February 19, 2019 • Retirement 101 / Articles and Insights

Is a Roth Conversion Right for You?

Taxes. Nobody likes them, but they’re a necessary part of just about everything we do—including (unfortunately) retirement. 

If you’re like most people, your retirement plan probably includes money you’ve saved in your employer’s retirement plan or your own individual retirement account (IRA). Traditional IRAs and 401(k)s are tax-deferred vehicles, meaning you aren’t taxed currently on the amounts you contribute to them. But, at some point, the money you’ve saved in these accounts will have to be withdrawn (usually at age 70 ½) and will be taxed as ordinary income. No one knows what taxes will be by the time you retire—and that uncertainty can make it difficult to plan for how your retirement savings will be taxed. 

One way of helping manage your post-retirement taxes is converting some of the savings in your Traditional IRA or qualified plan to a Roth IRA. The converted amount is taxed as ordinary income at the time of conversion, but comes with some potentially significant benefits down the road—like tax-free withdrawals and no required distributions at age 70 ½. These unique features of a Roth IRA can give you added flexibility in retirement.

Is a Roth conversion right for you? It completely depends on your own financial situation—but here are a few things to consider when making the decision to convert to a Roth. 

Your View on Taxes

If you think taxes are likely to stay the same or even decrease as you approach retirement, then staying put in tax-deferred accounts like IRAs and 401(k)s may be the right choice for you. Every dollar you put into these accounts comes with a deduction on your current income and is taxed when it comes out. If you think tax rates will be lower in retirement than they are now, you’ll end up paying less in taxes over time than if you converted now.

But if you think that taxes are likely to be higher by the time you retire, then converting all or a portion of your pre-tax IRAs now may be something for you to consider. You’ll pay taxes on the converted amount now, but may avoid higher taxes later when you need the income in retirement. That’s because qualified Roth IRA distributions are never taxed—which means that as the balance of your account grows, the gains will not be taxed when you take them out. Keep in mind, in order for it to be a qualified distribution, you have to be at least 59 ½ and your account must be open for at least five years. 
If tax rates remain the same, then keeping your traditional IRA or opting to consider a Roth conversion will have the same tax consequence; whether you choose to defer taxes until you distribute your traditional IRA in retirement or whether you pay taxes now on a Roth conversion, the tax result will remain the same in a stable tax environment.

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Your Other Sources of Retirement Income

Think about how the other sources of income earmarked for your retirement will be taxed. If most of your money will be taxable in retirement, such as distributions from your 401(k) or IRA, a portion of your Social Security benefit could be subject to taxes. For example, if your provisional income exceeds certain limits, you may have to pay income taxes on part of your Social Security benefit. Provisional income is defined as the sum of your adjusted gross income, your non-taxable interest income, and 50 percent of the Social Security benefits you collect annually. Higher taxable income in retirement may also mean you must pay higher premiums for your Medicare Part B and prescription drug coverage. Implementing a Roth conversion to your pre-retirement strategy could help reduce or even eliminate the impact of these possibilities once you hit retirement, since qualified distributions from Roth IRAs aren’t included in income. 

Flexibility at 70 ½ and Beyond

Unlike Traditional IRAs and 401(k)s and other employer sponsored plans, Roth IRAs don’t require lifetime distributions to begin at age 70 ½. If your income needs are met through other retirement vehicles, your Roth IRA can remain untouched, and hopefully growing, for many years. This makes the Roth IRA a great asset to leave to your heirs as they, too, may enjoy a tax-free income stream over many years, provided certain conditions are met.

Qualified Roth IRA distributions are never taxed—which means that as the balance of your account grows, the gains will not be taxed when you take them out. 

It Doesn’t Have to Be All or None

If you want to convert to a Roth IRA, you don’t have to convert everything at once, or ever. Converting smaller portions of your Traditional IRA over several years is an option if you’re looking to spread out the burden of paying taxes on the amounts you’re converting. You may want to consider converting later in the year, when you have a clearer picture of your tax liability for the year. 
There’s no right or wrong answer on whether to convert to a Roth IRA. Your current and future projections on tax rates, your ability to pay taxes now on the conversion, the tax structure of your other retirement savings, and even your legacy plans can all play a part in making the choice that’s right for you. If the benefits of a Roth IRA interest you, your tax advisor or insurance and financial professional can help you create a strategy that works with your retirement goals.

Not affiliated with the Social Security Administration or any other governmental agency. This article is designed to provide general information on the subjects covered and is not intended to provide specific legal or tax advice. 

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