Contribution or Conversion?

contributionWhatever you are allowed to contribute to your IRA account, you can contribute to a Roth IRA account instead. Eligibility depends on the amount of your Adjusted Gross Income, line 37 of your Form 1040 tax return.

If you are not eligible to contribute, you can still convert existing IRA value into Roth IRA value: that counts as a withdrawal, fully taxable as ordinary income and you would be wise to pay the tax with money you have set aside outside your IRA.

Is converting some of your IRA value into your Roth IRA worth the tax cost? The answer hinges on your answers to three questions:

  • Do you believe future tax rates will increase (which would make paying the tax now more attractive)?
  • Will the annual taxable Required Minimum Distributions (RMDs) that start at age 70 cost you a great amount in taxes during your later years?
  • Is it better to have your retirement money accumulate tax-deferred, with both earnings and principal fully taxable upon future withdrawals… or to have your retirement money accumulate tax-free and be available tax-free in your later years?

Sometimes conversion is really worth doing; this is a good time to find out.