Denton County Living Well Magazine September/October 2016 | Page 44

Roth Conversions

To Convert or Not to Convert Your Traditional IRA
By Len Nowak, CFP, AWMA, CTS

T

he discussion of whether to convert your IRA to a
Roth IRA evokes a wide range of opinions regarding if, when, and how you should convert the assets
in your account. Some advisors believe you should
always convert all your Traditional IRA (also called
a Contributory IRA) assets to a Roth, while others feel you
should never convert. The truth lies somewhere in between.
It’s important to understand the different tax treatment of
IRAs. A Traditional IRA is funded by making contributions,
and if you qualify under IRS rules, you can deduct your contribution from your taxable income. You get the tax break
up front, but when you take the money out of the account in
retirement, your contribution and the profits are fully taxed
as income. A Rollover IRA acts in much the same manner.
You receive the tax deduction when you contributed to your
retirement plan, before you rolled that money to a Rollover
IRA. When the money comes out of the account in retirement, it is fully taxable as income.
Tax-wise, Roth IRAs act in a manner opposite to Traditional
IRAs. The money you put into a Roth IRA from the conversion has already been taxed––it is taxed when it is taken
out of the Traditional IRA and moved to a Roth IRA account––but the investment grows tax free from then on, and
comes out of the account completely tax free when you take
distributions. When considering converting to a Roth IRA,
it’s important to keep in mind that if you are under 59 ½
and withhold state or federal taxes when converting, that
could be considered a premature distribution, and trigger a

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DENTON COUNTY Living Well Magazine | SEPTEMBER/OCTOBER 2016

10% penalty on the withholding. You will need to plan for
the additional federal and possibly state taxes owed for the
tax year you convert to avoid any penalties and interest.
Paying taxes now as opposed to later may sound unpleasant, but that depends on your tax situation now and in the
future. Let’s look at three basic scenarios (which are based
on current tax laws):
1. You expect to be in the same tax bracket for
the rest of your life: In this scenario, a Roth Conversion does not make much sense. The added income
from the conversion could push you into a higher tax
bracket, causing you additional taxes. At best, you
make the conversion, pay the taxes, it grows until you
take it out at the same tax rate, and you end up with
the same amount of money as if you did nothing in the
first place.
2. You are in a higher tax bracket now and will
be in a lower tax bracket in retirement: Under
this scenario, you are paying a higher rate of taxes
now. If you wait until retirement you will be taxed at a
lower rate. Therefore, by paying taxes now, you have
less money to grow tax free. Moreover, when you withdraw the money, you will have less than if you had kept
it in the Traditional or Rollover IRA. A Roth Conversion
doesn’t make sense for you.
3. If you are in a low tax bracket now, but will
be in a high tax bracket in the future when
you expect to take withdrawals: This is where
converting now makes sense. You pay less tax now