Investing in a traditional IRA while earning a paycheck is a good way to defer income taxes on the money you contribute. Currently, taxpayers who aren’t covered by a retirement plan at work may deduct the full amount of their annual contributions to a traditional IRA.
Those who do participate in a work plan may be able to deduct partial contributions, subject to the following income limits:
|Filing Status||Modified AGI||Deduction Status|
|Single, Head of household,|
or Married filing separately and did not live with spouse at any time during year
|$61,000 or less||Full deduction up to contribution limit|
|$61,000 to $70,999||Partial deduction|
|$71,000 or more||No deduction|
|Married filing jointly|
or Qualifying widow(er)
|$98,000 or less||Full deduction up to contribution limit|
|$98,000 to $117,999||Partial deduction|
|$118,000 or more||No deduction|
|Married filing separately||Less than $10,000||Partial deduction|
|$10,000 or more||No deduction|
So, after years of contributing to a traditional IRA, why would anyone convert it to a Roth IRA before retiring? First of all, if you anticipate that income tax rates will increase in the future, you can avoid that bill on your retirement income by paying at a lower rate now. Second, some individuals make the conversion when they’re already retired and in a lower tax bracket. This could benefit their eventual beneficiaries who are in a higher tax bracket. However, converting may not be a good move if individuals or their beneficiaries expect to be in a lower tax bracket when the funds are distributed in the future.
The issue at hand is that contributions in a traditional IRA grow tax-deferred until distributed. Contributions to a Roth are taxed up front, grow tax-free and then are distributed tax free. So the decision to convert depends on when the individual expects to receive the funds and what tax bracket they expect to be in when that happens.
There are a few strategies a traditional IRA investor can use to help mitigate future tax bills. One is to make the conversion gradually, moving over just enough money each year to stay within the current tax bracket. Also, it may be worth considering converting before the investor turns 70 ½ to avoid having to take a taxable required minimum distribution (RMD) first.
And finally, be aware that while traditional IRA RMDs begin at age 70 ½, an individual can convert the funds to a Roth IRA at any age thereafter. A Roth IRA does not require minimum annual distributions.
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