To Convert, or Not to Convert, that is the Question

by: Joshua P. Itzoe, CFP©, AIF®

For most people, the Roth IRA is a wonderful retirement savings vehicle due to the potential for enormous tax-free growth, lifetime tax-free withdrawals, and no Required Minimum Distributions (RMDs).

Unfortunately, not everyone is eligible to contribute to a Roth IRA on an annual basis because of income limits. While anyone can contribute to a Traditional IRA regardless of income, the right to use a Roth is phased out as your adjusted gross income (AGI) rises from $95,000 to $110,000 on a single return and from $150,000 to $160,000 on a joint return.

The good news is that you may convert all or some of a Traditional IRA into a Roth IRA if you qualify and follow a few simple rules. First, your modified adjusted gross income (MAGI) must be less than $100,000 in the year of conversion (this limit is for both single
and joint filers). Second, the conversion must be completed by December 31 of the year concerned. Third, you must be able to pay the taxes upfront (at ordinary income tax rates) on any amounts that you decide to convert.

Although there are many attractive reasons to convert to a Roth IRA, it is not a “one-sizefits-all” decision. There are several factors to consider such as your level of income, your current and future tax rates, the ability to pay the taxes due on the conversion, your need
for the money in your IRA during retirement, and your overall estate planning strategy.

Assuming you meet the MAGI limitations, you may want to consider a Roth IRA conversion if:

• You don’t need the money to live on in retirement and want to pass these assets to younger beneficiaries. Roth conversions are a great estate planning tool and can usually derive the most benefit if left to younger beneficiaries due to longer periods of compounded tax-free growth.

• You are able to pay the taxes necessary on the conversion (it is best to use money available outside your IRA)

• You expect to be in the same or higher tax bracket in retirement (paying taxes now in a lower tax bracket should save you income taxes later on)

• You are within the MAGI limits this year but may not be in future years (which will make you ineligible to do a conversion)

You may not want to consider a Roth IRA conversion if:

• You need to use part of the money in the IRA to pay the taxes due on the conversion (you may be subject to a 10% penalty if you are younger than age 59½)

• You will need the money in your IRA for living expenses during retirement and will be in a lower tax bracket (depending upon your age and/or market conditions you may not have enough time to earn back the money you pay in taxes on the conversion)

• The additional income will push you into a higher tax bracket and affect your eligibility for certain items that are tied to adjusted gross income (AGI)

Remember that a Roth IRA conversion is not an “all or nothing” proposition. You may convert only some of the money in your Traditional IRA or convert portions of your account over multiple years. For instance, you could convert 20% of your IRA each year
for a period of five years, in effect paying the taxes in installments.

If done correctly, a Roth IRA conversion can be a wonderful part of your overall financial planning strategy. However, you should always consult an advisor who has expertise in IRA planning to determine the most appropriate strategy for your individual situation.

The information in this article is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, and does not purport to be complete and is not intended as the primary basis for financial planning or investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.