Does it make sense to convert to a Roth IRA while I'm living on my savings?April 26, 2012: 5:05 AM ET
I am 50 and have decided to take a gap year—a year off work to refresh and recharge before the final push to retirement in about 10 years. During this year, I'm going to live on savings that have already been taxed. Generally speaking, I will have little or no taxable income. Does it make sense for me to convert conventional IRA funds to Roth IRA funds this year? My wife doesn't work either, and we file jointly, so I figure I can convert about $11,900 with little or no tax consequence. What are your thoughts?
—Jerry Yamate, Roswell, Ga.
"Go for it," says Ed Slott, founder of IRAhelp.com. "This is a great way to take advantage of a unique situation."
As you know, Roth IRAs have a special tax advantage: contributions are made with after-tax dollars, but withdrawals can be completely tax-free. Also, unlike traditional IRAs, Roths don't require annual minimum withdrawals starting after age 70 1/2—a boon for those hoping to pass along their account as an inheritance. These days, anyone can convert a traditional IRA to a Roth, while paying the taxman along the way. Previously deductible contributions and earnings are taxed at ordinary income tax rates.
Generally speaking, a conversion makes sense if you expect to be in the same tax bracket you're in now or higher when it comes time for withdrawals—and you have money outside the IRA to pay the tax bill. (To crunch the numbers, there are a number of Roth conversion calculators online like this one at TIAA CREF's site).
A situation like a year-off from work is particularly compelling since it can place the IRA owner in an exceptionally low tax bracket. In fact, because the standard deduction in 2012 for married couples filing jointly is $11,900, one could theoretically convert that amount tax-free, although the couple's total tax bill for the year will obviously depend on what else is on the return.
If you're really sold on the Roth—and have more funds in your traditional IRA—consider converting more, says Slott. "Even if it's going to cost a little in taxes, it can still be worth it to get into tax-free territory," he says. Given that many folks expect tax rates to rise in the future, that may be very hospitable territory indeed.
-- Stephanie AuWerter
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