Does It Make Sense To Convert IRA to Roth?


When you no longer have to worry about income limits in an IRA to Roth conversion, why should you make the change?

Let me play the devil’s advocate here: you still end up paying income tax on the taxable part of the money you transfer to a Roth.

However, it still makes sense to convert your IRA to Roth and pay your taxes now.

The case for Roth IRA conversions

It all boils down to whether you’re going to face the same, or higher, tax rates when you retire. There is no conjecture here. Since the Bush tax cuts will expire in 2011, the possibility of higher taxes in the future is almost certain. Again, if you are at least forty years old and convert your IRA to Roth, you will pay some tax now. You will still benefit, however, if you belong to a lower tax bracket when you retire.

Not convinced? Let me illustrate with an example. Jake, who is 45 years old, is in the 28 percent tax bracket. He converts IRA to Roth and falls into the 15 percent tax bracket. It may look like he’s behind by the time he’s 65 years old. However, when he takes his distributions throughout his retirement, he will more than make up for the taxes he paid. Why? It is because of the tax-free growth of his Roth IRA.

As usual, time makes all the difference. If you are over 60 years old, you may feel that converting IRA to Roth is not a good idea, especially if you are likely to fall into a lower tax rate when you retire. But, do you know for certain what your tax rate will be when you retire? Consider spreading your savings across investments that could carry different tax rates.

Roth IRAs also give you other benefits. For instance, if you want to leave something to your heirs, you can do it through a Roth IRA. Your heirs can cash this in right away or choose to receive a tax-free income for the rest of their lives.
Even after you are 70 ½ years old, you don’t need to worry about withdrawing money from your Roth IRA, unlike with a traditional IRA. Another benefit is that the money you take from a Roth IRA has no bearing on the taxability of your Social Security benefits.

What will Uncle Sam say?

You cannot completely ignore the IRS. When you convert IRA to Roth IRA, the money you transfer will raise your taxable income. This will take you into a higher tax rate bracket. The good news is that you can get around this by converting small amounts over a period of time. Another way is simply to wait until you enter a lower tax bracket.

Regardless of what tax bracket you’re in, do not touch the account you are in the process of converting to pay your taxes. Why? The reason is simple. You will have less money invested, and this will affect your long-term benefits.

Can I undo a conversion?

The answer is yes, but only if you take action before the deadline for filing your income taxes for the tax year in which you converted IRA to Roth.

You must deal with any doubts you have about your conversion within this tax year. As always, talk to a trustworthy financial consultant before you actually convert IRA to Roth.

Return from Convert IRA to Roth to Roth Ira


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