Is Now Time to Consider Converting your Traditional IRA to a Roth?

Is Now Time to Consider Converting your Traditional IRA to a Roth?

By:  Sherry S. Johnson, CPA, Tax Partner

Along with the Coronavirus, there has come a heightened amount of uncertainty about our economy, including a high rate of unemployment, stock market declines and reduced income for a tremendous number of individuals.  Now may be the time to consider a Roth IRA conversion, which shifts money from a traditional IRA into a Roth IRA.  Income taxes will have to be paid on the converted funds for the year of conversion; however, once the funds are in the Roth IRA, future earnings and withdrawals from the account escape income tax.  There are also no minimum distribution requirements for owners of Roth IRAs. You do not have to convert the entire amount of your traditional IRA funds at one time.  It can be done in various amounts over time which minimizes the tax bite from being all at once.  If considering the conversion, make sure you have expendable personal funds outside of your IRA to pay the income taxes due on the conversion.

Money distributed from a traditional IRA and reinvested within 60 days into a Roth IRA is called a conversion contribution.  The distribution is taxable to the extent it does not represent a return of nondeductible basis.  A conversion contribution can also be accomplished through a trustee-to-trustee transfer or a same trustee transfer where the trustee simply redesignates a traditional IRA as a Roth IRA without having to open a new account.

A key factor in whether this decision should be made is considering the present and future income tax rates.  With this being an election year, the current, historically low, income tax rates could increase in future years.  If income tax rates rise, this makes a conversion now make more sense.  Also, if you expect your tax rate to be higher in retirement than your present tax rate, the conversion will also pay off as long as you do not have to use your IRA funds to pay the income taxes due on the conversion.

If you have your traditional IRA invested in the stock market, making the conversion while assets are depressed in value, and before the value of the assets rise again, will result in lower income taxes on the conversion.  We have experienced a substantial decline in the stock market thus far in 2020, which makes this worth considering.

In addition, consider the conversion in a year in which you fall in a lower tax rate than normal.  This can be the case if you become unemployed for a period of time, switch jobs or have any type of reduction in income, such as not receiving a continual bonus or a realization of lower profits from owned business entities.

For those receiving social security benefits, a word of caution is that a conversion may trigger more of your benefits being subject to income tax due to the increase in your income from the conversion.  In addition, a conversion could mean higher Medicare premium surcharges in the future since the additional income from the conversion is included in the calculation of the modified adjusted gross income for surcharge purposes.

Another word of caution is if distributions are made from the Roth IRA within five years of the conversion, the 10% early withdrawal distribution penalty may apply even if the distribution is not otherwise taxable unless there is a qualifying exception.  The five-year holding period for this purpose begins with the tax year in which the conversion is made.

With all this in mind, there is another drawback to consider. Once the conversion is completed, it cannot be reversed or recharacterized back to a traditional IRA for income tax purposes.   In light of this, it is prudent to make sure it is a decision made at the appropriate time with all the risks and benefits considered.  Please contact BRC if you have questions or we may be of assistance with any of your IRA or future tax planning needs.

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Sherry S. Johnson Partner, CPA

Sherry is a partner in our firm and has worked for over 35 years in public accounting, providing tax, accounting, auditing and consulting services. Education Barton College, Bachelor of Science in Accounting Johnston Community College, Associate in Applied Science in Accounting Professional and Civic Memberships American Institute of Certified Public Accountants (AICPA) North Carolina […]