By Sarah Brenner, JD
Director of Retirement Education
The clock is ticking if you are considering converting your Traditional IRA to a Roth IRA in 2020. More IRA owners are making this move this year as historically low tax rates and COVID-related income losses have combined to make this an ideal time to trade off the tax hit of a conversion for the promise of future tax-free Roth IRA earnings. Before you make your move and do a 2020 conversion, here are 10 things you must know:
1. Anyone with an eligible retirement account can convert. A long time ago (before 2010) there used to be income limits on conversions. Those days are long gone, but some still haven’t gotten the message. Anyone with an eligible retirement account can convert to a Roth IRA. If you have a traditional IRA, you have the opportunity to convert it.
2. Deciding to convert is an art, not a science. There is no easy answer to the question of whether you should convert. While software can be helpful, it does not tell the whole story. You must weigh factors such as current tax brackets, your time frame and your comfort level with an immediate tax bill.
3. It’s not all or nothing. If you are unsure that conversion is for you, you can ease into it. It is not all or nothing. Consider a partial conversion in 2020 and maybe more in future years.
4. There will be a tax bill. Yes, conversion almost always comes with a tax bill. Get ready. Also, be sure you understand that the pro rata formula applicable to traditional IRA distributions also applies to conversions – meaning you cannot just convert any basis you may have in your traditional IRAs and leave the taxable funds behind.
5. There will be some side effects. Because a conversion is included in income it can affect things like financial aid for college, the taxation of social security, and Medicare surcharges. Its best to understand all of this before going forward rather than have surprises later.
6. The trade-off is worth the temporary pain. Any increase in income due to a conversion would only happen in 2020, the year of the conversion. The trade off is no more taxable IRA distributions down the road to raise income in retirement years.
7. Watch the deadline. If you want to do a 2020 conversion, the funds must leave the traditional IRA by December 31, 2020. Don’t wait until the last minute. You may be out of luck as some custodians impose earlier deadlines to ensure transactions get done.
8. There are no do-overs. You will want to be sure that conversion is the right move for you. That is because there are no do-overs. The ability to undo a conversion (recharacterization) is gone now. It was eliminated as part of the tax reform law effective for 2018 conversions.
9. You can still contribute. Don’t miss out. If you are eligible you can convert and still make a 2020 Roth IRA tax year contribution. You can do both in the same year.
10. Your pay-off is tax-free distributions. Keep your eyes on the prize. While conversion may be a hard decision and may cause some tax pain in 2020, the end result is worth it. You will have years of both tax-free Roth IRA growth and distributions ahead.