Forbes: Should you convert your IRA to a Roth?
Thursday, February 02, 2012
You’ll be helping the country address the 2012 deficit, but is it the right course of action? Here are four things that you should consider in making that conversion decision, keeping in mind that we’re assuming the continuation of current tax law:
Cash available outside of the IRA to pay taxes
This is the most important factor when it comes to conversion. The amount of tax you pay on a Roth conversion depends on the size of the IRA you convert and your subsequent tax bracket. If you convert a $50,000 IRA and have a 20% marginal tax rate, you’ll need $10,000 to pay the taxes. It’s possible to pay the taxes from the converted account, but that pretty much eliminates the benefit of conversion.
Purpose of the IRA
IRA owners need to determine the eventual use for the money. Will the money be used for retirement income? If so, conversion is probably a wash at best. Will the money eventually pass down to beneficiaries? Converting to the Roth eliminates the need to take Minimum Required Distributions at age 70 ½. If you’re leaving the account to kids or grandkids, the freedom to let it grow tax deferred and then disperse funds tax-free makes it an extremely attractive inheritance asset.
Future tax rates
We can assume taxes will be going up in the next few years, but what about many years from now? Given the country’s fragile condition and huge entitlement liabilities, it’s a safe bet that tax rates will continue to increase. That leans in favor of Roth conversion.
A very seldom used strategy is the “Recharacterization” of the Roth IRA, which is essentially a do-over. If you convert your IRA today when it’s worth $100,000 and the account drops in value to $70,000 in December, you have until April 15, 2013 to recharacterize the account back to its original IRA status. This eliminates a tax liability based on $100,000 for an account only worth $70,000.
Each person’s financial situation is different. There are many places on the web where you can analyze Roth conversion, so plug in the numbers and see if it works for you.