Roth IRA: Convert or Contribute?
I have been pondering a scenario and wondering what suggestions the discussion forum may have. Here’s the scenario. Seems to be a scenario many of my peers are faced with today. Consider a married couple in their mid to late 30’s who expect tax rates to increase in the future. They have enough disposable income available at the end of the year to make max Roth contributions, but not much more. They have existing retirement assets in a pre-tax rollover IRA from a former employers 410k. Should they consider converting as much of their IRA balance as they can afford using the $12,000 earmarked for Roth contribution to pay tax on the conversion? Assume the the conversion is taxed at 24%, allowing them to afford a total conversion of $50,000. Is it better to get more assets into tax free bucket sooner or better to to make the annual Roth contribution and increase total retirement assets?
Permalink Submitted by [email protected] on Wed, 2022-08-31 18:40
Since this was addressed to the discussion forum, I’ll give you my input.My take would include these thoughts – since they expect to be in higher tax brackets in the future, conversions now may make sense. But, if they convert the old ER 401k, they have to pay taxes on it. If they were to withhold the taxes from the conversion amount, they would suffer a 10%premature distribution penalty on that withheld amount. To avoid that, they should use other funds to pay the taxes. If their only other available money is the 12k of surplus cash flow, it could make good sense to use that to pay the taxes on the conversion vs funding a Roth IRA. If they have other NQ assets that could be used to pay the taxes, then you could use those and still contribute the 12k to Roth.The other thought is on accessibilty of the money – any money they contribute to the Roth IRA is available for withdraw immediately without tax or penalty. So, if they expect they may need the money, but are not sure, they may be better to fund the Roth IRAs as contributions. But, a conversion done this year will also be avaiable for withdrawal without taxes or penalty AFTER 5 years. So, again, if they don’t expect to need the money within 5 years, a conversion may make more sense.My 2 cents – m