For Roth IRA distributions to be made on a tax-free basis, they must be made after a five-taxable-year period of participation and must occur when or after you reach age 59 1/2. In the case of a conversion, five years must have passed since the conversion. A Roth IRA conversion can make a lot of sense for some. On the other hand, there are certain cases when it makes no sense at all. Before you convert to a Roth, ask yourself the following questions.
Are You Near Retirement and in Need of IRA Income?
If you’re approaching retirement or need your IRA money to live on, it’s unwise to convert to a Roth. Because you are paying taxes on your funds, converting to a Roth costs money. It takes a certain number of years before the money you pay upfront is justified by the tax savings. If you are taking retirement income, you increase that timeline. To get a sense of whether you would be better off converting, a Roth conversion calculator can help. The challenge with relying solely on a Roth IRA conversion calculator is that the assumptions are based on future income tax expectations. It is difficult to predict where income tax rates are headed in the next one to two years. Imagine how challenging it can be to predict tax rates 10, 20, or even 30 years from today when you will be taking funds from your Roth IRA. Be sure to review your current and projected income tax bracket before converting a traditional IRA to a Roth IRA. Then complete a budget plan for retirement to estimate your anticipated tax bracket based on your projected retirement income plan.
Can You Afford the Taxes?
A Roth IRA conversion can be costly because you must pay taxes on your existing IRA. Ideally, the money should not come out of your retirement savings. If you have to use funds from your traditional IRA to pay the taxes, it will cost you to convert to a Roth, and you’re better off letting the funds sit tight. One technique to consider is to spread the cost of conversion over a few years. That may also prevent you from pushing yourself into a higher tax bracket.
Do You Want To Pay the Taxes?
Sometimes, making a good financial move can be a difficult thing to do. That’s the feeling many traditional IRA owners get when considering a Roth IRA conversion. Can you imagine someone having $300,000 in an IRA and, right up front, giving up $75,000 of it? A Roth IRA conversion may look good on paper, but in the real world, it may be more complicated. Tax deductions may be an effective strategy to lower the tax cost of a Roth IRA conversion. However, you must first have the financial resources and a desire to gift to a charitable organization to use this strategy.
Will You Be in a Lower Tax Bracket in the Future?
If you think you will retire in a lower income tax bracket than you are in now, it doesn’t make sense to convert. You will pay higher taxes on the conversion than you would if you were to withdraw the money from your traditional IRA at retirement. A Roth IRA conversion can be a good idea for some IRA investors. Consider your potential conversion carefully before making any moves to convert your savings.
