Roth IRAs have been around for 20 years now. While many taxpayers have taken advantage of the tax-free benefits of these accounts by converting their traditional IRAs or employer plans to Roth IRAs, others have hesitated. Perhaps you are one of those who held back. The year 2018 may be the year to change your mind.
Tax Reform and 2018 Conversion
Why is 2018 a good year to convert? Tax reform has lowered tax rates for many and scaled back the Alternative Minimum Tax ("AMT"). These historically low tax rates will not last forever. Now may be the time to take advantage of this window of opportunity. Like many of the changes under tax reform that affect individuals, the lower tax rates are scheduled to sunset in a few years. The future is always unpredictable, but with large deficits a likely possibility many predict future tax rates as much higher. Converting now is a way to lock in today's low rates and avoid worries about the uncertainty of future taxes.
How It Works
When you convert your traditional IRA to a Roth IRA, your pretax traditional IRA funds will be included in your income in the year of the conversion. This will increase your income for the year of the conversion. This may impact deductions, credits, exemptions, phase-outs, the taxation of your social security benefits, and Medicare Part B and Part D premiums; in other words, anything on your tax return impacted by an increase in your income. That is a tax hit for sure but keep it in perspective. Remember, the extra income is only for the year of the conversion. The trade-off is the big tax benefit down the road. If you follow the rules for qualified Roth IRA distributions, all of your Roth IRA funds, including the earnings, will be tax-free when distributed to you.
Thinking conversion may be the right move for you? You should ask yourself these three questions:
1. When will the money be needed? Do you need your IRA money immediately for living expenses? If so, converting may not be the best choice for you.
2. What is your tax rate? If your income is lower, that may favor conversion.
3. Do you have the money to pay the tax on the conversion. Paying
the conversion tax from non IRA funds is always best.
Is Conversion the Right Choice for You
Should everybody convert? No, absolutely not. Conversion is not a one size fits all. Beginning in 2018, conversions are irrevocable. There is no more recharacterization or the ability to undo a conversion. This means you must be very sure before you go ahead with the transaction. Are you a good candidate? Is 2018 the year for your conversion? Professional advice is more valuable than ever. Discuss your conversion options with a knowledgeable financial or tax advisor.
Have a Question about your Retirement funding?