Like many other retirement plans, including 401(k) plans and traditional IRAs, the earnings within the account are tax-sheltered, meaning they are not subject to income tax while invested within the account. However, income tax is levied on withdrawals from these other plans, while withdrawals from a Roth IRA are generally not taxed. Therefore, generally, earnings from a Roth IRA permanently avoid income tax.
One of the most important benefits is the flexibility that a Roth IRA provides. The owner of a traditional IRA must begin to make lifetime required minimum distributions (RMDs) after attaining 70 ½ years of age. Owners of Roth IRAs are not subject to the RMD requirement; however, beneficiaries of Roth IRAs are. Accordingly, the IRA owner has flexibility in determining when he or she takes withdrawals from the account. The ability to defer distributions enables investors to benefit from the tax-sheltered growth of the account.
The catch is that the rollover to a Roth IRA will be fully taxed, assuming the rollover is being made with money that was deductible when contributed to an IRA. For example, if you are in the 28 percent federal tax bracket and roll over $100,000 to a Roth IRA from a regular IRA funded entirely with deductible dollars, you will owe $28,000 in federal income tax. As a result, you will be paying tax now for the future privilege of tax-free withdrawals and freedom from the RMD rules. If, however, you have only a regular IRA that was not deducted on a prior tax return, the conversion to a Roth is not taxable up to the amount of accumulated earnings.
There is no uniform answer that can be given to this question. Your WK advisor can help you analyze whether you could benefit from a Roth conversion. In general, if any of the following circumstances apply to you, we recommend you consider a Roth conversion.
It is important to consider your family’s entire financial situation before you plan for a large rollover to a Roth IRA. A thorough understanding of your situation is essential to fairly evaluate the merits of a Roth conversion. There also are many details to consider, such as whether the amounts you are thinking of switching to a Roth IRA are eligible for the rollover, whether you can make rollovers from your employer-sponsored plan, and the tax impact of rolling over amounts that represent nondeductible as well as deductible contributions.
Our firm’s broad service offerings in the areas of tax, estate, and small business succession planning places us in a unique position to help you to consider how a Roth conversion might fit within your overall financial plan and to navigate the mechanics of the conversion process. Contact your WK advisor at (573) 442-6171 or (573) 635-6196 to discuss the pros and cons of conversion to a Roth IRA.