Five reasons to consider initiating a Roth conversion

By Vincent R. Birardi, CFP®, AIF®, Wealth Advisor at Halbert Hargrove.

Clients often ask me if they’ll stand to benefit from converting their traditional IRA to a Roth IRA. My short answer: It depends.

A key benefit of doing a Roth IRA conversion is that it can lower your taxes in the future. While there’s no upfront tax break with Roth IRAs, your contributions and earnings will grow completely tax-free for you and your spouse – and distributions are tax-free. In other words, once you pay taxes on the money that goes into a Roth IRA, you’re done paying taxes, provided the distributions you ultimately take are qualified.

A few facts:

  • An IRA conversion changes your account classification from a traditional IRA to a Roth IRA.
  • Beginning in 2010, the federal government began allowing investors to convert their traditional IRAs into Roth IRAs, regardless of the amount of income they earned.
  • There are no income limits for conversions.

These are five compelling reasons for making a conversion:

  1. Your current personal income tax rate is currently low and you expect your tax rate to be higher in the future.

Marginal tax rates were generally cut in the Tax Cuts and Jobs Act of 2017, which has been beneficial to many taxpayers. If you have significant assets held within IRAs, it’s very likely that your eventual IRA distributions will be taxed at a higher rate.

  1. You want to provide a tax-free income source for your heirs.

If you do not need income from an IRA during your lifetime, converting to a Roth IRA will offer continuous tax-deferred growth and tax-free withdrawals for your children or grandchildren. However, unlike spousal beneficiaries, most non-spousal beneficiaries must take RMDs within 10 years of inheriting the account.

  1. You have enough cash or after-tax funds to pay the tax on the conversion.

For conversions, cash is king. You need to have enough cash or after-tax funds set aside to pay the tax on the conversion during the tax year in which the conversion occurs. All converted amounts are added to your Adjusted Gross Income (AGI) for the tax year. If you are under 59½, don’t take cash from an IRA because there are penalties associated with withdrawals. Additionally, incurring a capital gains tax to raise cash may make the conversion too expensive.

  1. Your traditional IRA account value, or a security you hold in it, is down in value this year

If you have a specific security or a Rollover IRA that’s down in value this year, you might consider transferring the security in-kind from your Rollover IRA to a Roth IRA.  This is very likely the case for many given overall market underperformance so far this year.   By converting in a down market, you’ll pay less in income taxes in the tax year of the conversion relative to those taxes that would be due in better performing markets.

  1. You’re not likely to change your mind.

The ability to re-characterize or “reverse” your Roth conversion back to a traditional IRA is no longer allowed, so if market performance is not what you expected, you’re stuck with the results. The conversion should fit in with your long-term planning goals.

Before you make a Roth conversion, you should be aware of the potential tax impacts of increasing your Adjusted Gross Income for that year. I’ve listed several of these impacts below. Don’t hesitate to contact your HH team members with any questions about how a conversion would impact your tax picture and overall financial situation.

  • A conversion would increase the dollar amount of the 7.5% Adjusted Gross Income floor for deducting your out-of-pocket medical expenses.
  • You’d increase the taxed amount of any Social Security income.
  • Your capital gains rate could increase – from either to 0% to 15% or from 15% to 20%.
  • You could face higher annual Medicare premiums.
  • And lastly, you may need to pay quarterly taxes after you make the conversion.

How do you balance having the life you want to enjoy today with what you’re going to need in the future? Are you doing what it takes to enter your dream retirement? TAKE OUR QUIZ to find out.