Is a Roth IRA Conversion Right For Me?

If you have a traditional IRA, you may have already considered converting to a Roth IRA. A Roth IRA conversion refers to taking all or part of the balance of an existing traditional IRA and transferring it into a Roth IRA account. During this transfer, you would pay taxes on the funds at ordinary federal and state income tax rates, but then the account would grow tax-free and could be withdrawn tax-free as long as it has been 5 years since the conversion and the account owner is 59 1/2 years or older. A Roth conversion is a great tax planning strategy, but it is not right for everyone.

Questions to consider when deciding if a Roth IRA conversion makes sense for you:

Will You Need The Money In Five Years Or Less?

As a conversion must be held in the account for 5 years to enjoy the tax benefits, you must be certain that you won’t need the money for at least 5 years. If you do need the money in 5 years or less, the discussion should focus on investment strategies to preserve the account as much as possible so you ensure it is there when needed and accessible.

Will Your Tax Bracket Be Higher In Retirement?

If you think that your tax bracket will be higher in retirement, or that tax rates will increase, you may want to consider a Roth conversion to pay taxes at a lower rate and enjoy tax-free income in retirement. If your taxes rise because of increases from the government—or because you earn more, putting you in a higher tax bracket—a Roth IRA conversion can save you considerable money in taxes over the long term.

Do You Have Funds Set Aside To Pay The Income Taxes?

Ideally, the money to pay the taxes should not come from your retirement savings. If you have to use the IRA to pay the taxes, it may be better to defer the conversion. Why? For one, the money you use from the traditional IRA to pay the taxes is no longer in the account to benefit from long-term growth. In addition, if you are under 59 1/2, the funds you used to pay the conversion tax would be treated as an early distribution. For example, if you want to convert $60,000 to a Roth IRA and are in the 25% federal tax bracket, setting aside state income taxes, you would owe the IRS $15,000. The penalty tax is 10%, meaning you’ll need to pay an additional $1,500 in taxes you may not have anticipated.