Roth Conversions: What You Need to Know

October 06, 2016

Taxes are a common theme in all areas of financial planning - they almost always impact your bottom line. That’s certainly true when it comes to taking income from your retirement savings.

The Roth IRA has only been around since 1997. Many individuals who have stashed away savings over the years have done so on a pre-tax basis. That is, they’ve been deferring the income taxes due on those contributions until they make a withdrawal – or a Roth Conversion.

In 2010, the IRS removed the income limitations that prevented the eligibility of converting their pre-tax dollars. This brought Roth Conversions to the forefront of retirement tax planning discussions – and rightfully so.

The question many ask is, should I convert? And if so, how much?

To answer that, a multitude of questions should ensue:

  1. What do you project your taxable income levels to be before and after your working years? The hope is to pay taxes on your IRA assets at your lower tax rate, but this can be difficult to project. However, it’s still necessary to compare your working income from your projected retirement income.
  2. When do you plan on retiring and starting withdrawals? When your working income stops, your income tax base may drop as well.  Depending on the assets you’re using for retirement income, this can be an attractive time to convert. A common approach is to convert enough to take you to the top of your next tax bracket without going over. However, this is not an exact science, and a tax advisor is extremely helpful in determining a reasonable amount.
  3. Do you have any legacy plans with your assets? Lastly, a Roth IRA can be a great asset to leave to your heirs. While there will be Required Minimum Distributions to your beneficiaries, the distributions will be tax free. The longer your investments stay inside your Roth, the greater potential of having increasing tax free earnings – this most certainly depends on the investments you have and how well the market does.

However, the biggest question everyone should be asking is, where do federal marginal tax rates go in the future? While I agree that the tax code is more complex than rocket science, you can begin to answer that question by looking at the past. Historically speaking, marginal tax rates are much lower than what they have been.

A forewarning to the Do-It-Yourselfers: There are numerous Roth Conversion calculators floating around on the internet, but many of them do not feature future tax rate increases on their income tax projections. A tax advisor can do a lot of the heavy lifting when it comes to number crunching, but be prepared to be hit with an hourly fee.

There’s certainly some guesswork that goes into the decision of whether to convert or not. But the aforementioned personal income and legacy plans, combined with future federal tax rate expectations, should be a great starting place for many.

If you are considering a Roth conversion and would like to talk further about how it might fit into your retirement planning, please contact us at Kemp Harvest. The earlier you start to plan, the better.

If we at Kemp Harvest Financial Group can help you in any way, please feel free to contact us.

For more topics like this, check out our radio show “Retirement Plain and Simple” every Saturday morning at 8 on WNPV 1440 AM and like us on Facebook!

The opinions voiced in this article are for general information only. They are not intended to provide specific advice or recommendations for any individual and do not constitute an endorsement. To determine which investments may be appropriate for you, consult with your financial professional. Please remember that investment decisions should be based on an individual’s goals, time horizon, and tolerance for risk.