Is it Time to Convert to a Roth IRA?

/ Freidel & Associates, LLC/

An Individual Retirement Account (IRA) can come in two formats, a Traditional IRA, and a Roth IRA.

In simple terms, a Traditional IRA is funded with pre-tax dollars, and will be taxed upon future disbursement (including gains upon investments in the account). A Roth IRA is funded with post-tax dollars, that will be tax free upon future qualified distributions (including gains upon investments in the account).

Conversion to a Roth IRA will not be suitable for everyone in every circumstance, as it can increase your taxable income by recognizing the deferred income of your previous traditional IRA contributions and gains. However, current market conditions may provide an opportunity for some taxpayers to convert all or a portion of their IRAs at lower current market values.

Some other factors you should consider with a Roth IRA conversion include the following:

  • Converting during a low-income year, which could result in the IRA conversion being taxed at a lower tax rate. We highly recommend using multi-year income projections and retirement income forecasts to assess expected current vs. future tax rates, and to take advantage of situations when current tax rates are lower. After proper planning, we typically consider selective targeted Roth conversions based on your specific tax situation and tax brackets for the year of conversion.

  • There are no minimal required distributions for a Roth IRA, so it is possible to hold the account in its entirety for tax-free growth without forced distributions beginning at age 72 that are required with a Traditional IRA.

  • A Roth IRA represents a tax rate “hedge”, as these funds should remain exempt from future potential tax rate increases.

  • A Roth could provide you with retirement account “diversification”. For instance, if you have a large specific cash need in retirement, availability of a Roth account may allow you to avoid a large income bump into a higher tax rate that may occur with a Traditional IRA distribution. On the flip side, having a Traditional IRA account can be valuable if you have a lower income year in retirement, as that would be when you would typically choose to withdraw taxable funds. In many circumstances, having a mix of Roth and Traditional IRA funds can prove valuable in retirement.

  • If you expect to be subject to the estate tax, a Roth IRA conversion can be valuable as you will pay the income tax on conversion out of your taxable estate, thereby reducing your estate tax exposure.

  • Think twice if you believe you’ll need the funds in the next five years and you are under age 59 1/2. There is a general five-year waiting period after converting to a Roth IRA to avoid a 10% additional tax.