Until now we have only discussed IRA basics. Earlier posts provided information on Traditional IRAs and Roth IRAs. Once you understand that converting a Traditional IRA to a Roth typically creates a tax liability for the amount converted, why would anyone convert? Since the idea of accelerating income flies in the face of traditional tax planning, you must be asking yourself, “Why would anyone want to convert?” My response – “A very good question!”
So is all this talk about IRA conversions just an idea dreamed up to increase tax revenues, put money into the hands of your advisers and to earn additional fees for the financial institutions? Again, I say “A very good question!” Let me begin by saying that hopefully you refer to your financial advisor as a “Trusted Advisor” and no doubt has your best interest at heart. OK, now to answer the question, but first the CYA.
While this material is factual in nature and/or is the professional opinion of the author, the subject matter is complicated. It is impossible to know how a Roth Conversion will affect any individual without having all the facts and circumstances of their situation. Seek qualified professional advice before making a decision.
There are a number of legitimate reasons to consider converting a Traditional IRA to a Roth in spite of typically creating a tax liability for the amount converted; I will list 10.
- The overall estate is reduced and therefore reduces estate taxes
- After-death distributions to beneficiaries are tax-free
- The converted account (Roth) permanently generates tax-free earnings
- You have the ability to undo the conversion if it turns out not to be advantageous
- No more Required Minimum Distributions as with a Traditional IRA after 70 1/2
- Pay the tax on conversion using favorable Married Filling Joint rates Vs Single tax rates of a surviving spouse
- Roth funded Unified Credit bypass trusts may allow for greater wealth transfer
- Tax attributes (NOLs, Contribution carry-forwards, etc) reduce the income tax liability created by converting
- Greater wealth may be transferred with the payment of income taxes on the conversion before death
- Tax rates are expected to increase
Item #4 is intriguing to me; please see my future post entirely devoted to this subject.
Decision charts and conversion calculators can certainly assist with the decision. In the end, you must answer this simple question “Can I benefit by paying taxes on my IRA now (Roth Conversion), rather than paying taxes as I withdraw from my IRA during the retirement years?” Simple answer; I recommend that you seek professional help with the answer.