Money Watch: Benefits of converting to Roth IRA
- Roth IRA will grow tax-free in the future
- Heirs also can benefit from tax-free growth
- But rolling over could temporarily put you in a higher tax bracket
Money Watch, a personal finance column that runs every Saturday, features a financial planner from the National Association of Personal Financial Advisors answering reader questions about saving, protecting and growing your money. To submit a question, e-mail USA TODAY personal finance reporter Christine Dugas at cdugas@usatoday.com.
Q: I am 65 years old and plan to retire in one-and-a-half to two years. Does it make sense to convert a portion of IRA rollover (about $40,000) into a Roth IRA? I am concerned that if I do this I will not recoup my money. I am currently in the 15% tax bracket.
A: There are many advantages to having a Roth IRA. Traditional IRAs allow you to deduct contributions on your tax return, and any earnings grow tax-deferred until you retire. But you have to pay taxes on the back end when you withdraw money in retirement.
Roth IRAs are the opposite. You pay taxes on the front end. And you don't have to pay taxes when you withdraw funds in retirement. I like the tax diversification that a Roth IRA offers in retirement. The fact that your Roth Conversion account will not be subject to required minimum distributions is another advantage.
However, there are a few items to keep in mind. Since you are continuing to work and will have earned income, the conversion dollars will add $40,000 to your taxable income in the year of conversion and may push you into a higher tax bracket.
Do you have funds outside of your IRA Rollover to pay the additional taxes that you will owe? If you do not have outside funds to pay the taxes and need to tap your IRA Rollover, you will incur additional income taxes on this withdrawal.
Are you currently receiving Social Security? If so, this conversion will increase your income and could cause your Social Security payments to be taxable.
You can consider waiting to make the conversion when you have retired and may be in a lower tax bracket. Because you will pay income taxes on the conversion amounts when you file your tax return, you may want to divide the conversions over a number of years.
Finally, you mentioned a concern that you may not recoup your money. If you need these funds in the near term, you have negated the main benefit of a Roth and in effect prepaid your taxes during your working years.
If you do not need it anytime soon, a Roth IRA will offer great long-range flexibility and control over you after-tax income. And it is a great asset to pass onto future generations, which stretches out the tax cost.
Ronda Koehler, NAPFA-Registered Financial Advisor
Ritter Daniher Financial Advisory, Cincinnati
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