A Roth Conversion is when funds are taken out of an IRA and converted into a Roth IRA. This conversion results in taxable income. Here are 4 Reasons to do a Roth Conversion:
1) You’ve Got the Cash From Another Source to Pay the Income Tax- When a Roth Conversion is done, the money coming out of the IRA is taxable. To make a Roth Conversion work, you really need to have cash from another source to pay the income taxes. This can be a stumbling point for many that are considering a conversion.
2) You’re Young- Young here of course is a relative term. Someone under the age of 30 should strongly consider a Roth Conversion. Generally speaking, they won’t have accumulated as much in a 401(k) plan or IRA and typically their tax bracket is more modest. It is much more difficult for someone in their 60’s to consider a conversion. They typically have more assets in their tax-deferred accounts and have a higher tax bracket. People in this situation may want to consider a partial conversion. Another alternative is to look at your employers’ retirement plan. While many employers offer a 401(k) plan, more are beginning to offer the Roth 401(k) plan option. If your employer offers this plan, see if it is appropriate in your circumstances.
3) You Think Tax Rates will be Higher in Retirement- We have all been educated to defer taxes into the future. This was usually done by using either a 401(k) plan an IRA or both. This allowed for tax-deferred investing. Don’t pay taxes currently; let the account grow tax-deferred and pay taxes only when there are distributions in the future. The assumption was that your tax bracket would be lower in retirement. This may or may not, be a valid assumption for some people now. The Federal and State Governments need revenue. So far, the Federal Government has held off on any income tax increases due to the challenging economy. The State of Connecticut however enacted its largest income tax increase in 2011. The highest income tax rate in Connecticut is now 6.7%.
4) You Don’t ‘Need’ the Money- Tread lightly here. The word ‘need’ is in quotes. For people with a significant net-worth, the Roth IRA becomes an excellent wealth transfer vehicle. One of the big advantages of the Roth IRA is that there are no Required Minimum Distributions (“RMD”) on the account owner or their surviving spouse. This allows the account to continue to grow over time. A non-spousal beneficiary, like a child, will however have the RMD requirement.
ACTION ITEM: People with IRA’s should look carefully at a Roth Conversion. Depending on your situation, it may make sense to do a conversion.
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