Our clients often ask us if they should convert their Traditional IRAs to Roth IRAs.
The main appeals of the Roth IRA are that when you take money out, there are no taxes on it and you don’t have to take Required Minimum Distributions.
The problem is that when you convert, you need to pay tax on the conversion. So if you are having a successful career, and everything is going well, it ordinarily doesn’t make sense. If you are paying tax at a much higher marginal rate now than you will in retirement, it doesn’t seem to make sense to pay taxes on your IRA both sooner and at a higher rate.
For instance, if you are in the 25% marginal rate or higher, while you’re working, any income that you convert, any money that you convert from the IRA to the Roth, is put on top of that and taxed at that rate or higher. Whereas if you left it in there, when you retire, you are likely to be taxed at around a 10-15 percent effective rate. Under most circumstances, that wouldn’t appear to make sense.
There are exceptions. If you have a bad year income-wise, or if you lose a job and don’t have any other income for the year or have little income for the year, it might make sense to convert some or all of your IRA to a Roth IRA that year under those circumstances.
Also, if you retire, and you wait to take social security until 70, and you are living on your savings, and have no other or little other taxable income, it might make sense to convert or use some of your IRA while your income is so low. Use whatever money you need to take out of it, if you have to, or if you have other savings you could live on and convert those amounts to a Roth where you pay little or no tax. Then that might make sense.
Like everything else, it’s complicated, and depends on your situation.