5 Key Roth Conversion Considerations

Roth IRAs are a powerful retirement savings vehicle—but should you trade in your traditional IRAA type of account in which funds can be saved and invested without being subject to tax until the account holder reaches retirement age. for one?

The answer comes down to taxes.

What makes them so popular is that money placed in a Roth IRA can grow tax-free and then be withdrawn tax-free in retirement. Money you contribute to a traditional IRA also grows tax-free, but you pay taxes on the money you withdraw during retirement—and you are required to take the money out 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 transition.

That means that timing and tax rates are crucial factors in whether a conversion makes sense for you. Generally, if you have a low-income year due to early retirement or some other reason, it may make sense to take the opportunity to convert. This strategy can be especially effective if you’ve elected to defer Social Security to age 70, dropping your tax rate even further.

That doesn’t mean you must wait until you’re poised to retire to convert. Tax rates are currently at historical lows. If they rise in the future, making the move now may look like a smart decision.

Here are five considerations as you contemplate converting traditional IRA assets to a Roth:

1. Time Frame. The longer you have before you need the money, the more sense it makes to convert assets to a Roth IRA. Once you convert to a Roth, qualified withdrawals will never be taxed. Leaving those assets untouched for as long as possible to grow tax-free over time allows you to get the most juice out of the conversion.
2. Paying for the Conversion. If taxes on the conversion are paid from IRA money, 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 moneys, conversion might not be wise.
3. Required Minimum Distributions (RMDs). You are required to withdraw money from traditional IRA accounts starting at age 70½. 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.
4. Legacy. Roth IRAs are a better asset to pass to your heirs than traditional IRAs. Where traditional IRAs create taxable income, inheritors don’t have to pay tax on Roth IRAs and can choose how they want to draw the account down over time. In other words, your heirs will thank you if you convert to a Roth.
5. 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 converting to a Roth.

Whether to perform a Roth conversion isn’t a straightforward decision, and every situation is unique. We can provide you with advice tailored to your circumstances. Please contact us at (800) 492-6868 to learn more. We are always happy to assist.