The Tax Benefits of Converting From a Traditional IRA to a Roth

by Mark Kennan

In 2010, the Internal Revenue Service removed all income restrictions that prevented people from converting a traditional IRA to a Roth IRA. That does not mean that a Roth IRA is automatically in your best financial interests, but depending on your circumstances, a conversion to a Roth IRA offers several benefits.

Lock In a Lower Tax Rate

The drawback to a Roth IRA conversion is that you must pay income taxes on the amount of the conversion. However, paying the taxes in the year of the conversion allows you to lock in a potentially lower tax rate. By making the conversion, you eliminate the uncertainty of how high tax rates could climb in the future, which makes it easier to budget for your retirement needs. For example, if you have a year where you take a severe cut in pay so that you fall in a low tax bracket, converting your traditional IRA to a Roth IRA locks in that low rate.

Tax-Free Qualified Distributions

Though you must wait five years from the date of the conversion, and be at least 59 1/2 years old to take qualified distributions, once you qualify you can remove the contributions and earnings from the Roth IRA without paying any income taxes. You can also leave the Roth IRA as an inheritance for your heirs so that they do not have to pay the income taxes on the distributions, either. If you left the money in your traditional IRA, you would have to pay taxes as you, or your heirs, distributed the money from the account.

Avoiding Mandatory Distributions

The IRS requires owners of traditional IRAs to remove money from their accounts beginning in the year they turn 70 1/2. When you remove money, it no longer grows tax-sheltered; this can be detrimental to the growth of your investments if you have to remove money when you do not need to. When you convert your Roth IRA to a traditional IRA, you no longer have any responsibility to remove the money as long as you are alive. This is especially useful if you want to leave as much as possible to your heirs in a tax-sheltered account.

Special Advantages for Nondeductible Contributions

If your traditional IRA contains nondeductible contributions, you get to take the nondeductible contributions out of the account tax-free, but your earnings on those nondeductible contributions count as taxable income, even when you take qualified distributions. When you convert the money into a Roth IRA, you do not have to pay taxes on the nondeductible contribution portion of the conversion. In addition, any earnings on those nondeductible IRA contributions also come out tax-free when you take qualified distributions from the Roth IRA.

About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."