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IRAs (Individual Retirement Accounts)

Converting a Traditional IRA to a Roth IRA

IMPORTANT NOTE: See the section Roth IRA Conversions to learn about Roth IRA conversions that may be available to you even if you do not meet the criteria for a Roth IRA.

When a traditional IRA is converted to a Roth IRA the taxpayer has to pay tax on the deductible contributions and any earnings in the account at the time of the conversion. The 10% early distribution penalty does not apply on the conversion.

Here are some key assumptions you will need to formulate when determining if you should convert an existing IRA to a Roth IRA:

  • The amount of time until you will begin taking withdrawals from the IRA
  • The number of years you plan to take withdrawals from the IRA
  • The rate of return you expect to earn before retirement
  • The rate of return you expect to earn during retirement
  • Your current income tax bracket
  • Your income tax bracket in retirement
  • The amount of tax you will be required to pay if you make the conversion

The longer the period until withdrawal, and the higher your expected rate of return, the more advantageous it may be to convert. The greater the amount of earnings in the account, the greater the tax-free advantage upon distribution. If you are close to retirement, it may not be as beneficial to convert. Keep in mind that the larger the IRA account balance you have to convert, the more tax you will have to pay.

SUGGESTION: If you are eligible to set up a Roth IRA and you have money sitting in a previous employer's plan, you can roll that money into a traditional IRA and then convert it to a Roth IRA. (This can be done as a one-step process.) You would be required to pay tax on the contributions and earnings in the account, but qualified distributions in retirement would be tax-free.

SUGGESTION: Roth IRAs may make contributions to some employer retirement plans less attractive since amounts contributed to those plans are tax-deferred, while amounts earned in a Roth IRA are tax free and qualified distributions are also tax-free.

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