When Should I Not Perform A Roth Conversion?

As mentioned in previous postings (Minimize Your Tax Bill and Recharacterizing a Roth Conversion), converting a traditional IRA to a Roth IRA is likely not beneficial for investors who believe they will be in a lower tax bracket during retirement than during their working years. After all, why pay taxes now at a higher tax rate to avoid having to pay taxes later at a more favorable rate?

Another group that may not benefit from a Roth conversion are individuals who will likely have a large amount of itemized deductions on their federal tax returns during retirement. Itemized deductions such as mortgage interest, health care costs (only amounts over 7.5% of adjusted gross income can be deducted), state taxes, and donations can be used to offset income. The IRS does not consider withdrawals from a Roth IRA to be income, so itemized deductions cannot be used to offset Roth distributions. Conversely, itemized deductions can be used to offset traditional IRA distributions.

For example, an individual who converts to a Roth IRA and then has a large amount of medical expenses later in life would ultimately pay taxes up front and fail to take advantage of itemized deductions which would have reduced income taxes on traditional IRA withdrawals. In this case, the individual would have been better off deferring income taxes until he or she had itemized deductions to offset income from traditional IRA withdrawals.

Not sure of the value of your future itemized deductions? A great strategy would be to convert a portion your traditional IRA to a Roth IRA to achieve “tax diversification.” A tax diversified individual would have the option of withdrawing money from a traditional IRA account in years when there were itemized deductions to offset the income, or taking tax-free withdrawals from the Roth account in years when itemized deductions were not available. If you need help identifying the best strategy for you, give me a call.

For more information, visit http://www.utahfinancialadvisor.blogspot.com.

Thanks to Walt Bleak for collaborating with me on this subject!

About the author

Lon Jefferies, CFP®, MBA

Lon Jefferies is an investment advisor representative with Net Worth Advisory Group, a fee-only financial planning firm in Salt Lake City, Utah. He is a Certified Financial Planner (CFP®) and a member of the National Association of Personal Financial Advisors (NAPFA). He possesses an MBA and bachelor's degrees in Finance and Marketing from the University of Utah. Lon writes articles for local magazines such as Utah CEO, Business Connect and Utah Business Magazine, and he consistently contributes articles to online magazines such as FIGuide.com and FILife.com (by The Wall Street Journal). Additionally, Lon is an expert author at EzineArticles.com. Lon has been quoted nationally in publications such as the NY Times and Investment News.

Lon can be contacted at (801) 566-0740 or lon@networthadvice.com. Learn more about Net Worth Advisory Group at http://networthadvice.com and visit Lon's blog at http://www.utahfinancialadvisor.blogspot.com.

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