Is it better to transfer money from a traditional individual retirement account to a Roth IRA slowly or all at once?
In most cases, it wouldn’t be wise to convert all in one year, as the increasing distribution creates an ever-higher tax bracket, says Jay R. Blanchard, a financial planner at NEXT Financial Group Inc. in Williamsville, N.Y.
However, clients with the goal of converting a portion of their IRAs should plan with tax and financial professionals the smartest way to do that over several years.
“Tax situations, especially for small-business owners and investors, can change drastically from year to year,” Blanchard says.
Still, he cautions that Congress “could see the trillions of dollars stored in IRAs as a honey hole and change the rules at any time, limiting deductions on contributions and raising taxes on withdrawals.”
“It would be hard to see the reverse scenario working itself out in lower taxes,” Blanchard says.
“Therefore, for clients that like the idea of a conversion, now may be the time to consider prepaying those taxes,” he says.
Clients who truly think that IRA conversions will be limited soon could decide to pay all the tax now, says Jennifer B. Harper, founder and director at Bridge Financial Planning LLC in Chattanooga, Tenn.
Those who think that could happen in a few more years or not at all should work with their planners and accountants to determine a plan over the next few years to spread the tax out in a more manageable way.
Terrance Martin, managing partner at Tranquility Financial Planning in McAllen, Texas, conducts tax projections at yearend, recommending that clients at the beginning of the year convert estimated amounts to a Roth IRA that would top off their marginal tax bracket.
“By doing this, one could always convert more throughout the year if needed and could extend filing their tax return up until October to re-characterize any amount not needed, all while seeing what the market is doing,” he says. “You could even go as far as doubling up the conversion amounts and dividing them into half stocks and half bonds to see which one outperforms the other.”
If converting from a traditional IRA to a Roth pushes a taxpayer over the net investment income tax threshold -- $200,000 for a single filer or $250,000 for married filing jointly -- then it may make sense to spread out the conversion, says Anjali Jariwala, founder of FIT Advisors in Chicago.
If a conversion pushes a client’s taxable income above $406,750 for a single filer and $457,600 for married filing jointly, the client would usually have to pay a higher capital gains rate.
If a client has funds outside a tax-deferred account to pay the tax liability, the client should convert sooner than later, but all facts need to be considered, including the client’s age, health, need of funds and estate planning considerations, says Daniel Sheehan, founder of Sheehan Life Planning in Fresno, Calif.
For high-earner clients who have Roth IRA contribution limits, Michael Solari, principal of Solari Financial Planning LLC in Boston recommends that they roll their IRA money out to their 401k/403b’s so that they do the “back-door Roth conversion.”
“Many of these clients are in their 30s so they have ample time to fill up the Roth component while contributing to their company plans,” he says.
Katie Kuehner-Hebert is a freelance writer in Running Springs, Calif. She has contributed to American Banker, Risk & Insurance and Human Resource Executive.
This story is part of a 30-day series on Social Security and retirement income strategies.