Should I consider doing a Roth conversion?

A Roth conversion involves moving money from a traditional IRA or 401(k) to a Roth IRA. The conversion triggers a tax bill on the amount converted, but the money in the Roth IRA can grow tax-free, and withdrawals in retirement are also tax-free.

Here are some of the important considerations to weigh before doing a Roth conversion:

Marginal Tax Rates: Roth conversions may make sense if you expect to be in a higher tax bracket in retirement than you are currently in. On the other hand, if you expect to be in a lower tax bracket in retirement, it may be better to keep the money in a traditional IRA or 401(k) and pay taxes when the money is withdrawn in retirement.

Ability to Pay Taxes: When doing a Roth conversion, the amount converted is added to your taxable income for the year, which can result in a significant tax bill. You should have the cash available outside of their retirement account to pay the taxes owed on the conversion.

Five-Year Rule: There is a five-year rule that applies to Roth conversions. The five-year clock starts on January 1 of the year the conversion is made. If you take a withdrawal from the Roth IRA before the five-year period is up, you may owe taxes and penalties on the earnings.

Impact of Income-Based Programs: Roth conversions can impact income-based programs like Medicare premiums and Social Security taxes. You should consider the impact of a Roth conversion on your eligibility for these programs.

Heirs: Roth IRAs have different distribution rules than traditional IRAs. Heirs of a Roth IRA can inherit the account and take tax-free distributions over their lifetime. If you plan to leave money to your heirs, a Roth conversion may be a good strategy.

It's important to consult with a financial advisor or tax professional before doing a Roth conversion to determine if it makes sense for your specific financial situation.

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Robert J. Pyle, CFP®, CFA, AEP® founded Diversified Asset Management, Inc., in 1996 to provide personalized, comprehensive wealth management services to successful individuals, families, single women, and business owners. His specialty is addressing the complex financial needs of self-employed professionals, corporate executives, and small-business owners. Our disclosure can be found here. The views, opinion, information, and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc. Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting, or tax advice.