CPA Advantage #5 | Should You Convert to a Roth IRA?
Published on by Andy Bertke, Ryan Lauer, in Video, Wealth Management
Can’t watch the video? Get the transcript.
Roth IRA Conversions: When Paying Tax Now Could Pay Off Later
Roth IRA conversions get plenty of attention as a retirement and tax-planning strategy. The basic idea sounds simple: convert money from a traditional IRA to a Roth IRA, pay the tax today, and potentially enjoy tax-free withdrawals down the road.
But as Barnes Dennig tax pros and wealth advisors Andy Bertke and Ryan Lauer explain in this episode of our CPA Advantage video series, deciding whether a Roth conversion makes sense is anything but simple.
What’s a Roth IRA conversion?
A Roth conversion moves money from a traditional IRA into a Roth IRA. Because traditional IRA distributions are generally taxable while qualified Roth IRA distributions are tax-free, converting means recognizing taxable income now in exchange for potential tax benefits later.
That tradeoff can be attractive, particularly if you’re currently in a relatively low tax bracket or expect your tax rate to be higher in the future. But your tax bracket is only one piece of the equation. The whole fact pattern needs to be there, say Andy and Ryan.
Look beyond the immediate tax bill
A Roth conversion increases your taxable income in the year of the conversion, and that increase can have consequences beyond the tax on the converted amount.
Depending on your individual circumstances, additional income could affect deductions, the taxation of Social Security benefits, medical benefits, and other income-based tax provisions or benefits. That’s why a conversion that looks advantageous at first glance may be a lot less attractive once you look at the whole picture.
How you pay the tax matters, too. Roth conversions can be more advantageous when you’ve got funds outside the IRA available to cover the resulting tax bill. Taking additional money out of the IRA to pay the tax can create even more taxable income and reduce the amount that ultimately makes it into the Roth, and it can create a downward spiral.
Be careful with online calculators.
Roth conversion calculators can be useful starting points, but their answers depend heavily on the assumptions built into them.
Andy and Ryan recently tested three different online conversion models using the same client information and received three different answers, ranging from “yes, it makes sense” to “no, it’s a bad idea.”
That’s a powerful reminder that retirement tax planning can’t always be reduced to plugging numbers into a calculator. The assumptions behind those numbers matter, and that’s where the right wealth management advisor plays in.
When could a Roth conversion make sense?
Every situation is different, but a Roth conversion may be worth exploring when you’re currently in a lower tax bracket, expect higher taxable income in the future, have funds outside your IRA to pay the conversion tax, or expect IRA assets ultimately to pass to children or other beneficiaries who may be in higher tax brackets.
The key is understanding not just the tax you’ll pay today, but how the conversion affects your broader financial and tax picture.
Before making the move, work with your tax CPA to model the potential outcomes, examine the ripple effects, and determine whether a Roth conversion supports your long-term goals.
Watch the video to see Andy and Ryan break down the factors that can make a Roth conversion a smart strategy – or an expensive mistake.
Related content
You might also be interested in the full CPA Advantage wealth management video series. We drop new episodes regularly, and Andy and Ryan are fun to watch. Don’t miss the blooper reel from the series shoot! Find out more about Barnes Dennig’s retirement planning and wealth management services, or download our free estate planning guide. And if you’ve got questions, contact us for a free consultation with one of our top wealth management pros. As always, we’re here to help.
