I want to transfer my 401(k) to a Roth IRA. Are there downsides?

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Q. I have an IRA with a company I no longer work for and a small Roth IRA with a credit union for many years. I want to transfer as much as I can to my Roth because I’m in a lower tax bracket now. I know I will have federal taxes to pay but will I have to leave the transferred money in my Roth for five years to avoid any other taxes or problems?

— Planning

A. You’re correct to say that when you convert money to a Roth IRA, the transaction will generate income tax both on your federal and state tax returns.

Although it can make sense to do this in a lower income year, you need to make sure you don’t cause unintended consequences, said Nicholas Scheibner, a certified financial planner with Baron Financial Group in Fair Lawn.

First, he said, an increase in income can affect your Medicare premiums.

“Medicare can increase your Part B premiums with an Income Related Monthly Adjustment Amount (IRMAA),” Scheibner said. “For an individual, if your income is over $87,000, you may pay an additional $144.60 per month.”

Also, if you live in New Jersey, those who are 65 and older may be receiving the Senior Property Tax Freeze. If your income exceeds $91,505, you may be ineligible for the credit, he said.

“If you are in a low tax bracket, and you do not have health coverage through work, or a spouse’s coverage, you may be on Medicaid,” he said. “Since Medicaid is income-based, check with your state’s Medicaid office to see if a Roth conversion will affect eligibility.”

You also mentioned the five-year rule. The five-year clock starts on Jan. 1 of the year of the conversion, and there is a separate clock for each conversion done.**
Per IRS.gov: “The 5-taxable-year period of participation begins on the first day of your taxable year for which you first made designated Roth contributions to the plan.”
** The original post of this story mistakenly characterized how the five-year rule works.

This story was originally published on Sept. 15, 2020.

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.