Rules governing IRAs have always been very complicated, and the seemingly simple Roth IRA is no exception. The option to roll funds from a traditional IRA into a Roth IRA might be a great thing – or it might be an expensive mistake. Know what to do before making a move.
Not everyone who has a traditional IRA is a good candidate for a Roth IRA conversion, according to The Motley Fool's article, "5 Things to Consider Before Making a Roth IRA Conversion." While every person's situation is different, there are five key elements to consider before making the change to your retirement accounts.
- Your tax bracket. These days it's not unusual for retirees to be in a higher tax bracket during retirement. However, many of us have the option of investing in a Roth IRA, which doesn't offer an up-front tax break—but lets you withdraw funds in retirement tax-free. If you think you are going to be in a higher tax bracket when you retire, you might consider converting some or all of your retirement savings to a Roth before you retire. Converting some or all of your traditional IRA money to a Roth IRA will also give you some tax diversification in retirement to hedge against future changes in tax rates and related rules.
- Estate planning. One of the great things about a Roth IRA is that it isn't subject to required minimum distributions (RMDs) at age 70½, unlike a traditional IRA, where you must withdraw an IRS-mandated amount annually at that age. Plus, it's subject to income taxes. Roth IRAs can continue to grow tax-free for as long as you live, and if your beneficiary is your spouse, he or she can roll over the account and make the Roth IRA his or her own with the same rules (non-spousal beneficiaries are subject to an RMD, but that distribution isn't taxed). In addition, non-spousal beneficiaries can take the RMDs over their entire life expectancy. This is a terrific benefit for younger beneficiaries like children or grandchildren.
- Be ready for the tax hit. The big minus for a Roth IRA conversion is that any funds you roll over will be subject to income tax in the year of the conversion. That means older folks should consider whether they can cover the tax bill and generate enough investment growth to offset the impact. Plus, there may be other considerations—like estate planning—that become more important than "payback" concerns.
- College financial aid. If you have college-age children who will be applying for financial aid, you may want to avoid Roth conversions when their aid is calculated. The extra taxable income could affect their eligibility or the amount of aid.
- Stock market declines. A drop in the stock market may give you a great opportunity for a Roth IRA conversion and get you more bang for your buck. You will be converting a lower amount and paying less in taxes. If you're thinking about rolling over your traditional IRA, consider taking advantage of the stock market correction by converting a larger portion of your old account, or think of it as another way of "buying low and selling high."
Before you do anything, make sure you understand the tax implications and the impact on other financial events that a Roth conversion will have. Speak with your estate planning attorney at Cottrell & Jacobs who can help you make this important decision.
Reference: Motley Fool (February 27, 2016) "5 Things to Consider Before Making a Roth IRA Conversion"