Is Now the Time for a Roth Conversion?

 – March 14, 2019
Is Now the Time for a Roth Conversion? Have you considered converting a traditional individual retirement account to a Roth IRA but weren’t sure if it was the right step? This may be a good time to revisit the possibility of a switch. Here are some key issues:

How Is a Roth Different?

With a traditional IRA, you may receive a tax deduction for qualified contributions to the account now, and you pay taxes on the qualified withdrawals you take. A Roth IRA works the other way around: No tax deduction now, but you don’t pay taxes on qualified distributions (subject to certain conditions). In addition, with traditional IRAs, there is an annual required minimum distribution (RMD) beginning at age 70½, and these distributions are taxable. Other tax-advantaged retirement accounts also often have their own RMD rules. There’s no RMD with a Roth, however. In both Roth and traditional IRAs, your money grows tax-free as long as it remains in the account. Consult your CPA for more important details on the differences between these accounts.

What Happens in a Conversion?

When you withdraw money from an existing traditional IRA and move it into a Roth IRA, you must pay taxes on the withdrawal. There is typically a 10% penalty for those who withdraw funds from a traditional IRA before age 59½, but this should not apply if the conversion to a Roth IRA is handled properly. 

When Is Conversion a Good Idea?

Why would you want to make the switch if you’re going to owe taxes on the money you move from a traditional to a Roth IRA? The first reason is low current tax rates. Recent tax reform reduced most individual tax rates, so if you want a Roth IRA, it may be a good idea to do a conversion now in case tax rates rise in the future. You may also want to take advantage of today’s relatively low rates if you think you might move up into a higher tax bracket in retirement. Another incentive is flexibility in retirement. With a Roth IRA, you can take as much money as you need each year after age 59½ and pay no taxes on it, as long as the IRA has been open for at least five years (ask your CPA about other contrasts between qualified and non-qualified Roth distributions). The chance to minimize your potential taxes and simplify your tax planning in retirement may be worth the cost of a conversion today. A conversion may also be a good choice for taxpayers who can’t open a Roth IRA directly because their income exceeds a certain level.   

What Drawbacks Should You Consider?

A Roth IRA conversion isn’t right for everyone. If you think your overall income will drop in retirement, that could mean that you’ll be in a lower tax bracket. In that case, the taxes you pay on a distribution from a traditional IRA in retirement may be lower than the taxes you’d pay today for a Roth IRA conversion. Consider, too, whether you have enough money to pay the taxes on a Roth conversion today. If you will have to go into debt to cover them, or dip into your retirement savings, the conversion is probably not a sound step. Keep in mind that the money you withdraw will be included in your taxable income, which may push you into a higher tax bracket, another possibility that should be considered in making your decision.

Consult Your Local CPA

Every day, local CPAs offer clients expert advice on a wide variety of financial concerns, including making a major purchase or obtaining a loan. Whatever your financial questions, your CPA can help you find the answers. Locate a CPA near you with our Find-A-CPA directory.

Copyright 2020 The American Institute of Certified Public Accountants.