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A traditional IRA is a fairly common retirement savings tool for investors. This tool allows individuals to contribute funds on a pre-tax basis thereby reducing their taxable income in the year the contribution is made. And since we all like to find ways to reduce our tax liability many individuals contribute to a traditional IRA. Some individuals have a traditional IRA because they  rolled over the funds from their retirement savings plans at previous employers.

A Roth conversion is when an investor decides to convert or re-characterize the funds in their traditional IRA to their  Roth IRA. Since the funds in the traditional IRA are ‘pre-tax’ dollars meaning the owner of the IRA did not give Uncle Sam their portion these re-characterized funds will be income to the Roth owner in the year of the Roth conversion. Therefore, the Roth owner must pay the taxes owed on this income in the year of the conversion. In short, converting traditional IRA funds to a Roth IRA trades the tax deferred benefit of a traditional IRA for the tax free benefit of qualified Roth withdrawals.

There are  income restrictions on who can contribute to a Roth however there are NO income restrictions on a person converting the funds.

There are 3 primary factors to consider before converting

  1. Taxes – will the additional income from the conversion put you in a higher tax bracket?
  2. Time – How long before you will need to use these funds?
  3. Costs – Do you have enough liquidity to pay the tax liability due on the conversion?

The answer to these questions will help you determine if a Roth conversion is right for you. As is the case with so many financial decisions, converting to a Roth IRA makes good sense for some and little sense for others. I recommend that you seek advice from a tax professional and a financial advisor to determine the answers to these questions. As a  financial advisor in Traverse City, I have helped many investors decide whether a Roth conversion is the right decision for them. 

Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.  Unless certain criteria are met, Roth IRA owners must be 59 ½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.

By Debbie Craig CFP®, MBA, CRPS®

Branch Manager

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