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Roth IRA Conversions – When Should I Convert?

By Sue Slowinski

Individual Retirement Accounts (IRAs) come in two varieties—the traditional IRA and the Roth IRA.

The traditional IRA allows you the opportunity to claim a tax deduction on your income tax return for contributions made into the IRA, and you must pay income tax on withdrawals from the IRA. The Roth IRA does not allow you to claim a tax deduction for contributions made into the IRA, but it allows you to withdraw money from the IRA, tax free.

You are allowed to convert money that is in a traditional IRA to a Roth IRA to build tax free assets. The question becomes “When should I convert some or all of my traditional IRA assets to a Roth IRA?” A common theme regarding Roth IRA conversions seems to be, “wait until you retire and then convert because your income will be lower and you will pay less income taxes on the converted amount.” While in theory this may appear to be true, here are three of several common landmines that could make that timeline for conversion more expensive than you expect:

  1. Social Security benefits may become taxable – If your Modified Adjusted Gross Income (MAGI) including the Roth conversion is above $32,000, and your filing status is Married /Filing Joint ($25,000 if filing Single), then 50% of your Social Security income would become taxable. If over $44,000 ($34,000 Single), then 85% of your Social Security income would be taxable.
  2. Medicare Part B premium may increase – It takes 2 years for Social Security to catch up to your tax return when calculating your monthly Medicare Part B premium. For 2015, the normal Medicare Part B monthly premium is $104.90. If your MAGI for any year including the Roth conversion year is between $170,000 and $214,000, and your filing status is Married/ Filing Joint ($85,000 and $107,000 if filing Single), your 2015 Medicare Part B monthly premium increases to $146.90. And, additional increases occur as your MAGI increases. 2015 Medicare Part B monthly premiums top out at $335.70 when your MAGI reaches $428,000 for married couples ($214,000 for singles).
  3. Additional 3.8% Medicare tax – If your MAGI including the Roth conversion exceeds $250,000 for Married ($200,000 for Single), your investment income such as interest, dividends, rents, royalties, and capital gains will have an additional 3.8% tax added on top of your current tax rate.

Everyone should be thinking about opportunities to do Roth Conversions every year, but there is not a simple answer to determine when a Roth conversion should take place and how much should be converted because the tax laws have become so complicated. The solution is consulting a comprehensive personal financial advisor with extensive tax expertise prior to performing any Roth conversions to determine the potential tax impact and help you weigh the positives and the negatives of a conversion.

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