Should you convert to a Roth IRA?

By Sunwook Jin, CFP®, CRPC®, CMFC®

If you’ve heard of an Individual Retirement Account (IRA), you probably have heard of a Roth IRA.  When someone is ready to begin contributing to a retirement account, we’ll frequently get asked about the difference between the two accounts.  But what if you already have a traditional IRA?  Do you know there is an option to convert your traditional IRA to Roth IRA?

Converting your traditional IRA to a Roth IRA can make a lot of sense depending on your situation.  Remember, consulting with your financial advisor before making financial decisions is never a bad idea. Let’s look at reasons for and against converting your traditional IRA to a Roth IRA. 

Why go Roth? –  There is a belief behind every Roth IRA conversion that future income tax rates will be higher. If you are one of the believers, then you may be compelled to convert. After all, once you are age 59½ and have had your Roth IRA open for at least five calendar years, withdrawals of the earnings from your Roth IRA are exempt from federal income taxes.  Even though some believe future income tax rates may be higher when you begin withdrawals, converting to a Roth IRA takes the uncertainty out of the tax situation.  If your money is in a Roth IRA, the income tax rate doesn’t affect your Roth IRA.  While there are certain stipulations for the account to be exempt from federal taxes, your Roth IRA contributions can be withdrawn tax free and penalty free at any time.

As the law is currently written, you never have to make mandatory withdrawals from a Roth IRA, and if your income permits, you can make contributions to a Roth IRA as long as you live.

Additionally, Roth IRAs can prove to be very useful estate planning tools. If I.R.S. rules are followed, Roth IRA heirs may end up with a tax-free inheritance, paid out either annually or as a lump sum. In contrast, the distributions of inherited assets from a traditional IRA are routinely taxed.

Why not go Roth? Two reasons: the tax hit could be substantial, and time may not be on your side.

A Roth IRA conversion is a one-time taxable event. The I.R.S. regards it as a payout from a traditional IRA prior to that money entering a Roth IRA, and the payout represents taxable income. That taxable income stemming from the conversion could send you into a higher income tax bracket in the year when the conversion occurs.

If you are nearing retirement age, going Roth may not be worth it. If you convert a large traditional IRA to a Roth when you are in your fifties or sixties, it could take a decade (or longer) for the IRA to recapture the dollars lost to taxes on the conversion.

In many respects, the earlier in life you convert a regular IRA to a Roth, the better. Your income should rise as you get older; you will likely finish your career in a higher tax bracket than you were in when you were first employed. Those conditions relate to a key argument for going Roth: it is better to pay taxes on IRA contributions today than on IRA withdrawals tomorrow.

On the other hand, since many retirees have lower income levels than their end salaries, they may retire to a lower tax rate. That is a key argument against Roth conversion.      

When you sit down and go over your financial plan, it may make sense for you to convert a certain portion to a Roth and still utilize both accounts.  As no one can fully predict the future of American taxation, some people choose to keep both. 

Regardless of which account you choose, be sure your decision fits in with your overall financial goals. 

Traditional IRA account owners should consider the tax ramifications, age and income restrictions in regard to executing a conversion from a Traditional IRA to a Roth IRA.  The converted amount is generally subject to income taxation.

This information is not intended to be a substitute for specific individualized tax or legal advice.  We suggest that you discuss your specific situation with a qualified tax or legal advisor.

The Roth IRA offers tax deferral on any earnings in the account.  Withdrawals from the account may be tax free, as long as they are considered qualified.  Limitations and restrictions may apply.  Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax.  Future tax laws can change at any time and may impact the benefits of Roth IRAs.  Their tax treatment may change.

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal.  Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.