Dear Rick:
I was at a library talk you gave a few weeks ago and one of the items you talked about was that people should look at potentially converting some of their traditional IRAs into a Roth IRA. I sat down with my accountant and had him compute the numbers. He told me that because of my income I could only convert about $10,000 in order to stay in the same bracket. With Michigan taxes and federal taxes, it’ll cost me about $3,500 in taxes. My question is where best to get this money? The two options I have are to either take a little larger IRA distribution and use the extra money to pay the tax, or to take the money from my personal checking account. My question to you is which option do you think I should take? My next question is I want to do another Roth conversion next year. It is best to wait until the end of the year or should I do it at the beginning of the year?

Thank you.

Ralph

Dear Ralph:
First, I think it is great that you’re doing a Roth IRA conversion. I think it is an excellent strategy and something more people should take advantage of. After all, if you can turn tax-deferred money into tax-free money, why not.

With regards to paying the taxes there’s no doubt in my mind that you should take it from your checking account. The reasoning is quite simple, and that is if you take an additional amount of money from a traditional IRA and use that to pay your taxes, you are taxed on the distribution. On the other hand, if you took the money from your checking account there would be no additional tax liability.

What many people forget about is when you do a Roth conversion there is a tax liability. That is why I always tell people that one of my rules of converting is that you must have the money available to pay the taxes without touching any of the money that you are converting. In addition, if you did withdraw extra money from an IRA for the conversion and you are under 59½, then in addition to the tax on that money you would also have to pay a penalty. Therefore, to make things easier you should always plan to pay your tax liability if you do a Roth conversion with non-IRA money.

With regards to timing of a Roth conversion, my general rule is I want to do it sooner than later. My reasoning is very simple and that is the sooner you convert, the more time your money has to grow tax free versus tax deferred. Therefore, if all things are equal, I would do my Roth conversion at the beginning of the year rather than at the end of the year.

If you do decide to do a Roth IRA conversion at the beginning of the year, make sure that if you need to make an estimated payment for your tax liability that you do so. So many people are under the mistaken belief that they can wait until the following April to pay the tax; unfortunately, that is not the case. As I’ve mentioned many times in the past, taxes are due on a quarterly basis and therefore, if you do a Roth conversion in the first quarter of 2018, it is important to look at your income tax situation to make sure you don’t have to make an estimated payment.

There is still time before the end of the year to do a Roth conversion; however, the clock is ticking. Remember, the Roth IRA conversion must be completed before the end of the year, and there are no extensions. Thus, if you are thinking about doing a Roth conversion, you should contact you IRA custodian as soon as possible so the transaction can be completed in plenty of time.

Good luck!

If you would like Rick to respond to your questions, please email Rick at rick@bloomassetmanagement.com.