Once the money is inside the Roth, though, future withdrawals are tax-free. In addition, there are no required minimum distributions that force owners to take money out at a certain age.
Still, it doesn’t make a lot of sense to pay a big tax bill now if the money can be accessed at a lower rate later. That’s the situation for most people since their tax brackets will drop once they retire and few have saved enough to leave much to their heirs. Another barrier to conversion is that people need to be able to pay the tax bill out of their current income or from nonretirement accounts.
WHEN CONVERSIONS CAN BE SMART
Conversions can make sense if the IRA owner expects to be in the same or a higher tax bracket in retirement. Good candidates for Roth conversions tend to be diligent young savers who expect their incomes to climb over the years and older people whose tax bills could jump when they start taking required minimum distributions.
Conversions also can be smart if the money is intended for heirs whose tax bracket is likely to be at least as high as the account owner’s. A retiree might not want to convert if the money will likely go to young grandchildren or other heirs in lower tax brackets, for example. But if money will be left to an heir in her peak earning years, conversion may be wise, especially now that inherited retirement accounts have to be drained within 10 years.
An ideal time for a Roth conversion can be after retirement but before required minimum distributions begin, financial planners say.
GET ADVICE BEFORE CONVERTING
Getting advice from a skilled tax professional is essential, however. A too-large conversion can push people into higher tax brackets, cause more of their Social Security benefits to be taxed and increase their Medicare premiums. Certified financial planner Linda P. Erickson of Greensboro, N.C., recommends hiring a certified public accountant who can model how various conversion amounts are likely to affect current and future tax bills.
Tax rates can change, of course, as can tax laws. But the advantages of a conversion can be substantial enough to make it a gamble worth taking, says Henry Luong Hoang, a certified financial planner, of Newport Beach, Calif.
Liz Weston is a columnist at NerdWallet, a certified financial planner and author of “Your Credit Score.” firstname.lastname@example.org; Twitter: @lizweston