One of the most common questions encountered by tax and financial professionals is whether their clients should convert their regular IRA accounts to Roth IRA accounts. Unfortunately, there is no simple answer to this important question, and it is important for every investor to examine his or her own situation before making a final decision.
How to convert your regular IRA to a Roth?
One of the most critical factors for many investors will be the taxes that would be triggered by such a conversion. When the funds in a regular IRA are converted, the taxes on the earnings will have to be paid, and if the IRA has been in place for a long time there may be significant taxes involved. Your accountant or tax preparer should be able to help you determine the tax liability that would be triggered by the conversion to a Roth IRA.
What is a regular IRA?
Of course the idea behind converting a regular IRA account to a Roth IRA is that the investor is paying the taxes today in exchange for tax free treatment when the funds are withdrawn. The idea, of course, is that the money in the Roth IRA will continue to grow and accumulate, and that the withdrawals in retirement will be tax free. This can be a smart move, especially for investors who expect to be in a higher tax bracket in retirement. For investors with a lot of savings and investments, this may well be the case.
Also Read: What to know About the New Roth 401(k)
In addition, many investors expect that the economic realities we see today, from underfunding of Social Security and Medicare to huge budget deficits, will leave future governments with no choice but to significantly increase taxes. If this happens, those with Roth IRAs may well be in an excellent position, and many investors are choosing Roth IRAs and Roth 401(k) programs for just such a reason.
What is a Roth?
No matter where you expect tax rates to be in the future, the conversion of a regular IRA to a Roth is not a decision to be made lightly. There are significant tax implications to such a move, and it is important to get plenty of advice from trusted advisors before making such an important decision. It may be a good idea to sit down with a good tax planner or accountant to run the numbers and determine if this move makes sense in your situation. Everyone’s financial situation is different, and it is important to take stock of your own needs before making such a major decision.
The Rule of Thumb For The Roth IRA
One of the most commonly asked questions among investors is whether to choose a traditional or a Roth IRA. There are two distinct choices of Individual Retirement Account IRA) – the traditional, or taxable, IRA and the Roth IRA, whose proceeds are tax free when withdrawn in retirement.
The traditional and Roth IRA also differ in how their taxes are handled when the contributions are first made. The contributions made to a traditional IRA are tax deductible, subject to income and other eligibility requirements, but the contributions made to a Roth IRA are not tax deductible. This is the tradeoff for tax free treatment when the proceeds are withdrawn.
Thumb rule for the Roth IRA
In most cases it will be preferable to opt for a Roth IRA if you expect to be eligible for these tax free distributions. It is important to remember that the funds must remain in the IRA until the worker is 59½. Those who expect to withdraw their IRA funds before 59½ may be best opting for a taxable IRA account.
For those in a low tax bracket during their working years, a Roth IRA is generally the better choice, while those in a higher tax bracket may benefit from the tax deductibility of a traditional IRA.
Those who are covered by an employer sponsored pension or 401(k) plan do not have to make a choice. Workers are allowed to contribute to both a 401(k) and an IRA.
Those who do not have sufficient funds available to fully fund both an IRA and a 401(k) will need to decide which option provides the greatest benefit. In general it is important to contribute at least enough to your employer’s 401(k) to get the maximum company match. After that goal is achieved it is important to determine whether further contributions to a 401(k) or contributions to a Roth IRA are the best move. A financial planner or certified public accountant can help with this important decision.