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How to Convert to a Roth IRA By: Guy Hockerman, CPA, CFP® Senior Vice President, Financial Planning Manager
If you haven’t considered including a Roth IRA in your retirement planning, perhaps now is a good time to do so. The recent tax law changes and volatile market conditions may make a Roth IRA even more attractive for your portfolio. With the lure of tax-free distributions, Roth IRAs have become increasingly popular retirement savings vehicles.

Convert an IRA
You can convert your eligible IRA assets to a Roth IRA regardless of your income level or marital status. While Roth IRAs can be attractive retirement planning tools under the right circumstances, there are important considerations you should take into account before converting to ensure it’s the right move for you. Creating a tax-free source of income is tempting, but first it’s important to talk with your tax professional and advisor regarding your personal financial situation.

CONSIDERATIONS BEFORE CONVERSION
Do you have funds available to pay the conversion tax? When you convert eligible assets to a Roth IRA, you have to pay taxes on the accumulated earnings and contributions that you took tax deductions on in previous years. Additional taxes created by the Roth conversion should be paid with available funds other than the converted IRA or other tax-deferred accounts. The larger the conversion and the higher your tax bracket, the greater the need for access to cash to pay the tax bill.

How much time do you have before you take distributions? The more time you have before distributions, the more favorable a conversion. Because Roth IRAs grow tax-deferred with no tax due on qualified withdrawals, the power of compounding tax-free generally outweighs the immediate cost of paying tax up front. Remember, Roth IRAs are not subject to distribution rules until they are passed on to a beneficiary, so withdrawals can be completely discretionary during retirement.

What’s your tax liability? Similar or higher future income tax rates will favor a conversion. Ideally you want to know the tax you will pay in the year of conversion versus what tax you would have paid if you had not converted and the timing of those tax payments. That’s impossible to know because the tax you pay in the future will depend not only on tax rates but also on your entire financial picture in retirement—your sources of income and deductions. If you are in your prime earning years today and you truly expect your tax rate to go down dramatically in retirement, consider holding off on a conversion until you hit those low tax years or perhaps bring in taxable IRA distributions to fill up lower tax brackets.

Is the majority of your retirement savings in tax-deferred accounts? The decline of the traditional pension plan has shifted the retirement savings burden from employer to employee. As a result, many employees are accumulating the bulk of their retirement stash in tax-deferred retirement plans. A Roth conversion with at least a portion of those assets may offer you more flexibility down the road to meet lifestyle and estate planning objectives without triggering income taxes with every withdrawal. You are in essence diversifying the tax attributes of your retirement resources.

Do you want to leave your IRA as an inheritance? Distributions from a Roth IRA to your non-spouse heirs can be deferred up to ten years—and still without income taxes upon withdrawal. When the tax on the converted Roth amount is paid, you have made a tax-free gift of future growth. The ultimate value of that gift is driven by how the account grows, both in your hands and in the hands of your heirs.

IRAs in Retirement

FUNDING A ROTH IRA
There are three ways to fund a Roth IRA: contribute directly, convert all or part of a traditional IRA to a Roth IRA, and roll funds over from an eligible employer retirement plan into a Roth IRA.

For 2020, the total contributions you make each year to all your traditional IRAs and Roth IRAs can’t be more than $6,000 ($7,000 if you’re age 50 or older), or if less, your taxable compensation for the year. The IRA contribution limit does not apply to a conversion or to rollover contributions. Also, beginning in 2020, there is no age limit on making regular contributions to traditional or Roth IRAs.

COMPLETING THE CONVERSION
If you determine a conversion is right for you, the process is relatively simple. You start by notifying your existing traditional IRA trustee or custodian that you want to convert all or part of your traditional IRA to a Roth IRA, and the financial institution will provide you with the necessary paperwork. You can also open a new Roth IRA at a different financial institution and then have the funds in your traditional IRA transferred directly to your new Roth IRA. The trustee or custodian of your new Roth IRA can give you the paperwork you need to do this.

IS A ROTH IRA CONVERSION RIGHT FOR YOU?
Determining whether a Roth conversion is right for you depends on many factors, including your current and projected future income tax rates, the length of time you can leave the funds in the Roth IRA without taking withdrawals, your state’s tax laws, and how you’ll pay the income taxes due at the time of conversion. Contact Commerce Trust Company today—we can help you evaluate your personal financial situation, explore your options, and determine if a conversion should be part of your retirement and estate planning strategies.

¹Source: Holden, Sarah, and Daniel Schrass. 2019. “The Role of IRAs in US Households’ Savings for Retirement, 2019.” ICI Research Perspective 25, no. 10 (December). 

The opinions and other information in the commentary are provided as of October 1, 2020. This summary is intended to provide general information only, and may be of value to the reader and audience.

This material is not a recommendation of any particular investment or insurance strategy, is not based on any particular financial situation or need, and is not intended to replace the advice of a qualified tax advisor or investment professional. While Commerce may provide information or express opinions from time to time, such information or opinions are subject to change, are not offered as professional tax, insurance or legal advice, and may not be relied on as such.

Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Commerce Trust Company is a division of Commerce Bank.

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ABOUT THE AUTHOR

Guy Hockerman, CPA, CFP® Senior Vice President, Financial Planning Manager Commerce Trust Company
Guy is a financial planner manager for Commerce Trust Company. He is a member of the financial advisory services team — a dedicated financial planning practice within Commerce Trust that provides objective financial advice to clients.

Following a thorough assessment of a client’s unique situation and thoughts regarding wealth, Guy develops holistic and coordinated plans to help clients meet their short-term and long-term goals as well as take full advantage of various planning, tax, and investment strategies along the way.

With more than 20 years of financial planning experience, he is responsible for providing quality advice to clients and prospects of Commerce Trust. Holding both Certified Public Accountant and CERTIFIED FINANCIAL PLANNER™ designations, Guy’s extensive experience in financial planning includes working for banking and accounting institutions as a financial planner and tax advisor. His expertise includes planning for financial independence, executive compensation, estate preservation, philanthropy, and business succession.

Guy received his Bachelor of Administration in business and economics from Wheaton College. Guy is a member of several organizations, including the Financial Planning Association and the American Institute of Certified Public Accountants. Guy speaks and writes regularly on financial issues and has served as a faculty member for ABA National Graduate Trust School. Guy serves as a board member at Riverside Church in Webster Groves. Additionally, he is a K-1st grade Sunday school teacher and men's ministry leader at church. Guy enjoys spending time outside running, hiking and fishing.
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