Is Converting to a Roth IRA Worth It?

Thinking about converting your traditional IRA to a Roth IRA? It’s a smart move for many, but it’s important to understand the ins and outs before you dive in. We’ve simplified the process to help you make the best decision for your financial future and discover for yourself is converting to a Roth IRA is really worth it.

Traditional vs. Roth IRA: What’s the Difference?

Before making the switch, let’s quickly recap the basics:

• Traditional IRA:
  • Pre-tax Contributions: Lower your taxable income today by contributing pre-tax dollars.
  • Tax-Deferred Growth: Your money grows without being taxed until you withdraw it.
  • Taxable Withdrawals: When you take the money out, it’s taxed as ordinary income.
• Roth IRA:
  • After-tax Contributions: You pay taxes upfront, with no immediate tax deduction.
  • Tax-Free Growth: Your money grows tax-free, and withdrawals in retirement are tax-free too.
  • No RMDs: You don’t have to take required minimum distributions, giving you more flexibility.

How Does the Conversion Work?

Converting a traditional IRA to a Roth IRA involves moving your funds from one account to the other. Here’s what you need to know:

• Taxable Income: The amount you convert is treated as income for the year, so you’ll pay taxes on it.
• Timing Tips: Spread the conversion over several years or choose a low-income year to keep the tax bill manageable.

Why Consider Converting to a Roth IRA?

Roth IRAs offer some unique benefits that might make the conversion worth it:

• Tax-Free Withdrawals: Enjoy tax-free income in retirement, a big plus if you expect higher tax rates down the road.
• No RMDs: You’re not forced to withdraw money at a certain age, giving you control over your retirement funds.
• Estate Planning Perks: Pass your Roth IRA to your heirs, and they can benefit from tax-free withdrawals too.

Potential Drawbacks

Converting isn’t without its downsides. Here’s what to watch out for:

• Immediate Tax Bill: Converting means you’ll owe taxes now, which could be significant depending on your situation.
• Higher Tax Bracket: The extra income could push you into a higher tax bracket, affecting other financial benefits.
• Medicare Impact: If you’re on Medicare, a higher income could increase your premiums two years down the line.

Age Matters

Your age plays a big role in whether a conversion makes sense:

• Younger Savers: If you’re early in your career and expect your income to rise, converting now could save you more later.
• Nearing Retirement: If you’re closer to retirement, you’ll need to weigh the immediate tax cost against the long-term benefits.

Strategize Your Conversion

A little planning can go a long way:

• Stagger Your Conversion: Convert smaller amounts over a few years to avoid a big tax hit all at once.
• Pick Your Moment: Convert during a year with lower income to minimize taxes.

Impact on Other Tax Benefits

Converting your IRA might affect other tax benefits you’re eligible for. Keep these in mind:

• Education Credits: American Opportunity and Lifetime Learning Credits.
• Family Benefits: Earned Income Tax Credit, Child Tax Credit, and Adoption Credit.
• Retirement Savings: Saver’s Credit.
• Health Costs: Deductions for medical expenses and potential hikes in Medicare premiums.

And don’t forget, a higher Adjusted Gross Income (AGI) might trigger the 3.8% Net Investment Income Surtax.

How to Pay the Taxes

When it comes to paying the taxes on your conversion, you have options:

• Use Other Funds: Ideally, pay the taxes from outside funds so your Roth IRA can grow untouched.
• Use IRA Funds: You can use the IRA itself to pay the taxes, but it’ll reduce your converted amount, and if you’re under 59½, you could face a 10% penalty.

Converting a traditional IRA to a Roth IRA could be a game-changer for your retirement, but it’s not a decision to take lightly. It’s all about finding the right balance between today’s tax bill and tomorrow’s benefits. It is important to ask yourself is converting to a Roth IRA worth it at this point in time? Reach out to Perlinger Consulting for all of your accounting and bookkeeping needs.

For more information from the IRS on retirement plans visit the IRS website.

Disclaimer: This blog is meant for educational purposes only. Articles contain general information about accounting and tax matters and is not tax advice and should not be treated as such. Do not rely on information from this website as an alternative to seeking assistance from a certified tax professional, experienced accountant or bookkeeper.