Converting from a Traditional IRA to a Roth IRA has been allowed since 1997. However, until 2010, taxpayers with an Adjusted Gross Income (AGI) of $100,000 or more were not allowed to convert. Beginning in 2010, this income limitation is no longer in place. As a result, there have been many articles in the press over the past year discussing the option to convert. This is an attempt to summarize the core questions related to this decision.
What is a Roth IRA conversion? Simply it is transferring some or all of an existing Traditional IRA to a Roth IRA. When the conversion is made, you will owe Federal income taxes on the converted amount of the IRA.
Why would I want to convert and have a bigger tax bill? In certain situations a taxpayer will have enough time for compounded tax-free growth to overcome the immediate tax liability. Generally speaking, the longer you have before you eventually tap Roth IRA assets, the more beneficial conversion will be.
May I convert a portion of my IRA? Yes. You can convert as little or as much of your IRA as you’d like.
How is the tax liability calculated? The amount of your conversion is included in your taxable income, thus you will be taxed in your current marginal tax bracket.
When should I consider a Roth IRA conversion? Every situation is different, but a few considerations generally favor taking advantage of the strategy. They include:
- You have enough cash to cover the tax liability rather than take it from the converted amount.
- You expectat to remain in a high or move into a higher tax bracket in retirement.
- You have a large amount of retirement assets (IRA, 401(k)) such that most retirement income will be taxable.
- You are currently in a lower tax bracket than expected in the future (starting a business, were out of a job but now re-employed, etc).
This is not intended to be an exhaustive review, simply provide some highlights in the decision-making. Everyone’s situation is unique. Call us today to determine if this would be right for your financial plans.