Is It Time to Convert to a Roth IRA?

Recent dips in the stock market might have you wondering if this is a good time to convert your eligible pre-tax retirement accounts to a Roth IRA. Your account values have taken a hit, so yes, this could be the perfect time. But is it the right time for you? Well, it depends on your situation.

No matter what, you will have to pay current income tax on any untaxed portions of your Roth IRA conversion amount. Paying taxes on pre-tax contributions and earnings can take a bite out of your account balances but it could be beneficial in the long run if you: 

  • Will be in the same or higher tax bracket when you withdraw.

It’s important to assess what your current tax bracket is and what you anticipate that your tax bracket will be when you plan to withdraw IRA funds. You also want to check whether an IRA conversion would bump you into a higher tax bracket. If the tax bracket bump is slight, the conversion benefits might still outweigh the difference in income tax.

  • Won’t need the converted funds for at least five years.

Converted IRA funds are not available for distribution until after a five-year waiting period from the conversion date. If you are close to retirement age and anticipate needing to tap those funds, you could end up paying a 10% penalty on withdrawals of money from the conversion of an eligible pre-tax retirement plan to a Roth IRA.

  • Can pay the conversion tax in cash.

You will be responsible for paying income taxes on any funds you convert, aside from prior after-tax contributions. It’s important to pay the conversion taxes with non-IRA assets, or you will lose the benefits of tax-free growth on the amount you take out. The cost of the taxes and loss of tax-free growth could outweigh the advantage of converting.

  • Want to leave a tax-free financial legacy to your heirs.

A Roth IRA doesn’t require minimum distributions, which means your account can continue to grow tax-deferred until you pass it on to your heirs. A spouse who inherits a Roth IRA also doesn’t have to take minimum distributions. You also eliminate the income tax your heirs would pay on withdrawals because you already paid it.

Another important thing to note – even if you want to do a full conversion of your traditional IRA to a Roth IRA, you don’t have to do it all at once. Under current tax law, you can split up the conversion amounts to avoid getting pushed into a substantially higher tax bracket.

The decision to convert your eligible retirement funds to a Roth IRA depends on your personal and financial situation and should factor in your potential for a greater ending portfolio value, your estate planning goals, and your tax-risk. Paying taxes on pre-tax contributions and earnings can take a bite out of your account balances but it could be time to convert to a Roth IRA.