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Retirement

Time to consider a Roth IRA conversion?

Robert Powell, Special for USA TODAY
For some people, now's the time to think about converting a traditional IRA into a Roth.

As the year winds down, year-end to-do lists ramp up. And chief among the items on financial lists of this sort is this: whether to convert all or a portion of your traditional IRA to a Roth IRA.

Doing so can give you the sort of "account diversification" that you'll need in retirement when you're trying to figure out ways to increase your after-tax income, experts say.

Without a Roth IRA, much of your income in retirement will likely be taxed as ordinary income if you're withdrawing money from a traditional IRA. Plus, you'll have to pay taxes on interest income, capital gains and dividends if you're withdrawing money from taxable accounts. And that doesn't give you much flexibility if you're trying to manage your income tax bracket.

With a Roth IRA, however, you'll be able to add an arrow to your quiver: You'll be able to withdraw money from accounts in ways that help you avoid having your next dollar of income taxed at a higher marginal rate. Income from a Roth IRA is not taxed. Also, Roth IRA account holders aren't required to take minimum distributions like those with traditional IRAs.

So what should you consider when contemplating a Roth IRA conversion? Here's what experts had to say.

The basic idea. You have a traditional IRA. You withdraw all or some of the money in the IRA. You pay the tax owed on the distribution with, best case, money that you had set aside for such financial tactics. And then you deposit the money into a Roth IRA.

By the way, if you have deductible and non-deductible IRAs, be sure to chat with your CPA about the tax implications of withdrawing pretax and after-tax money from an IRA before doing a Roth IRA conversion. There are all sorts of hoops you have to jump through if you have both types of traditional IRAs.

When you presto change-o a traditional IRA to a Roth, it costs you upfront, but could pay off down the road.

Talk first. Before you walk the walk, talk to a financial or tax professional who can perform a suitability assessment. "The primary purpose of such an assessment is to determine whether a Roth conversion would result in the individual paying a lower amount of income tax than ... had the conversion not been done," says Denise Appleby, the CEO of Appleby Retirement Consulting in Grayson, Ga. "Bear in mind that such an analysis makes certain assumptions, including projected future income and future income tax rate. While there is no guarantee that the analysis will provide accurate results, it allows the individual to make an educated decision."

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Is your income lower? If you happen to be in a lower income tax bracket this year than in years past now would be a good time to do a Roth IRA conversion, says Jean-Luc Bourdon, certified public accountant and principal at BrightPath Wealth Planning, in Santa Barbara, Calif.

"Everything else being equal, one would benefit from a Roth conversion if the tax rate paid on the conversion is lower than the expected tax rate when the funds are withdrawn from the retirement account," he says. "So, a temporary tax rate decrease may create an opportunity."

Jean-Luc Bourdon, certified public accountant and principal at BrightPath Wealth Planning

For example, a period of unemployment, a business loss, huge medical expenses, even an electric car tax credit could be an opportunity.

Also, if you're currently in a low income tax bracket due to retirement, and especially if you are delaying Social Security, consider a Roth IRA conversion, says John Kilroy, a certified public accountant with an accounting practice in the Philadelphia area.

A Roth IRA conversion would not, however, be suitable for someone in peak earning years and tax bracket, says Bourdon.

Best case, you'd work with a qualified professional who can help you determine how much of your traditional IRA to convert without being bumped up into the next highest bracket.

Net operating loss. Taxpayers with net operating losses should definitely convert, says Appleby. "For these individuals taxable income generated from a Roth conversion can be offset by the net operating loss," she says.

Do you have after-tax money in employer-sponsored retirement plans? According to Appleby, if you have after-tax money in your 401(k), a conversion of those after-tax amounts would be tax-free.

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Do you expect to be in a higher tax bracket later? If you anticipate seeing your income rising in future years, perhaps because you have to take required minimum distributions from your traditional IRA, a Roth IRA conversion this year might make sense as well, says Kilroy.

Others agree. "We see a fair number of clients who retire before 70 who can benefit by paying tax at lower brackets instead of waiting to tap the IRA at 70 in higher brackets," says Sue Stevens, the founder of Stevens Wealth Management in Deerfield, Ill.

Are your investments down? With the market being mostly down this year it makes sense to look at beaten-down positions in IRAs that should still be held long-term, says Bourdon. "Those might be candidates for a Roth conversion," he says, noting that the tax would be paid on the sale, not on the purchase price.

Can you do without the money? Consider, says Kilroy, a Roth IRA conversion if you don't need much if any income from your traditional IRA to fund your retirement expenses and you have a "legacy goal," a desire to leave money to loved ones. Unlike traditional IRAs, you don't have to take a required minimum distribution from a Roth IRA. However, owners of inherited Roth IRAs do have to take required distributions.

Denise Appleby, the CEO of Appleby Retirement Consulting.

When not to convert. Not surprisingly, there are times when it doesn't make sense to do Roth IRA conversion. "While a Roth IRA might seem like the best of all the tax-deferred retirement accounts, a Roth conversion is not for everyone," says Appleby.

Kilroy, for instance, suggests not doing a Roth IRA conversion if you don't have the resources outside of the retirement account to pay the tax on the conversion. Appleby agrees: Individuals who cannot afford to pay any income tax due might want to wait until they can."

Other reasons not to convert, according to Kilroy:

  • You anticipate being in a much lower marginal tax bracket once your required minimum distributions begin.
  • You intend to leave your traditional IRA account to charity.
  • You intend to move from a state with high state taxes to one with much lower or no state income taxes when your required minimum distributions begin.

Also consider. "Only eligible amounts can be converted, says Appleby. "If an amount is not eligible to be rolled over, that amount is not eligible to be converted to a Roth IRA," she says. "An example of amounts that are not eligible to be converted to a Roth IRA is a required minimum distribution (RMD). If an individual is required to take an RMD for the year, that amount must be taken before the conversion."

Plus, a Roth conversion is not an all-or-nothing option, says Appleby. "An individual can choose to convert a portion of a non-Roth retirement account balance," she says.

Robert Powell is editor of Retirement Weekly, contributes regularly to USA TODAY, The Wall Street Journal and MarketWatch. Got questions about money? Email Bob at rpowell@allthingsretirement.com.

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