When considering whether or not to go ahead with a retirement account conversion, it’s important to evaluate the essential differences between the two types of accounts: the traditional IRA and the Roth IRA. With a traditional individual retirement account (IRA), you’ll put money into the account before taxes are paid, reducing your taxable income for each year you contribute. With a Roth IRA, it’s the exact opposite: You make that investment with after-tax dollars (For more, see: What Are the Advantages of a Roth IRA? for the benefits of this type of account).
For most investors, the most appealing aspect of Roth IRAs comes later: Unlike traditional IRAs, contributions to Roth IRAs grow tax-free over time, which can lead to greater returns on your investment. For many people, this eventual payoff is what keeps them loyal to their Roth accounts and unlikely to convert to another type. If that’s not enough reason and you’re still on the fence, here are a few more reasons to keep your money where it is.
Reasons Not to Recharacterize Your Roth
1. You plan to keep working past the age of 70.
This is a compelling – but often overlooked – reason not to convert your Roth IRA to a traditional one. For older workers, the beauty of a Roth IRA is that unlike with traditional IRAs, contributions to a Roth are still allowed after the age of 70½.
2. You don't have to withdraw money unless you want to.
With a traditional IRA, there are required minimum distributions (RMDs), starting around age 70½. What's more, because you put in pre-tax dollars, you have to pay taxes on the money you withdraw (including everything it earned) – and a penalty if you fail to withdraw enough. But with a Roth, you can keep all the money growing in the account for as long as you please.
3. You prefer the benefits of paying taxes up front.
The “no pain, no gain” maxim applies to retirement accounts to some extent: No matter which type of IRA you choose, you’ll end up paying taxes at some point along the way. But when you actually pay them is something that’s under your control: With a Roth IRA, you’ll be taxed up front rather than years (or decades) later when you withdraw the money. For a closer look at this topic, see Traditional and Roth IRAs: Which Is Better for Taxes?
4. You can’t control tax rates.
Just as nothing may be certain except for death and taxes, you never know how high tax rates may climb in the future. After all, federal tax rates rose in 2013, and anyone withdrawing funds from a traditional IRA would have been hit with a steeper-than-expected tax bill. Not so with a Roth IRA, which leaves investments untouched by tax hikes.
“I tell my younger clients that taxes are at historic lows and are on sale now. When they retire (in 30 years or more), we don't know what tax rates will be,” says Carlos Dias Jr., founder and wealth manager of Excel Tax & Wealth Group in Lake Mary, Fla.
5. You hope to pass down a sizable inheritance – without a hefty tax bill.
Even if an IRA is designated as an inheritance, the account automatically becomes part of the taxable estate upon which heirs will be required to pay income tax.The beauty of a Roth IRA is that withdrawals are tax-free, whether withdrawn by the investor or beneficiaries; Roth IRAs also avoid the burden of income tax on estates. As long as a Roth IRA has been open at least five years and the investor is at least 59½, the earnings can be withdrawn without penalties or taxes.
6. You’ll make more money, more quickly.
According to the Employee Benefit Research Institute, traditional IRAs grew at only half the rate of the better-performing Roth IRAs in 2014.
The Bottom Line
In general, those who prefer delayed to instant gratification will appreciate Roth IRAs for the longevity of their benefits. While you’ll pay taxes on whatever pre-tax income you invest in a Roth IRA, distributions after age 59½ will be blissfully tax-free. For those who don’t plan on withdrawing funds in the early years of retirement, Roth IRAs offer another advantage: Unlike traditional individual retirement accounts, distributions at the age of 70½ are not required. For more on the differences between these two types of IRAs, see Roth vs. Traditional IRA: Which Is Right for You?