Can I roll my SEP IRA into a Traditional IRA or should I convert to a Roth?

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October 2016
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Hello,

To convert or not to convert is a question that depends on your current tax status and future goals. Because of overwhelming advantages that Roth can offer (under the current tax code), I usually suggest Roth. However, it may not work for anyone and everyone.

For example, if you’re currently in the 33% or higher tax bracket, by converting the SEP to a Roth lump-sum, it may push you to an even higher tax bracket. Moreover, based on your estimate that your retirement tax bracket may be, say 25%, the conversion is obviously not beneficial to you-to pay a higher current tax for a lower future tax benefit. You want the opposite, paying a lower tax at the present time and taking out the tax-free money at the retirement when your rate could be high.

Here’s another consideration. By not converting the SEP to Roth, you may not be able to do the two-step conversion like many high income earners can do each year. Why? You can’t cherry pick the amount you want to convert to Roth. You must have a clean slate to do the Roth conversion each year, which means the only time you have the traditional IRA is for the purpose of the conversion. For instance, assume you make the lump-sum SEP conversion to a Roth this year. Starting 2017, you do not have any types of traditional IRA. That’s when you set up a non-deductible traditional IRA, fully fund it, and immediately convert to Roth. The same cannot be true if you have a SEP or any other traditional IRA with a $10K balance. You need to do a pro-rata calculation to figure it out how much of the new contribution can be converted to Roth without paying tax.

I know it’s complicated, and that’s why you need to consult with a CFP® to make sure. Best!

October 2016
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