Roth Conversion Disadvantages
As with any financial strategy, a Roth IRA conversion is not the right answer for everyone. Here are some situations where a Roth conversion may not make sense, or at least where a careful analysis is required. Most of these types of decisions involve the merits of paying taxes now in exchange for the benefits of a Roth IRA at some point in the future.
When considering a Roth conversion, it’s important to look at the potential payback — specifically, the amount of taxes that will be due on the conversion upfront compared to your life expectancy. This is especially crucial for someone who is 60 or older. An analysis needs to be run to analyze a potential break-even point where the benefits of doing the conversion, such as tax-free withdrawals and not taking RMDs, outweigh the current taxes due on the conversion.
You may want to do a Roth IRA conversion as part of your estate planning strategy. This is a prime example of where all of the pros and cons of the Roth conversion need to be weighed. The estate planning benefits of the Roth conversion need to be weighed against the current-year taxes on the conversion.
Even for people who are 59 ½ or older, the five-year requirement for qualified distributions remains in effect. In the case of Roth IRA conversions, there is a separate 5-year rule for each conversion that starts on Jan. 1 the year the conversion occurs. If you will need to take a distribution from the converted funds prior to the completion of the 5-year window, any earnings will be subject to taxes, and if you are younger than 59 ½ penalties as well.
The extra income generated from the Roth conversion could bump you who are on Medicare into a higher cost bracket for your Medicare Part B benefits. For those receiving Social Security, the extra income may cause a higher percentage of their benefit to be subject to taxes in the year of the conversion.
In next blogpost, we will discuss Roth IRA conversion strategy.