Perfect Timing: Convert Your IRA to a Roth Right Away?

Most people don’t spend a lot of time thinking about their IRAs. It’s one of those investments people tend to set and forget. Except for an occasional check-in once a year, IRAs are placed on the Do Not Disturb list, left to idle along until retirement draws closer.

However, now could be a perfect time to consider manipulating your IRA investments for future gains, making a big difference to your retirement lifestyle. If you have a traditional IRA, consider the logic behind this lucrative and timely strategy.

As you know, a Roth IRA provides the holder tax-free growth until retirement, and then the withdrawals are tax-free in retirement. When you convert your traditional IRA into a Roth, your IRA account could benefit from accelerated growth without taxation until you are required to take tax-free distributions later in life.

4 Reasons

Here are four reasons why this could be the perfect time to convert your traditional IRA into a Roth IRA:

1. Tax rates are historically low. The recent Tax Cuts and Jobs Act resulted in the lowest tax rates in recent memory, and these tax rates are not likely to continue. Most Americans are anticipating an increase in income tax rates because of the burgeoning size of the government deficit. When these low tax rates disappear, owners of traditional IRAs will probably be facing a higher tax rate on both the principle and growth of their IRA when taking required withdrawals. Why pay higher taxes in the future at a time when you really want to conserve your wealth?

2. The markets have recently fallen substantially. The value of IRAs are presently lower than before, and investors are anticipating an eventual end to this bear market. By converting your traditional IRA into a Roth IRA, the tax you’ll pay now is less than when your account value was higher, and you are also positioning your account for untaxed growth when the recovery occurs.

3. If you own an inherited IRA, tax law requires full distribution within 10 years. New tax laws no longer allow stretch IRAs and this means that heirs are required to pay higher taxes over a shorter period of time. By converting your inherited IRAs to Roth, you will not have to pay those higher taxes.

4. Traditional IRAs must make required minimum distributions, but Roth IRAs are not. This additional time bonus means Roth IRAs can increase substantially over time compared with traditional IRAs which are subject to distribution.

Good Choice for You?

Taxpayers have been allowed to convert an unlimited amount of traditional IRA funds to a Roth IRA since 2010, but the tax you’ll have to pay on a conversion will be different depending on your particular circumstances.

If you are anticipating negative taxable income this year, doing a Roth conversion makes sense because the conversion will probably not generate tax, depending, of course, on the size of your conversion amount.

If you are in a low tax bracket, you should consider converting the amount of funds that takes the most advantage of the lower bracket.

However, if you are in a higher tax bracket, your decision must be weighed carefully given the opportunity for tax-free growth later versus the cost of paying taxes now at the time of conversion.

Pros and Cons

Here are some general guidelines to consider:

If you’re thinking about converting to a Roth IRA, you’ll need to consider how you’ll pay the taxes on the conversion. It’s best if you have outside funds you can use so you don’t have to use IRA funds, which would make this conversion more costly. Also, if you think marginal rates will decrease even further in the future, you might want to take a chance and delay the conversion.

Another consideration is whether or not you’ll be needing your IRA to augment your cash flow during retirement. The current tax on the Roth conversion may not sufficiently offset the tax you’ll be avoiding on future growth. Of course, if your family will be inheriting your IRA, then converting to a Roth now will be very helpful for them, but if you plan to will your account to a tax-exempt organization, there is no point paying taxes on the conversion now because the tax-exempt organization won’t be affected when they receive your funds.

A Final Thought

Taking advantage of the current economic situation by converting your traditional IRA to a Roth IRA could be in your best financial interests. Carefully consider the value of having a Roth IRA account grow tax-free, and then, as an added benefit, also provide tax-free income during retirement. If the cost of the taxes you’ll pay now are less than the benefits you’ll receive in the future, this might be a money-saving and wealth building opportunity that provides more resources for you later, which is exactly when you originally planned to make use of your IRA funds.

If you’d like to know more about making a Roth IRA conversion, call us for a conversation so we can assess your unique situation and discuss your options together.