Should You Convert Your Traditional IRA to a Roth IRA?
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Do You Qualify? Check to make sure your modified adjusted gross income is not too high. The limit for conversion is $100,000 for both joint and single filers.
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Can You Afford to Pay the Taxes on the Conversion?
When you convert your regular IRA to a Roth, you will have to pay tax on any earnings and pretax contributions. You do not want to use money from your IRA to pay the tax. If you do so before age 59 1/2, you will generally owe a 10% penalty on the amount you convert. Plus you'll permanently give up the opportunity for tax-free Roth IRA compounding of that amount.
Each dollar you roll over from a regular IRA is considered a "blended" dollar. This means that a percentage of the amount rolled over into the Roth account will be taxed according to the ratio of taxable funds to total funds in your IRA. You cannot choose to convert only non-taxable funds.
The best way to see how much the conversion will cost you in taxes is to prepare a tax return both ways – with the conversion and without the conversion. The conversion may cost you more than you initially anticipated, since it might move you into a higher tax bracket and disqualify you for credits such as the child credit and college tuition credit. It may also decrease certain itemized deductions, such as medical and employee business expenses. -
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How Old are You? In general, the older you are, the less you will benefit from a Roth conversion. The reason is that if you are older, you will have less time to earn tax-free dollars to make up for what you lost in taxes on the conversion.
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Do You Need to Use the Funds in Your IRA? If you don’t expect to need the money in your IRA, a conversion can make sense even if you’re older. Unlike regular IRA’s, Roth IRA’s require no minimum withdrawals during the life of the IRA owner, so you’ll be able to leave the whole amount untouched, if you want to.
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Do you expect your annual income to decrease substantially in the near future, when you retire, either completely or partially? If so, then it probably will not be a good idea to convert. When you pay tax on the conversion, it will be at your current higher rate. Your would be better off leaving the money in the IRA and pay taxes at your lower rate in retirement. You might want to consider moving small annual amounts from the regular IRA to a Roth IRA over a period of several years after your income goes down.
It can be difficult to answer the question of whether or not to convert a regular IRA to a Roth IRA without actually “running some numbers.” You can click on the following link to go to a Roth IRA Conversation Calculator that will help you make the right decision.