By Sarah Brenner, JD
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Roth IRAs have been around for 20 years now. Lots of taxpayers have taken advantage of the tax-free benefits of these accounts by converting their traditional IRAs or employer plans to Roth IRAs. But many have hesitated. Maybe you are among those who held back. The year 2018 may be the year to change your mind.
How Conversion Works
When you convert your traditional IRA to a Roth IRA, your pretax traditional IRA funds will be included in your income in the year of the conversion. This will increase your income for the year of the conversion which may impact deductions, credits, exemptions, phase-outs, the taxation of your social security benefits, and Medicare Part B and Part D premiums; in other words, anything on your tax return impacted by an increase in your income
That is a tax hit for sure but keep it in perspective. Remember, the extra income is only for the year of the conversion. The trade-off is the big tax benefit down the road. If you follow the rules for qualified Roth IRA distributions, all your Roth IRA funds, including the earnings, will be tax-free when distributed to you. Not a bad deal!
Thinking conversion may be the right move for you? You should ask yourself three questions. First, when will the money be needed? Do you need your IRA money immediately for living expenses? If so converting may not be for you. Second, what is your tax rate? If your income is lower, that may favor conversion. The third question to ask yourself is whether you have the money to pay the tax on the conversion. It is best to pay the conversion tax from non-IRA funds.
Conversion in 2018
Why might 2018 be a good year to convert? Tax reform has lowered tax rates for many and scaled back the Alternative Minimum Tax ("AMT"). These historically low tax rates will not be here forever. There is a window of opportunity to take advantage of them. Like many of the changes under tax reform that affect individuals, the lower tax rates are scheduled to sunset in a few years. No one knows for sure what the future will bring, but with large deficits a likely possibility many see future tax rates as much higher. Converting now is a way to lock in today's low rates and avoid worries about the uncertainty of future taxes.
Is Conversion Right for You?
Should everybody convert? No, of course not. Conversion is not one size fits all. Beginning in 2018 conversions are irrevocable. There is no more recharacterization or the ability to undo a conversion. This means you must be very sure before you go ahead with the transaction. Are you a good candidate? Is 2018 the year for your conversion? Professional advice is more valuable than ever. Your best way to find out what is right for you is to discuss your conversion options with a knowledgeable financial or tax advisor.