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Articles: Questions about Roth IRA conversions

The Roth IRA has evolved into a key retirement-planning tool for many retirement-savers.  Nevertheless, converting funds in a traditional IRA to a Roth is not always the best approach.

Basic premise:  Generally, distributions from a traditional IRA are fully taxable at ordinary income rates reaching as high as 39.6%.  Also, traditional IRA payouts may trigger or increase the 3.8% Medicare surtax due to the way it is calculated.  In contrast, qualified distributions from a Roth IRA in existence at least five years are completely exempt from income tax.

But the Roth conversion is currently taxable, and that is often the problem.  Here are several questions you should answer before you convert.

Q.  Can I afford the current tax?

A.  Determine if you will have to tap into your retirement funds to pay the conversion tax.  This will erode your nest egg and could actually hurt more than a conversion will help. The more money you convert and the higher your tax bracket, the bigger the tax hit.

Q.  What is my expected tax rate in retirement?

A. If you anticipate being in a lower tax bracket than you are now, it may be easier to absorb tax on future distributions than it is to pay a conversion tax this year.  Conversely, if you expect to be in a higher tax bracket in retirement, a cur- rent conversion is often sensible, absent extenuating circumstances.

Q. What are other expected sources of income in retireSment?

A.  If the bulk of your assets needed for retirement are socked away in vehicles like growth stock and a 401(k) plan, a Roth conversion may provide the flexibility you will need later in life.  It may help meet your lifestyle or estate-planning objectives without triggering tax on every withdrawal. Because you do not know how the tax structure might change over time, it may also be a good idea to build some tax diversification into your accounts.

Q. How do I plan to pass retirement assets to my heirs?

A.  With a traditional IRA, you must begin taking required minimum distributions (RMDs) by April 1 of the year after the year you turn 70½. For each subsequent tax year, the RMD must be made by December 31 of that year.  But there are no mandatory lifetime distributions with a Roth.

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