If you own a traditional or regular IRA, think about converting some or all of your traditional IRA to a Roth IRA. There are pros and cons to consider, as in any financial decision.
To be eligible to make a Roth IRA conversion, you must file your taxes as either head of household, single, or married filing jointly. If you file as married filing separately, you cannot convert any traditional IRA money to a Roth IRA.
Disadvantages of Conversion
When you convert money from a traditional IRA to a Roth IRA, you must pay ordinary income tax on the amount converted. The dollar amount converted is added to your income in the year of conversion. Depending on how much you convert, you may wind up in a higher tax bracket.
The other major disadvantage of converting to a Roth IRA is that you need cash in non-retirement accounts to pay the income tax. It’s generally unwise to use part of your traditional IRA funds to pay the income tax, because that money will also be subject to income tax. (You may also be hit with a 10 percent early withdrawal penalty on any non-converted amounts if you are under age 59½; the 10 percent penalty does not apply to amounts converted, regardless of age.)
Advantages of Conversion
On the plus side, withdrawals from Roth IRAs are not subject to income tax for you or your beneficiaries (if you withdraw after age 59½ and have owned the Roth IRA for at least five years.) You can take out as much or as little money as you wish, when you want, with no concerns about taxes. That flexibility can be a big advantage if you need more control over your income tax situation in retirement.
Who Should Convert?
If you expect to be in a higher tax rate in the future (especially in retirement)—or if you think the government will raise tax brackets in the future—converting now can make sense. The conversion can mean that you pay lower income tax than you anticipate paying in the future.
Also think about converting if your current traditional IRA investments have declined in value. Assume you convert to a Roth IRA and pay the income tax now on this lower account value; if and when your investments in the Roth IRA rebound, any growth will be income-tax free, forever.