Global Tax Insights
5 Things to Consider Before a Roth IRA ConversionNovember 20, 2017
Thinking about a Roth IRA conversion before year end? There are at least 5 things you should be asking before doing so.
A Roth IRA offers tax free growth potential and withdrawals during your retirement, but are there any drawbacks to converting a traditional IRA to a Roth? The process leading up to a Roth IRA conversion is a crucial part of the decision process, and knowing when to convert will make the process more beneficial for you, taking into account your individual tax situation.
5 important questions
- When should you convert? Converting later in the year will allow you to access your funds almost a full year sooner than if you chose to convert earlier. Making a conversion on December 31st 2017, under the “five-year rule” is considered the same as making a conversion on January 1st of the same year (2017). So if you convert later in the year, you are able to access penalty free earnings close to a full year sooner than if you converted earlier in the year. Converting close to year end also means that you will have significantly more information about your income taxes for the year, which will allow you to possibly convert a more targeted amount to avoid being bumped into a higher tax bracket.
- Does full traditional IRA balance need to be converted? You can choose the amount you wish to convert—as much or as little as you prefer, allowing you to manage the tax implications of the conversion. Knowing this, you might want to consider converting an amount that will allow you to reach the top of your current federal income tax bracket.
- How will taxes be affected? You have to pay income tax on any contributions from a Traditional IRA to a Roth (called the conversion tax). Your tax liability on an IRA conversion is based on the taxable income brought on by the conversion and your applicable tax rate. You need to know the kinds of contributions in all non-Roth IRA accounts (pre-tax or after tax) to determine what part of your conversion is taxable income. After tax contributions are non-deductible.
- Does my age affect my conversion? Yes—if you are age 70 ½ or older, you are typically required to take a minimum required distribution (MRD) every year from your tax-deferred retirement accounts (non-Roth), and MRD amounts unfortunately cannot be converted to a Roth. As far as withdrawing tax-free from a Roth IRA, you must have held the account for at least 5 years, and you must be at least 59 ½ to withdraw. If you’re younger than 59 ½ and use IRA funds to pay the conversion tax, you’ll be subject to a 10% federal penalty and perhaps other state penalties/ additional taxes.
Can you undo a conversion? Yes, you can undo a conversion and get a refund on taxes paid if you’ve determined that the benefits of a Roth have been reduced because:
- You’ve ended up in a higher/lower tax bracket.
- You don’t have enough to cover the taxes.
- The value of your investments in the converted IRA has gone down, so you are paying a higher tax bill.
As of the publication of this article, the House and Senate tax reform proposals would no longer allow the re-characterization of Roth IRA conversions. This repeal of this popular strategy would mean taxpayers can no longer undo their Roth conversion. Stay tuned for updates.
Questions? Contact any member of our Private Client Services Group.