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To convert, or not to convert to Roth IRA - tax is the question


When planning for retirement, it has long been known that taxation is one of many associated mazes.

Just like the labyrinth of legend, tax law is constantly changing with time and often seems purpose-built to instill confusion. With uncertainty on the horizon and potential rate increases looming, the question on many recent and future retirees’ minds is whether to pay taxes now or pay them later.

The concept of a Roth IRA is nothing new. You pay taxes on income at the time of earning to avoid taxation upon withdrawal. For many, this is a decision that was made early on in their careers and has slowly become more impactful as savings continue to grow.

For those who made the decision to put their retirement savings into a Roth IRA from the start, there isn’t too much to consider. Their taxes are paid, and the account balance they see upon withdrawal is what they get, plain and simple. But what about those who elected not to use a Roth IRA for some or all of their retirement savings? Should they consider conversion?

Should you convert to a Roth IRA?

If you chose not to pay income tax as you earn and are waiting until retirement, you might not have considered changing your mind. For many, this makes sense. Targeting a percentage of your pre-retirement income to live on throughout retirement is a very common strategy, after all. If your retirement income is less than your income while earning, you can pay a lower tax rate. However, that relies on the tax rate of your retirement income remaining lower than the rate you would pay as you’re earning. And as any shrewd investor knows, nobody can predict the future.

That’s not to say that there are no factors that are well within your control that are useful in making this decision. In fact, most Roth IRA conversions are the result of changes to one’s personal financial situation, not a reaction to a potential change in the overall financial landscape.

Some of the reasons you might choose to convert to a Roth IRA are:

  • You expect your tax bracket to stay the same or go up in retirement – Paying taxes up front when you expect they will be the same or higher when you withdraw can both save money in the long term and provide a clearer picture of your balances upon retirement.
  • You want to avoid being required to take minimum distributions (RMD) – A Roth IRA conversion will eliminate the RMDs associated with a Traditional IRA.
  • You want to transfer unused tax-free funds to the beneficiaries of your estate – A Roth IRA conversion can be a great estate planning tool if you intend to leave portions of your retirement savings to your beneficiaries since the funds will not be taxed upon distribution.
  • You want to make your retirement savings more diverse – Having a tax-diverse retirement plan can help to add flexibility to your expense management and allow for more predictable income and cash flow.
  • You have the means to pay conversion tax without dipping into the savings themselves – Having the ability to pay taxes now on your retirement savings without needing to rely on the savings themselves for that expense can add security and help reduce uncertainty regarding how much tax you may pay later.

Similarly, there are also reasons to avoid a Roth IRA conversion. It might not be your best option if:

  • You need to access the converted funds within five years – When converting to a Roth IRA, there is a five-year waiting period before you can begin to distribute funds without owing an additional 10% tax penalty.
  • You would be significantly burdened by the conversion taxes – Just because you’ll need to pay taxes on your retirement income eventually doesn’t mean that now is the best time for you to do it, especially if doing so means depleting other assets that would otherwise serve as a source of income or appreciation.
  • You are not completely sure about the decision – One of the most important things to consider when contemplating a Roth IRA conversion is that it cannot be undone, so it is crucial to work with your trusted financial advisor and weigh the pros and cons for your own personal situation.

What we know about the unknown

Recently, there has been a spike in interest among retirees regarding Roth IRA conversion resulting from rumors, reports, promises and other speculation about the future of taxation on retirement wealth. The reality of the situation is that only you and your financial advisor can determine the right path for your retirement. Make sure that if you do decide on a Roth IRA conversion, it’s for the right reasons. Changes in the system are only one factor in your financial situation, your retirement and your choices.

Next steps

  • Get together with your financial advisor and discuss whether a Roth IRA conversion is right for you
  • Do some research and gain insight into the future of taxation so you can best decide for yourself if you need to make changes to your retirement plan
  • Don’t make any hasty decisions that will affect your retirement and remember that any changes to taxation will take time, which you can use to make a solid and stable plan
  • Consider the implications a Roth IRA conversion could have on your estate, especially if you intend to leave a significant portion of your retirement savings behind to your beneficiaries

Raymond James and its advisors do not offer tax advice. You should discuss any tax matters with the appropriate professional.

Unless certain criteria are met, Roth IRA owners must be 59 ½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.

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