When Not to Convert a Traditional IRA to a Roth IRA

You hear the talk at cocktails parties about your friends converting their Traditional IRA accounts to Roth IRAs and now it is nagging you…are you missing out? Should you convert your Traditional IRA assets to a Roth IRA? Converting a traditional IRA to a Roth IRA can offer advantages such as tax-free growth and withdrawals in retirement. However, this financial decision requires careful consideration as it may not always be the best choice for everyone.

Understanding the circumstances under which it might be wise to avoid converting a traditional IRA to a Roth IRA is crucial in making informed financial planning decisions. Below I will outline some scenarios to consider before making the decision to convert your traditional IRA.

• Do you have an immediate Need for Tax Deductions: One key advantage to contributing to a traditional IRA is the potential for tax deduction on the contributions, therefore reducing your taxable income in the current tax year. If you are currently in a high tax bracket and need immediate deductions to lower your tax liability, converting to a Roth IRA could result in increased taxes. In such cases, it might be wiser to maximize the benefits of traditional IRA until your tax situation becomes more favorable.
• A Limited Time Horizon: Converting to a Roth IRA requires paying taxes on the dollar amount converted. If you have a relatively short time horizon before retirement and do not expect to benefit significantly from the tax-free growth and withdrawals, it may not be worth the tax hit. Converting a traditional IRA to a Roth is most advantageous when there is ample time for investments to grow and appreciate, maximizing the potential tax benefits.
• Inability to pay the taxes: Converting from a traditional IRA to a Roth IRA triggers a taxable event, requiring you to pay taxes on the amount converted. If you lack sufficient funds outside of the IRA to cover the tax bill, it may not be financially feasible to convert. Using the funds from the IRA itself to pay the tax bill erodes the potential benefits and may even result in some penalties if you are under 59 ½ years old.
• Uncertain future tax landscape: tax rates are subject to change over time, and it can be challenging to predict what the taxes will look like in the future. If you believe your future tax rate will be significantly lower than your current tax rate, it may be prudent to delay or avoid converting your traditional IRA. By deferring the conversion, you can potentially save on taxes by paying them at a lower tax rate in retirement.
• Your Beneficiaries are Charities: One of the attractions of a Roth IRA is the tax-free growth, however, charities are nonprofit organizations and therefore typically exempt from paying taxes on distributions from IRAs whether it is a traditional IRA or a Roth. Converting to a Roth and paying the taxes results in the charity of your choice receiving less at your death.

Converting to a Roth IRA can be a good strategic financial move, however, it is not always the optimal choice for everyone. It is important to evaluate your circumstances, including current tax situation, time horizon, ability to pay conversion taxes, expected future rates, and the ripple effect of the increased income on items such as Medicare premiums, eligibility of your child’s financial aid if they are in college, etc.

Remember each person’s financial situation is different, and what works for one may not be the best choice for another. Talk to your advisor and tax professional to determine the best path for you. To paraphrase our friend Robert Frost when you come upon two account choices, sometimes taking the one less converted by, makes all the difference…

About the Author: Maggi Keating, CFP®: Maggi brings over 24 years of financial industry experience to her practice. Maggi values her client relationships and delights in her role as an educator to her clients, helping them create tangible goals for their financial life. Prior to joining FBB Capital Partners, Maggi spent 12 years at Charles Schwab & Co., Inc., specializing in assisting families and high-net-worth individuals and foundations. Maggi holds a Bachelor of Science degree from Radford University and is a Certified Financial Planner™ practitioner and a NAPFA associate with the National Association of Personal Financial Advisors (NAPFA). Maggi and her husband Pete, a retired Marine Corps Colonel, live in her native Virginia. As the parent of two children, Maggi is very active in their sports activities.