IRA Tax and the Roth Conversion

By: Clay Wyatt

A tax-deferred account, such as an IRA, can be converted to a Roth IRA. The money will then be taxed at the present time, at the time of conversion, instead of during retirement. Whether or not this is a good option for you depends on your financial situation and how much IRA tax you will pay and when it will be paid.

Is it good to do a Roth IRA conversion? Let's take a look at some factors to consider before making a decision.

IRA Tax-Bracket

Your current and expected future tax-bracket are critical pieces of information when wondering 'Is it good to do a Roth IRA conversion.' If you expect to be in a higher tax-bracket when you retire than you are now, then a Roth conversion is likely to work well for you. You'll pay taxes now on yur IRA funds and your contributions and earnings will then be tax free during your retirement. Given the current federal budget deficit situaiton, do you believe your tax rates could be higher in the future?

Alright, we've seen how things may work if you plan to have a higher tax-bracket down the line than you do now. Is it good to do a Roth IRA conversion if you plan to be in a lower tax-bracket in the future?

If you plan to be in a lower IRA tax-bracket during retirement than you are in now, then a Roth conversion probably will not work for you. You'll end up paying higher taxes now instead of waiting to pay them when you are in a lower tax-bracket. However, as the earnings on Roth IRA contributions are not taxed, it may be worthwhile to consult a financial advisor to determine the nuts and bolts of your situation.

Will You Use the Money or Pass it On?

The answer to 'Is it good to do a Roth conversion' partially depends on your future intentions for your money. If you are swimming in money and don't anticipate needing much of your retirement savings, then a Roth conversion will work well for you. The reason for this is that there is no age at which minimum withdrawals must begin with a Roth IRA. However, with traditional tax-deferred accounts, minimum withdrawals must begin by age 70 ½, so you won't be able to pass on the entire amount of your IRA to your heirs if you reach that age.

The last issue on minimizing IRA tax when considering the Roth conversion is whether you can leave the Roth account alone for at least 5 years after conversion (i.e. not take any withdrawals). If you will need significant portions of the account for expenditures, then the mechanics of IRA taxation probably argue not to convert.

Conclusion

So, is it good to do a Roth conversion to minimize IRA tax? The mentioned factors are just some of those that you should consider. Before making a final decision, contact a financial advisor for advice unless you are absolutely sure of what you are doing. If you are still wondering 'Is it good to do a Roth conversion' after reading this and similar articles, then it is probably a good bet to go to a financial advisor or tax specialist. After all, that is a better bet than rolling the dice with the tax man, right?