A Roth IRA conversion allows you to move a sum of money from a traditional/rollover IRA into a Roth IRA, pay the taxes due, and thereby convert the future distributions into a tax-free stream out of the Roth IRA for yourself or your heirs. You probably already know that the IRS requires you to start taking mandatory distributions from your traditional IRA when you turn 70 1/2, even if you don’t actually need the money. A Roth IRA has no such annual minimum distribution requirement for the original owner and spouse. So the question is: can you do a Roth conversion at that late date, and thereby defer distributions forever?
The answer is that you CAN do a Roth conversion at any time, including after age 70 1/2. But that might not be ideal tax planning. Why? Because at the time of the conversion, you would have to pay ordinary income taxes on the amount converted—basically, paying Uncle Sam up-front for what you would owe on all future distributions. So, from a tax standpoint, you’re either paying taxes on yearly distributions or all at once. (Or, if it’s a partial conversion, on the amount transferred over.) If the goal was to avoid having to pay taxes on that money until you needed it, the conversion kind of defeats the purpose. Unless, of course, you have little other taxable income, and adding a Roth Conversion amount costs you little or nothing in taxes
The traditional reason people made Roth conversions was to pay taxes at a lower rate today than the rate they expect to have to pay on distributions in the future. They might also want to convert in order to leave the Roth IRA dollars to heirs who might be in a higher tax bracket (keep in mind that a heir who is not your spouse is required to take a minimum, albeit non-taxable, distribution from a Roth IRA). But with the new Republican Administration taking over, and Republicans controlling both houses of Congress, tax rates are odds-on favorites to go down, not up, in the near future.
If you still want to go ahead and make a conversion after the mandatory distribution date, the law says that you have to take your mandatory withdrawal from your IRA before you do your conversion. That means that you can’t make a 100% conversion of your traditional IRA if you are subject to minimum distribution requirements. Regardless, you or your tax advisor should “run the numbers” to ensure that you understand the taxes and tax rates that apply before and after the Roth Conversion.
If you would like to review your current investment portfolio or discuss any other tax or financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.
The MoneyGeek thanks guest writer Bob Veres for his contribution to this post