When Is an Opportune Time to Convert Your Traditional IRA to a Roth IRA?
Submitted by Desmond Wealth Management, Inc. on October 11th, 2023If your traditional IRA is invested in stocks and/or mutual funds, any substantial downward slide by the stock markets may provide a unique opportunity to convert your traditional IRA to a Roth IRA at a low cost, and then benefit when the markets recover.
Why would you want to do that? Because Roth IRA distributions provide tax-free retirement benefits while payouts from Traditional IRAs are taxable.
Of course, there is never an assurance that the markets will not continue to decline, and any given time may not be the most opportune time to make a conversion in your specific circumstances, but it is something to consider. Conversions provide the most benefit to younger individuals who can look forward to many years of tax-free growth provided by a Roth IRA.
You don’t have to convert all of your traditional IRA in one year. You can just convert what you can afford to pay the tax on each year.
Here Is How It Works
The tax code allows individuals to convert any portion of their traditional IRA to a Roth IRA by paying tax on the conversion as though taking a distribution from the traditional account. Thus, if you make a conversion, you are taxed on the conversion based on the tax rates that apply to your normal income plus the traditional IRA amount being converted.
Of course, if, in the year you do the conversion, you have an abnormally lower income, that could make the conversion tax even less.
2023 Federal Income Tax Brackets and Rates
Marginal Rate | Single | Married Filing Jointly | Head of Household |
---|---|---|---|
10% | $0 to $11,000 | $0 to $22,000 | $0 to $15,700 |
12% | $11,000 to $44,725 | $22,000 to $89,450 | $15,700 to $59,850 |
22% | $44,725 to $95,375 | $89,450 to $190,750 | $59,850 to $95,350 |
24% | $95,375 to $182,100 | $190,750 to $364,200 | $95,350 to $182,100 |
32% | $182,100 to $231,250 | $364,200 to $462,500 | $182,100 to $231,250 |
35% | $231,250 to $578,125 | $462,500 to $693,750 | $231,250 to $578,100 |
37% | $578,125 or more | $693,750 or more | $578,100 or more |
Example When Using Table
Let’s say you are filing married filing jointly and your household’s taxable income without an IRA conversion amount is $45,000, which has a marginal rate of 12%, and you are converting $40,000. This brings your taxable income to $85,000, which is still in the 12% bracket (it’s more than $22,000 but less than $89,450, the start of the next rate). This means the tax on the conversion would be $4,800 (12% of $40,000). If you did the conversion in a year when your other income was more and when combined with the conversion amount you are in the 22% bracket, the tax on the conversion would be $8,800, which is $4,000 more than when you are in the 12% bracket.
Other Issues
- There is no income limitation on making a conversion, thus anyone can do a conversion.
- Higher-income taxpayers can use the conversion to circumvent the AGI limits for contributing to a Roth IRA.
- Once a conversion is made it cannot be undone.
- Some individuals for various reasons have made non-deductible contributions to their traditional IRAs. For distribution or conversion purposes, all an individual’s IRAs (except Roth IRAs) are considered as one account, and any distribution or converted amounts are deemed taken ratably from the deductible and non-deductible portions of the traditional IRA, and the portion that comes from the deductible contributions would be taxable.
Feel free to give our office a call if you would like to explore the possible benefits of a traditional to Roth IRA conversion.