Is there enough money available outside the IRA to meet needs?
Roth IRAs do not have required minimum distributions. For investors who wish to leave their traditional IRAs to their heirs, they can convert them to Roth IRAs, pay the resulting tax bill, then leave the assets untouched to be passed on.
How does the current tax bracket compare with what's expected in the future?
Investors who expect their tax rate to be lower in the future -- say, due to retirement -- may end up paying higher taxes now through a conversion than simply paying taxes later when they receive distributions. On the other hand, investors who expect their tax rates to increase -- say, young investors who expect their earning power to increase -- may see a substantial benefit by paying a lower tax rate now and letting their assets grow tax free.
How much time is given to pay the tax bill resulting from a conversion?
As mentioned earlier, tax liabilities for conversions occurring in 2010 can be stretched over a two-year period. Regardless of when the conversion occurs, the tax bill will come due. To get the most benefit out of the conversion, those tax liabilities should be paid using outside dollars, not money currently in the IRA, which could be subject to early withdrawal penalties. Another option is to do a partial conversion if the money is either not available to comfortably pay the conversion taxes, or if a full conversion results in moving to a higher tax bracket.
Will the IRA be left to charity?
Donating an IRA to charity is a tax-free event. In this case, it would not be prudent to convert to a Roth because this would create an unnecessary tax bill.
What if husband and wife want to convert? Each IRA is tied directly to the Social Security number of the account owner. If a husband wants to convert his IRA and the wife doesn't, that's okay. Also, if both want to convert in 2010, they don't have to choose the same method for paying the resulting tax. The husband can opt to stretch his tax liabilities over 2011 and 2012, while the wife can pay the resulting tax all in 2010 (or vice versa).
Am I taking the homebuyer tax credit?
The homebuyer tax credit ($8,000 for first-time buyers, $6,500 for repeat buyers) is subject to income limitations. Doing a Roth conversion means seeing an increase in taxable income. If these two factors aren't considered simultaneously, it could jeopardize tax credit eligibility.
Tomorrow, we'll summarize and leave you with a few last-minute items on conversions.
Follow the series: Roth IRA Conversions