Roth Conversions (03/07/2018)

Now might be your golden opportunity to convert your traditional IRA to a Roth IRA. The Tax Cut and Jobs Act that was signed into law in December lowered the top individual income tax rate to 37% from 39.6% and reduced many other rates as well. That means if you convert your traditional IRA to a Roth and agree to pay taxes on those funds now, you will be paying at a lower rate than in the past.

Let’s review how traditional and Roth IRAs differ. In a traditional IRA, contributions you make are tax-deductible, so you don’t pay taxes up front. When it comes time to withdraw funds from your traditional IRA, the money that you withdraw will be taxed as ordinary income. In a Roth IRA, you get the reverse treatment. Contributions into these accounts are made with money you’ve already paid income taxes on. At retirement, if the account has been open a minimum of five years, funds and earnings can be withdrawn tax-free.

You need to fall under certain income limits to contribute money into a Roth. For example, a married couple filing jointly with modified adjusted gross income of $199,000 or more is restricted from contributing in 2018.  However, people of all incomes can open a Roth and transfer (convert) their traditional IRA balances into it.

Why would you convert? The Roth may be a better option if you are relatively young and you believe you’ll be in a higher tax bracket later in life. Another reason would be to create a future tax-free income stream in retirement to coordinate with your taxable 401(k) so that you are not paying tax on all distributions.

Some groups of savers wouldn’t benefit from a Roth conversion. People who don’t have sufficient funds outside of the traditional IRA to pay the tax bill of converting should not make this move. Using IRA funds would generate more taxable income and a higher tax. If you are under 59 1/2, you would also incur a penalty. For funds in taxable accounts, you want to be aware of short-term and long-term gains before liquidating to pay for a conversion.  If you need the money that you will be converting to a Roth in less than five years, you would lose certain tax benefits of converting.

It may make sense to wait until later in the year to decide if converting your traditional IRA will work for you. You will have a clearer picture of your income and tax situation. You may find setting a five-year plan to convert will work best for you.  Like most financial planning, your decision depends on your circumstances, goals and objectives.

Lisa Dugan

March 7, 2018