ROTH Conversion – A Reason at Any Age

ROTH conversion for any age

ROTH Conversions – The cool kid in class

ROTH conversion is a hot topic in the financial planning community.  It is the new cool kid in class—the one everyone wants to hang out with.  The kid wearing the light up BK’s (you know you wanted to own a pair so badly).

The main question is whether or not it makes sense to convert a traditional IRA to a ROTH IRA.  I will use this blog post to discuss when a ROTH conversion may make sense.

Before we dig into the details, it’s important to understand what will happen if you make a ROTH conversion.

  1. You choose to take a traditional IRA, and make it a ROTH IRA (aka, the conversion).
  2. You will be issued a 1099R at the end of the year that you need to claim on your tax return. The amount of conversion is taxable as ordinary income.
  3. You will need to pay any tax due from the conversion out of pocket. For example, if a $100,000 conversion creates an additional tax due of $25,000, you need to find $25,000 of personal assets to pay the taxes.
    • You might find yourself saying—“um….why would I want to pay more taxes to do this conversion?” AKA what “N” asked immediately after reading steps 1-3. Answer: you pay the taxes now, but you never pay them again.
  4. The investment growth in the ROTH IRA will be tax deferred, just like it is in your IRA. Assuming qualified withdrawals from the ROTH IRA, all future distributions will be tax-free.

Here are a few times when you might find yourself saying yes to a conversion:

ROTH Conversion as an Investment Strategy

This strategy rings true if you don’t need the money right away.  The longer your investment time horizon, the longer the investment has to grow, and the more you can accumulate tax-free.

Leaving your money to just “be” gives you time to make up the upfront taxes you paid on the conversion.  Let me ask you this, would you rather have $1,000,000 that is taxable…. or $1,000,000 tax-free?

So if you have time to invest (I am looking at your Gen-Xer’s & Gen-Yer’s), it may make sense to pay income tax now and leverage years of market performance.

ROTH Conversion as a Tax Strategy

Understanding your tax return can present great ROTH conversion opportunities.

Is there a year when your income is to be significantly lower than previous years?  Maybe you have been out of work, or have a special tax deduction from a charitable contribution or net operating loss.  During this year, your tax bracket might lower than normal.  If that is the case, it may make sense to convert.

On the other hand, you may be headed for a higher tax bracket next year.  Are you expecting a big raise?  Are you losing itemized deductions because you paid off the mortgage this year?  Are your kids grown and no longer dependents?   All these things could lead to a higher tax bracket.  A higher tax bracket leads to a ROTH conversion that is more expensive.  You should consider converting now while you haven’t hit that higher bracket.

ROTH Conversion as an Estate Strategy

Some retirees have more money in their IRA than they will ever need.  A strategy often implemented defers paying taxes on this money as long as possible, typically until age 70.5 when the IRS mandates distributions (yes, the IRS eventually requires you start taking money from your IRA).

While deferring taxes as long as possible may be a good strategy, you might consider taking distribution before 70.5 as a ROTH conversion.  Here is why:

  • Your required minimum distributions (RMD’s) may push you into a higher tax bracket at age 70.5. If you are going to be in a high tax bracket anyways when you take the money out of the IRA, does it make sense to take distributions early as a ROTH conversion?
  • By making a ROTH conversion early, you are likely lowering your total required minimum distribution.
  • If you have more money than you need, a ROTH IRA may be one the best thing for your children (beneficiaries) to inherit. Not only is it tax-free inheritance, it continues to grow tax deferred.



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2 Responses to ROTH Conversion – A Reason at Any Age

  1. Betty November 28, 2014 at 7:00 am #

    Good morning, Daniel. I hope you enjoyed your Thanksgiving….
    Can you expand a tad on Item #4 ‘The investment growth in the ROTH IRA will be tax deferred….’ Thank you !

    • Daniel Zajac, CFP®, AIF®, CLU® November 29, 2014 at 9:42 am #

      Hi Betty
      Tax deferral means you do not pay tax growth in the account until a later date (it is a feature of both ROTH and traditional IRA’s). The taxes you would have owned are “deferred.”

      For example, lets assume you buy one share of stock for $100. If that stocks grows to $150 and you sell it, you have a gain of $50. If this money is not in an IRA, you will be required to claim $50 as a capital gain on your tax return (you will receive a tax notice at the end of the year).

      If the same stock is held in an IRA, the $50 gain would not be taxable in the year of the stock sale. The gain would be deferred, and taxes would be paid later (potentially never if in a ROTH).

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