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Is a Roth IRA conversion right for you?

Cash Flow and Retirement

Deciding between a Roth IRA and a traditional IRA generally depends on whether someone is better off paying taxes now (Roth) or later (traditional). This article lists factors that suggest someone might want to convert a traditional IRA to a Roth IRA, including current income temporarily falling into a lower tax bracket.

Have you considered converting your traditional IRA into a Roth IRA? This strategy may offer several benefits, and it’s available regardless of income level. However, a Roth IRA conversion isn’t a no-brainer. Whether you’d be better off with a Roth IRA or a traditional IRA depends on your circumstances.

Tax now or tax later

Traditional IRA contributions can be deductible, but withdrawals of contributions and earnings are then taxable. Conversely, Roth IRA contributions are nondeductible, but qualified withdrawals of contributions and earnings are tax-free. As a general rule, deciding between the two depends on whether you’re better off paying taxes now (Roth) or later (traditional).

When you convert a traditional IRA into a Roth IRA, you’re immediately subject to income tax on the amount you convert that’s attributable to deductible contributions and earnings. In other words, doing a conversion means paying tax now rather than later.

When it makes sense

A conversion might be the right choice if:

  • You expect your taxes to be higher when you withdraw funds from the IRA in retirement because, for example, you believe your income will go up or Congress will increase tax rates.
  • Your income in the current year has fallen into a lower tax bracket, providing an opportunity to do a Roth conversion at a lower tax rate.
  • You have a tax situation — such as a large net operating loss or charitable deduction — that would offset taxable income created by a conversion.
  • Asset values in your IRA are depressed — perhaps due to market volatility — reducing the tax cost of a current conversion.

Tax rates aside, there may be other reasons to pursue a Roth IRA conversion. For example, Roth IRAs aren’t currently subject to required minimum distributions (RMDs). So a conversion would give you the flexibility to allow funds to continue growing tax-free indefinitely. And from an estate planning perspective, a conversion would allow you to pay the tax now, preserving the entire account balance for your beneficiaries.

Role of QCDs

On the other hand, a traditional IRA may be preferable if you plan to make significant charitable donations. Starting at age 70½, you can make qualified charitable distributions (QCDs) of up to $100,000 per year from a traditional IRA. QCDs can be applied toward your RMDs and they’re excluded from your gross income. So they may be more valuable than ordinary charitable income tax deductions.

Ultimately, the choice will hinge on your specific circumstances. Talk to your financial advisor.