Is converting my traditional IRA to a Roth a good idea?

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Last Updated on: 25th December 2020, 06:26 am



What is a Roth IRA ?

A Roth IRA allows you to protect your savings from taxation just like a traditional IRA. But the contributions you make to this type of IRA are taxed at your normal income tax rate. You won’t be taxed though when you do make withdrawals in retirement. The maximum contribution amount is $5,500 for 2015, you can add an extra $1,000 if you are aged 50 or over for a total of $6,500. The contribution period for tax year 2015 runs till the tax filing deadline, which is April 15, 2016.

Withdrawals are not taxed if made after the age of 59½  and when you have held the account for at least 5 years. You can make contributions from income earned or you can roll a traditional IRA. Contributions made from a traditional IRA will be taxed at your normal income tax rate.

You are allowed to hold all types of assets including Gold and other precious metals.

Main differences

The main difference is that with the Roth IRA your contributions are taxed at your normal income tax rate. With a traditional IRA your contributions are not taxed and you are taxed when you make withdrawals. Whereas with a Roth IRA your withdrawals are not subject to any taxation.

With a Roth IRA you are not obligated to make minimum distributions from your account after the age of 70½. This allows you to leave the money there longer while it continues to accrue revenue tax free. You may want to leave the money there for later on in life or you may even choose to leave it as part of your will.

Your inheritors will be able to benefit from the tax free revenue growth of the money in a Roth IRA for the duration of your lifetime. However once you are gone they will have to start making tax free withdrawals immediately. They can also dilute these distributions over their own lifetime, this allows for a large amount of the funds to continue to generate tax free income.

Is a change right for you?

Deciding whether to convert or not to a Roth IRA will depend on a variety of factors. Your current age, life style, future goals, current and future income tax rates are the things to take into consideration.

It certainly makes sense if you are in the early years of your career and your projections are to end up earning much higher amounts ilater on in life. In this case you will be making most of your contributions while in a low income tax rate bracket. Whereas your distributions will see you in a higher income tax rate bracket. Converting to a Roth will allow you to make contributions at a lower tax rate and avoid a higher tax rate when you make your withdrawals.

You will need to make the conversion in small enough amounts as money that is rolled from your traditional IRA is considered income. If your IRA is large enough converting the whole amount may push you into a higher income tax bracket.

You may want to convert to a Roth to help keep your Social Security retirement income taxed at a lower rate. If in retirement you have an Income between $25,000 and $34,000 50% of your benefits may be taxable. If you have an income of more than $34,000 then 85% of your benefits may be taxable. Distributions from a traditional IRA add to your taxable income. This may push you up into a higher tax rate, or make more of your Social Security income taxable, or even both.

If your idea is to leave your IRA to your heirs then you would probably be better off with a Roth. Your heirs will be able to see their inheritance grow tax free for your lifetime. They will then receive tax free distributions. However they will be able to distribute those withdrawals over a long period of time allowing for them to see most of that account grow tax free. The set-up is not easy so you will need the help of a tax professional to make it work.

You would probably not benefit if you are an older investor or professional that is currently in a higher tax bracket than you expect to be in retirement. Even though you may keep your money in a Roth much longer it still may not compensate for a much higher tax rate while making contributions.

It is always a wise move to speak to a tax professional to seek appropriate advice before executing any conversion or advanced tax strategy.


Gino D'Alessio
Gino D'Alessio

Gino has over 20 years experience as a Trader/Broker in financial markets, particularly in Bonds, FX, Derivatives and Futures, extensive knowledge of Stock Markets. He also obtained CAIA Charter in April 2015.

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