When to Convert Your Traditional IRA to a Roth

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Roth individual retirement accounts are one way to reduce taxes in retirement. Debuting in 1997, these IRAs allow workers to pay taxes on their contributions now and then let money in the account grow tax-free.

Here’s an example: A 30-year-old man investing $5,000 in an IRA now would have $73,927 in his account at age 65. (That assumes he deposits nothing more and receives an 8 percent annual rate of return on the investment.) He would get a $5,000 deduction at the time of his contribution but could end up later paying taxes on the $73,927 account balance. Under this scenario, with a Roth IRA, the man would pay taxes on only the $5,000 contribution and nothing on required minimum distributions he takes in retirement.

It’s no wonder Roth IRAs have become such a popular savings option. However, it’s an option that may not have been around when you opened your IRA. Fortunately, you can convert your traditional IRA to a Roth, which financial experts say can be a smart money move at any age.

“The main thing you have to be aware of is that you’ll pay income tax on the amount you convert,” says Keith Klein, a certified financial planner and owner of Turning Pointe Wealth Management in Phoenix.

However, converting at the right time can help minimize those taxes. U.S. News spoke with financial professionals who explained the three times you should make a conversion.

1. When You Expect Your Income and Tax Rate to Go Up

While some may dispute whether taxes are ever truly low, Klein says current rates are relatively modest from a historical standpoint. That alone may be reason enough to convert now rather than risk rates increasing in the coming years.

However, more important than tax rates is whether a worker expects to earn more in the future. That’s why Roth IRAs are an obvious choice for younger workers who are early in their career and can reasonably expect their income and tax bracket to go up as the years go by.

2. When You Are in a Low-Income Period

Since converting an IRA can result in taxes, some people may hesitate to do so during a period when they aren’t making much money and have limited discretionary funds. However, low-income periods can be a good time to convert to a Roth IRA.

“If you don’t have any [other] taxable income, [consider] converting an amount lower than your standard deduction and exemptions,” says Steven Elwell, vice president of financial planning firm Schroeder, Braxton & Vogt in Amherst, New York. Following this strategy should eliminate the need to pay taxes on the converted amount.

This can work well because there is no minimum dollar amount for an IRA conversion, and you can choose to convert a small portion of your account every year. Individuals on disability, enrolled in school or going through a period of unemployment may be in a prime position for a conversion.

“Another scenario that’s fantastic for slowly converting an IRA is when someone retires early before collecting Social Security,” Elwell says, noting his firm is working with one couple hoping to avoid any taxes on their IRA by using this strategy.

3. When You Are Doing Estate Planning

Even if you’re well into retirement, a conversion to a Roth IRA may make sense. Lockwood’s firm has an 84-year-old client who is in the enviable position of not needing all his IRA money. Rather than passing on a traditional IRA, he is looking into converting it now as a gift to his children. Since his income is less than that of his children, the Roth conversation will be taxed at a lower rate than what his heirs would pay if they decided to convert the account later.

“If you have a large enough estate,” Elwell says, “by converting from an IRA to a Roth IRA, you can reduce estate taxes too.” Depending on an individual’s tax bracket, income tax on the converted amount may be less than the estate tax for that amount. For those with estates just over the federal exemption level, paying income taxes for a conversion could also bring its value low enough to avoid the estate tax completely.

Regardless of whether you’re converting an IRA to save money for yourself or heirs, financial planners say you need to watch out for any unintended consequences. “One of the dangers of converting is that taking on that extra [income] can push you into a higher tax bracket,” Klein says. Not only could that income result in more taxes, it could affect eligibility for certain benefits, tax deductions or credits. To avoid any unforeseen complications, consult with a financial professional.

For midcareer and older workers, the decision may not be so clear-cut. Doug Lockwood, a certified financial planner and partner at Hefty Wealth Partners in Auburn, Indiana, says individuals should keep an eye on their time horizon when it comes to converting their IRA. He suggests working with a financial adviser to determine whether it makes sense to convert now or wait and pay taxes later.

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