2012 is an excellent time to convert your traditional IRA to a Roth IRA, given that tax rates are expected by many experts to increase in 2013. Let’s start with the basics:

  • How does a Roth IRA compare with a traditional IRA? Distributions from a traditional IRA are required once you reach age 70 ½ and they are taxed at ordinary income tax rates. Conversely, there are no mandatory distributions from a Roth IRA and, in most cases, distributions are not taxed.
  • You pay the tax on a Roth conversion amount in the year of conversion – thus, the focus on converting while tax rates remain low.
  • The advantages of a Roth conversion include:
    –   If there is a balance remaining in your Roth IRA at your death, your heirs don’t pay tax on their distributions.
    –   If you have a traditional and a Roth IRA, you can alternate distributions from each so that you take advantage of lower tax brackets.
    –   Similarly, if you plan to continue to work while retired, Roth IRA distributions can reduce tax due on your social security income
    –   Finally, if you can pay the tax on the Roth conversion from sources outside of the IRA, you can convert taxable assets into tax-exempt investments.
  • Disadvantages of a Roth IRA conversion include:
    –   Paying the tax now – and running the risk of lower tax rates in the future (which is not believed to be likely, however, there is some amount of risk.)
    –   Taking the risk that Congress will not change the Roth IRA rules in the future
    –   Taking the risk that the investments held in the IRA will decline in value after you have paid tax on them

Beyond the basics, there are other considerations, such as having the ability to change your mind about the conversion and doing partial IRA conversions:

  • If you convert your traditional IRA to a Roth IRA right now, the tax on the conversion isn’t due until 4/15/13 – OR 10/15/13 if you extend your return. You have until those due dates to change your mind and convert the Roth IRA back to a traditional IRA – this is most useful if the value of your IRA has dropped in the intervening time frame.
  • You can take portions of your traditional IRA and convert them into different Roth IRA’s. Then, should the value of one drop and the value of another increase, you can change your mind about the Roth IRA that dropped but retain the Roth IRA that increased in value

In summary, the best candidate for a Roth IRA conversion is someone who:

  • Believes tax rates will be higher during retirement
  • Has other, non-IRA assets to pay the conversion tax, and
  • Believes there is a good chance that some IRA balance will be left to heirs.

If you would like more information on converting your traditional IRA, please call Diane Burke at (302) 656-6632.


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