Investors facing the Roth-conversion decision tend to see it as an either/or proposition: keep everything in the traditional IRA, or convert everything into a Roth.
But there’s a third option: leaving some money in the traditional IRA while converting the rest.
The most obvious reason would be to prevent the conversion from kicking you into a higher tax bracket. Income tax must be paid on deductible contributions and investment gains, and these sums are added to your taxable income. If converting everything would boost you from a 15% to 25% tax bracket, it could make sense to limit the conversion so you can keep the lower tax rate.
Many people doing that plan a sequence of conversions over several years until everything is moved into the Roth.
But it may be worth thinking about leaving some of your funds in the traditional IRA for good, to hedge against the uncertainty over future tax rates.
Generally, a Roth conversion makes sense if you expect to be in a higher tax bracket in retirement, since you could pay tax at today’s lower rate to avoid a bigger tax later. But if you expect your tax rate to fall, you’d pay less by sticking with the traditional IRA and paying at the lower rate when you make withdrawals later.
The problem is that, even if you can predict the size of your taxable income in retirement, no one knows what the tax laws will be in five, 10, 20 or 30 years. In the worst case, Washington could change the rules to give you a higher tax rate even if your income goes down.