Deciding whether to roll over to a Roth IRA.

• Author: Ellentuck, Albert B.
• Position: Individual retirement account

Taxpayers must consider AGI-sensitive deductions and credits, Social Security income, possibilities of future changes in tax policy, and Medicare premiums before completing a Roth IRA rollover.

It is impossible to reach a single conclusion that applies to all taxpayers when deciding whether to roll over a traditional IRA or qualified plan account into a Roth IRA. Whether it makes sense to trigger the resulting tax liability depends on factors such as how long the taxpayer intends to leave the funds in the Roth IRA, what the taxpayer's tax rate is now and what it will be when withdrawals are taken, and whether the taxpayer will have to use the funds from the IRA or qualified plan account to pay the tax due at conversion. As with most tax planning alternatives, the practitioner should calculate the numbers before deciding on a particular strategy.

Taxpayers will generally benefit from converting funds to a Roth IRA if all of the following conditions apply:

* The taxpayer (or beneficiary) will not need to take withdrawals from the Roth IRA for at least 15 to 20 years;

* The taxpayer's (or beneficiary's) tax rates when withdrawals are taken are no less than they are at the time the conversion occurs; and

* The taxpayer can pay the tax due on the rollover with funds outside the IRA or qualified plan.

Other factors and practical considerations that should be addressed or discussed with the client include the following.

Paying the tax with funds outside the IRA or qualified plan is generally necessary to making the rollover economically beneficial. If a taxpayer does not have available funds, it is unlikely a rollover will make economic sense (because the funds withdrawn from the IRA or plan and used to pay the tax are subject to income tax and, in many instances, the 10% premature distribution penalty). Practically speaking, many taxpayers may not have outside funds available to pay the tax on a conversion that results in significant taxable income.

Income generated from a conversion may create unexpected tax consequences. For example, items sensitive to changes in adjusted gross income (AGI) (e.g., itemized deductions, the child credit, education credits, etc.) may be adversely affected because of the increase to AGI caused by the IRA conversion income.

This case study has been adapted from PPC's Guide to Tax Planning for High Income Individuals, 17th edition (March 2016), by Anthony J. DeChellis and Patrick L. Young. Published by Thomson...