A ROTH conversion makes sense in either of the two circumstances below:
- You are in a low tax bracket now, and anticipate you will be in a higher one later on when you will need to use your retirement assets.
- You anticipate you will never need to use a portion of your retirement assets and you want to use the ROTH IRA to leave a tax-free asset to heirs.
The five questions below will help you determine if those circumstances apply, and thus if a ROTH conversion may make sense for you.
1. Do you have tax deductions that exceed your income, or nonrefundable tax credits, or are you temporarily in a lower tax bracket?
When you have a year with plenty of deductions, and not much income, you will want to take a close look at converting all, or a portion, of your traditional IRA to a ROTH. You would want to run a tax projection so you could match the right amount of income against your deductions. It may also make sense to convert enough to fill up the 10% and 15% tax brackets if you think you will be in a higher bracket later when you may need to use the ROTH funds.
2. Do you have sufficient funds outside of your IRA to pay the income taxes that a ROTH IRA conversion would trigger?
You do not want to have to take a withdrawal from your IRA to pay the tax on amounts converted to a ROTH IRA. If you do not have sufficient funds to pay the tax, and still leave yourself with an adequate amount of cash reserves, then a ROTH conversion may not be right for you.
3. Will you have sufficient income from non-retirement account sources to support you in retirement?
If you will have a sufficient income stream from non-retirement account assets like rental property, after-tax investment accounts, municipal bonds, or other such sources, and a small amount of assets in traditional retirement accounts, then you may want to consider converting your retirement accounts to a ROTH.
4. Do you have enough retirement assets that you anticipate you will not need to use them all to support your own lifestyle, and you would like to pass along some of these assets to heirs?
If you have a large amount of money in retirement accounts; enough that you would not use it all for your own needs, then converting the portion you won’t need to a ROTH will allow you to pass that portion along to your beneficiaries income-tax-free.5. Will your assets have enough time, and be invested in a manner that you anticipate you will be able to recoup the money you pay in taxes to do the conversion?
You can use a ROTH IRA conversion calculator to crunch numbers and tell you, over the long run, which strategy would result in the most after-tax money.
