A Roth conversion is simply the process of taking a pre-tax IRA (that grows tax-deferred until withdrawn) and converting it into a Roth IRA, paying the taxes now, and allowing it to grow tax-free until withdrawn. Roth conversions are generally good for people that pay at lower tax rates today than they anticipate paying in the future.
While it is usually framed as a decision based on the tax impacts, the real test of this strategy is whether conversion makes realization of your goals and objectives more or less likely in the future. There are also many non-tax considerations to this decision including health insurance and estate planning.
Some online calculators will attempt to quantify the impact for you; but more often, it’s necessary to have a deeper discussion about whether the strategy makes sense for you.
For example, this calculator on Bankrate.com says you can decide based on eight numerical inputs to their calculator.
Source: Bankrate.com. Modera is not affiliated in any way with Bankrate.com or any of its related entities. While such third parties are deemed to be reliable, Modera makes no representations as to the accuracy of any information presented by a third party.
While these inputs are a big part of the equation, financial planning involves both the art and science of these decisions.
Here are the inputs and some of the things you should consider in the process. As you can see, many of the inputs are not binary but rather a range of potential values.
Other considerations this calculator ignores:
In addition to closely analyzing the inputs above, we take into account the following:
Diversification: Much like the diversification that we seek in our investment approach, we look to create tax diversification for clients. The assets in an ideal client portfolio will be diversified in taxable investment accounts (typical brokerage account), tax deferred accounts (Traditional IRA/401K) and tax-free accounts (Roth IRA/401K). This structure allows you to draw from different buckets as needed and maintain some control over the timing of taxable gains/income recognition.
This is especially true in today’s precarious tax environment. Placing all of one’s assets in one of these buckets may seem ideal now, but Congress can and does change the rules along the way with some frequency, so having multiple options provides you with additional control.
Other Planning Areas that Could be Impacted: Second, we consider the big-picture and address other areas that are lacking from the simple online calculators, such as the health insurance and estate planning issues mentioned above.
The question “To Roth or Not to Roth” is one that is best answered with in-depth analysis, and not simply with a few simple inputs. If you would be interested in learning more about our thought process on the financial decisions you face, please reach out to us.
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