Is now the time to make the switch to a Roth IRA?

Now may be a good time to convert your traditional IRA to a Roth IRA.

The primary differences between a traditional and a Roth IRA are income level and when the taxes apply.

Traditional IRAs allow the investor to deduct contributions and in turn get a tax break for the year the contribution is made. With a Roth, though, contributions are made with after-tax dollars and they cannot be deducted from taxes. What this means in practice is the Roth IRA distributions are generally tax-free and penalty-free if they are paid out after a five-year period that begins with the first year for which you made the contribution to the Roth.

While there are certainly tax advantages to a Roth, remember that you will have to pay income tax on the converted funds for the year of the switch. Afterward, though, contributions to the Roth can be taken out at any time, and future earnings that you take from the Roth are tax-free, provided you are 59 ½ or older and at least five years have passed since you first put funds in any Roth IRA (either by contribution or conversion).

Present and future income tax rates are important to keep in mind when deciding to convert to a Roth. If you expect the tax rate you will pay in retirement will be equal to or higher than the rate on conversion, then switching to a Roth can be beneficial. If your income tax rate in retirement will be lower, tax-free Roth payouts may not be as advantageous.

Federal income tax rates are relatively low right now, but there is no guarantee that will remain the case. For example, the current tax rates are set to expire in 2025 unless Congress acts. Secondly, President Biden and Congressional Democrats have proposed tax rate increases on those with incomes over $400,000. Finally, Democrats have introduced bills that would curb large retirement accounts and bar Roth conversions of high income earners. While these bills do not appear to be gaining any traction, these are priorities that could always be revived later.

Aside from the income tax implications, some other points to consider when thinking of converting to a Roth are:

  • There are no required minimum distributions for owners of Roth IRAs. If you are 72 or older at the time of conversion, you must take your RMD from your traditional IRA for the year of the conversion.
  • You do not need to convert the entire amount to a Roth at one time. You can transfer the money in increments over time to space out the impact to your taxes.
  • Converting can pay off if you expect your IRA assets will increase in value or if they are currently depressed in value.
  • The additional income from converting can trigger higher Medicare premiums. Income from converting to a Roth is included when calculating modified adjusted gross income, so doing a Roth switch this year could lead to higher monthly Medicare premium surcharges in 2024.
  • Once you have made a conversion to a Roth, you can no longer reverse that conversion, as a result of the 2017 tax reform law. In other words, if you convert to a Roth, you will be tied to your original income tax bill, even if the value of your Roth IRA assets decreases soon after conversion.

If you would like to learn more about your retirement options, please contact our office today.

Tamra Newman, CPA, CVA, is a Tax Manager with Antares Group, Inc. She can be reached at Courtesy: The Kiplinger Tax Letter

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