Starting in 2010, it became possible for high income people to convert traditional IRA accounts to Roth IRAs. This can be an important decision and we urge you to spend the time to figure out if it is right for you. Because there is already a ton of information online on this topic, and because it is impossible to cover every scenario here, this discussion will be kept very high level.
Please contact us if you want to have a more detailed conversation on Roth Conversion.
At its simplest, if you expect your tax rate to be lower when you take the money out in retirement, stay in the traditional IRA. If you expect your tax rate to be higher, convert. If you expect it to be about the same, a more detailed analysis is required. Often there is still an advantage to the Roth conversion because the converted money will be able to grow tax free while the opportunity cost from the taxes paid from post-tax accounts will be subject to taxes on dividends and capital gains along the way.
One other potential advantage of the Roth is it is not subject to Required Minimum Distributions. Thus, if you don’t need the money from retirement accounts, you can let them grow tax free longer.
You don’t have to convert everything at once. For those who are already retired and plan to withdraw more than about $70,000 each year from investment accounts, it is often a good plan to live off withdrawals from your taxable accounts and convert a modest amount of your IRA each year to a Roth. If you do only enough to stay below the 25% federal bracket, it can be a powerful way to reduce taxes in the long run. Watch out for Social Security taxes if you are already taking it.
It is nearly impossible to predict income tax rates far into the future. If you are still working, realize you will probably pay a lot less in taxes when you are retired. If you believe the nation’s debt situation will force taxes to go up, it argues in favor of converting. One nice feature of the Roth is it takes away the uncertainty of this factor, assuming the government does not go back on its promise to keep Roth withdrawals tax free. This would be political suicide so it is probably safe.
Usually, don’t convert unless you have plenty of money available to pay the taxes from non-retirement accounts.
Converting part or all of a traditional IRA to a Roth may also be advantageous for estate-planning purposes. Roth accounts are still included in the gross estate, but balances can stay larger because there are no required minimum distributions. This allows heirs to withdraw income-tax-free over their lifetimes. Also, income tax paid at the time of conversion can reduce the gross estate. If you are certain you will be leaving money behind, there are powerful incentives for a Roth Conversion.
Craig Birk, CFP®
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