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Should I Convert My IRA To A Roth – 5 Things To Consider Before Doing It

August 19, 2021

Today, we’re going to talk about five considerations you should make before doing a Roth conversion.

First, what is a Roth conversion?

Simply put, it’s when you decide you want to take money from a pre-tax account – like a traditional IRA or a SEP IRA – and pay taxes on it to convert it to a Roth IRA.

The reason for doing that is that you’re ripping the band-aid off and paying the taxes now versus paying it later. Now, there are a lot of benefits to a Roth IRA, which we talk about in other segments.

Now let’s talk about five things you should consider before doing a Roth conversion.

Roth Consideration # 1: Cost.

When you do a conversion from a traditional IRA to a Roth IRA, you’re going to get that converted amount reported on a 1099 that you get in the following January.

You treat that amount as normal income added to your adjusted gross income, and you pay normal income tax on it.

So, the first question you want to ask yourself is for the amount that I convert: “Can I afford to pay the taxes on that when it comes to tax time?

Roth Consideration # 2: What do you think your tax bracket will be in the future?

Now, a lot of us don’t have a crystal ball.

It depends on how far you’re trying to look in advance, but some people consider “Well, if I’m making less money now, and I plan to make more money later, I’ll be in a higher tax bracket.

So oftentimes, depending on your current tax situation, you may want to do a Roth conversion because you’re in a lower income or lower income tax bracket.  But, if you’re in a higher income tax bracket that may change things.

Roth Consideration # 3: Recovery period.

This is a big one.  

You have to decide where your breakeven point is.

That is, comparing the taxes you paid to convert to the investments now in your Roth IRA, when are you going to see the breakeven point when it comes to your tax-free growth?

This is important when it comes to your investments.  Some investments take a short time to hit that recovery period.

If you’re invested in something like a CD, you may never see the recovery period, and so it might not make sense. However, that’s not because the conversion doesn’t make sense, because it’s the investment that doesn’t make sense.

Roth Consideration # 4: What’s the investment?

This is the biggest consideration that you should make (from our perspective).

Depending on what your investment is, how much profit you’re going to have, and how much time you have to make profit, those are the ultimate decision factors as to whether to pay tax now or pay tax later.

If you’re very conservative with your investments and you want to make contributions to a traditional IRA or SEP and the deductions outweigh your tax-free profit, then this story changes for you.

But, if you’re putting small amounts of money in or your investments are gaining large returns, then the tax-free growth is much more beneficial.

The ultimate decision maker that outweighs all the other ones is: what is the investment?

We’ve seen real estate investors take a small amount of money, buy a rental property, or buy a fix-and-flip and sell it in eight weeks for a 40% profit. If the investment is something like that, it makes sense to convert because your breakeven point, the fact that you paid the taxes, you outweigh that in the first eight weeks and everything past that point is profit.

Roth Consideration # 5: Generational wealth.

Remember that when you pass away your IRAs – whether it’s a traditional IRA or a Roth IRA – are passed to your beneficiaries. There is a tremendous amount of power in passing on tax-free wealth to the next generation.

Imagine having real estate or rental properties within a Roth IRA. When you pass away, and you’ve still got assets within that account, that account doesn’t go away.

It changes into an inherited Roth IRA. Those assets continue to grow at least for another 10 years completely tax-free to your next generation.

Not only do you get the ability to live tax-free and penalty-free off the income generated in your Roth IRA from 59 and a half onward, but when you die, your beneficiaries also get to live tax-free through an inherited Roth IRA.

So before deciding on a Roth conversion, take the considerations shown above.

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