That day is finally here…December 31, 2012. This is your last chance to convert your traditional IRA into a Roth IRA before we go off the “fiscal cliff” tomorrow. Here’s one final look to see if a conversion is your best course of action.
When you convert, you have to pay the taxes on all pre-tax contributions as well as any earnings. It’s best to have cash on hand to pay off these taxes and not money from your IRA. If you do, you’ll pay a 10% penalty and that’s less money in your retirement account working for you. Moreover, you will owe taxes no matter what. You can’t simply roll over your after-tax contributions.
Will the rollover disqualify you from certain tax benefits? The conversion income might put you into a higher tax bracket and therefore disqualify you from tax benefits like the child tax credit and higher education tax credits.
Are you young enough to make the conversion worthwhile? If you are nearing retirement, you don’t have as much time to make up for the taxes you pay when you convert. However, if you plan on leaving your IRA to an heir, it makes sense for an older person to convert as well. The main reason being that there are no required minimum distributions to make with a Roth IRA. You can let all the money grow in the Roth leaving more to your heir(s). Also, the income tax you pay when you convert will reduce your taxable estate thus reducing taxes for your heir(s).
One last thing to consider is what tax bracket you will be in when you retire. If you’re bracket will drop significantly (say from 35% to 25%) then it doesn’t make sense to convert now and pay higher taxes than you’ll owe when you retire.