Roth Rules for Retirees: What Should You Convert?


With 2010 fast upon us, the option of converting a traditional IRA into a Roth IRA opens up for millions of investors no longer barred by the $100,000 income limit. Now begins the tricky process of choosing which investments to convert, and when.

That’s no problem for anyone who has decided to convert all traditional IRAs into Roths at once. But many investors will shy away from this because the tax bill would be too high, or because the conversion would lift them to a higher tax bracket.

Others may want to hedge their bets. Conversions make the most sense for people who expect to be in higher tax brackets when they withdraw IRA funds in retirement. Investors who think this could be the case, but aren’t sure, can better control future tax bills by keeping both types of IRAs. That way they will be able to take tax-free money from their Roths in high tax years, and from their traditional, taxable IRAs in years when taxes are low.

Anyone doing a partial conversion must decide which traditional IRA accounts, or which assets in those accounts, should be moved into a Roth. Should it be the big winners or the big losers, for instance?

First, let’s talk about what you cannot do: cherry pick candidates to minimize or eliminate the conversion tax. That would be possible if each converted asset were taxed individually. You could then convert a holding that had lost money, like the United States Natural Gas ETF (Stock Quote: UNG), down about 55% this year, so there would be no tax.

But the rules don’t allow that. Instead, all traditional IRAs are lumped together to determine what percentage is taxable. That is the portion attributed to deductible contributions and investment gains. Non-deductible contributions are not taxed upon conversion. If 80% of all your IRA holdings are taxable, 80% of your converted amount is taxed, even if the conversion is from a single, relatively new IRA composed entirely of non-deductible contributions.

So choosing a conversion candidate has no effect on the immediate tax bill. It could, however, have a big effect on future taxes if you intend to keep some of your holdings in a traditional IRA, as withdrawals from that account will be taxed.

In a partial conversion, it makes sense, then, to put into the Roth the holdings that would create the largest tax bills if left in the traditional IRA.

If a $10,000 stock fund grows to $30,000 over the next 15 years, you would face income tax on the $20,000 gain if the fund were kept in a traditional IRA. That gain would be tax-free in a Roth.

Because of the way IRAs are lumped together to figure conversion tax, it doesn’t matter whether an individual holding has made money or lost it in the past. But a money-losing investment would be a good candidate for conversion if you thought it would rebound. If you don’t expect that, it should probably be sold and the proceeds used for a new investment in either the traditional or Roth IRA.

It also does not matter whether an investment is likely to produce profits through long-term capital gains, short-term gains, interest or dividends. Though each type of profit is taxed differently in a taxable account, they are all taxed as income in a traditional IRA or upon conversion.

So the bottom line is that investments likely to produce the biggest gains are the best conversion candidates, regardless of what they’ve done in the past.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at

Show Comments

Back to Top