How can I determine if converting an IRA to a Roth IRA will be worthwhile?

I'm 65 years old and retired. I would like to convert some of my traditional IRAs to Roths in the coming years to reduce my RMDs. How can I figure out if this strategy will be worth it considering the additional tax hit? Right now, I'm in the 15% tax bracket.

Retirement, IRAs, Taxes
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April 2017
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As you are aware, one of the benefits to converting to a Roth is the avoidance of having to take the required minimum distributions (RMD) after the age of 70.5 each year. Converting a traditional IRA to a Roth gives you this flexibility after you reach retirement age. Contributions to a Roth IRA come from after-tax income, so there are fewer restrictions on how you use these assets. Unlike a traditional IRA, which has a required mandatory distribution (RMD), a Roth IRA has no required mandatory distribution (RMD), so you may continue to use your Roth IRA as an investment fund for as long as you like. With a traditional IRA, you must begin to collect distributions by the age of 70.5 through annual RMDs. The RMD for each year is calculated by dividing the IRA account balance as of December 31 of the prior year by the applicable distribution period or life expectancy. Again, this rule does not apply to Roth IRAs.

Keep in mind that the IRS also allows you to re-characterize your Roth IRA back to a traditional IRA which may be valuable if your investment value declines or if your financial situation changes and you do not want to pay your tax bill that year, as you can recoup the taxes paid for the conversion.

Converting while in the 15% tax bracket can be a smart money move at any age. The critical element is that you will pay income tax on the amount you convert, this allows Roth IRA holders the opportunity to eliminate future taxes on their retirement plans, thereby compounding their total return. There is no minimum dollar amount for a Roth IRA conversion, so you may choose to convert a small portion of your account every year if appropriate. Therefore, individuals on disability, students, or unemployed may be suitable for a conversion. Another case for a partial conversion done over a period of years is when someone retires early before taking Social Security.

A conversion may also be appropriate if you are well into your retirement. From an estate planning perspective, if your estate is large enough by converting to a Roth IRA, you could reduce estate taxes as well. Depending on your individual tax bracket, income tax on the converted amount may be less than the estate tax for that amount.

Your heirs will also receive Roth funds tax-free versus at their top tax bracket.

One precaution of converting is that taking on that extra income could push you into a higher tax bracket. More income could result in more taxes, or it could affect eligibility for tax deductions or credits. As always, it is best to consult with your CPA and Investment Advisor before making any decisions that pertain specifically to your individual financial situation.

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