A Roth conversion occurs when you move all or part of your money in an existing Traditional IRA to a Roth IRA. Anyone can convert their eligible IRA assets to a Roth IRA, regardless of income or marital status. Despite the benefits of Roth conversions, though, it might not be the best idea in every situation. The benefits of converting to a Roth IRA need to be balanced against a variety of considerations, like the taxes that must be paid and the amount of time between when the conversion is made and when the assets are expected to be used.

Benefits of Roth Conversions

Tax-free withdrawals – when you withdraw money from your Traditional IRA, you must pay taxes on any contributions you originally deducted from your taxes plus any of the earnings. For most people, that requires paying taxes on all withdrawals. With a Roth IRA, as long as you meet certain requirements (for example, you are older than 59 ½ or you become disabled), all of your withdrawals are tax-free.

No required minimum distributions – since there are no required minimum distributions (RMDs) from a Roth IRA, you are free to leave your money in the account indefinitely and enjoy the tax-free earnings. With a Traditional IRA, you must take RMDs each year after turning 70 ½ years old, whether or not you need the money.

Tax-free inheritance – Beneficiaries of a Roth IRA receive money tax-free as long as the account has been open at least five years.

Factors to Consider

Do you need the money quickly? – There may be a 5-year holding requirement on withdrawals of money that were part of a Roth conversion. If you need access to the money before the 5-year holding period is up, you may not want to do a Roth conversion.

What about your tax bracket? – If you believe you will be in a higher tax bracket when you retire and start withdrawing money from your Traditional IRA, a conversion may be advantageous to you because you pay taxes at your current lower tax bracket on the conversion amount, and then enjoy tax-free withdrawals later. But if you believe you will be in a lower tax bracket when you retire and start withdrawals from your Traditional IRA, it may make sense to keep the money in your Traditional IRA and pay the taxes later as you withdraw your money.

Do you have enough money to pay the taxes? – When you convert money from a Traditional IRA to a Roth IRA, you need to pay taxes on the contributions to your Traditional IRA that were deductible in previous years. Depending on the amount of your conversion and your tax bracket, this could be a substantial amount of money. So before making the conversion, you will want to identify how much the tax will be and where you will get the extra money. If you take a distribution from your IRA to pay the tax bill and you are less than 59 ½ years old, you may also be subject to a 10% early withdrawal penalty.

Roth conversions are a good choice for certain circumstances. Be sure to consult your tax advisor and your CERTIFIED FINANCIAL PLANNER™ Practitioner, who can help you make the right decision for your particular situation.

Andrea L. Blackwelder, CFP®, ChFC, CDFA® and Joseph D. Clemens, CFP®, EA are the founders and partners of Wisdom Wealth Strategies. Their shared passion is simple: to bring financial empowerment, understanding, and peace-of mind to people who wish to improve their financial future, build wealth for their families, and achieve financial independence. Click here to find out more about how you can work with the Denver Financial Advisors at Wisdom Wealth Strategies.