Roth IRA Conversion

Want to convert a traditional IRA to a Roth? 

Now might be a good time to consider it. Of course, you’ll have to pay income tax on the converted funds for the year of the switch. But once the money is in the Roth IRA, contributions can be taken out at any time. And future earnings that you take from the Roth account are tax-free, provided you are 59½ or older and at least five years have passed since you first put funds in any Roth IRA, either by contribution or through a Roth conversion. 

Present and future income tax rates are key in figuring whether a Roth conversion makes sense taxwise. If you expect the tax rate that you’ll pay in retirement will be equal to or higher than the rate on conversion, then switching to a Roth IRA can pay off, provided you don’t have to tap IRA funds to pay the tax bill on the conversion. If your income tax rate in retirement will be lower, tax-free Roth payouts are less advantageous. Federal income tax rates are low right now. But there are three things to keep in mind. First, the lower tax rates expire after 2025 unless Congress acts. Second, President Biden and Democrats in Congress have proposed to raise the rates for people with incomes over $400,000, although we don’t see this going anywhere because of Republican opposition and infighting among Democrats. Third, there are Democratic bills on Capitol Hill to curb mega retirement accounts and to bar Roth conversions of high-incomers, but these are stalled, and we also don’t see them rearing up again anytime soon. 

Now turn to other factors to consider when pondering a Roth conversion. 

There are no required minimum distributions for owners of Roths. Keep in mind, though, that if you are 72 or older at the time of the conversion, you must first take your RMD from your traditional IRA for the year of the switch. You don’t need to convert the entire amount to a Roth in one swoop. You can transfer the money in increments over time and space out the tax hit. Converting can pay off if you expect your IRA assets will soar in value. The same rationale applies if you have IRA assets that now are depressed in value. The additional income from converting can trigger higher Medicare premiums. Individuals with 2020 modified adjusted gross incomes over $91,000…$182,000 for joint filers…pay a monthly surcharge in 2022 for Parts B and D coverage on top of their regular premiums. These figures will be somewhat higher in 2022 for figuring 2024 monthly Medicare premium surcharges. Income from converting to a Roth IRA is included when calculating modified AGI, so doing a Roth switch this year could lead to higher monthly Medicare premium surcharges in 2024. 

Another thing to consider: You can’t undo the conversion for tax purposes.

The 2017 tax reform law ended so-called recharactsrizations of Roth conversions. You can still convert your traditional IRA to a Roth, but you won’t be able to undo it. So if you do a Roth conversion, you are stuck with your original income tax bill, even in cases where your Roth IRA assets go down in value soon after the conversion.