As a CPA I recommend moving your traditional IRA into a Roth might be a very smart move for you. Roth IRS’s grow untaxed, which is not so for conventional IRAs, where you pay tax when you start tapping them.
How do you convert a traditional individual retirement account to a Roth IRA? It is best to consider doing a Roth conversion when your current tax bracket declines temporarily below the bracket you expect to be in when you will need to make withdrawals. Discuss this with your CPA prior to conversion.
Examples of two ways you might suddenly find yourself in a lower tax bracket are losing a job or having a bad year in a business you own. An unfortunate scenario I see every day as a CPA.
The strategy is to estimate how much additional income would bring you to the top of the lower income tax bracket, then convert that amount from a traditional IRA into a Roth IRA. You will pay tax on the amount converted just as if you had made a withdrawal from the IRA, without the early withdrawal (before age 59½) penalty of 10%. To make this strategy worthwhile, it is very important that the dollars used to pay the income tax on the converted amount come from a source other than the IRA.
As a CPA I explain to my clients that the biggest challenge of negotiating a Roth conversion is knowing what your income will be for the year. This is something a person often doesn’t know until late in December, which is often too late for most custodians to start the mechanics of a conversion.
There is an easy fix for this, according to Gustavo A Viera, a Miami CPA. Deliberately convert more than enough to fill the income gap to the next bracket. Then, when you or your CPA finishes your tax return, simply send any excess amount converted back to your IRA. This is known as a Roth re-characterization.
There are a few things you need to do in order to make a re-characterization work. You need to put the conversion amount into a separate Roth IRA, not commingle the funds with an existing Roth IRA. You also need to send the funds back to your traditional IRA by Oct. 15 of the following year.