Roth Conversions and the 2013 Taxes

By Beverly DeVeny, IRA Technical Expert

Follow Me on Twitter: @BevIRAEdSlott

A Roth conversion could cost you more in 2013. That’s because of several new and/or increased taxes in play for this year. The top income tax bracket is 39.6% for individuals married filing jointly with taxable income in excess of $450,000. A large Roth conversion could easily push an individual into the highest income tax bracket. When adjusted gross income for our married couple exceeds $300,000, personal exemptions and itemized deductions begin to phase out. And, when modified adjusted gross income exceeds $250,000, net investment income for our married couple becomes subject to the 3.8% surtax. So you can see how a Roth conversion could cost an individual more in taxes this year.

So, why do a Roth conversion? The above mentioned taxes are all “permanent,” at least until Congress changes the tax law again. When considering a Roth conversion, you do not want to look short term. Short term means all we are looking at is the taxes due today on the conversion. You want to look long term. Long term you are going to have to deal with these taxes each year. When you get to age 70 ½ you will have mandatory distributions from your retirement plans. Consider whether or not those required minimum distributions (RMDs) will push you up over any one or more of the limits described above. The only way to get out of RMDs is to get rid of your traditional IRA and similar retirement funds. One way to do that is to do a Roth conversion.

Doing nothing means you could feel the pain year, after year, after year. The taxes owed on a Roth conversion are a one-time hit – you only feel the pain once. Later on, when you would have to be taking those taxable RMDs, you can take income tax-free distributions from your Roth IRA instead, if you need money.

There are other considerations when doing a Roth conversion. You must have the funds to pay the income tax on the conversion – preferably non-retirement funds. Using non-retirement funds has the added benefit of reducing future net investment income that could potentially be subject to the 3.8% surtax. If you are going to need to spend your retirement funds in your retirement, a Roth conversion may not be the best thing for you to do. You might be better off spreading the tax out over a number of years.

You can do partial conversions of your IRA to a Roth IRA. Many individuals do this to “fill up a bracket” or to lessen the amount they have to pay in income tax each year. When using this bracket method, you convert only the amount that takes you to the top of your current income tax bracket.

Deciding to do a Roth conversion is a complicated process. This article only discusses a small number of the variables to be considered. You should consult with an advisor before making your final decision. You can find a list of Ed Slott trained advisors on our web site, www.irahelp.com.

A final note – Roth conversions are not an irrevocable decision. You can recharacterize (undo) a Roth conversion up to October 15th of the year after the conversion.