Ask the Expert: Why Should I Convert an IRA to a Roth IRA?

QUESTION: Why should I convert my traditional IRA to a Roth IRA? What are the benefits?

ANSWER: Depending on your personal situation, there are many reasons why a conversion from a Traditional IRA to a Roth IRA may be a good idea. The primary benefit is that Roth IRA dollars and all the growth attached to the investment will be distributed in retirement tax free.

Conversion to a Roth IRA may be beneficial:

• If you currently find yourself in a lower tax bracket, but you anticipate that you will one day be in a higher tax bracket. This means that you would pay taxes now, while you are in a lower bracket, opposed to later when they may be higher.
• In a tax year where you have other (non-IRA) losses and deductions. A conversion can offset the additional taxable income.
• For individuals who may not have qualified previously (due to income limitations) but would now like to take advantage of the benefits.

Additional benefits include:

• No required minimum distribution at the age of 70 and ½.
• No impact on taxable retirement income (as distributions are tax-free).
• Roth IRA assets are passed along tax-free to your beneficiaries (post-death).

This option has been very popular in recent years because of the depressed economy. When IRA values are down, people can choose to pay taxes on the smaller balance and convert to Roth IRA. As market values grow in the account, the assets will be distributed tax-free from the Roth IRA.

Some items to be aware of:

1. Make sure you can afford to pay the additional income taxes that this will trigger. This will increase your adjusted gross income and can potentially place you in a higher tax bracket for the year of the conversion.
2. It is not advisable to use IRA dollars to pay the taxes on the conversion, as this will be penalized and you’ll have additional tax if you’re not 59 and ½. Any amount not converted is considered a distribution to you. (Yes, even if you’re paying it directly to Uncle Sam.)
3. You should not consider this option if you plan or need to use the funds in less than 5 years from the establishment of your Roth IRA.
4. Additionally, a Roth IRA may not be the best idea if you plan on being in a much lower tax bracket during retirement and paying your living expenses from your IRA funds (that is, not passing assets to beneficiaries).
5. A Roth conversion is also less attractive than a Traditional IRA if you plan on donating your IRA dollars to a charitable organization.

However, whether you choose a Traditional IRA or a Roth IRA, the most important thing is that you’re saving for retirement one way or another! We all need to be setting aside money for our future-selves to enjoy in retirement. Regardless if you take the tax benefits today (Traditional IRA deductions) or during retirement (Roth IRA distributions), use these tax benefits to your advantage to prepare for your future. For difficult decisions, always consult a trusted financial advisor for guidance.