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Series 7 practice questionhardRetirement Accounts — Roth Conversion Scenario

A 55-year-old client with a high current income but expecting significantly lower income in retirement is considering converting her Traditional IRA to a Roth IRA. Which of the following is the most important consideration?

  1. AThe converted amount will be subject to ordinary income tax in the year of conversion, increasing her tax liability in a high-income year✓ Correct answer
  2. BRoth conversions are not permitted after age 50
  3. CRoth IRAs have lower contribution limits than Traditional IRAs
  4. DThe conversion will trigger a 10% early withdrawal penalty
Explanation

Why A — The converted amount will be subject to ordinary income tax in the year of conversion, increasing her tax liability in a high-income year

When converting a Traditional IRA to a Roth IRA, the entire converted amount is treated as ordinary income in the year of conversion. Since this client currently has a high income, the conversion would be taxed at her high marginal rate. It may be more tax-efficient to wait until retirement when her income (and tax bracket) is expected to be lower. There is no age restriction on Roth conversions, and the 10% penalty does not apply to conversions (though it may apply to converted amounts withdrawn within five years).

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