Why Convert an IRA to a Roth?
The Internal Revenue Service allows you to convert money in a tax-deferred individual retirement account to a Roth IRA. You can do this either through a rollover or a transfer. However, simply because the IRS permits you to convert does not mean that you should. When you convert, you have to pay taxes on the amount converted.
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Lower Taxes at Retirement
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For most people, the most important difference between tax-deferred IRAs and Roth IRAs is that you do not have to pay income taxes on the qualified distributions from Roth IRAs. This means it makes the most sense to convert money to a Roth IRA if you expect that you will be paying a higher income tax rate at retirement, when the Roth IRA withdrawals come out tax-free, than the present year, when the conversion will be taxed.
No Mandatory Distributions
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If you do not want to have your IRA subject to required minimum distributions, rolling it over to a Roth IRA solves this problem. Unlike tax-deferred IRAs, which require you to start taking distributions in the year you turn 70 1/2, Roth IRAs never force you to remove money from the account. This gives you more flexibility as to when you use the money and allows you to take advantage of the tax-deferred growth for a longer period of time.
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Tax-Free Distributions for Heirs
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When you die, if you have a traditional IRA your beneficiaries will have to pay income taxes on the distributions they take. However, if you convert your tax-deferred IRA to a Roth IRA, when you die and the Roth IRA goes to your beneficiary, your beneficiary will be able to take money out of the Roth IRA without paying any income taxes. However, this does not mean that a Roth IRA is exempt from the estate tax, if applicable.
Non-Refundable Tax Credits
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If you have nondeductible tax credits that reduce your income tax liability below zero, you will not be able to claim the full value of those credits unless you increase your tax liability. For example, if you have a tax liability of $2,000 but $2,500 in non-refundable tax credits, you would not be able to take advantage of the last $500 of tax credits. However, if you roll over enough money from your traditional IRA to a Roth IRA, you would be able to use that $500 to offset your additional income tax rather than it going to waste.
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