Convert Rollover IRA to ROTH IRA?

ptilda · ‎10-16-2014

I have a small (less than $3,000) Rollover IRA created from my 401K from a previous employer. I have the option of converting this into a ROTH IRA, but I'm not sure the benefits of doing so. Can anyone weigh in on this?

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compassion101 · ‎10-16-2014

Very often worth doing it. The major con being that you would have 3k of extra income this year to pay tax on. The upside is that you won't have to pay any future taxes on either the 3k or the earnings it makes. If you leave it in a traditional IRA you would not have to pay the extra taxes on 3k of income, but when you withdraw the money later you will have to pay taxes on the 3k plus all the earnings.

Another pro is that you can withdraw the original 3k without any penalty in the roth but not the traditional. However, there may be a waiting period of 5 years before you can do this due to rollover

nightglider · ‎10-16-2014

If you believe you will be in a lower tax bracket later on, it would be best to wait. If you believe you will be in a higher tax bracket later on, you should do it, now. If your bracket will not change, then this doesn't matter.

Keep in mind, I believe the amount that you convert from a Traditional to a Roth is added to your taxable income for the year, so if you're on the cusp, the conversion itself might bump you up. I'm just some guy on the internet, though.

compassion101 · ‎10-19-2014

@nightglider wrote:
If you believe you will be in a lower tax bracket later on, it would be best to wait. If you believe you will be in a higher tax bracket later on, you should do it, now. If your bracket will not change, then this doesn't matter.

This isn't true because all your returns are taxed later with a traditional IRA, not just the money you put in. With the roth it is just the money you put in that gets taxed.

But it really depends on your tax brackets and time to retire, and rate of returns. Let's say you are in the 15\% bracket today and expect to be in the 10% bracket when you retire in 30 years. Assume a 7% avg yearly return so you will have 23k after 30 years. With the roth you will pay $450 in taxes today and nothing when you retire.With the traditional IRA you will pay nothing today and $2300 (10% of 23k) when you retire. So $1850 savings, sort of.

However, it is worth thinking about what $450 is worth to you now. For onstance, if you take the $450 you would have paid in taxes and instead add it to the 3k investment, you show an extra 3k in profit 30 years from now at 7% return. So the extra 3k you make less the tax on it (300) comes to 2700, which is better than the 1850 tax savings.

So it really depends on your real circumstances and on what you would do with the $450 if you don't use it to pay extra tax this year..

nightglider · ‎10-19-2014

@compassion101 wrote:
@nightglider wrote:
If you believe you will be in a lower tax bracket later on, it would be best to wait. If you believe you will be in a higher tax bracket later on, you should do it, now. If your bracket will not change, then this doesn't matter.

This isn't true because all your returns are taxed later with a traditional IRA, not just the money you put in. With the roth it is just the money you put in that gets taxed.

I'm aware of this distinction, but I fail to see how it makes my statement false. Doing the conversion gradually would still allow you to control which tax bracket you fall under, regardless of time to retire or rate of return.