Finance, Loans & Insurance
Should You or Shouldn’t You Convert Your Traditional IRA Into A Roth IRA?
You can convert your conventional IRA savings to a Roth IRA – but should you or shouldn’t you? Well like anything, there are obviously some factors that would support your decision of conversion while there are some that don’t.
Here are the pros and cons that would help you make the right decision about whether or not you should convert your IRA.
Merits of Conversion
Save taxes in long run – If you convert some or the entire amount in your traditional IRA account to Roth, you need to pay income tax on the converted amount that year. Even so, it might be a smart decision if you end up in a higher marginal tax bracket afterward or if overall tax rates rise. Once you’ve paid due taxes on that amount, it becomes tax-free thereafter, irrespective of whether or not the tax rates change. Moreover, the money you earn in that account is completely tax-free. On the other hand, money in a traditional IRA is tax free until it is withdrawn. But when you take it out, you need to pay taxes on original contribution as well as the amount it has earned over time.
Avoid RMDs and unwanted penalties – In case of traditional IRA, you have to take out certain percentage of the money from your account every year as you reach a specified age. Or else, you may have to face huge tax penalty – 50% of what you didn’t withdraw, while you’ll owe income tax on the amount you take out. But with a Roth, Required Minimum Distribution (RMD) is never mandatory throughout your lifetime. If you don’t need to withdraw any money from your Roth account, you can keep the money intact. But, if you need to take out the money and you’re under 59 ½, you can do it but not its earnings – without penalty.
If you want to opt for a Roth IRA but earn too much so you can contribute, converting your money in traditional IRA to a Roth is the only possible option.
Demerits of Conversion
May have to pay more in taxes in long run – Conversion from a traditional IRA to a Roth makes sense only if the income tax rates rise in future. Also like many retired people, if you belong to a lower tax bracket later, it would be better not to convert.
May face huge tax bill – Depending on the amount you convert, your tax bill may be quite large and the money you have to pay has to come from some other source. If you want to pay off the taxes by taking out extra bucks from your traditional IRA account, you may have to pay a 10% early withdrawal penalty provided you’re under age 59 ½ . Even if you don’t have to pay any penalty, you’ll still reduce your retirement savings towards tax payment. Getting money from a non-retirement account would be a better option though not a perfect one.
So considering the above facts, it can be said that converting your traditional IRA into a Roth IRA provides tax-free income in the long run. But you have to pay the taxes on the saved amount now at a rate that may or may not be higher than what you’ll owe during retirement.
Sam is a passionate blogger and a news editor. She regularly writes for her blog. She also contributes in leading news sites like DX.