Roth Conversion Checklist - Adviser Investments

Roth Conversion Checklist

Roth IRAs are a smart option right now—but should you trade in your traditional IRA for one?

The answer comes down to taxes. Money placed in a Roth IRA can grow tax-free and be withdrawn without a levy in retirement. By contrast, contributions to a traditional IRA also grow tax-free, but you pay taxes on the money you take out during retirement—and you are required to withdraw the money at some point.

As great as tax-free growth and tax-free withdrawals are, Roth IRAs aren’t a free lunch. If you want to convert a traditional IRA into a Roth, you have to pay income taxes on the amount you move over.

Here are several factors to help you decide whether a conversion makes sense for you.

  • Tax rates. Generally, if you have a low-income year due to early retirement or other reasons, it may make sense to take the opportunity to convert. This strategy can be especially effective if you’ve elected to defer Social Security benefits to age 70—dropping your tax rate even further.
  • Time frame. The longer you have before you need the money, the more sense it makes to convert assets to a Roth. Once you convert, qualified withdrawals will never be taxed. Leaving those assets untouched for as long as possible allows them to grow tax-free over time. This will squeeze the most juice out of the conversion.
  • Paying for the conversion. If taxes on the conversion are paid from IRA assets, less is left in the Roth to grow, eroding the benefit of the conversion. The best practice is to cover the tax bill from cash on hand or taxable investments. If you can’t cover the taxes with other money, a conversion might be unwise.
  • Required minimum distributions (RMDs). You are required to withdraw money from traditional IRA accounts starting at age 72. But you are not required to take money out of your Roth. If you don’t need to tap into IRA funds to cover living expenses, a Roth IRA gives you the freedom to choose when or if you take withdrawals over your lifetime.
  • Legacy. Roths are a better asset to pass to your heirs. Traditional IRAs create taxable income, but heirs don’t pay tax on Roths and they have several choices for how they draw the account down over time. In other words, your heirs will thank you if you convert to a Roth.
  • Where you’ll live in retirement. Individual states tax retirement income differently. If you plan to move to another state in retirement, check to see whether required distributions from IRAs are excluded from your state income tax. If so, you may save more on taxes by sticking with a traditional IRA than you would by converting to a Roth.

General rules aside, a Roth conversion isn’t a straightforward decision. If you have questions, please contact your portfolio team. We are happy to assist. After all, we are The Planner You Can Talk To.

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