By performing a Roth IRA conversion, the taxpayers are allowed to move the money from a traditional IRA or a qualified retirement plan to a Roth IRA, paying income tax on the amount converted at present for future tax-free growth.
Perhaps the most compelling reason to convert is the option to deliberately divide the taxable income over a number of years so as to stay within the lower tax brackets. This point will be even more valid if the future tax legislation results in higher marginal rates. If the taxpayers have the money for the conversion from outside the retirement funds, they usually get the biggest long-term advantage, as then the full value of the Roth account can increase without any tax deduction.
In addition, a Roth IRA has some significant benefits both for retirement and estate planning purposes. Compared to traditional IRAs, Roth IRAs do not require the account holder to take minimum distributions during the owner’s lifetime, and the retirees have more freedom to decide on their withdrawal plan. Inherited money can be taken out without paying any taxes, and although most beneficiaries have to use up the account within 10 years, the fact that there is no income tax on these withdrawals can mean a great deal more of the inheritance that is finally received.
Meanwhile, there are a few practical considerations that could change the timing and results of the operation. Fluctuations in the market, surprise income, withholding decisions, and estimated tax requirements can all have an impact on the total tax cost of a conversion. In a few instances, taxpayers taking such risks convert in small tranches or wait until the end of the year when their income situation is clearer.
A Roth IRA conversion is, on the whole, a great potential planning instrument, mainly for those who are expecting to face higher tax rates in the future or looking for more efficient ways of passing on their wealth.
