You could be spending a lot of time with your 2018 taxes this month. While you're at it, consider your tax picture for retirement—and whether converting your traditional IRA to a Roth IRA might improve it.
"The Roth offers a great deal of flexibility," says Steven Weisman, an estate planning attorney and lecturer at Bentley University in Waltham, Massachusetts. "It provides tax-free retirement income, and you can decide whether to take withdrawals or not. For younger people especially it's a great idea."
Why consider a Roth IRA?
Although contributions to a Roth IRA are not tax deductible, the qualified distributions from them are tax-free—meaning you'll never be taxed for the investment earnings in the account.1 And unlike traditional IRAs, Roths don't require minimum distributions starting at age 70½, so you won't have to withdraw the money if you don't need it.
To contribute to a Roth IRA for the 2018 tax year, you must have an adjusted gross income of less than $135,000 if you're single, or $199,000 if you're married and file taxes jointly. For 2019 tax year contributions, those limits increase to $137,000 for single tax payers and $203,000 if you are married filing jointly. These income limits don't apply to Roth conversions, though, so anyone with a traditional IRA can make the switch.
But converting has a cost: income tax on some or all of the amount rolled into the Roth IRA. If you can't pay the tax bill in cash, a conversion probably isn't the right move. If you can, it's worth considering.
Who would benefit?
Consider a Roth if any of the following describes your situation:
- You anticipate a higher tax rate in retirement. Converting to a Roth lets you pay tax on savings now rather than later, which is favorable if your current tax rate is lower than your likely future rate. Of course no one can predict tax rates, but Weisman notes that current rates are historically lower, and holding assets in a Roth can help hedge against potential increases.
- Retirement is many years away. The longer you hold a Roth, the more time your investments have to grow tax-free.
- You plan to pass the account to heirs. Because Roth IRAs don't require minimum distributions during your lifetime and withdrawals are tax-free, you can increase the effective value of your legacy.
- You want to plan for large potential expenses. Say you face a large long-term care bill during retirement. Withdrawing money from a traditional IRA would increase your tax liability and could even push you into a higher tax bracket. A Roth account instead allows you to withdraw the money you need without affecting your tax status.