Roth IRA Conversion – You Are Now “On the Clock”

October 16, 2012

For those of us that are sports fans, both football and basketball drafts are once a year events that require a great deal of strategy and preparedness on the part of the drafting teams.  For example during the NBA draft, a team only has 5 minutes to decide what choice to make once they are “on the clock”.   Now something far more important is now on the clock – your IRA.

Less than ninety days separate almost 50 Million IRA households from a critical decision that may impact their retirement – and even their heirs.

It’s mostly about taxes.  If you have a SEP, Traditional, Simple IRA¹, or a retirement that can be rolled into an IRA this year, regardless of your income, you can elect to convert those funds to a Roth IRA.  Here is the difficult decision – pay taxes voluntarily now, or later when you take a distribution.

This year brings an additional complexity to the decision – where will individual tax rates be in 2013 and how will your marginal tax rate be affected?   If Congress does nothing, the Bush era tax cuts will expire, and the top federal income tax rates will rise from 35% to 39.6%, an increase of 15%. For those fortunate IRA holders that are in the top bracket, a decision to convert their traditional IRA to a Roth IRA in 2012 may come at a 15% discount than if they wait a few months until 2013.

Perhaps your taxes in 2012 will be lower due to diminished earning or write-offs.  This may also provide the impetus to make at least a partial conversion this year at a lower personal rate.

Here are a few positive reasons to do a Roth IRA conversion:

• Never face a Required Minimum Distribution after the age of 70.5 years old.  As a matter of fact, you need never to withdraw those funds.
• The heirs to your Roth IRA will also not have to pay taxes on their distributions.
• Of course, any distributions you take from your Roth IRA once achieving the age of 59.5 are free of any federal taxation.
• If you hold an asset that you expect to appreciate significantly, convert while the tax basis is low, and enjoy the gains tax free.

Potential drawbacks of a Roth IRA Conversion

• The tax rate in your retirement years will be significantly lower than the tax rate paid for your conversion.
• The investment in your converted Roth account decreases in value.
• The additional money used to pay the taxes on the Roth conversion is no longer available for investment and represents  a significant lost opportunity.

There are hundreds of Roth calculators on-line which will allow you make your own forecasts and come to a decision that best fits your situation.  By all means, work with your financial or tax professional to discuss whether you need to make a move to a Roth IRA this year.  Unlike making your IRA contribution, the deadline for Roth conversions in 2012 tax year ends at midnight on Dec 31^st this year.

¹ Simple Plans must be held at least two years prior to conversion

Glen Mather is President of NuView IRA, Inc., a leading self-directed IRA administrator in Florida. He can be contacted at 407-367-3472 or gmather@nuviewira.com.