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Factor status into Roth conversion

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Have you contemplated a Roth IRA conversion but failed to pull the trigger? There may be plenty of reasons, including the high tax price owed on a conversion.

Strategy: Re-examine your situation in 2017. In particular, if you’re married and one spouse is in ill health, you might want to convert sooner rather than later.

Essentially, a Roth conversion may make sense while you’ll still benefit from joint tax rates.

Here’s the whole story: With a traditional IRA, contributions may be wholly or partially deductible, but deductions aren’t available to higher-income individuals. When distributions are received, you’re taxed at ordinary income rates on the portion representing deductible contributions and earnings. Currently, the top federal income tax rate is 39.6%, although this rate may be lowered if proposed tax reforms are enacted in 2017.

Conversely, contributions to a Roth IRA are never tax deductible, but qualified distributions from a Roth are 100% tax free. For this purpose, “qualified distributions” include payments made after age 59½; on account of death or disability; or used for first-time homebuyer expenses (up to a lifetime limit of $10,000), as long as you’ve had at least one Roth account open for more than five years. Thus, the main tax attraction of Roth IRAs is on the back end when you can receive tax-free qualified distributions.

Of course, you must pay tax on a conversion, and therein lies the problem. The federal income tax liability is based on the amount transferred to the Roth account on the date of the conversion. Plus, the conversion could trigger or increase the 3.8% tax on “net investment income” (NII). That could be enough to steer some high-income taxpayers away.

But consider all your personal circumstances. For instance, suppose one spouse is gravely ill. In that case, the tax on a conversion under the current tax rate structure for joint filers could be far less than the tax for a surviving spouse using the rate structure for single filers in the future. Typically, couples in higher tax brackets would be affected.

Also, consider possible tax rate reductions, including a repeal of the NII tax. This creates an added incentive for conversions in 2017.

Finally, if you subsequently decide a conversion wasn’t the best move, you can undo it. In fact, you have until Oct. 15, 2018, to reverse a 2017 conversion.

Tip: You still might wait until retirement to convert if you’ll be in a lower tax bracket then.

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