Q&A: What's best way to convert big IRA fund into a Roth?

Correction: An earlier version of this story incorrectly described how a Roth IRA conversion is treated as it relates to the 3.8% Medicare surtax.

Q: I am a 67-year-old, retired female with about $600,000 in traditional IRAs invested in the stock market. I currently receive spousal Social Security at about $1,000 per month. This will go up to about $3,000 when I’m 70 years old. I understand that I need to withdraw required minimum distributions from my IRAs beginning at age 70½. What is your opinion about converting my traditional IRAs into Roth IRAs?

– Sun B.

A: While converting to a Roth IRA is often times a good idea – withdrawals are tax-free and there are no estate tax consequences – there are a few things that have to be addressed to see if it is right for you, says Jeffrey Cutter, president of Cutter Financial Group.

First, are tax consequences. “We have a progressive tax system,” says Cutter. “If you convert all of the money in your traditional IRAs at once it will force you into the 39.6% ordinary income tax bracket.” Remember, money being converted is considered a distribution and taxed at ordinary income rates.

One bit of good news: Taxable distributions from any retirement accounts, including 401(k)s, 403(b)s, 457(b) plans, profit-sharing plans, IRAs, and Roth IRAs, as well as Roth conversions, will not be treated as “investment income” for the purposes of the 3.8% Medicare surtax.

Still, were you to convert the $600,000 in your traditional IRA into a Roth IRA all at once, you’d have to pay Uncle Sam about $200,000 in taxes, which represents one-third of the overall assets based upon the single taxpayer table.

“This would not be the optimum solution,” says Cutter.

If you still want to do a Roth conversion, consider staggering the conversion over, say, 10 years. “Each year, convert one-tenth of the assets until fully converted. “This will significantly reduce the overall tax liability to about half of what it would be for a single conversion,” says Cutter.

Another suggestion: Make sure you have the amount of tax due each year saved outside the IRA. “You would not want to pay taxes out of the IRA,” says Cutter.

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Another thing to consider is age. “Normally, the younger you are the better opportunity for a Roth conversion because you have more time on your side to recapture what you lost in tax payment,” says Cutter.

One last thing to mention is this. Talk to a financial planner about your goals and whether a Roth IRA will help you meet those goals. There might be other ways to accomplish your goals without having to convert all the money in your traditional IRA into a Roth. For instance, maybe you need only convert a portion of the traditional IRA into a Roth. Or maybe, if you’re trying to reduce the amount of your RMDS, consider using qualified charitable distributions or QCD.

Generally, according to the IRS, a qualified charitable distribution is an otherwise taxable distribution from an IRA (other than an ongoing SEP or SIMPLE IRA) owned by an individual who is age 70½ or over that is paid directly from the IRA to a qualified charity. Read more here.

The point being this: It’s never easy to give advice in a vacuum. An adviser needs to examine all your facts and circumstances, and goals to suggest the best course of action. Converting your traditional IRA to a Roth IRA might make sense, but it could just as easily ruin your financial plan were you to do it without talking to a financial planner/adviser.

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