brackets in retirement. You may also convert to a Roth IRA if you worry that tax rates will increase by the time you retire or you intend to pass your account on to heirs who are in higher tax brackets.

3. You Have Money to Pay Your Taxes Outside of Your Retirement Account

When you use outside money to pay the conversion tax, it is equivalent to contributing to the account. If you had, otherwise, invested the funds used to pay the conversion tax, you would have to pay taxes on any earnings you make. Therefore, by transferring the value into a Roth IRA, the future earnings grow tax-free.

4. You Might Retire Before You’re 65

65 is the earliest age you become eligible for Medicare. Therefore, if you plan to retire before then, you may need to purchase health insurance coverage through the Affordable Care Act. Your tax income determines the subsidies from that program, which means that tax-free withdrawals from your Roth account work out great in your favor.

5. You Plan to Use the Money in Five or More years for a Non-Qualified Expense

After conversion, you can withdraw the full amount in five years for any reason and at any time without a penalty or tax. Beware, however, that withdrawing any post-conversion earnings before you reach 59 and a half years, will see you paying income taxes on top of a 10 percent penalty tax.

✓ Things to Keep in Mind

Converting may not be advisable if you expect to fall in a much lower tax bracket during your retirement. Also, individual state income taxes have an impact on your Roth conversion decision.

You should base any decision to convert on your financial status, anticipated future tax rates, current tax rates, age, goals, and estate planning intentions. To help with your conversion decision, consider using a Roth IRA conversion calculator (found online). It’s also advisable to consult a personal tax professional or financial planner.