Investing / Wealth Management

Should You Convert Your IRA into a Roth IRA?

Published by Bob Gustafson

Should You Convert Your IRA into a Roth IRA?

The question of should you convert your IRA into a Roth IRA and when is, of course, dependent upon your personal situation and financial position. Your financial advisor can help you look at where you are in your life right now – your age and financial outlook – to help determine if making the switch from IRA/401K to a Roth IRA makes sense for you.

First, what is a Roth IRA?

A Roth IRA is a retirement account that you can fund with post-tax income, giving you a retirement account that you can withdraw funds without having to pay any additional taxes. Unlike traditional IRAs, there is no up-front tax deduction.

Who is eligible to contribute to a Roth IRA?

There are eligibility limits based on income. If you make too much money, Roth IRAs may not be your best option. However, most American families do qualify and it is an option if you want to have a tax-free savings account that can grow at a better rate than a traditional savings account. Plus anyone at any age can contribute to a Roth IRA as long as you have earned income from a job.

Who do Roth IRAs benefit most?

Younger people in their 20s and 30s can benefit from Roth IRAs since they likely have many years for this investment to compound interest. That’s one angle of the benefits of Roth IRAs. But this is not to say that you’re out of luck if you are currently in your retirement years. Roth IRAs can work well for you during your post-work era as well. Here’s why:

When you established an IRA, you knew that someday you would have to fulfill minimum distributions each year after reaching age 70 and 1/2. When you put the money in the IRA, it was tax-deferred, with taxes due on those required minimum distributions. You would either pay the taxes on what you withdrew, or if your IRAs go to your kids someday, the taxes would be due on those withdrawals.

With an IRA conversion to a Roth, it’s different. You get the taxes out of the way upon establishing the new Roth IRA and then the interest compounds on that investment. There is no minimum distribution requirement. And when your heirs receive the money from this account, there will be no taxes due. Under current rules, your heirs may stretch the distributions out over the course of their life.

So if you’re young, you should consider a Roth IRA as part of your portfolio, and if you’re older, converting IRAs to Roth IRAs may be a more ideal situation for your portfolio and its tax burden in the future.

Another possible benefit of a Roth IRA

Another facet to consider regarding your decision between IRAs and Roth IRAs: it’s hard to know what your tax bracket will be in the future. Compare the following two scenarios:

  • If you are in your 30s and in your peak earning years, putting money into a tax-deferred investment now can give it time to grow. Plus you will likely be making less money annually and in a lower tax bracket at the time of your retirement. When IRA funds are needed, you will have to pay taxes on the money that has grown in your IRA.
  • Apply the same principle to having a Roth IRA. If you put $5,000 into a Roth IRA when you are in your 20s, it could conceivably grow to $60,000 when you reach your retirement years. When you pull that money out for your needs, you won’t have to lose a chunk of those funds to a heavy tax burden in the future.

So for some people, putting post-tax money into a Roth IRA may be a good choice to ensure you get to use all of the money that accrues when possibly you need it most. Find out more by listening to our podcast:

Contact me if you’d like to discuss your own, individual financial situation to see if a Roth IRA makes sense for you and for your family. The IRS, of course, has rules about Roth IRAs that are important to understand, and I can help you explore all of the details of converting to a Roth IRA now, as part of your grander financial plan to help create a more comfortable retirement for you in the future.