For some investors, a Roth IRA may provide greater after-tax income during retirement than a Traditional IRA. While converting to a Roth is a taxable event, the benefits may outweigh the tax consequences for many. Additionally, tax laws that previously prevented higher-net-worth investors from converting to a Roth have changed. Regardless of your annual income or tax-filing status, you can convert a Traditional IRA to a Roth.
You also can convert your SEP or SIMPLE IRA to a Roth, or roll over funds from an eligible employer retirement plan, such as a 401(k). We can discuss Roth conversions with you in more detail.
Roth Conversion Benefits
- Tax-free Withdrawals During Retirement - Any qualified withdrawals from a Roth IRA during retirement are tax free.
- Protection Against Future Tax-Rate Changes - Because you don’t pay taxes on Roth withdrawals in retirement, you may avoid the risk of future tax-rate changes.
- Tax Diversification - One strategy for retirement investing is to incorporate tax diversification — taxable, tax deferred and tax free — to your portfolio. Converting your Traditional IRA to a Roth is one way to achieve the tax-free income component.
- Withdrawal Flexibility – You don’t have to take a required minimum distribution on a Roth IRA at age 70 ½. And, you can continue to contribute to your Roth as long as you have earned income.
- Legacy Planning – Unlike a Traditional IRA, a Roth IRA allows you to potentially leave a tax-free asset to your heirs. A Traditional IRA will be taxable at your beneficiary’s marginal income-tax rates.
Before converting, consider:
- Current and future income tax rates.
- Current age and life expectancy.
- Ability to pay the taxes due on a conversion from a source other than your IRA.
- Anticipated spending needs during retirement.
- Other sources of retirement funds and retirement income — pre-tax and post-tax.
- Age and life expectancy of beneficiary(ies).
- Type of contributions made – deductible and/or nondeductible — and IRS rules governing partial conversions.
Special Recharacterization Provision
After you convert you may revert back to a Traditional IRA. Known as recharacterization, the transaction must be processed by October 15 of the year following the year of the conversion.
A Roth conversion might not be a favorable strategy if any of the following apply:
- You are unable to pay the tax bill for the Roth conversion from a source outside of your IRA.
- You are nearing or are in retirement and intend to fund all or a large portion of your retirement income with your pre-tax retirement savings.
- You feel your tax bracket is likely to drop during your retirement years.
- The conversion will put you in a higher tax bracket. If this is the case, you might consider a partial conversion.
- You have named a tax-exempt charity as beneficiary of your IRA.
Roth conversion analysis is complex. You may want to consult with your tax advisor as well.