By Thomas Rindahl, CFP
I am frequently asked about whether it is a good idea to convert your traditional IRA into a Roth IRA. My standard answer is “it depends”.
Let’s look at the basics of each.
The traditional IRA is going to be what most of us will have, either by setting one up to make normal annual contributions to or because we wanted to move retirement funds out of and away from a former employer’s group plan. The account is funded with pre-tax dollars and gains remain tax deferred until you start making distributions. The IRS then requires you to make distributions starting at age 72. Any distributions made before age 59 ½ may be subject to an additional 10% penalty.
The Roth IRA is a similar vehicle, although it is funded with after-tax contributions and the funds grow tax free as long as your account is open for 5 years. There is no age at which you are required to make distributions, but you still may be subject to the 10% penalty on any gains you withdraw before age 59 ½.
Here are some of the reasons you may want to convert your traditional IRA into a Roth IRA:
- Since you are paying the taxes up front, you then will have tax-free distributions in retirement.
- No RMD (required minimum distribution) at age 72. If you don’t need the money for your lifestyle because of other income sources (Social Security, pension, rental income, dividend income, etc.), then why not just let the funds continue to grow tax-free?
- Who is inheriting the money? Spouses can inherit a traditional IRAs without tax consequence until the surviving spouse starts taking distributions. Everyone else will be forced to make taxable distributions on an inherited IRA in order to liquidate it in no more than 10 years. On the other hand, anyone can inherit a Roth IRA tax-free.
- What’s your tax bracket? You may be in a lower tax bracket right now due to any number of reasons (deductions, working part time as you shift into full time retirement, disability, etc.) and you think taxes will be going up in the future. Converting now at a lower tax rate may make sense.
- Market volatility. This one is not generally thought of, but whenever there is a fairly decent pullback in the market (assuming you have cash on the sidelines to pay the taxes), your account can be converted with less of a tax liability.
The Roth IRA conversion is a wonderful tool for investors, but it may not be right for everyone. Make sure to consult your tax advisor if you are considering it.
About the author: Thomas Rindahl
Thomas Rindahl, PhD, MBA, CLU®, ChFC®, CFP®, LUTCF, BFATM, is a financial advisor in Tempe, AZ. Through comprehensive and holistic financial planning, he has helped his clients to navigate the twists and turns of life for over 20 years.
Securities offered through Securities America, Inc., Member FINRA/SIPC. Advisory services offered through PFG Advisors. TruWest Wealth Management Services, TruWest® Credit Union, Securities America, and PFG Advisors are separate entities. Securities, insurance, and advisory offered through Securities America, PFG Advisors or their affiliates are: Not NCUA insured. No credit union guarantee. Not credit union deposits or obligations. May lose value.