If you’re in the investment game, you’ve probably asked yourself the fundamental question, “Traditional or Roth?” For most people, income is higher during working years than it will be during retirement, so “traditional,” which is deductible now, taxable later, makes more sense than “Roth,” which is taxable now, tax-free later. But what if things change?
What’s a Roth Conversion?
It is possible to switch from a traditional IRA to a Roth IRA. Say you stand to inherit a block of apartment buildings which will fund your retirement by producing thousands of dollars in monthly rent payments. If that’s the case, then your tax bracket during “golden years” might be higher than it is now. You’d benefit from the tax now, tax-free later treatment of a Roth.
The paperwork part of the conversion is easy. The tough part is the tax bill. If you switch from traditional to Roth, you have to pay taxes on the whole balance. For example:
If you have $50,000 in a traditional account and you convert the entire balance to a Roth, you’ll have to pay taxes on the entire shebang, $50,000.
But there is a way dull the pain: you can spread the conversion over multiple tax years. Reminding yourself of the reward at the end of the rainbow may also help.
Of course, a stack of rent-producing apartments might be a bit pie in the sky. If you ever believed that money grows on trees, the sobering events of the past few years have likely taught you a thing or two.
Some folks, who’ve plain had it, find online jobs and bail to more affordable climes. If you’re one of those few who manage to escape, there’s no better time to convert to a Roth. While living abroad, the first $97,600 of your income is excluded from U.S. taxation. If you’re earning less than $97,600, you’ll have $0 in taxable income, which puts you in the very lowest bracket for your Roth conversion. Though you may not be in line for a high-income retirement, a Roth could still be worth your while because five years from conversion, you’ll be able to take withdrawals without tax or penalty.
For most, the traditional IRA is still the best bet: take the deduction during higher-income working years and pay taxes during retirement when income is low. But there are times when Roth makes sense. Whether your outlook on the future has changed for the better or you just want the flexibility to take withdrawals without penalty, you can convert.