Last week, we revisited the idea of converting traditional IRA dollars to a Roth IRA. We discussed who we feel would do well to convert and who shouldn’t convert. This week we will speak to those who are considering converting (deadline for a 2012 conversion is 12/31/12).

Partial Roth Conversions

For many people, converting all of the dollars in your traditional IRA is infeasible. Maybe you don’t have enough cash on hand to pay for the taxes generated or maybe the conversion will push you into a higher tax bracket. Whatever the reason, don’t let it stop you from doing a conversion this year.

A partial Roth IRA conversion is just how it sounds: instead of converting your entire traditional IRA, you convert only a portion of the dollars to a Roth IRA. This option can be very attractive to many, especially those that may have a large traditional IRA account.

When a Partial Conversion Makes Sense

There are a few situations where a partial conversion can make the most sense:

  • When you can’t afford the tax on a full conversion – Since you will be paying income tax on the converted dollars, converting an entire account can create a pretty hefty tax bill for you. If you feel conversion makes sense for you, but you only have enough cash on hand to pay the tax on a partial conversion, go ahead and do the partial conversion. You don’t have to wait until you have enough cash on hand to do a full conversion.
  • When a full conversion pushes you into the next tax bracket – This point can get complicated depending on your income, deductions, etc. If you have a $50,000 IRA you want to convert, but you are $20,000 away from the next tax bracket, adding those extra dollars in income will push you into the next tax bracket. You will then be paying more in taxes on those dollars (which no one wants!). Instead, figure out how much you can convert while still keeping yourself within your current tax bracket.
  • When your current income/tax situation allows you to convert without paying any tax – For some people, between their income, deductions, etc., converting traditional IRA dollars to a Roth IRA will not cost them anything in taxes. This is because their current income vs. deductions, etc. eliminates all their tax liability, allowing some wiggle room for conversion dollars to be added to their income. If you are in this situation and are interested in converting, don’t let the opportunity pass you by!

Tips for a Partial Conversion

Before making the final decision to do a partial conversion, please take the following into consideration:

  • Reevaluate your situation every year. If you convert $10,000 this year, don’t assume you should do the same next year. You may be able to convert more or may have to do less.
  • Talk with your tax advisor before making a move. Partial conversions can become complicated, especially for those with more complex tax situations. Never make a conversion unless you know for sure that the tax consequences will be.
  • Keep your Traditional IRA and Roth IRA Conversion at the same investment institution. This often simplifies both paperwork and reporting and makes partial conversions over several years easier to manage.
  • Keep recharacterization in mind. If you make a partial or full conversion by the 12/31/12 deadline, and for any reason decide it was not the right decision, you have until 10/15/13 to recharacterize that account, which simply means the converted dollars will be moved back into your traditional IRA and you will not owe any tax.

 

  • Disclaimer: The information on this blog is not meant for specific financial advice. The ideas/opinions stated are not suited for everyone, and readers should use their own judgment in applying them in their financial lives.

 

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