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To Convert or Not to Convert My IRA to a Roth. That is the Question.

In order to save for retirement, some individuals are considering converting their traditional IRAs to Roth IRAs in order to maximize their low-income years in a challenging economy. But how do you know if that’s a good move for you?

MarketWatch recently published an article entitled—simply enough—“Should I convert my traditional IRA to a Roth?” that runs through the what’s and the why’s of making this decision.

Traditional IRA contributions can be tax deductible, but money taken out is considered income and is taxed. Contributions to a Roth IRA typically aren’t tax deductible, but the withdrawals aren’t subject to income taxes or capital gains taxes, provided you are over 59½ and have had the account for five years or more.

A big benefit of Roth IRAs is that, unlike a traditional IRA or 401(k) account, there are no required minimum distributions after the investor reaches 70½: the money can grow tax free and be left alone for when it’s needed.

Traditional IRA account holders who convert their accounts into a Roth IRA must pay income tax on the amount of the conversion. Whether to convert to a Roth IRA involves a variety of factors, like your age, your financial and life goals, and your current and future income. For some, the tax on the conversion from the traditional IRA to a Roth doesn’t compensate the money earned. Here are a few ideas on deciding whether or not to convert:

YES! A conversion from a traditional to a Roth IRA is a good idea if:

  1. You’re pretty young or a business professional currently in a low tax bracket expecting to be in a higher tax bracket when you retire. A Roth can help to protect you from increased tax rates that you’ll encounter during your working life.

  2. You break up your conversion in smaller parts so that you don’t get bumped up into a higher income-tax bracket immediately since the conversion amount is considered income.

  3. You want to decrease your estate for estate taxes.

  4. You live in a state that’s exempt from income taxes (or it has lower income-tax rates) and plan to move to a state with higher tax rates for your retirement.

  5. You are single or a widower. Since federal taxes are usually designed with married individuals filing jointly in mind, converting to a Roth IRA would let you have lower joint tax rates and later the money would be yours tax free during the rest of the years that you’re single.

  6. You want to enjoy limits on how much your Social Security retirement income is taxed, as up to 85% can be taxed if the remainder of your income is at a certain level. Putting your money in a Roth will help keep your income tax level low. As such, your Social Security benefits will be taxed lower too.

  7. You want to help your family succeed financially in the future. A Roth IRA doesn’t require distributions; the money can continue to grow even after you die. Your family can make tax-free withdrawals for the rest of their lives.

NO! A conversion from a traditional to a Roth IRA doesn’t make sense if:

  1. You’re an older investor or business professional currently in a higher tax bracket expecting to be in a lower bracket when you retire, as the money lost now considered as income in the conversion could wipe out any benefits of a lower income tax rate down the road; or

  2. You don’t have any financial mechanisms in place that can reduce your year’s income subject to taxes, such as tax deductions or loss carryforwards.

You should always talk with your estate planning attorney before executing any conversions or advanced tax strategies.

Reference: MarketWatch (November 25, 2015) “Should I convert my traditional IRA to a Roth?”

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