Since the income limit on converting from a Traditional IRA to a Roth IRA has been eliminated every investor should consider whether it is to their advantage to convert. The Roth IRA provides tax free income in retirement and is a powerful investment vehicle because of compounding earnings and tax advantages that build wealth in IRAs. The downside of conversion is paying the income taxes on the amount withdrawn from the Traditional IRA. The tax on the money withdrawn from the Traditional IRA should always be paid from money outside the IRA. If IRA money is used to pay the tax you may owe a 10% penalty on IRA withdrawals before age 59 ½.

Who Should Convert to a Roth IRA?

Young Investors. The longer you have to wait before making withdrawals the longer the money has to grow tax-free. Those in their 20’s and 30’s would almost certainly benefit from converting. The number of years of compounding makes it almost impossible for them to not come out ahead. Most people in their 40’s will benefit too.   

Unemployed and Underemployed.  Those who have lost jobs or had their income cut significantly but have the savings to pay the tax can convert and pay a much lower tax rate than if their income were high. It’s possible to not even have to pay any tax, making conversion a no-brainer.

Retirees Who Don’t Need the Money. Unlike a Traditional IRA, a Roth IRA is not subject to the required minimum distributions (RMDs) during retirement. Regardless of how old the owners are, they do not have to withdraw from the Roth IRA if they don’t need the money.

Investors Who Want to Pass Wealth to Future Generations can reduce their estate tax bill by converting to a Roth IRA. If your potential estate is near federal estate-tax exemption, converting to a Roth IRA could reduce or even eliminate your estate’s tax bill. The money required to pay the taxes on your Roth conversion would no longer be part of your estate. The amounts remaining in the IRA continues to compound tax-free. Although the heirs of the estate would be subject to mandatory distributions on inherited Roth IRAs, they would benefit because there will be no income tax on the withdrawals. The heirs can stretch out the withdrawals over their life expectancy; not the original owner’s life expectancy; another big benefit.

The Great Debate: Traditional IRA, Roth IRA, or Both? 

The personal finances of each individual are unique, but I definitely fall in the BOTH camp. Diversification has advantages even when it comes to having different kinds of IRAs!

Related Reading:

Should You Use A Roth IRA for College Savings?  - Bible Money Matters