Retirement Planning

Should You Consider a Roth Conversion?

In Cash Flow and Budgeting, General Financial Planning, Personal Financial Planning, Retirement Planning, Tax by Chip Hymiller

With the belief that tax rates are likely to rise over time, many people are considering the merits of converting their traditional IRAs into Roth IRAs.  The decision of whether or not to convert an IRA into a Roth IRA is a big one with far-reaching financial implications.

Before considering the merits of a Roth conversion, it is necessary to discuss the benefits of Roth IRAs in general.  The following are several advantages of Roth IRAs:

  • Qualified distributions from Roth IRAs are not subject to income tax (as they are with 401(k) plans and traditional IRAs).
  • Investment earnings are completely tax exempt.
  • There are no required minimum distribution (RMD) requirements at age 70 1/2, allowing these accounts to grow tax-free indefinitely.
  • Original Roth contributions, including conversions, can be withdrawn prior to the age of 59 ½ without penalty.

In the past, only those taxpayers with an adjusted gross income of $100,000 or less were able to convert existing IRAs/401(k) Plans into Roth IRAs.  Congress has now suspended the adjusted gross income limitation for Roth conversions.  As such, taxpayers at any income level have the ability to convert their IRAs into Roth IRAs.

While this may represent a golden opportunity for some, there are a number of issues to consider prior to executing a Roth conversion including the following:

  • What will be the tax cost of the conversion?
  • Will the additional taxes from the Roth conversion be paid from the conversion itself, through paycheck withholdings or through other means?
  • Will a Roth conversion create adverse financial implications like the deductibility of medical expenses or increased costs of Medicare Part B premiums?
  • How will a Roth conversion impact required minimum distributions (RMDs)?
  • Are there alternatives that could be considered that can reduce the tax impact of a Roth conversion (i.e. accelerating charitable gifts to offset the tax liability created by the conversion)?
  • What are the intra-family financial planning benefits/negatives of a Roth conversion strategy?

We suggest that prior to implementing a Roth conversion strategy that you fully understand the short term and long term implications of this strategy.