Q: As a retired couple with income from a pension and Social Security, do we have the option of converting any part of our IRA to a Roth?
A: 'Tis tax season, since I have been getting questions on the Roth IRA, the retirement savings vehicle that allows for tax-free withdrawals in retirement.
The short answer to your question is "yes." You can convert all or part of your traditional IRA into a Roth IRA. (What you can't do is put new money into any kind of IRA without earned income.)
"The longer answer is there's a lot you'll want to consider before deciding whether it makes sense to do," says Craig Bartlett, division consulting manager at U.S. Bancorp Investments.
Let's briefly touch on the specifics of a Roth conversion. A conversion means taking money from your tax-sheltered traditional IRA funded with pretax dollars and moving the money into a Roth, which is funded with after-tax dollars. (You can convert your old 401(k) or comparable employer-sponsored retirement savings plan, too.) The lure of a Roth is withdrawals are tax free. Another advantage is there is no required minimum distribution starting at age 70 ½ with a Roth, a requirement with traditional IRAs and 401(k)s. In making the conversion, you'll pay income taxes on the withdrawn tax-sheltered savings.
I've mentioned this in previous columns, but it's worth emphasizing again: In almost all cases, conversion doesn't make sense if you don't have the savings to pay the tax levy elsewhere in your household portfolio. You don't want to use your tax deferred savings in your traditional IRA to meet the government's tax bill. The alternative pot of savings is a simple, quick test to see if it's worth taking the time to run more complex conversion scenarios.
In addition, when thinking through a financial strategy like conversion, the answer doesn't only rest with the specifics of the maneuver. You shouldn't just focus on the conversion itself. It also matters how the change will affect the rest of household finances. A classic example: Let's say you have the additional savings to pay the tax bill. But does using the money to pay for the conversion drain savings that you might need for another purpose, say, in an emergency fund or to pay for the grandkids' summer camp?
"Pulling on the conversion lever will have other impacts elsewhere as well," says Bartlett.
Many people find the conversion math doesn't really work in their favor in retirement if their income is down. Still, it's always worth running the numbers with a question like yours. In this column I typically address an issue in broad strokes. Yet in the end there is always a very personal aspect to finances. You can test the idea on your own with one of the retirement calculators at analyzenow.com or tap into the expertise of a professional.
Finally, on a personal note to all readers, I hope you have a wonderful, happy New Year! And keep the questions coming in 2015. I love hearing from you.