ROTH IRA – IS IT A GOOD TIME TO CONVERT?

As stock market values have fallen recently, many taxpayers are considering converting assets in their traditional IRA to a Roth IRA.  Current laws allow taxpayers to contribute a maximum of $6,000 directly to a Roth IRA and $7,000 if you’re age 50 or older (for 2022).  Direct Roth IRA contributions are also limited by income levels and filing status.  Because of these limits on direct contributions, many taxpayers choose to fund a Roth IRA by converting funds from a traditional IRA to a Roth IRA, since there is currently no limit on how much you can convert to a Roth during a single year. 

When you convert traditional IRA funds to a Roth IRA, you pay tax on the converted amount in the year of the conversion.  Converting traditional IRA funds to a Roth IRA while the account value is lower due to market conditions means that more assets can be moved to the Roth IRA, and those assets may later increase in value and eventually be withdrawn tax-free.  Because volatility in the stock market may have left some IRA balances depressed, the income which must be recognized on the Roth conversion may be reduced if the conversion takes place while account values are down. 

However, it is important to understand that income generated from a Roth conversion may have unintended tax consequences.  For example, certain tax items that are income-sensitive (medical deductions, child or education tax credits, passive losses from active rental property, etc.) may be adversely affected if a taxpayer’s income increases for the year due to a Roth IRA conversion. 

There are other situations which may not be ideal for a Roth conversion.  For example, taxpayers need funds outside of the IRA or other retirement accounts to pay the tax that will be due from the conversion, since paying the conversion tax with funds outside the IRA is generally necessary to make the conversion economically beneficial.  Also, taxpayers generally cannot withdraw the earnings in the Roth IRA tax-free and penalty-free unless they are at least 59 ½ years old and it has been at least five years since the contribution to the Roth was made.  Finally, taxpayers who anticipate that funds in their IRA may be used to cover potentially large medical expenses and/or nursing home expenses in the future may not want to convert, since deductible medical expenses may offset some of the tax that would be due from taking withdrawals from their traditional (non-Roth) IRAs in the future.

The decision regarding conversion to a Roth IRA should be planned in conjunction with your tax advisor who understands your overall tax situation.  Please don’t hesitate to contact us if we can be of assistance to you with this decision or any other matter.