18 Oct Should I convert my traditional IRA to a Roth?

Q. I recently retired and my $90,000 pension covers my bills. I qualify for the pension exclusion. I have a traditional IRA and a Roth, both worth $500,000 each. How can I decide if I should convert the traditional to the Roth? I don’t want to pay more in taxes than I have to, so could I just convert enough to keep me under the pension exclusion cutoff?
— Planning ahead

A. Congratulations on your retirement.

You are fortunate to have a pension that covers your bills and a nest egg you can rely on.

The best way to approach this decision is to look at your combined tax rates now — both federal and New Jersey) and compare them to your combined tax rates in the future, said Howard Hook, a certified financial planner and certified public accountant with EKS Associates in Princeton.

“A Roth conversion makes sense mathematically if the tax you would pay now on the conversion, both federal and New Jersey, would be less than the tax you would be paying in the future when you take those funds out,’ Hook said. “The combined rate is important because even if you wind up paying more New Jersey tax now, it will still make sense if that amount and more is saved on federal taxes in the future.”

There are other reasons to do a Roth IRA conversion, Hook said.

For example, if you don’t believe you will spend all your money and wish to leave something for your children and grandchildren, then converting to a Roth IRA might make sense because the amount you convert and its earnings would no longer be subject to required minimum distributions (RMDs), saving you tax money.

SECURE Act 2.0 requires most beneficiaries – with a few exceptions – to liquidate the inherited retirement account, including an inherited Roth IRA, within 10 years after the date of death, he said.

“For inherited IRAs, this condenses the period of time for which the account can grow tax deferred – for example – someone say age 50 inheriting a $500,000 traditional IRA prior to 2020 could spread the income taxes on the $500,000 plus earnings over their life expectancy which according to the IRS is 36.2 years,” he said. “Now the same beneficiary post 2020 has to liquidate and pay taxes on that amount over 10 years. If the inherited IRA was a Roth IRA, no taxes would be due so the condensed amount of time (10 years vs. 36.2 years) would have less impact on the beneficiary.”

For people concerned about children or grandchildren spending all of their inheritance, using a trust could be appropriate, Hook said.

“A trust as a beneficiary of a Roth IRA is much better tax-wise than if the trust is a beneficiary of a traditional IRA,” he said.

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This story was originally published on Oct. 19, 2023.

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.