Should I Convert My IRA to a Roth?

November 30, 2021 — It is amazing how many times this question comes up, usually from people who we consider very proactive about their retirements. There are no easy answers to the question, but there are some guidelines. Adding to the mix, if the provision of the Build Back Better plan concerning Roth conversions is included in any final bill that gets congressional approval, there might never be a better time to consider it than right now.

The legislation being considered would prohibit the conversion of after-tax assets from traditional IRAs and employer-sponsored retirement plans into Roth accounts after December 31, 2021. No one knows what will happen in congress these days. But, if you think that law has a chance of passing, this could be your last chance to convert.

What is a Roth IRA?

Basically, in a Roth IRA you contribute after-tax income into a tax friendly retirement account. The money you contribute and future income and gains are shielded from future taxation. Unlike regular IRAs, you don’t have to withdraw anything from it during your lifetime. And if you do, you won’t pay taxes on those withdrawals. The SECURE Act changed the law on how long a period your heirs (except spouses, minor children, etc.) have to withdraw the money – it now has to be completed over 10 years. Unlike contributions to a regular IRA or employer-sponsored retirement plan, you cannot deduct the initial contribution from your current income.

Is this a good time to convert some or all of your IRA money to a Roth?

Obviously, if the law changes so IRA money can’t be moved into a Roth, that would be a very big reason to convert some or all of it now. But who knows if the proposed provision will survive, or if any part of the bill passes a gridlocked congress.

But beyond the proposed prohibition legislation there are some other reasons to convert:

You have big balances in your IRA. A very large IRA balance means large RMD’s (Required Minimum Distributions) that will increase by a formula as you age. Let’s say you are lucky, have $1 million in your IRA, and are 72 years old. Your current RMD is just over $39,000. But move forward 10 years, and assume your IRA increased in value by 20% in that time to $1,200,000. Your RMD is now over $70,000. If you live to 92 and see another 20% increase in your portfolio, your new RMD is $141,000, all of which is taxable income at the federal and state level. Those RMDs mean your income for determining Medicare Part B premiums will be higher too.

Your current income is very low or you have big tax losses. This can be a great time to convert a big portion of your IRA. Although you will have to pay taxes on the entire balance you convert to an IRA, if you can offset that with losses or minimal other income, the net tax problem might be slight, compared to how much you might save in the future.

Future withdrawals by your heirs are tax free. As an estate planning tool Roth IRAs are more advantageous for your heirs. Because the new law mean they have to take the money over 10 years, if you have very large traditional IRA balances they could be subject to very high taxes.

Disadvantages of converting to a Roth

The biggest disadvantage is that the money you convert is taxable as ordinary income. This could throw you into a very high bracket and thus reduce the amount that gets into your new Roth account. Advisors generally recommend choosing an amount for conversion that doesn’t change your bracket by too much, rather than converting it all at once.

Get professional advice first!

Roth IRAs are complicated animals, and there are a variety of rules affecting what you can and can’t do. Before you make any decision, consult with your tax or financial advisor. Fidelity has an excellent article on Roth conversions that will make a great starting point in your studies.

Comments? Have you converted some of your IRA balances into a Roth, or are you considering doing so? Let us know your thoughts in the Comments section below.