May 13, 2024

5 Things to Know About Roth Conversions

In a previous article, we explored the benefits of Roth IRAs, particularly tax-free growth and qualified withdrawals in retirement. This article delves deeper into a powerful strategy to leverage those benefits: Roth conversions. Here are 5 things we believe you should know about Roth conversions.  

1. Tax Today, Reap Benefits Tomorrow

Traditional IRA accounts are tax-deductible but taxed later upon withdrawal. Roth IRAs pay taxes today but have tax free growth in the future and tax-free withdrawals. Roth conversions allow you to move money from your traditional IRAs to your Roth IRAs penalty free. The only caveat being you pay the income taxes on that withdrawal today rather than in the future. 

2. Strategic Timing is Key

The ideal scenario for Roth conversions is when your current tax bracket is lower than what you expect in retirement. This minimizes the upfront tax hit from the conversion. Consider factors like your current income, potential future income sources like Social Security, and projected tax rates. 

Example: John is currently in the 12% tax bracket. John’s financial plan shows that in retirement he will be in the 15% tax bracket and may even creep into the 25% tax bracket due to his pension and social security. 

John is choosing to do a Roth conversion (move a portion of his traditional IRA to his Roth IRA) in his current 12% tax bracket vs potentially pulling out money at the 15% or even 25% bracket.  

3. Chunking for Comfort 

If the upfront tax implication of a large conversion gives you pause, you can consider "chunking" or "laddering" your conversions. This involves spreading out the conversion process over multiple tax years. This can help manage the tax impact and potentially benefit from fluctuating tax brackets.

4. Escape Required Minimum Distributions (RMDs)

Unlike traditional IRAs, which mandate withdrawals starting at age 73 (RMDs), Roth IRAs do not have a minimum distribution requirement. This allows your money to continue growing tax-free indefinitely, even after retirement. This flexibility can be advantageous if you don't need immediate income in retirement and prefer to let your savings grow for future needs or beneficiaries.

5. Maximizing the Benefits 

While Roth conversions offer significant advantages, they might not be suitable for everyone. The decision on whether or not you should do Roth conversions heavily relies on your financial plan. We can help build your financial plan to weigh the tax implications and explore strategies to potentially optimize your retirement savings plan.

If you are interested in hearing more about what Roth conversions could do for your financial plan, reach out or schedule a call through the contact us information below. 

Disclosures:

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax

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A short guide to understanding what happens at different ages throughout retirement - for example:

  • Age 50 - Catch-Up Contributions for 401(k)s, employer-sponsored plans, and IRAs begin. $7,500 for 401k ($30,500 total), $1,000 for IRAs ($8,000 total)
  • Age 55 -Certain employer-sponsored retirement plans allow distributions without penalty beginning at age 55. HSA contributions are now eligible for a $1,000/year additional catch up for those over age 55.
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