A Roth IRA conversion is an interesting opportunity. When you first deposited to your IRA, you may have had the chance to choose between the Traditional IRA or the Roth. While your investments may have been chosen for the long term, the choice of Traditional IRA did not have to be forever. You have the opportunity to convert, any or all of your Traditional IRA to a Roth, and if any of your IRA deposits were post-tax money, the tax due for the year of conversion is prorated. For example, say you have a total Traditional IRA balance of $100,000, and you’ve tracked the amount you were not allowed to deduct on form 8606 over the years, and this figure is $20,000. Now, you decide to convert $10,000 to a Roth IRA. Since 80% of your account is pre-tax money, 80% of that $10,000 conversion is subject to tax at your marginal rate.
Why convert at all? Good question. You’re a couple with taxable income in the $71K+ range, in other words, you last taxable dollars are taxed at 25%. This year, one of you has some time between jobs and you realize your 2012 taxable income will be below $70,700, or 15% marginal. So you convert just enough to end 2012 at exactly $70,700, the converted amount being taxed at 15%.
Another thought – your company offers good matching on the 401(k), but by putting in as much as you can, you find the pretax deposits drop you into the 15% bracket. So you use the same strategy of converting to increase your taxable income and top off that 15% bracket. The best thing about the Roth Conversion is that you are in control of the timing. It offers a way to smooth out your taxable income a bit to help keep you from hitting the next marginal bracket (by simply staying with pretax savings) or to top off your current bracket by converting in low income years.
These are just two illustrations of how a conversion might make sense for you. Have you thought about converting your IRA to a Roth?