Taking into account the likely tax increases for 2013, it makes sense to accelerate income into the 2012 tax year as a way to minimize your tax liability over 2012, 2013, and possibly beyond. One aspect of income acceleration not being discussed as much as it should is the conversion of your IRA to a Roth IRA.
To review, here are a few differences between the two types of IRAs:
- Taxes on Roth IRA contributions are paid up front, so if you convert now before tax rates rise, you can pay taxes on the converted amount in 2012 while rates are lower.
- Assets from a Roth IRA are not taxed upon withdrawal. And that applies to the earnings as well.
- Distributions are not required at age 70 ½ with a Roth IRA, but they are with traditional IRAs. Converting is a way to reduce future required distributions from your traditional IRA which are taxable.
- The Roth IRA allows you to accumulate earnings tax-free with no time limit and you can bequeath the Roth IRA to your beneficiaries income-tax free.
If converting from a regular IRA to a Roth is something you’ve been contemplating for a while, making this move now may make sense. However, don’t let the tax tail wag the dog. In other words, initiate the conversion only if it works with your established estate plan and goals. Basically, if you can’t afford to pay the tax now — which is required if you convert to a Roth — you shouldn’t do it. Talk it over with your financial advisor. A Roth makes particular sense for younger people because, generally, they have more time for the Roth to grow, which helps make up for the cost of the conversion.
Your financial advisor can help you decide whether converting your IRA now fits into your overall financial plan, especially in light of the expected increase in tax rates.