21 Jun Can I convert some of my traditional IRA to a Roth?

Q. I am 74 years old and wanted to convert a portion of my traditional IRA to a Roth but my adviser keeps telling me that I need to have earned income in order to do that. Is that correct? I am retired and my only source of income is from a pension, Social Security and investment income. I’m looking to convert about $200,000 because I think it would be better for the kids and the grandkids in the long run.
— Investor

A. Converting a traditional IRA to a Roth IRA is a common question.

And it seems your adviser may be a little confused.

There is no age or income restriction to convert the funds, said Mindy Neira, a certified financial planner with Modera Wealth Management in Westwood.

She said your advisor may be referring to new contributions to a traditional or Roth IRA, which indeed does have income requirements.

It’s important to keep in mind that converting an IRA is a taxable event, Neira said.

“Assuming 100% of your Traditional IRA is pre-tax, the amount you convert is reported to the IRS as ordinary income,” she said. “That amount then grows tax free within the Roth IRA with the caveat that any growth withdrawn in the first five years is subject to taxes.”

It’s best to consider converting an amount that you can set aside for at least that five year timeframe to maximize the benefits of tax free growth, she said.

It’s also important to remember that the passage of the SECURE Act has changed the way your heirs will inherit your retirement accounts.

In general, Neira said, most non-spouse heirs are now required to withdraw the entire inherited IRA or inherited Roth IRA balance after 10 years of your death. For minors, the 10-year count begins when they turn age 18.

That differs from the old law, which allowed beneficiaries to “stretch” withdrawals over their lifetime by taking Required Minimum Distributions (RMDs).

The impact now is that the taxes your heirs will pay on an inherited traditional IRA is accelerated and the time frame for additional tax-free growth in an inherited Roth IRA is shortened, Neira said.

“A benefit to converting your traditional IRA is that you are prepaying the taxes for your heirs, allowing them to withdraw tax free upon inheritance,” she said. “The decision to do this will depend on your current IRA balance, your need for the account to supplement your income throughout retirement, yours and your heirs current and estimated future tax brackets and your personal preference and goals.”

Before you make a move, you should work with your adviser or a tax professional who can run the numbers and help you see the big picture of a conversion.

And one last note: If you do convert some of the funds, it’s helpful if you can pay the income taxes owed from a source other than the IRA, Neira said.

“This will allow you to maximize the tax free balance within the Roth IRA,” she said.

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This story was originally published on June 21, 2021.

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.