Why a Roth conversion isn’t simple

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Q. I have an IRA I won’t need, and I’d like to convert it to a Roth so my kids can inherit a tax-free account. How can I decide if I should?
— Thinking about it

A. That’s a very generous proposal.

No one wants to leave a tax bill to their heirs, but the truth is, someone will have to pay the taxes on the account one way or another.

You’ll have to do a lot of figuring here.

“If you convert money from a traditional IRA into a Roth, your tax rate for the year you convert could go up,” said Nicholas Scheibner, a certified financial planner with Baron Financial Group in Fair Lawn.

So if you decide to explore the conversion, please review with your accountant when to convert, as ideally, you would want to convert in a year that you expect your taxes to be lower, Scheibner said.

A conversion would do a couple of things.

First, it would provide a greater tax diversification to your overall portfolio, Scheibner said.

That’s because you will potentially be reducing the Required Minimum Distribution (RMD) amount from your IRA by converting IRA assets to Roth IRA assets.

That’s because Roths don’t have RMDs.

Scheibner said the financial breakeven point for a Roth conversion is different for everyone, but there are some general principles for the calculation.

If tax rates increase in the future, this conversion may be worth more, he said. If tax rates stay the same, or go lower, there may be less of a benefit, he said.

“You may want to consider the opportunity cost of investing all monies today as opposed to using a portion for taxes,” he said. “The longer you live the more you may benefit from having the Roth assets grow tax-free.”

Then there’s the benefit to your children, who would get a tax-free inheritance if you don’t use the money during your lifetime.

But keep in mind: As always, the government can change the rules for Roths.

“However, the government would be hesitant to betray a rule that gives people an incentive to save on their own for retirement,” Scheibner said.

It’s probably time to review this information with your accountant before you make any news.

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This post was originally published in September 2017. 

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.