What do I need to consider when deciding whether it’s worthwhile to convert a traditional IRA to a Roth?
You need to ask yourself five key questions before you move your money to a Roth IRA:
1. Can you afford to pay the tax on the conversion with money from outside your IRA?You must pay taxes on the amount in a traditional IRA (except for any nondeductible contributions you have made) that you convert to a Roth, but then you’ll be able to access the money in the Roth -- including all future earnings -- tax-free in retirement.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The conversion won’t be as good a deal, though, if you need to tap the account to come up with the cash. Any money you withdraw now to pay the tax bill won’t be around to produce that glorious tax-free income. Plus, if you’re younger than 59½ when you pull the money out to pay the tax, you’ll be hit with a 10% penalty . . . on top of tax on the withdrawal in your top bracket. One benefit of converting in 2010 is that you can delay paying the tax until you file your returns for 2011 and 2012 (split evenly over those two years), giving you extra time to save for the bill.
See FAQs on the New Roth Conversion Rules for more information about the tax bill.
2. Do you expect to be in a higher tax bracket in the future?
If you do, a Roth IRA is an easy decision: You pay the taxes at your lower bracket now and take the money out tax-free later, dodging the higher tax bill that would otherwise apply at that time. It’s particularly valuable to convert to a Roth now if your income is unusually low -- if, for example, you were unemployed for part of the year -- so you’ll pay the taxes at a lower rate.
Although you can pay the tax on conversions made in 2010 over 2011 and 2012, you also have the option of paying it in full when you file your return for 2010, which could make sense if you expect your tax bracket to be lower this year than it will be in the following two years. Just remember that money you convert will be added to your other income for the year, which could push you into a higher tax bracket.
See What You Need to Know About Roth Conversions for more information about making the switch.
3. Will you need your IRA money in retirement, or do you think you’ll be able pass most of it on to your heirs?
Converting to a Roth IRA can be a particularly good deal if you won’t need to tap the account for your retirement expenses every year. Unlike traditional IRAs, Roth IRAs never force you to take required minimum distributions, and heirs inherit the money income-tax free. (Those who inherit traditional IRAs must pay tax on withdrawals in their top tax brackets.)
4. How long do you plan to keep the money in the account?
The longer you keep the money in the account, the more you can benefit from tax-free growth. See The Complexities of Roth Conversions for more information about the calculations that can help you decide whether a Roth is right for you, especially if you’re retired now or expect to retire soon.
5. Do you plan to pay college bills soon?
Converting to a Roth increases your taxable income for the year of the conversion -- or for 2011 and 2012 if you make a 2010 conversion and choose to spread the tax bill over those years. That could affect your child’s ability to qualify for financial aid. See The Impact of Roth Conversions on Financial Aid. If this is a potential problem, you may want to delay your conversion until after your child’s junior year in college, when the extra income won’t affect your family’s aid award.
For more information about Roth conversions, see our Roth Conversions for Everyone special report.
-
Getting Out of an RMD Penaltyretirement When your brokerage firm miscalculates your required minimum distributions, you have recourse.
-
Borrowers Get More Time to Repay 401(k) Loans
retirement If you leave your job while you have an outstanding 401(k) loan, Uncle Sam now gives you extra time to repay it -- thanks to the new tax law.
-
It’s Not Too Late to Boost Retirement Savings for 2018
retirement Some retirement accounts will accept contributions for 2018 up until the April tax deadline.
-
How Your HSA Can Reimburse You for Medicare Premiums PaidMedicare Even if your Medicare premiums are automatically deducted from your Social Security check, you can take tax-free withdrawals from an HSA to reimburse yourself.
-
How to Correct a Mistake on Your RMDs from IRAsretirement If you didn't take out the correct required minimum distribution because your brokerage firm made a mistake, the IRS may show some leniency.
-
Ways to Spend Your Flexible Spending Account Money by March 15 Deadline
spending Many workers will be hitting the drugstore in the next few days to use up leftover flexible spending account money from 2018 so they don’t lose it.
-
Making the Most of a Health Savings Account Once You Turn Age 65
Making Your Money Last You’ll face a stiff penalty and taxes if you tap your health savings account for non-medical expenses before the age of 65. After that, the rules change.
-
Reporting Charitable IRA Distributions on Tax Returns Can Be Confusing
IRAs Taxpayers need to be careful when reporting charitable gifts from their IRA on their tax returns, or they may end up overpaying Uncle Sam.
