To Convert or Not to Convert

This year marks a turning point for retirement plan holders. Those who were previously unable to convert to a Roth IRA because of the $100,000 income restriction will now have an opportunity to switch over when the cap is lifted. Before deciding to convert, however, there are several considerations to make.

“One should always consult with his or her tax advisor prior to converting to a Roth IRA to be sure that the Roth IRA is appropriate for their given circumstances,” says Sarah Place, President and CEO of Place Trade Financial, Inc., in Minneapolis.

Make these considerations to determine if converting to a Roth IRA is right for you:

How long will it be before you retire?

Place says that if you have more than five years before retirement, you’ll benefit from converting to a Roth, but she mentions that some experts suggest a minimum of 10 years to reap the most benefits.

According to Rob Stenzel, Senior Financial Consultant and Vice President with First Midwest Bank, five to 10 years is a significant amount of time to let your money grow, but if you have less than that before retirement, switching might not make much of a difference. In addition, you’ll have the added responsibility of having to pay all the taxes on the amount of your traditional IRA funds that you convert.

What kind of tax bracket will you be in during retirement?

If you’re going to be in a higher income tax bracket during retirement, switching to a Roth IRA is an easy choice, Stenzel says.

“Paying taxes at 20% today is better than paying taxes at 30% tomorrow,” he says.

However, if you anticipate being in a lower tax bracket during retirement, Stenzel advises not to convert because it’s better to pay lower taxes down the road rather than higher taxes now.

If you’re unsure about your future tax bracket, Stenzel says to estimate what your income will be from your retirement assets, including factors such as a pension, 401(k), Social Security or a potential side job. With various assets, some people could potentially make more income during retirement. Some assets, such as your pension and your Social Security, are set amounts, but Stenzel recommends speaking with a financial advisor to discuss how much you’ll be taking out of your taxable retirement accounts because your decision can dictate the tax bracket you’ll end up in.

But, if you don’t want to make an assumption on the future, Stenzel recommends splitting the difference and converting only a portion of your traditional IRA to a Roth IRA. This is the most conservative method because “you’re sort of hedging yourself,” Stenzel says. “Whether the tax rates go up or down, you’ll protect yourself.”

The only real risk is missing out on more money in the long run. For instance, if tax rates go up in the future, you miss out on converting to a Roth IRA and paying the lower taxes on all of your money rather than only half.

Stenzel recommends discussing with a First Midwest Financial Consultant or a First Midwest Wealth Management Advisor about how much you should split between conversion to a Roth IRA and staying with your traditional IRA because the best decision depends on the individual and his or her situation.

Can you afford to pay the taxes on your existing IRA in the near future?

Because you haven’t been paying taxes up to this point, you’ll be responsible for paying them on the money you’re converting. Luckily, if you convert this year, you’ll be able to spread your tax bill over a two-year period, paying one half on your 2011 tax return and the other half on your 2012 tax return.

“This is a one-time special opportunity,” Place says. “If [you] choose to convert before or after 2010, [you] will be required to pay the entire tax bill in the year that they convert to the Roth IRA.”

How are you planning your estate?

You are never required to take distributions from a Roth, but you must take distributions from a traditional IRA or you’ll face penalties from the IRS. If you have another source of income during retirement and don’t need to make distributions from your IRA, or if you’re planning on leaving all your retirement funds to your family or other beneficiaries, Place advises switching to a Roth. 

You are leaving the First Midwest website.

Redirecting to

This is a link to a third-party site. Note that the third party's privacy policy and security practices may differ from First Midwest Bank's standards. Complete details regarding third-party links are available in our Terms of Use.