While income limits don’t apply in order to convert your IRA, SEP or SIMPLE IRA to a Roth IRA, it may not always make financial sense to proceed.
First, a SIMPLE IRA can only be converted to a Roth IRA once two years have passed since the first SIMPLE IRA contribution.
Following are some reasons to not process a Roth IRA conversion:
Reason 1: Yow Won’t be Able to Cover the Taxes Due on the Conversion
When pre tax IRA funds are converted to a Roth IRA, it is considered a taxable event and you can’t change your mind once the conversion has been processed. And don’t even consider taking a distribution from your IRA to convert the taxes due on the conversion as the distribution will also be taxable.
Reason 2: Taxable Event
When an IRA is converted to a Roth IRA, the amount converted during the year is taxable at earned income tax rates. As a result, it could very well bump you into a higher income tax bracket. The increase in ordinary income for the year may result in the loss of tax credits and deductions, in addition to the possible taxation of Social Security. For seniors, the conversion may increase Medicare charges since the Medicare Income RelatedMonthly Adjustment Amount(IRMAA) surcharges for Part B andPart D have a two-year lookback.
Reason 3: Impact on Financial Aid
While having an IRA does not impact your kids’ college financial aid, processing a Roth IRA conversion does because it impacts your ordinary income tax rates for the year of the Roth IRA conversion. When you go to complete your kids financial aid forms such as the FAFSA and the CSS Profile, you will be required to list your ordinary income tax for the year which may result in not qualifying for all or no financial aid.
Reason 4: Qualified Charitable Distributions (QCDs) Don’t Apply to Roth IRAs
If you are planning to give to charity once you reach RMD age, a qualified charitable distribution (QCD) from your IRA may be advisable. QCD excludes the amount donated from taxable income such as distributions from IRAs. Also, QCDs don’t require that you itemize, which due to the recent tax law changes, means you may decide to take advantage of the higher standard deduction, but still use a QCD for charitable giving. You must be 73 or older to be eligible to make a QCD and age 75 starting in 2033.
Reason 4: Roth IRA Renege by the Government
The government could go back on its promise not to tax Roth IRAs. In the last few years the government has tried to pass legislation to tax some of the Roth IRA gains, but the bills have failed to pass. This serves as a reminder that just because the current tax laws provide tax free growth to Roth IRAs, the government may still try to change that especially if it gets hungry for tax revenue. As the old saying goes, “the only things guaranteed in life are death and taxes”.
